Category Archives: Venture Capital

The Three Un’s of Founders

[Edited 4/16, see notes at bottom]

I’ve worked with scores of founders and companies over the years and I’ve come to make bright-line distinction between founders and managers.  Let me demonstrate it with a story.

One day long ago I was in a board meeting.  We were discussing the coming year’s budget.  The hotly contested question was:  do we spend $8M or $9M on R&D?  After much wrangling, the board agreed that we should spend $8M.  The meeting adjourned shortly thereafter.  The VCs left first and I was walking out of the room with only the founders.  The CEO said to the CTO as we were leaving, “spend the $9M anyway.”

My jaw hit the floor.  I was aghast, dumbfounded.  What the CEO said was literally incomprehensible to me.  It wasn’t possible.  That’s just not how things are done.

At that moment I realized the difference between a manager and a founder.

As a professional manager [1], we grow up climbing the corporate hierarchy.  We have savoir faire.  We know the rules.  We disagree and commit.  We horse trade.  We split the difference.  But, unless we want to do a deliberate end run to the person in charge, we abide by the decisions of the group.  We are team members in an organization, after all.

Founder aren’t.  While they may strive to be some of those things, in this case, the founders were fresh from university, with little work experience and certainly no ladder climbing.  This wasn’t some organization they were part of.  They started it, based on their research.  It was their company.  And if they thought it spending an extra $1M on R&D was the right thing to do, well, they were going to do it.  That’s a founder.

I write this post in two spirits:

  • To former-manager founders [2] as a reminder that you are now a founder and need to think like one.  It’s your company.  Your investors and advisors will have plenty of opinions but if you end up buried, you will be buried alone.  Unlike your VCs and advisors, you have but one life to give for your company [3].  Act like it — you’re not an EVP at BigCo anymore!
  • To investors [4], advisors, and startup execs as a reminder that founders are not managers, even though sometimes we might like them to act more as if they were.

Example:  a founder is raising a seed round off $1M in ARR and a VC is asking a lot of questions about CAC and LTV.

  • Manager response:  “Well, I know a CAC of 1.7 is high but we are ramping quickly and carrying a lot of unproductive sales capacity that hurts the CAC ratio.”
  • Founder response:  “This is a seed round.  I have two barely qualified SDRs and me selling this stuff.  We don’t have a sales model, so why are you calculating its efficiency?  The only thing we’ve been trying to prove — and we’ve proven it — is that people will pay for our software.”

The manager tries to be reasonable, answer the question, and preserve optionality in raising money from this target.  The founder highlights the absurdity of the question, wonders if this is a VC that they want to partner with in building their company, and isn’t shy about letting their feelings leak out.

The first example, combined with many other experiences, has led me to create the three “un’s” of founders.  Compared to managers, founders are:

  • Unreasonable.  Heck, the whole idea of starting a company is unreasonable.  Taking it to $10M in ARR is unreasonable.  Thinking you have the best product and company in the category is unreasonable.  Becoming a unicorn is unreasonable.  There’s nothing inherently reasonable about any of the things a founder needs to do.   In fact, that’s one reason why some founders are successful:  they don’t know what they can’t do.  Don’t expect someone take a series of very unreasonable risks and then be entirely reasonable in every subsequent management discussion thereafter.  It’s not how it works.  We expect every parent to think their child is the greatest and want what’s best for them; the same holds for founders and companies.
  • Uncompromising.  Managers are trained to split the difference, find middle ground, and keep options open.  In essence, to compromise.  Founders can’t compromise.  They know they will fail if they try to be all things to all people; they know the old saw that a camel is a horse designed by committee.  They know intense focus on being the best in the world at one thing is the key to their success.  If one VC on the board wants to go North and another wants to go East, a manager will tend towards Northeast, North, or East.  A founder — because in their mind it’s their company — will make up their own mind about what’s best for the company and potentially travel in another dimension, like up or down.  Getting promoted in a big company is about keeping those above you happy.  Creating a successful company is about getting the right answer, and not whether everyone is happy with it.
  • Unapologetic.  Managers are professionals who are paid to do things right.  Thus, they tend to count negatives like errors and strikeouts.  They apologize for missed quarters or bad hires.  Founders own the team.  They want to win.  While they don’t like errors and strikeouts, they neither obsess over them nor even necessarily care about minimizing them; they’re not trying to keep their resume free of red correction ink.  They’re trying to win in the market and create a leading company.  Errors are going to happen.  Fix the big ones so they don’t happen again, but let’s keep moving forward.  Yes, we missed last quarter, but how do we look on the year?  We don’t belabor the mistakes we made in getting to where we are, we focus on where we are and where we’re going.

I’m not saying all these un’s are great all the time, and I would encourage founders to recognize and appropriately mitigate them.  I am saying that manger-founders, particularly those who founded companies (or took over as CEO) after long successful careers at big tech companies, need to think more like founders and less like managers.

# # #

Notes
[1] Having never founded a company and as someone who has indeed climbed the corporate hierarchy I view myself as a manager — an entrepreneurial, and perhaps difficult, one — but a manager nevertheless.

[2] And, to some extent, first-time CEOs

[3] You are not living, as one friend calls it, the portfolio theory approach to life.

[4] Who probably don’t need the reminder, but the advisors might.

[Edited] I remove the word “successful” from the title as it was a last-minute, SEO-minded addition and a reader or two correctly called me out saying, “plenty of unsuccessful founders have these three traits as well.”  That’s true and since arguing that “the three un’s” somehow separate successful from unsuccessful founders was never the point of the post — they are, imho, what distinguishes founders (or founder mentality) from managers (or manager mentality) — I removed “successful” from the title.

A Tip of the Hat to Grid On Their Launch Day

It’s not every day you hear about a startup in Iceland, founded by a guy whose last company was a data marketplace that he sold to Qlik.  And it’s a small world when a friend and fellow board member had independently discovered the same tool and built a SAFE calculator  and an inverted pipeline model using it.  Moreover, I included this tool, Grid, almost tangentially in my next-generation EPM round-up, as it’s not really an EPM tool, but it looked interested anyway and I thought it was worth mentioning.

With all this karma pointing me towards Reykjavik, I sat down for a Zoom call the other day with the guy in question, Hjalmar (pronounced like Hallmark without the k) Gislason, founder and CEO of Grid.  After being impressed with him and the tool, I decided to do a quick post to support their official launch, which is today.

Grid is pretty simple in essence.  It’s not a reinvention of the spreadsheet.  It’s not a replacement for the spreadsheet.  It’s a layer atop spreadsheets, a no-code tool that lets spreadsheet users build interactive web documents using their spreadsheets as data sources and publish them on the web.

Here’s an example of what you can build using it in about two minutes.  Among other things, it gives a whole new look to driver-based planning.

The company raised a $12M series A back in August, led by NEA. Congratulations to Grid on their official launch and best of luck to Hjalmar and the team going forward.

Congratulations to Nuxeo on its Acquisition by Hyland

It feels like the just the other day when I met a passionate French entrepreneur in the bar on the 15th floor of the Hilton Times Square to discuss Nuxeo.  I remember being interested in the space, which I then viewed as next-generation content management (which, by the way, seemed extraordinarily in need of a next generation) and today what we’d call a content services platform (CSP) — in Nuxeo’s case, with a strong digital asset management angle.

I remember being impressed with the guy, Eric Barroca, as well.  If I could check my notebook from that evening, I’m sure I’d see written:  “smart, goes fast, no BS.”  Eric remains one of the few people who — when he interrupts me saying “got it” — that I’m quite sure that he does.

To me, Nuxeo is a tale of technology leadership combined with market focus, teamwork, and leadership.  All to produce a great result.

Congrats to Eric, the entire team, and the key folks I worked with most closely during my tenure on the board:  CMO/CPO Chris McGlaughlin, CFO James Colquhoun, and CTO Thierry Delprat.

Thanks to the board for having me, including Christian Resch and Nishi Somaiya from Goldman Sachs, Michael Elias from Kennet, and Steve King.  It’s been a true pleasure working with you.

My Two Appearances on the SaaShimi Podcast: Comprehensive SaaS Metrics Overview and Differences between PE and VC

The SaaShimi podcast just dropped the first two episodes of its second season and I’m back speaking with PNC Technology Finance banker Aznaur Midov, this time discussing some of the key difference between private equity (PE) and venture capital (VC) when it comes to philosophy, business model, portfolio company engagement, diligence,  and exit processes.  You can check out the entire podcast on the web here or this episode on Spotify or Apple podcasts.

I’ve also embedded it below:

Dave Kellogg on SaaShimi Discussing Differences between Private Equity and Venture Capital.

 

If you missed it and/or you’re otherwise interested, on my prior appearance we did a pretty darn comprehensive overview of SaaS metrics, available here on Apple podcasts and here on Spotify.

I’ve embedded this episode as well, below:

Dave Kellogg on SaaShimi with a Comprehensive Overview of SaaS Metrics.

 

Thanks Aznaur for having me.  I think he’s created a high quality, focused series on SaaS.

Appearance on the Sage SaaS Success Series: Best Practices in Forecasting for Fundraising

Just a quick post to highlight that I’ll be speaking in a panel discussion with Mihir Jobalia, managing director of technology investment banking at KPMG, and David Appel, head of the subscription and SaaS vertical at Sage Intacct, on  2/23 at 11AM pacific time.  It’s part of a four-part SaaS Success Series, hosted by Sage Intacct, with episodes including:

  • The 100-Day Ramp Plan for New Finance Hires
  • What is the Next SaaS Finance Technology Stack?
  • 3 Best Practices for Forecasting and Fundraising (our session)
  • How to Plan for Your ASC 606 Revenue Recognition Scenario

They all look super  interesting. Well, except for the last one — just kidding, #revrec matters (and ASC 606 does some interesting things, in particular to subscription-based companies not delivering via an online service).

Thanks to David Appel for inviting me.  I look forward to speaking with David and Mihir on the panel.

I hope you can join us.  Those interested can register for the series here.

(Revised 2/18 to remove speaker who dropped out.)

Are We Due for a SaaSacre?

I was playing around on the enterprise comps [1] section of Meritech‘s website today and a few of the charts I found caught my attention.  Here’s the first one, which shows the progression of the EV/NTM revenue multiple [2] for a set of 50+ high-growth SaaS companies over the past 15 or so years [3].

meritech saas multiples

While the green line (equity-value-weighted [4]) is the most dramatic, the one I gravitate to is the blue line:  the median EV/NTM revenue multiple.  Looking at the blue line, you can see that while it’s pretty volatile, eyeballing it, I’d say it normally runs in the range between 5x and 10x.  Sometimes (e.g., 2008) it can get well below 5x.  Sometimes (e.g., in 2013) it can get well above 10x.  As of the last data point in this series (7/14/20) it stood at 13.8x, down from an all-time high of 14.9x.  Only in 2013 did it get close to these levels.

If you believe in regression to the mean [5], that means you believe the multiples are due to drop back to the 5-10 range over time.  Since mean reversion can come with over-correction (e.g., 2008, 2015) it’s not outrageous to think that multiples could drop towards the middle or bottom of that range, i.e., closer to 5 than 10 [6].

Ceteris paribus, that means the potential for a 33% to 66% downside in these stocks. It also suggests that — barring structural change [7] that moves baseline multiples to a different level — the primary source of potential upside in these stocks is not continued multiple expansion, but positive NTM revenue surprises [8].

I always love Rule of 40 charts, so the next fun chart that caught my eye was this one.  meritech r40 score While this chart doesn’t speak to valuations over time, it does speak to the relationship between a company’s Rule of 40 Score and its EV/NTM revenue multiple.  Higher valuations primarily just shift the Y axis, as they have done here, uplifting the maximum Y-value by nearly three times since I last blogged about such a chart [9].  The explanatory power of the Rule of 40 in explaining valuation multiple is down since I last looked, by about half from an R-squared of 0.58 to 0.29.  Implied ARR growth alone has a higher explanatory power (0.39) than the Rule of 40.

To me, this all suggests that in these frothy times, the balance of growth and profit (which is what Rule of 40 measures) matters less than other factors, such as growth, leadership, scarcity value and hype, among others.

Finally, to come back to valuation multiples, let’s look at a metric that’s new to me, growth-adjusted EV/R multiples.

meritech r40 growth adjusted

I’ve seen growth-adjusted price/earnings ratios (i.e., PEG ratios) before, but I’ve not seen someone do the same thing with EV/R multiples.  The basic idea is to normalize for growth in looking at a multiple, such as P/E or — why not — EV/R.  For example, Coupa, trading at (a lofty) 40.8x EV/R is growing at 21%, so divide 40.8 by 21 to get 1.98x.  Zoom, by comparison looks to be similarly expensive at 38.3x EV/R but is growing at 139%, so divide 38.3 by 139 to get 0.28x, making Zoom a relative bargain when examined in this light [10].

This is a cool metric.  I like financial metrics that normalize things [11].  I’m surprised I’ve not seen someone do it to EV/R ratios before.  Here’s an interesting observation I just made using it:

  • To the extent a “cheap” PE firm might pay 4x revenues for a company growing 20%, they are buying in at a 0.2 growth-adjusted EV/R ratio.
  • To the extent a “crazy” VC firm might pay 15x revenues for a company growing at 75%, they are buying in at a 0.2 growth-adjusted EV/R ratio.
  • The observant reader may notice they are both paying the same ratio for growth-adjusted EV/R. Given this, perhaps the real difference isn’t that one is cheap and the other free-spending, but that they pay the same for growth while taking on very different risk profiles.

The other thing the observant reader will notice is that in both those pseudo-random yet nevertheless realistic examples, the professionals were paying 0.2.  The public market median today is 0.7.

See here for the original charts and data on the Meritech site.

Disclaimer:  I am not a financial analyst and do not make buy/sell recommendations.  I own positions in a wide range of public and private technology companies.  See complete disclaimers in my FAQ.

# # #

Notes 
[1] Comps = comparables.

[2] EV/NTM Revenue = enterprise value / next twelve months revenue, a so-called “forward” multiple.

[3] Per the footer, since Salesforce’s June, 2004 IPO.

[4] As are most stock indexes. See here for more.

[5] And not everybody does.  People often believe “this time it’s different” based on irrational folly, but sometimes this time really is different (e.g., structural change).  For example, software multiples have structurally increased over the past 20 years because the underlying business model changed from one-shot to recurring, ergo increasing the value of the revenue.

[6] And that’s not to mention external risk factors such as pandemic or election uncertainty.  Presumably these are already priced into the market in some way, but changes to how they are priced in could result in swings either direction.

[7] You might argue a scarcity premium for such leaders constitutes a form of structural change. I’m sure there are other arguments as well.

[8] To the extent a stock price is determined by some metric * some multiple, the price goes up either due to increasing the multiple (aka, multiple expansion) or increasing the metric (or both).

[9] While not a scientific way to look at this, the last time I blogged on a Rule of 40 chart, the Y axis topped out at 18x, with the highest data point at nearly 16x.  Here the Y axis tops out at 60x, with the highest data point just above 50x.

[10] In English, to the extent you’re paying for EV/R multiple in order to buy growth, Zoom buys you 7x more growth per EV/R point than Coupa.

[11] As an operator, I don’t like compound operational metrics because you need to un-tangle them to figure out what to fix (e.g., is a broken LTV/CAC due to LTV or CAC?), but as investor I like compound metrics as much as the next person.

 

The Pipeline Chicken or Egg Problem

The other day I heard a startup executive say, “we will start to accelerate sales hiring — hiring reps beyond the current staffing levels and the current plan — once we start to see the pipeline to support it.”

What comes first: the pipeline or the egg?  Or, to unmix metaphors, what comes first:  the pipeline or the reps to prosecute it?  Unlike the chicken or the egg problem, I think this one has a clear answer: the reps.

My answer comes part from experience and part from math.

First, the experience part:  long ago I noticed that the number of opportunities in the pipeline of a software company tends to be a linear function of the number of reps, with a slope in the 12-18 range as a function of business model [1].  That is, in my 12 years of being a startup CEO, my all-quarters, scrubbed [2] pipeline usually had somewhere between 12 and 18 opportunities per rep and the primary way it went up was not by doing more marketing, but by hiring more reps.

Put differently, I see pipeline as a lagging indicator driven by your capacity and not a leading indicator driven by opportunity creation in your marketing funnel.

Why?  Because of the human factor:  whether they realize it or not, reps and their managers tend to apply a floating bar on opportunity acceptance that keeps them operating around their opportunity-handling capacity.  Why’s that?  It’s partially due to the self-fulfilling 3x pipeline prophecy:  if you’re not carrying enough pipeline, someone’s going to yell at you until you do, which will tend to drop your bar on opportunity acceptance.  On the flip side, if you’re carrying more opportunities than your capacity — and anyone is paying attention — your manager might take opportunities away from you, or worse yet hire another rep and split your territory.  These factors tends to raise the bar, so reps cherry pick the best opportunities and reject lesser ones that they’d might otherwise accept in a tougher environment.

So unless you’re running a real machine with air-tight definitions and little/no discretion (which I wouldn’t advise), the number of opportunities in your pipeline is going to be some constant times the number of reps.

Second, the math part.  If you’re running a reasonably tight ship, you have a financial model and an inverted funnel model that goes along with it.  You’re using historical costs and conversion rates along with future ARR targets to say, roughly, “if we need $4.0M in New ARR in 3 quarters, and we insert a bunch of math, then we’re going to need to generate 400 SALs this quarter and $X of marketing budget to do it.”  So unless there’s some discontinuity in your business, your pipeline generation doesn’t reflect market demand; it reflects your financial and demandgen funnel models.

To paraphrase Chester Karrass, you don’t get the pipeline you deserve, you get the one you plan for.  Sure, if your execution is bad you might fall significantly short on achieving your pipeline generation goal.  But it’s quite rare to come in way over it.

So what should be your trigger for hiring more reps?  That’s probably the subject of another post, but I’d look first externally at market share (are you gaining or losing, and how fast) and then internally at the CAC ratio.

CAC is the ultimate measure of your sales & marketing efficiency and looking at it should eliminate the need to look more deeply at quota attainment percentages, close rates, opportunity cost generation, etc.  If one or more of those things are badly out of whack, it will show up in your CAC.

So I’d say my quick rule is if your CAC is normal (1.5 or less in enterprise), your churn is normal (<10% gross), and your net dollar expansion rate is good enough (105%+), then you should probably hire more reps.  But we’ll dive more into that in another post.

# # #

Notes

[1]  It’s a broad range, but it gets tighter when you break it down by business model.  In my experience, roughly speaking in:

  • Classic enterprise on-premises ($350K ASP with elephants over $1M), it runs closer to 8-10
  • Medium ARR SaaS ($75K ASP), it runs from 12-15
  • Corporate ARR SaaS ($25K ASP) where it ran 16-20

[2] The scrubbed part is super important.  I’ve seen companies with 100x pipeline coverage and 1% conversation rates. That just means a total lack of pipeline discipline and ergo meaningless metrics.  You should have written definitions of how to manage pipeline and enforce them through periodic scrubs.  Otherwise you’re building analytic castles in the sand.