How Startups Create Enterprise Value and Returns

How Startups Create Enterprise Value and Returns

Alliance of Angels Seminar with Dave Parker, Author Trajectory: Startup: Ideation to Product/Market Fit—A Handbook for Founders and Anyone Supporting Them

How Startups Create Enterprise Value and Returns

Alliance of Angels seminar

Yi-Jian:     Alright good morning everyone welcome to the alliance of angels workshop on: “How startups create enterprise value in returns”. We are privileged to have Dave Parker, join us today – Dave is a best-selling author and leader in our startup community so we really appreciate his time. Before we go in just a bit of logistics we want to keep this interactive session, right so if you have any questions for Dave along the way please don’t be shy, feel free to jump in right this is a standard Zoom meeting so anyone can speak up, so uh feel free to do that if you were rather texting something through the chat window that would be fine too but this tends to work best if you are uh willing to jump in and have a have a conversation right and but however on the flip side of that if you are not speaking we do ask that you keep yourself on mute.

Right so I’m sure you get your – your kids are adorable you have a really cute dog etc but they don’t have to be part of our session today so let’s just have a quiet environment so everyone can have a great learning session together. So and before we start I’m going to share a few words about alliance of angels; this is the organization I run and my name is Yi-Jian, right this is Angel group here in the pacific northwest we have 140 angels in the organization. Every year we put about 10 million dollars into 20 companies, most companies that are fundraising from us they’re looking for a total of between half a million and 1.5 and our typical check size is 250 to 500 right and if folks invest right so to be very clear we’re not a fund right we’re a group of people so when folks invest they go directly onto your cap table usually it’s four to six people each person putting in 25.50 or 100 and the sum total that is 250 to 500, right.

Sector-wise we’re about half IT about a quarter consumer the rest is life sciences, hardware, energy et cetera but that’s it we are a sector agnostic investor we also stage agnostic right this is never too early to hit us up so uh our main heart felt however is that we focus on the pacific northwest. So if you’re an entrepreneur and you’re interested in see if you’re fundraising you’re interested in uh approaching my organization feel free to send me your notes my email is below, right or if you’re an angel investor you’re interested in learning more about how you could participate in my community feel free to send me a note as well.

Alright so with that I’m going to stop talking and I’m going to hand the session over to our guest today – Dave

Dave:        Hey Yi-Jian thanks very much I appreciate it. I’m going to hit share screen here make sure everything see my screen okay yeah all good?

Yi-Jian:     Looking great

Dave:        Awesome well thanks everybody for joining I’m going to share some – some excerpts and resources today um and a little bit about me and the big topic today is really driving enterprise value so if you’re a founder thinking about; how you value your company? Especially between the early stage and late stages, we’ll talk about that if you’re investor I want to give you some context around how to think about your investment thesis relative to what types of companies? And it’s really driven by data, so one of the things that I’m kind of a nerd about at this point from the book perspective is looking at data where the data is available so that we can really look at that as a driver for valuation and outcomes.

So give you a little bit about me – the big market valuation drivers um which every almost all investors have at least in their head some of them actually score them, and we’ll talk about individual company valuation drivers how do you create deliver and capture value? I’ll walk you through the 14 revenues and the data from the revenue models and the encouragement there is if you’re founder really it’s about picking a primary and a secondary and walk you through those and then some final wrap up with some public market comps around how companies actually get valued when you sell which impact both when you start as well as when you sell. So that’s kind of the agenda for today.

So first about me I so raise 12 exited 85. So no unicorns mostly singles um sold three of those five closed two of them so you learn more from your failures than your successes sadly um and I was the senior VP of programs at up global which is Startup weekend and Startup America and was CEO there so uh author recently and thanks Yi-Jian for the shout out on Trajectory Startup just went live on last Tuesday was the publication date and uh it was fun to hit 44 on the on the list of best sellers for this category super niche category of a new business um but it was fun to get ahead of Bradfield at least in a couple of the books because Brad wrote the forward to the book as well.

So I’d call twice a venture capitalist I’m a random angel um and done about 13 transactions total and now with Nexpath and Markups and with next path advisors helping companies’ founders exit their companies at the end so kind of how i split my time. So resources here I will share the excerpt with you in the notes um so you can get the free excerpt from the book which breaks down the 14 revenue models as well as the unit economic information and the slides will be available after the program from AOA alright.

First let’s talk about the big revenue drivers and big market drivers as it relates to your investment thesis um and again these ones are kind of company agnostic where we’re gonna get very specific to the company how the company can actually do things to drive revenue value, but these are the big ones um as a market driver and one as the last fund I was at and I’ve ran a family office for three years as well we would look at these as kind of our big like the things we want to say yes to before we really look at detail at the company so first off big and new and nascent markets so um if you have a big big market uh and your timing’s particularly good um it’s kind of like riding a big wave right versus a small wave, and the thesis there is that from a market perspective generally speaking markets win.

Team comes next no it’s probably closer to a 1a and a 1b which is why i didn’t number these so do you have the right team for the right product is it a balanced team do they have the right skill sets uh but the sediment here is or sentiment i should say there is that a great team in a bad market is still going to produce a ma result where a mediocre team in an awesome market could be a blockbuster right so just know that market and team are kind of a 1a and 1b.

Product is next stickiness does it solve a problem or is it just fun so if it’s B2C and you’re building games if it’s not a fun game then the answer is it won’t sell but you really have to focus on the pivot around the problem first and the solution second. So think about it from that perspective, does the product really solve a problem uh timing ultimately timing’s not in your control Bill Gross did a great video on a TED Talk about timing – it’s brilliant it’s the best seven minutes on the internet for startups, but i think timing is one of those things we only know in retrospect right we can look backwards and go by our timing on that investment was awesome but at the time we put the money in we kind of look at it as headwinds and tailwinds.

Competition big factor here if you’re a founder has your competition already sucked the oxygen out of the room by raising you know multiple companies raising over 100 million dollars you’re probably going to be in a tough market to raise capital because it’s already been over funded.

Traction early indication of proof and is the flywheel spinning so if you’re still pre-revenue or some of your pre-product um but if you’re pre-revenue you don’t really have traction yet right so getting some data will be helpful.

Unit economics is the next one so which is revenue model sales marketing we’re going to kind of dive deep into that data set today and ultimately is it efficient or not efficient capital think Tesla versus Snap. So Tesla when the first investors put money in it took him a long time to get that money out and there was lots of additional dilution that came in because it is not a capital efficient business to build electronic or any cars for that matter. So those are the big market drivers and I know that if you’re an investor you have those in your head and sometimes you have them on a checklist I would encourage you to think about providing feedback to those founders around here’s where I didn’t like the pitch because of these things but those are the big drivers let’s get around what the drivers are than for what are good for companies.

Couple other things first stage matters, so one of the things that’s important to understand here is that early stage startups for as look at as you think about revenue drivers and revenue models and unit economics will look way different at the early stage than they look at scale. At scale they have revenues and they have customers and they may have multiple revenue models but at launch you typically have one you’re focused on so just know the stage of the company is different also contextually know that if you’re B2B or B2C you have a different set of unit economics and a different set of lifetime values associated with that and if your products are services or if you’re blend of both so know that all of those things will categorize your company slightly differently if you’re a b2c product company or b2c service company versus a b2b product company so some things to think about as you categorize your product and solution.

Finally just kind of two views before we get into some of the details there’s the founder view we tend to think very product out and then unit economic second and then oh what’s the valuation at the end and what’s the return but  investors tend to think about it as returns first and then work your way to unit economics and ultimately say is it a cool product so just now we’re looking at the two sides of the coin very differently right in the investors are looking how do i get money out of it and from a founder perspective it’s easy for an investor to check into your company but it’s very hard for them to get a check out of your company so know that that’s part of the thing that investors need to get answered as you’re out pitching your company.

So there’s some context about valuations all right so let’s break down um the business model breakdown into its components um the first thing is there’s think of this as a van there’s three components of the business model and i just want to make it less black boxish and more metrics driven. So you create value through your product or service you deliver value through how you sell and monetize it and then you capture value or that’s the outcome that is the result of in top line revenue and net margin. so let’s break them down in a little bit of detail; so first creating value the top chart is your product or your service or a blend of the two it’s your cost to build it relative to how big is the team? How many people are required? How many engineers? How many person months to build it? So but it also includes hosting or could include manufacturing and it also includes the cost of delivery or support, so there’s difference between customer success cost of sale and a cost of support or technical support on the back end. So those are all of your costs associated with creating value that’s all about the product.

So now the next question then becomes is how do you sell it? What’s your cost of selling? So your components in delivering value are your revenue model which will break down the 14, your pricing how you price it relative to market and what the value-based pricing is versus cost-based pricing and your customer acquisition cost or CAC so what it costs to market to create leads how many people does it require somebody sell it or not sell it and then know that your lifetime value then becomes part of that calculus as well and one quick note here is I don’t want i want you to distinguish the difference between promotions or not pricing or revenue models. So for example a freemium is a promotion a time-based trial is a promotion right but it that by itself is not a revenue model it’s actually just um yeah it’s just a promotion so know that that’s part of it as well.

So capturing value is what’s left over uh ultimately the question then becomes how much revenue do i drive? And what’s my net profit relative to (sorry my keyboard just said it need to get plugged in i hate it when it happens) so my gross margins and my net profit. So ultimately you control these things by controlling the cost to build it and the cost to deliver it that’s where your controls are this is just an outcome so you don’t have much controls over those things you have to control them at the first two.

Alright, so those are your the three pictures of the van if the event is out of sequence and your ultimate capturing value is low or people won’t pay for it then you have a different problem is it a product problem or your price is wrong, so if you follow the CB insights data the number one reason startup fail is they build a product that nobody wants and nobody wants this defined by two things it’s not useful or fun and nobody’s willing to pay for it so those two things make up that um that piece of it.

Alright, so product market fit this is a product market fit is; this is elusive things it’s like unicorns it’s actually not product market fit is just math um so I’m gonna give you the math for product market fit, so the definition of PMF um is really being in a good market with a product that satisfies the need of that market or the demand of that market so think of it as the no more pivot stage. So we have a product market fit when we’re like we have a product and we don’t have to pivot it anymore.

Pre-product market fit kind of looks like this from a math perspective my leads are increasing, my closing ratios are increasing, my time to close is decreasing, my referrals are increasing, you kind of get the point. This is all about the math that we can look at early with the CEO of the company before they have a probably a VP of marketing or VP of sales and look at like what’s the math and the outcome of this early pre-PMF stuff is the equivalent like um compound interest right if you’re trending in this direction, if lead volume is going up and time to close is going down and average contract value is going up woohoo – like it’s going to be an exciting time to invest. If they don’t have any of the data yet you’re going to use a different method to value the company and you’re going to go back to does it have a big market and do i like the team or not but as they start to have data you’re going to evaluate a company based on data. No data, you’re basing it on the total addressable market and the and the team. So know that product market fit ultimately isn’t a mystery it’s not a unicorn it’s just math and these are some of the components of the math

Alright so how do you monetize let me go through this the 14 revenue models in the background of how i got here and by the way I’m totally open to a 15th model if you come up with one I have just found over the last six plus years of watching this data that there are 14 in tech there’s other outside attack but within tech there’s 14. So here’s a quick um note though that don’t use this as the i have a calculus way to calculate my valuation if i’m a pre-revenue startup the answer is revenue models is one impact of your evaluation but it’s a heuristic. It’s not a calculus so just know that that’s part of the process. Alright, so the data this came up as a process probably almost seven years ago now i was running the founder institute here in Seattle I just got to work for startup weekend somebody came to me and said hey can I have your financial model and i was like well that’s yes you can have it because i’m a community guy and i’m happy to give it to you but you’re going to break it and frankly it’s a little different so mine was a business to business subscription business and theirs was a business to consumer marketplace so it raised the question of like – how many templates would you need to cover 80 of the market?

So every time somebody asked for a template they i could hand him a template say use this one so innocently enough at the time with no idea that i was going to start a quest i reached out to the CEO of Crunchbase and said hey can you pull a list from me of every seed funded company over the last 18 months so then it took longer than i thought to get to all the answers but what we did was we tracked those 2654 companies over a longitudinal study of six years never planned on that that’s just kind of the way it worked out um so the surprises in there were the number of seed rounds seed rounds went from seed one to seed ten and part of the reason for that was they had the seed rounds got broken into milestone driven rounds versus straight valuation derivatives so um and then we were looking at um I’ll show you the combinations next the other thing we looked at was what the results of the failures were we went back to the Wayback machine and looked at all the companies who were no longer in business and hadn’t been acquired and the aha there was that 80 percent of them on the Way back machine is the internet archive had the cached pages of their last pages before they went out of business or closed and consistently 80-85 of those companies had no call to action they had no pricing page and they had no clear way for the customer to buy. So think of it as the pages that said call us for more information, call us for price so my analysis there with the aha of looking at all those pages was the equivalent of if Yi-Jian was my boss and said hey go find us a product that does x and i found four products and yours was one of them but i had to call you for price the answer is you didn’t make the short list of people i present to my boss and i’m sure there’s other reasons they went out of business as well but very consistently around the trend that was one of the surprises. So we then took that data ran it through mathematica uh i worked for a hedge fund family office for a while and uh it was great to have access to the tools and the analysts you’ll notice a couple ahas here; one was combination models this is the metric here on the bottom is from seed round to A round funding in days and the uh on the this one is from A round to B round funding in days what you’ll see here is a combination models so service plus subscription as an example got funded super-fast from seed to A but about normal from A to B because they were showing early revenue from services revenue is most likely the case.

You’ll also note here that gaming companies matured about the same rate in funding as others but their time from A round to B round was super-fast um because they had consumer based driven demand and they had some data as my guess. So but you’ll see this is the way the general models broke down in their timing to funding. So let me walk you through the model; so I’m going to walk you through these kind of quick I’ll give you a summary of the 14 at the end and i’ll give you examples as we go but since this is an investor-centric pitch or presentation more so than founders I’m less concerned about you picking the right model for your startup but you’ll get a list at the end and you can do that too.

So first one is fee for service originally i thought it was not going to be there because it’s not scalable revenue and investors don’t like it but the fact is services revenue is still legit revenue and you’ll see it in companies that are especially in combination models of companies so Accenture is a great example, Stride is a publicly traded company that is in the education space this model works in both b2b and b2c of course it’s based on bill rates and pay rates. So if i bill Dave out at $100 an hour to a client I pay Dave $50 an hour i have a 50 percent gross margin. So just know it’s not scalable because as you add more customers you have to add more people that’s a bit of a challenge in scaling the business and it’s good from a bootstrapping perspective it’s tough from a scaling perspective.

Second one is product as a service this is a derivative from the customer’s perspective instead of buying hours from Perkins Coie or whoever my law firm is at Wilson Sancini I’m buying an outcome so I’m buying a skew and there’s people and technologies in the background that are delivering that skew and again this is one that Southwest Airlines is an example IBM these days is a little bit more that example because most of their revenue comes from services but they have a product service mix and you’ll find that in companies in that nature Gaiden financial is a company in Bellevue that I’m on the board of and uh that’s our business we sell a skewed product there’s people in technology in the back end the customer doesn’t care about the people or the tech they just want to buy the outcome works both B2B and B2C Moz is a great example when they were SEO moz they built tools and provided services then they sold the services business and just went in the tools business so sometimes it’s hard to make that split because the revenue is pretty addictive.

Commerce is third so example here is Wayfair and Lululemon on different ends of the scale Wayfair sells other people’s products on commerce, Amazon by the way was this at launch but today they’re a combination really they’re a conglomerate market today. Lululemon sells their own brand so this one works both B2B and B2C your key metrics here your wholesale cost of goods sold your average margin and the number of the average basket and the number of baskets per month that’s your key metric, so it could be for physical goods or virtual goods.

Fourth is subscriptions – subscriptions are super popular subscriptions everywhere these days uh Salesforce is a subscription, Spotify is a subscription you can buy a subscription to Lecroy water on Amazon. If you’d like, so subscriptions have become pretty much the standard and there’s a reason for it it’s based on the multiple of revenue that companies get at exit so just know there’s a cause for that subscription migration it’s about predictable and forecast able revenue your key metrics on subscription are what’s my average revenue per user or rpoo it could be average contract value ACV as well my conversion ratio from users who are trial or users who are free to paid depending on b2b or b2c and typically within this you’re going to see tiered pricing within the subscription model or you should see tiered pricing relatively quickly to address different ideal customer profiles within the subscription okay so that’s subscription number four super popular.

Number five was the only new one that actually came on during the six year time frame was the metered service model so think Twilio, AWS, Uipath and Plaid tech are all examples of meter service, so this is the API economy and the emerging API economy the multiples on these ones are really, really fascinating and I’ll walk you through the public com multiples here in a minute key metrics here similar to subscription a lot of these start at subscription and then do metered services up it’s b2b only i’ll give you the b2c example would be your T-mobile or Verizon bill typically viewed as a negative from a consumer perspective but as a business perspective typically viewed as a positive if my AWS bill went up it means my customers are using more of it usually means i made more money so again looks a lot like a subscription value completely different than a subscription all right that’s number five.

Number six transaction fee or rental your examples here are Stripe and Chegg, though the transaction fee and the rental model are different uh different models they the mechanics are very much the same so it works B2B and B2C in the case of Chegg they’re renting an academic or college level book and turning that a certain number of times so in this one it’s your average transaction revenue the fee or percentage of that transaction in your fee or commission and the number of transactions per month. So Stripe is a great example there too Stripe does not book the top line revenue of your sale they’re only booking the transaction fee of your sale so that’s the transaction for your rental business.

Marketplaces are next think Ebay, Alibaba and Uber these are all marketplaces. Uber obviously does other things as well but it launches a marketplace so your key metrics here your average transaction amount, the number of transactions per month, in your commission percentage per transaction. Marketplaces is typically book top line revenue versus transaction fees only book the fee so just know that there’s some little nuance there and there’s two sides in the marketplace, so you’re gonna have to track your marketing on the seller side and then the buyer side because if you mix those two economics together you’re going to kind of have a mess so that’s number seven marketplaces

Number eight is combinations so as i mentioned a great example Smartsheet publicly traded most of you know them if you’re here in the northwest 25 of their revenue comes from professional services and the market doesn’t hammer them on that revenue because that professional services shortens their sales cycle so that they can sell more subscription revenue so that’s an example of combination another trend we see right now in marketplaces is a transaction fee plus a subscription. So subscription premium customers get a different fee structure, so they’re adding that model of transaction fee plus subscription. So know that that’s combinations are just taking the previous seven models and how do you combine them together.

So typical of this previous seven all right we started getting a little more obscure ones here going and let’s go relatively quick through them because the less it matters you see these ones less frequently so gaming is an example so king if you’ve uh followed z2; z2 sold to king for a big number when you make virtual swords the margins are amazing so just know that that’s definitely the case this is B2C only key metrics here are downloads percentage of people who play and the average in-app purchase and the number of in-app purchases per month there’s your key metrics for that and 21-day uses pattern matters a lot.

Advertising and search is an example of one clearly it works Facebook and Google are good examples but it only works at scale so know that if you’re a startup and you want to do advertising in search the key question is how do you get two million unique users per month and how much will it cost you to do that so that you can monetize it with advertising your search. So let’s say a CPM rate of $35 which would be a highly competitive CPM rate today on a cost per thousand basis and i wanted to monetize my blog. My blog gets between 3,000 and 5,000 users a month at $35 that’s 90, $100 to $150 a month so it’s not worth monetizing around advertising your search. Unless you have the users so then the question is how do you get the users? And how much is your cost to customer acquisition? So that’s advertising search

New media is when somebody says we’re going to go viral that’s they mean new media so clubhouse is an example of going viral. Snapchat’s an example of going viral again this one is b2c only because it’s all about the consumer and for every consumer you pay to acquire you acquire more than two unique additional consumers that actually not just register but register and actually refer somebody else. so I’ve worked on one of those in my 20 plus years and it was classmates.com and we were 2.02 on the k-factor which was you know unicorns and butterflies and pixie dust it was amazing. So pretty rare and it only works b2c so but somebody says if you have a b2b example of going viral let me know I will definitely write a check for that one. LinkedIn did it for a very short period of time where they introduced the tool to load all of your contacts so they spiked and then went back down to less than one.

Big data is the next one this one again only works at scale so Splunk patients like me are great examples of this one. It’s really where i can I  have to have the data to monetize the data Splunk kind of crosses the line between both big data and metered service but a little bit more on the big data side, so they price it accordingly but if you don’t have big data you have to take the time to acquire big data like you would do for search or uh yeah search and average it.

13 is lead generation if you remember Mint they have a new equivalent competitor today called Chime when the product is free i always tell people you’re the product so Chime is a great example they get paid a lead referral fee from credit card companies to refer you to them so they’re the new version of Mint. All-star directories locally was one of those examples too. Again this is this is B2C in the sense that I’m  selling consumer data but the life insurance companies may be the ones who actually do the work or sell or buy the leads.

Sorry landscaping guys showed up.

Alright so that’s lead generation 14 is licensing if you remember back to Microsoft 15 years ago there’s lots of concern around like uh can we switch from licensing to subscription lots of handwringing and in retrospect the answer was kind of ah obvious but licensing still works today and it’s the 14th model, so if you’re licensing and a revenue on a for a geography or particular field of use you’ll still see this as one of those.

So here’s a quick summary if you’re a startup founder I would encourage you to pick your primary model and your secondary model know that that’s kind of where we’re starting with your revenue models all right so here’s we’ll get geeky with the data and give you some relative data points. So what i did then was i took these revenue models and went back to the public comps equivalent and did an analysis of um assuming you’re gonna exit to a public company and not go public which is where the majority of companies will exit the question is – is your revenue accretive? And what’s your revenue worth?

So we went back down and broke through the concept of enterprise value and the enterprise value is the price or the market cap divided by sales trailing 12 months to give you a forecast able revenue number relative to benchmarks. Obviously i can’t do ebitda because multiple early stage startups don’t have any um profit so it doesn’t really matter and then a quick note here combination revenues are a little bit more like a conglomerate, so it’s hard to separate AWS revenue from Amazon’s revenue total uh and the current – stock prices you’ll see in in the data really reflect the uh current market conditions so we’ll just kind of monitor them and see how they go – so that’s the public comp data.

Let me swap screens here real quick.

Alright, so I’ll give you the data and i’ll give you this the summary data as well so what we took here was i took for example Facebook the ticker the average of the last trailing 12 months on a quarter by quarter basis of their pricing history and you’ll see here that it created ranges so Google was 6.67, Facebook was 9.2, Splunk was 11.4 um and basically broken them all down into here’s transaction fee businesses here’s subscription businesses and here’s productized service businesses um and by the way if you want to help contribute to this data set at some point you’re definitely welcome to reach out to me because i’d like more brains looking at it to say how early can we push this data down to the startup phase because it clearly affects when we’re out marketing a company to sell this data has a dramatic impact on what their exit valuation is so that’s the original data set so i’m trying to get that up to of 400ish companies and obviously today we’re it you know less than 50.

So the summary then becomes this so services businesses trade at 0.75 to 1.75 – 1.5 x valuations not a big surprise um if we had a million dollar company that was predominantly services it would sell for a million dollars so not a surprise with that one um productized services businesses think IBM’S business today 1 to 2x revenues so it’s a good way to bootstrap a business if you can’t raise funding but it’s not going to give you great exit valuation, um commerce businesses have a fairly wide range the Lululemon if you’re selling your own brand is 8x so a niche commerce business was building its own brand at 8x but products selling somebody else’s more like four 4.4 amazon actually with combined revenue between mostly commerce marketplace and then AWS is 4.4x on revenue. Metered service then Twilio, AWS 24 times Uipath is going public here soon uh Uipath fits in that one as well so definitely one that i would tell you the trend to look for as you’re investing is how do you look for metered services companies that can go from subscription to metered services and can track it um most of our companies happen in the subscription business 8 to 12 x revenue is pretty standard the gates there I would tell you are if you’re super niche business you’re going to be at the low end of that and if you’re if you have a big target um total addressable market you’re going to be at the high end of that so a million dollar business there could sell for 8 to 12 million could push up a little bit higher if there’s still a big runway and room to run um.

Marketplaces four to eight times revenue combinations wide range there again eight to twelve, um new media so i would categorize media here as new media trending towards old media so new media being Snap and clubhouse old media being companies like Mashable who just went public and split their stock into a cloud company and a media company and then lead generation Chime is a good example 4 to 5x and finally licensing is somewhere between 5 and 9x so the revenue there not a big surprise based on the public comp data.

So let me hit stop share on that i’ll go back to the slides, so this will be in the slide deck for you but again if you want to uh if you want to contribute to the data set i’m happy to happy to discuss because there’s definitely more thinking around it than one person can do so those are your public company comps so some quick notes on that as it relates to you all, so a few additional sell side notes so if you’re at the end of the process this isn’t going to impact you early in the process so park this if you’re a founder don’t over index on this on your pitch deck it has nothing to do with your pitch deck it has to do with how we sell your company at the end.

So rule of 40 matters are you growing more than 40 a year or do you have a mix of between 40 or 20 profit and 20 growth so rule of 40 is going to matter so is there a logical and inquisitive up market buyer. So um versus going public like if you’re the biggest player in a super niche space the answer is may be hard to get acquired because people don’t necessarily get what you do. Is your capital to revenue model under three to one? So ideally if you’ve got a million dollars in capital raised and you’re doing a million dollars in revenue it’s pretty easy to find a buyer if you’ve taken four million dollars in capital and you’ve only got to a million dollars in revenue can be kind of hard right both because of the preference stack and the lack of traction uh or lack of capital efficiency and then can we create competition between buyers that ultimately will positively impact your valuation so know that that’s part of the process again this is the end of the deck this doesn’t go into your pitch deck if you’re a founder this is just what influences the outcome when you sell.

And then last slide a couple notes um so keep in mind Dave did not say this is the way I calculate my enterprise value of my company if I’m a startup based on zero revenue that’s not the case this is; there’s too many variables early on if you want to calculate an early enterprise value you can use Dave Berkus’s the Berkus method has got a 20-year track record. Dave actually wrote a blurb for the back of my book which was awesome because I feel like I’ve been internet stalking him forever uh and then uh. Picking up potential buyers based on your track record um so look at um what the size and the stage and the technology is one of the things we think about a lot at the end of the process is how do we do business development as a process to find you a potential buyer based on the right partnerships and right product fit and then this data as I mentioned still a work in progress so you’ll get a copy of the PDF from the slide presentation today but um if you want access to the data let me know i’m happy to uh to do that from an open source perspective.

And then ultimately in startups you need to be creative so marketing  matters a ton and it’s a super creative process um but marketing is not a revenue model so and what i’ve found in watching this data set for the last few years is revenue new revenue models are super rare like new marketing strategies happen all the time but just separate out in your business model components you gotta create value deliver value and ultimately capture value so with that i will open it up to questions.

I see there’s a few notes as we go so i’ll answer this or just come off mute and ask alright. Where did consumer products business model fit i.e. beverage muffins marijuana edibles?

That’s a great question so you’re it’s going to fit closer to the commerce model and the hybrid commerce model of like Lululemon so it’s going to be manufacturing costs so in the in the original data set some of the ones i looked at in the unicorn list were folks like Spacex and Tesla right but if you’re thinking consumer products it’s really going to be the cost of manufacturing goes into your cost of goods sold and does it scale in a predictable way and then still you’re back to average margin i still have a cost of sale associated with it but it’s going to be my cost of sale is going to be more controlled versus a wholesale cost of goods. So think of it that way from a manufacturing perspective these definitely are focused on tech right predominantly on tech um.

So are too many buyers a problem? I don’t know that too many buyers can ever be a problem when it looks at yet you have to think about it though as a process if you’re going to at the again end of end of your startup lifecycle you go to sell the company um you have to run a process to get as many buyers at the table as fast as you can once you have that first buyer leaning in so know that that’s the that’s the part of the process that helps you get the competition price up. Having a single buyer however we’ll definitely we see a difference between you know 30 and 50 percent valuation at the end by not having competition versus creating competition.

Alright um other questions i know i blew through that but i’m sending you the docs i’ll make it worthwhile so.

Guest:       Hey Dave could you recap the uh rule of 40 again for me?

Dave:        Yeah! So the rule of 40 is are you growing it greater than 40 percent a year or a combination of 40 percent 20 percent growth and 20 percent profits. So in the early stages you could be growing 150 percent a year but your number may be too low to actually um be interesting from an acquisitive perspective like if you’re doing less than a million dollars in revenue like big companies aren’t going to care very much so and when you’re starting off a basis of super low numbers it’s easy to double or do 200 – 300 percent a year. So in that case we’re going to look at monthly growth but if the business has gone flat right and you’re not growing it greater than 40 percent a year then it’s going to negatively impact the valuation but if you’re going at 40 percent a month? It probably means you’re coming off a base of a super small number.

Guest:       Thank you

Dave:        Any other questions you have?

John:         On one of the earlier slides transaction i think you mentioned not starting your price too low uh.

Dave:        So yeah actually it was in market I think marketplace let me go back to it um. So the big thing here is that you can’t start your pricing and your margins too low so in in the case of a transaction fee business i want it to be above 15 percent um versus if you remember um Upwork before it was Upwork was the Odesk and their margins were like 12 percent right and when they brought in a new CEO after merging the two companies they had to get the margins up to 20 percent so because you still have a cost of customer acquisition in a transaction fee or marketplace business In the marketplace business you have two costs right i have the cost of acquiring the sellers and the cost of acquiring the buyers and i have to track those two things differently so i would rather see you if you’re a new startup keep your price high and create a promotion for the first year that discounts it but it sets a pricing expectation going into year two your price is going to be back up so that’s what i mean by don’t start the pricing too low um

Dave:        Red great question um the only thing i’ve seen on the data around the product market fit math is what i just published in the book because i was so frustrated by it because i was one of those like well product market fit like when you go if you’re a founder you’re going to go see a VC and they’re going to be like that’s awesome let me know when you have traction come back and see me again and you’ll say well what would you like to see for traction they’ll go i don’t know it’s kind of like pornography you’ll know it when you see it that’s BS right? It’s because they don’t know either by the way I’m not I’m not digging on the investors i think you know an investor doesn’t want to say no because if you’re right they want a chance to invest at the same time it’s a lot of work to do the product market fit math so if you can sit down with a founder early on and say like here’s your key metrics that i would measure and part of what i’ve tried to do with the revenue models and the excerpt that you can download is i’ve identified some key metrics you can use for each of those 14 revenue models. You may find your one unique key metrics i’ve had this argument with a few VCs or like every business has its own unique key metric maybe but in the meantime these ones are prescriptive like you can use them and they will be a good place to start i hope that’s helpful Red.

Dave:        Corey is there a standard margin investors look for an e-commerce model? If so my guess is probably it depends on the size of the transaction. So if it’s b2b or you’re selling bonds you can do basis points but any business that runs on basis points makes me super anxious like my first startup was  in the software licensing business and our average transaction was like twelve thousand dollars so in that case i can be in margin points that are less than ten percent but you don’t wanna be if your average uh revenue per transaction is twenty five dollars you’re gonna need to be in a thirty percent range so again it’s a it’s a slider and these are heuristics. There’s also some heuristics around LTV to CAC ratios so for example if you’re B2B because your price point is high my LTV to CAC ratio should be greater than five if i’m B2C my LTV to CAC ratio should be greater than 10.

So and what i mean by that is if my lifetime value of the customer calculated at 12 months is a thousand dollars and i’m a consumer product i might be able to spend a hundred dollars to go get that customer but i can’t spend a thousand or two thousand dollars right because i’ll go negative and i can’t calculate my LTV at 24 months or 36 months just because I want to i can i have to start at 12 and then as I have real data i can increase that value.

Alright uh so Social Benefit Corp um standard method is evaluating so the SBC question is really interesting because it has more to do with what you’re committing the SBC to do in advance so are you committing to give a percentage of revenues away a percentage of profit away are you committed to doing good things and then the revenue model is really separate than the structure right so know that you have to the key here is within SBC is you have to disclose to your investors that we’re gonna have you know we’re gonna – Tom’s shoes was one of the first examples it was a buy one give one as long as your margins are high enough you can totally do that but you have to disclose it to your investors before you take their money you can’t change it after you take their money right. I was a for-profit was a for-profit now i’m a for purpose but you already put money in you can’t change it so just know that i’d separate those two things out you still need a revenue model right when i look back to early social investing the answer was well you don’t really need a revenue model if you’re doing it for social purposes now you still do because you need to get to self you know breakeven and self-funding otherwise you’re a non-profit.

So uh thinking about starting a company with the end in mind what are your cautions would you give around over architecting a company for one acquirer?

Yeah i so i don’t think you can it’s a great question Patrick so you can’t really optimize around exits at the early stage you have to optimize around the problem right and then you can pivot the product around the problem and you really have to focus on that Salesforce for example or sell them buys a company less than 10 million in revenue so in that case you’re going to spend seven years trying to optimize for Salesforce you’ll forget about Salesforce in about you know three months so know that you i think having in mind what revenue model will produce the best result in advance is super useful like we could Patrick and i could start a services business and do consulting and build a billion dollar business and it will sell for a million dollars or we could create a subscription business right that will sell for more than ten million dollars that would seems like a good place to start but optimizing around exit i’d say don’t spend too much time doing that early on.

Uh let’s see Michelle’s question for marketplaces is 30 percent commission considered too low? Again same sliders as commerce it really depends on what your average transaction fee is. If you’re if it’s a $10 000 um marketplace commission or transaction then 30 percent is going to be ridiculously high because you sell bulldozers and commercial equipment if you’re selling um you know Etsy type shirts and dresses the answer might be it maybe it’s okay but it really comes down to this is think of it this way from a founder  perspective and i guess this works for investors as well if you if the back of the napkin math doesn’t work the complex math won’t work either right so you have to have a thesis on your basic math and this one just says pick one of the 14 test it out if it doesn’t work for you great like i want to be recurring revenue but i’m really a transaction free business that’s what you are right unless you can create a product so in guidance case one of the things we’ve been working on is creating a technology platform that our customers can subscribe to as well and if you look at the multiples on revenue from those companies you’re doing the same it’s tough to break out of service multiples and find a product multiple revenue.

Alright uh John i really appreciate a clear definition of creating enterprise value creating a business that addresses senior citizens and their families? I’ve been cautioned that companies like AARP could easily copy oh i love the copy question um all right so Clayton Christensen’s book um the innovator’s dilemma is a brilliant book for you so the one so Clayton passed away last year used to be Harvard business school ran the entrepreneurship school there his point around innovator’s dilemma is that big companies have two things you don’t have as a startup they have revenue and they have customers you have something they don’t have which is you have innovators because all the innovators have left the big companies so it’s always a concern could Microsoft come along could Google come along could AARP come along and the answer is most of the time they won’t right because they’re not in the business of innovating they’re in the business of buying companies so in the case of Microsoft they’re going after multi-billion dollar companies today when they bought Nuance but when nuance started what 15 years ago voice technology was a super small market it was new and nascent very much like Airbnb or very much like Uber it just took a lot longer to mature right because getting your the voice stack into a Toyota center console took a long time so when it launched it was a new and nascent market but it had to become a multi-billion dollar market before Microsoft really cares about it. So depending on what you’re launching regarding the AARP question if it’s not already a multi-billion dollar market may not matter

Uh let’s see a couple other questions here repeat the author’s name of the innovator’s dilemma yes or i can Google it for you Clayton Christensen so brilliant author very consistent uh Christensen um okay

George asks here are there any rules of thumb for establishing a pre-revenue very early revenue value of the startup? Oh great question so in the Berkus method that i gave you a highlight to so Dave Berkus early angel investor based in Los Angeles kind of one of the first early super angels he gives you a method for evaluating the business based on a number of factors; team, market size, et cetera and it’s really a  heuristic based on pre for pre-revenue companies so just keep in mind the early stage if you’re going to go up and to the right really based on the total addressable market um the product right so the first few of the list i gave you in the big valuation drivers and but the more you have data the more it’s going to be based on the actual data conversion metrics ratios and growth because you’re going from risk capital early stage what AOA does to growth capital later stage private equity and as you go up that stack or that that funding stack if you will you have different sets of requirements so look at Dave Berkus’s the Berkus method as a way to do that B-E-R-K-U-S and it’s a link in the dock that um that i sent over as well so uh yeah terrific great question there um and again keep in mind your goal there as an early stage founder if you’re pre-revenue is really around what i would call being on the pitch so think of this as if you’re in if you’re playing soccer or football from  my friends outside of the US if you’re on the pitch and you’re the heuristic is like we’re raising a half million dollars at a three and a half million pre and it’s like and it’s a big market it’d be like kind of sounds about right what you don’t want to do is you don’t want to be in the stands or out on the street right so you’re like we’re raising a half million dollars on a 10 million pre with zero revenue i’d be like no and keep in mind that every stage of funding has information asymmetry so in the earliest stage when you take friends and family money i want you to give them the best deal of everybody who invested in your company because they’re taking the most risk but at that stage you know more about the valuation than they do because they’re investing in you as you get to angels who’ve done repeat deals you’re going to get feedback of like that price seems a little high and they have more data than you do because they’ve seen deals they’ve invested in deals they passed on or deals they’ve missed the same is true as you go up to VCs right there’s more information asymmetry so what you’re looking for is the heuristic of like am i kind of on the pitch or not right if you’re up in the stands right so we have this angel investor call early stage VC call that Yi-Jian and his team has run forever and we’ll be like oh yeah i saw that deal um i thought it was price too high right and you may have told me one price and Yi-Jian a different price so just think about it be consistent no we’re talking too and that’s super useful for you and your process of outpitching investors, alright other questions.

Brian:        Hey Dave this is Brian i got one quick question for you,

Dave:        Go for it

Brian:        Yeah I was curious you mentioned in early in the deck i think about picking primary and secondary revenue model so is that mostly around just ensuring you’re kind of doing the tracking the key metrics and then evolve that over time or can you just elaborate a little bit on how to kind of execute against it?

Dave:        So the concept there Brian is what you’re building i hope is unique but it may not be but how you make money is like seldom if ever unique so picking a primary revenue model is called subscription you’re like i think we’re going to monetize on subscription and at least having a thesis about how you’re going to monetize matters a lot versus like we’re going to create a new revenue model and the answer is maybe and again if it’s 15 i’ll totally write about it right but the challenge is there is now you have a level of complexity that’s just way off the charts i have to get product market fit for my product and i have to prove out a new revenue model and the answer is dang that’s like crazy hard versus like we’re just going to sell on subscriptions right or we think we’re going to as we scale we’re going to build tools so we can track metered services great or hey we’re going to charge a transaction fee and this is what the market will bear so just know that so a couple of quick examples of that when we first started the data set do you guys  remember Groupon crazy Groupon thing Groupon ultimately became just a commerce company with legion so revenue models by themselves are not defensible so you can go all the way back to pay-per-click models with go to net becoming Yahoo becoming a copycat by this new company called Google who Yahoo sued and right that whole thing that was actually a patented revenue model that ultimately wasn’t defensible either because pay-per-click as a revenue model wasn’t defensible so Groupon had remember the thousands of competitors they had like it was like we’re just like Groupon only better and in this city so ultimately that revenue model peaked and became commerce and Legion then we saw this fictitious one that that was a flash in a pen remember coins and tokens that one came up and then there was actually there was no way to actually track the unit economics or conversion rates consequently it’s not really a revenue model it was a funding model and the SEC ultimately said it was not legal but that’s a different issue so but it wasn’t a revenue model but then we did see um metered service launch out of subscription which is super cool right and we also see kind of the decline the long-term decline of licensing but of know again it’s six plus years of i know i’m super geeky about this stuff but after six years the answer is if you have a new one i’m super anxious to look at it but uh focus on your product being unique less on your revenue model being unique just be a copycat there.

Brian:        Yeah sounds great thanks

Dave:        Yep

David:       Hey Dave yes sir um i have a unique experience and it’s very limited as you know because you’re helping us through it but um having gotten acquired by servicenow they’re very focused on team and tech talent and they’re not really looking for high revenue companies and so um just on that front i put out basically just some blogs about my experience when a company is really interested in the team and the tech and not necessarily the revenue and one thing that i learned just if you’re an entrepreneur on this call is that the bigger tech team that you have does make a difference in the acquisition price because they’re thinking about okay I’m acquiring technical talent at a certain benchmark of you know one to two million dollars per head or whatever you would compare that to with other comparison companies but do you have any thoughts or comments on that i was going to just link to the my experience there in the chat but did you have any comments on like number of technical people that you’ve seen in other deals where that actually matters for the acquisition price?

Dave:        Yeah you bet on the continuing pattern you totally spot on the continuum of early revenue and we’re seeing a lot of early exits these days which is really fascinating um lots of observations that could be drawn from that but the idea there is my cost to acquire a team is equal to my cost of recruiting plus first year ramp rate plus you know does the talent work together so i can now get to a multiple of people instead of a multiple of revenue and hopefully in like your case doing a multiple of both early revenue and people gets the number up if you create competition um most startups will you’re going to have your first look is going to be based on revenue first and the trajectory of your revenue growth unless it’s an early exit and in that case it has to be part of a strategic fit for the buyer so like in your case totally spot on right the product team looks at it and says this is a product we need and we can either go build it or we can buy them now we’re going to value them based on the multiple of people as well as revenue yeah i think the big fit there for everybody is to recognize is that you have to connect with not the Corp Dev person you have to connect with the product owner or if they’re smaller company the CEO who really looks at it and says like this product we need to have this product in our roadmap and if we do it’s a great acquisition if you talk to the Corp Dev people and the product isn’t in their roadmap then their answer is like i guess…

David:       I’m just going to say that Dave that’s being on the inside of servicenow I’ve actually been doing a lot of networking with startups that are looking to get acquired by servicenow and that’s one of the first questions is um let’s go let me get you with the product team and see if that’s even on the roadmap and if it is and you guys look uniquely interesting then um you kind of want to staff up and make sure you’re bringing a good team so but yeah i just have a i linked it there in the chat for you but

Dave:        Thank you for speaking to that and David thanks for adding the notes on the Berkus method as well by the way I’ve totally internet stalked Dave Berkus for years and years like commented on his blog a couple times I use this as a marketing hack for you all if you’re a startup founder um so I reached out to him and commented on his blog and said this is really awesome thanks for doing this and then at one point i reached out to him and said hey Dave you don’t know me i’ve been kind of an internet stalker for years and i just finished this book can i send you a copy and if you like it would you write a blurb and he sent me back a note and said I not usually skim these and i write a blurb he’s like i actually read yours cover to cover and it’s super awesome and it’s going to be the handbook for blah blah and i was like wait a  total internet stalker paid off right in a good way stalker not in a bad way stalker so just know you can do that with thought leaderships in thought leaders in your area of your market and but do something reach out to them and comment on their stuff first um my now my quick observation is I have three to five thousand readers a month on my blog i will get on average three comments if you comment on my blog more than two times i clearly know who you are right so and then when you need something like you’re like you’re a super fan i would totally do something for you what are you talking about.

Alright uh George asked the question impact early state valuation does early adopter discount contract spring in the early adopters we’re getting an example 74? So this is a pricing question and we do a pricing seminar for WTIA so if you haven’t if you’re not familiar if you’re a founder and you’re not familiar with WTIA startup programs yet look at I chair the board there for start-up programs so we do a pricing seminar so think about this pricing question that George is asking what do i do with discounted contracts like POCS and proof concepts early on?

The answer is set a market except a price of what you think you’re going to charge and then give the discount for the early adopter price but set the  expectation for the customer that the price is going to go back up to the market rate at a later date the big question there becomes you can always discount but it’s hard to raise prices once you’ve discounted them publicly but we do a whole seminar on pricing and how to test pricing and how to ab testing and all that as well but yeah pricing has a big driver in your evaluation ultimately it’s one of your inputs on delivering value right revenue models and input marketing costs sales costs and you know customer success costs are all part of that cost um investors recognize you’re getting POCs but you just need to show me a path that i can go from a $29 a month customer to a $250 a month customer if that’s really your question um great other questions we got oh we’re the top of the hour Yi-Jian it’s back to you.

Yi-Jian:          Thanks you thanks to everybody for participating and having such a great engaging conversation and thanks very much to Dave you know for sharing all his insights and analysis with us today. So as Dave mentioned we’ll be sending out the slides afterwards and uh if you are interested in this book please uh feel free go to the link um do you send it out Dave the link to your?

Dave:        I’ll put it in the chat window right now yep so i’m a lousy self-promoter i got to get better that my publisher says

Yi-Jian:          I see some folks have already bought it in real time while you’re speaking so um anyways uh do send it out and uh leave a five-star review of course for four days so we support our local community leaders and with that i’d like to thank everyone for joining us today uh have a fantastic rest of the week thank you to all enjoy the weather everybody thanks goodbye.

The End

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