I had a great week. I met 7 startups I hadn’t seen before and caught up with four more. I heard from some great entrepreneurs. I saw some excellent ideas. I enjoyed real fun conversations. I also visited a new co-working space in Glasgow which was fantastic. You can see a picture of the Govan Workspace above. Congrats to Mike Hayes (@_MDHayes) and the team for setting it up. Most startups I meet are looking for funding or aiming for the next stage of growth. Every founder I saw had some kind of plan or pitch to share.
The details of the plan vary with the maturity of the business. There is no fixed rule but investors expectations also change as your business grows. I have set out below my quick reckoner for the key points at each stage. Before that, I thought you might enjoy the product from one of the businesses I met this week.
This link will take you to a living infographic from Stipso (@stipso). Stipso is an Edinburgh based company. They are aiming to transform the way data gathering works for marketing. They do this with a new kind of infographics. User engagement jumps when Stipso goes live in the real world. My thanks to Brian Corcoran and Steven Drost for letting me share one with you. The infographic does not show in some browsers (may fault) so click the button underneath of the screen below is blank. Enjoy.
The 7 Ages
"And one man in his time plays many parts,
Napkin - First scribble your idea on the back of a napkin. The only person you need to convince is yourself. If I meet you at this stage, I will try to show you the risk and dangers of becoming an entrepreneur. Building a start up is hard so it is not for everyone.
Accelerator - If you like your idea the next step is to start building something. You may choose to apply to an accelerator or a similar startup support programme. The biggest criteria for entry is the quality of the team. the only other thing that matters being different. Your idea or your company need to stand out from the crowd.
Development - An accelerator (or just a few months hard work) will get you an early product. Maybe your first customers. Continuing development is likely to need funds. Now its time for seed funding, maybe through angel investors. You might be asked for quite a lot of detail at this stage. I am only looking for three things: a great team; some evidence of market traction; and a clear description of the business model.
Follow on - Seed funding arrives after intense scrutiny by investors. Often accompanied by much stress for entrepreneurs. The investment basis is an over optimistic business plan. Soon you need follow on money. The main source will be the original seed investors. No-one wants you to fail at this stage. I need to see the same things with one extra. Some evidence of execution. Mistakes and over optimistic assumptions are fine. But I want to know you have used the money in a focused way. You have made real progress and you have learned from the things you have done.
Growth - You establish product/ market fit. Then you build a repeatable, predictable growth engine. You are ready for growth. It is time for Series A (and B and so on). VCs and strategic investors get involved. Your numbers come under much closer scrutiny. Detailed market analysis and revenue forecasts supported by full financial projections are the order of the day. Team and traction are still essential. I also want to know precisely how you will spend the money and the results you expect to produce. Most of the cash should be on sales and marketing through proven channels.
Scale - Deliver results from VC investment and you will be ready for an exit. This either an IPO or a sale to a strategic investor. In turn, a sale could be to a trade player or an investment fund. Information requirements are set by Regulations and industry practice. This is also the first point where valuation counts for me. I now have enough information. I can determine whether the price will yield an acceptable return on investment.
Its not all plain sailing
Fund raising is an unpredictable process and issues can arise for lots of reasons. It is worth highlighting three common sources of tension:
Corporate Planning - Even if your company is the next Microsoft or Google you will not escape. I admit that if you turn out to be Bill Gates or Larry Page you will be reviewing the plans. Not writing them. For normal mortals the corporate world means quarterly and annual planning cycles. As an investor I have no interest in this aspect of the rat race. As an advisor, I would say remember it is still a pitch. The corporate planning cycle is a way of allocating shareholder resources. Deciding which investments in people, assets, product or markets offer the best return.
Which of the 7 Ages is your business? Let me know if you need any help or ideas.
Seek global opportunities
He builds his career in the Law. Law was a new profession then. The Tudor version of the Internet. His business connections with the wool industry are strong. In that era, wool was the source of England's economic power. That power arose from trade. Think globally. Build a business with large market potential.
True to people and principles
When the first book opens Cromwell is working for Cardinal Wolsey. Soon after, Wolsey falls from the King’s favour. Cromwell remains loyal. True to both his patron and his principles. Despite the importance of patronage in that time and place, his rise continues. Stick to your guns.
Honesty and clarity
Throughout the stories the character speaks with clarity and honesty. He is a man of few words, chosen with care. The dialogue is often simple. Great issues decided in a short conversations. Keep it simple and be consistent. Use your intelligence and make the most of any meeting.
Perhaps most fascinating are his dealings with his family and household. He treats everyone from his son to the lowest servant with care and consideration. He recognises a duty to nurture and protect. He builds up a group of younger men around him as assistants. Developing and promoting talent is central to his model.
This takes constant care and attention. The author paints a picture by sharing many of her main character's innermost thoughts. He spend his time thinking about his people and the Royal agenda. His people demand attention to the smallest detail. Careful balance of challenge and reward. Approaches tailored to each individual in the team. There is no formal organisation or structure. No job titles. Just give each person a fair challenge and freedom to work.
Focus on the core customer need
It is different with the King. Cromwell devotes his tireless energy around one major issue. How can Henry divorce Catherine of Aragon. Everything else is secondary. He makes sure small things don't get in the way. Organising hunting trips, finding a favourite musician and so on. His thoughts focus on one priority. Henry is Cromwell's customer. Identify a core customer need and focus your efforts.
Leadership is a top start up challenge
Wolf Hall shows us a man with great experience of the real world. He is true to his principles and loyal to his friends. In business he has two priorities. Addressing the needs of his customer and growth and development for his people. He pays close attention to individuals and to detail for his team. But his focus is the big picture for his King.
Growth and investment are the biggest challenges for most startups. Building a successful business also requires leadership. Thomas Cromwell offers a great example. Of course history tells us it all ended badly. Creative destruction still applies!
What are the biggest leadership challenges you face as an entrepreneur? Where are the role models and lessons of experience that will help you?
The best SaaS business model thinking
There is a lot out there about the economics of SaaS business models. Tom Tunguz publishes regular insights about the performance of listed SaaS companies. David Skok offers some excellent analysis. His blog describes the formulas and ratios that drive growth and profitability. SaaStr provides practical tips and advice that are valuable to any entrepreneur. You could build up a list of metrics from these sources that runs to 10 pages or more.
I am not about to try to summarise all this great material in one blog post. This is not a guide to the economics of a SaaS business model. Reading great analysis and working with SaaS startups is a great way to learn. Some key ideas strike me as worth sharing.
CLV is key to unit economics
SaaS is about unit economics. You can calculate a realistic customer lifetime value (CLV) from the available data. I wrote a detailed post on the subject a couple of months ago - find it here. CLV is the building block of long term value. It shows the route to sustainable profit. The formula for CLV includes direct cost and cost per acquisition. Your direct cost should take account of cost to serve. Few SaaS companies can just sign up a customer and watch the money roll in. Those awesome margins need to support a proper service framework. You must keep your users engaged.
Every startup need to get to product/ market fit. At this stage SaaS companies are gaining paying customers with a repeatable process. The results of this process are also predictable. They can estimate the CLV of each customer. But they are not profitable. Now SaaS suffers from an old fashioned challenge. New Business Strain (NBS).
New Business Strain
NBS is an idea from the life insurance industry. In simple terms the cost of acquiring a customer is all incurred upfront. Value is realised over a period of years. Accounting and cash flow follow a more basic model. Growing a business means high short term CPA. This outweighs annual profits from recurring customers. You need more money than you are earning to keep growing. Financing this strain is the purpose of Series A investment and beyond. The alternative is slower growth.
B2B is not viral
Consumer business models can generate hyper growth and profits. This occurs when viral spread reduces CPA to near zero. This kind of viral growth is not open to B2B SaaS. Viral cycle times are much longer. Months not hours. When recommendations do happen they generate warm leads not direct sales. It may be slow and partial but viral still matters. Jason Lemkin wrote a great post about this. Over time, references from your customers will make a difference. Growth will multiply and CPA will come down. When this kicks in, NBS will shrink fast. It just takes time.
Lifetime is a key word in CLV. The number that determines L is churn. The value of your business is sensitive to tiny variations in churn. 2% per month gives a half life of 3 years. That is you will lose 50% of your current customers by the end of three years. Increase this to 3% and the half life reduces to just 2 years. Churn should be a small number. But your margin for error is tight.
Engagement is the great unknown
The biggest gap I see in current SaaS thinking is engagement. Measuring the economics of engagement is hard. We have a crude measure for pre sales engagement. Conversion of leads into paying customers. We have another simple number for post sales engagement. Churn. The process between is more of an art than a science. Finding which steps in the process reduce conversion rates would generate immediate value. Fine tuning service and support to reduce churn will pay long term dividends. Concentrate on measuring behaviour first. If you can attach a numerical value great. Build the model specific to your business from the ground up.
I am leading a workshop for a bunch of Scottish SaaS companies in early March. We will focus on one aspect of engagement. Looking forward to learning some best practice then.
Benchmarks - handle with care
Smart analysis of SaaS performance has led to some well constructed benchmarks. For example Annual Contract Value (ACV) to marketing cost ratio should be around 2:1. This shows a healthy level of NBS. Or Brad Feld's recent suggestion the rule of 40%. The sum of your net margin and your growth rate should be at least 40%. There are many other examples. All are rules of thumb suggested by experienced investors and entrepreneurs. Such benchmarks are due respect. But handle with care. General rules like this are a good indicator of progress but a bad way of setting goals. Think of benchmarks like a thermometer. They give a rough guide to general health. They are not a management tool. You would stay sick for a long time if doctors just focused on reducing your temperature.
I encourage you to read and follow some of the blogs suggested in this post. If you would like help building a SaaS model for your business, get in touch.
What is a growth engine?
A key element of your business model is the growth engine. Your start up needs a repeatable and predictable set of activities which will enable you to build customers and revenues - this is your growth engine. Your growth engine determines the processes you will adopt, your sales and marketing strategy and many of the staff you will hire. It also enables you to identify the best metrics for your business. Tracking these metrics and taking actions to improve them will become the core of your management model.
Are you ready for growth?
Start ups needs to scale and a powerful growth engine is an essential part of a scalable business model. Note that the growth engine only comes into focus at the right point in the development of a start up. Identifying and developing customers and establishing product/ market fit must come before you fire up your growth engine.
Every business will have a unique growth engine adapted specifically to your products, customers and users. Different business models have growth engines with different core characteristics. For example B2B is different from B2C, SaaS is different from usage based revenue and so on. But we can identify the core common components.
The 4 cylinders
Your growth engine has 4 cylinders:
Do not view this as a linear process. Like a real engine, each of the four cylinders needs to fire in unison to generate real power. It is common to to find start ups who can make one or two of the 4 elements work - acquire customers easily perhaps or make find a price where the customers they do have would be very profitable if only they had enough. True growth only happens when all four elements are working well.
Measure, Measure, Measure
Measurement is the vital element to make the growth engine work. Analytics have come a long way and we are now able to precisely track user behaviour and action in real time. Measure to understand how your product is used and build patterns of user behaviour. These numbers drive the heart of your business in 3 ways:
How do you find your growth engine? Sign up for our newsletter to get regular ideas and tools that will help.
Kenny Fraser is the Director of Sunstone Communication and a personal investor in startups.