Category: Entrepreneurship
When I wrote Startup Boards: Getting the Most Out of Your Board of Directors with Mahendra Ramsinghani, our goal was to help entrepreneurs understand how to create an excellent board of directors, manage it effectively, and get optimal value out of it. This was challenging to do, as the topic of boards can be boring. Based on the feedback we’ve gotten, including consistently positive reviews on Amazon, I feel like we accomplished that goal.
Last year the Kauffman Foundation, with which I’ve had a long relationship and am a big supporter of, approached me about doing a Kauffman Founders School video series on Startup Boards. We completed it early this year – the teaser follows.
There are seven modules that are each five to ten minutes long.
- Board Functions and Responsibilities
- Forming and Organizing Your Board
- Choosing Your Board Members
- Recruiting Your Board Members
- How to Run a Board Meeting
- Managing Your Long-Term Relationships
- Managing Company Transitions
Each module also has suggested additional readings, beyond our book Startup Boards.
I’m proud to be part of the Kauffman Founders School, which includes some great courses such as the ones listed below by folks like Dan Pink, Steve Blank, Bill Reichert, and Meg Cadoux Hirshberg.
Several years ago, Alex Iskold wrote a great overview of What It Is Like To Sell Your First Company. I thought it was a great description and encourage every entrepreneur who has never been through the sale of a company to read it.
Rereading Alex’s post inspired me to write my first person account of selling my first company. I’m sure I’ll get stuff wrong since it was over 21 years ago (I was 27.) But I’ll try to capture the good stuff that I can remember, especially since I know I had absolutely no idea what I was doing and could only rely on verbal conversations with other entrepreneurs I knew to help me figure things out since there was no web, no real books to read, and entrepreneurship still wasn’t a word being used regularly. When I reflect on it, independent of the modest economics, the experience changed the trajectory of my life in a very powerful and positive way, even though it was an extremely confusing time for me.
It 1993, I sold my first company, Feld Technologies, to a company called Sage Alerting Systems (which, after several name changes, became AmeriData Technologies.) It was a six month journey for me and my partner Dave Jilk which was at some points exciting, often stressful, and occasionally extremely confusing. It didn’t help that I was in the middle of a deep two year depression which I kept hidden from everyone in the world except Dave, Amy (who I was living with at the time before we got married), my parents, Eric von Hippel (my PhD advisor), and my therapist.
It started, like many things, completely randomly. When we installed a network for a client, we used a company called Allcom (run by two brothers – Jim Galvin and Mike Galvin.) They were great guys, easy to work with, and we sent some business back and forth. This was before WiFi networks so the cabling jobs, especially in downtown Boston, were never trivial, especially in the older buildings. One day, Jim called me and said something like, “Brad – we’ve been acquired and the chairman of the company wants to get together with you for lunch.” At the time I had no real idea what this meant, but figured, what the hell, I’ve got to eat.
I had lunch with Jim and Len Fassler at a restaurant near our office by South Station in downtown Boston. I can’t remember the name but it was a funky place I went to all the time. Jim and Len showed up a few minutes after me and we sat at a table. Len looked like a cross between a powerful New Yorker and Yoda – sharply dressed in his jacket and tie but short and with a friendly face weathered from experience. I was nervous. Very nervous.
We ordered and chatted for a little while. Len asked me softball questions about myself, Feld Technologies, what we did, how we did it, how many people we had, and what our backgrounds were. I can’t remember if Dave was there, but I don’t think he was. In the middle of lunch, Len said, “Jim speaks very highly of you. We’d like to buy your company.”
I was in the middle of a bowl of soup. I remember having to use all my self control so it didn’t get spit out all over the table. I wasn’t expecting this in any way, shape, or form.
We kept talking. I asked a bunch of naive questions, in the form of “What do you mean?” I remember feeling completely clueless and out of my depth. Len explained Sage Alerting Systems’ strategy, talked about how as a public company they were doing a rollup and growing quickly through acquisition, and said they were looking for a lot of small companies in the IT services business. They’d acquired a few companies so far and had LOIs out to a few more. They were really happy with Jim, Mike, and Allcom and wanted to buy more companies in Boston. I learned that they weren’t in New York, but were in Stamford, Connecticut, which I’d never been to.
Lunch ended and Len told me to think about it and call him if we were interested. I don’t really remember the next few conversations with Dave and my Dad (who was an advisory and co-owner) but I do remember a lot of vacillation on my part. Eventually Dave and I decided to go to Stamford to visit Len and his partner Jerry Poch.
We made the drive down on what I remember was a brilliantly sunny day. We didn’t really know what to expect, but when we got to Sage’s office, it was a mad-house of phone calls, people moving from room to room with stacks of paper, and rapid discussions. It was a small but lovely office overlooking the Stamford Canal (I think the address was 700 Canal Street). Len’s assistant Mildred, who I ended up getting to know pretty well over the years, greeted us and put us in the big conference room, which wasn’t very big. A new guy I hadn’t heard of yet named Jerry LeBow came in. Jerry, along with Len and Jerry Poch became a very close friend over time, but in this meeting we just sat and listened to him tell us about Sage Alerting Systems (which he was President of), the emergency warning system (which he knew more about than anyone else on the planet), and the technology he was working on. It was a one-way conversation and it became clear at some point that Lebow was filling up airtime while we were waiting for Len, but that was ok because it was interesting and we were nervous.
Eventually Len came in, apologized for keeping us waiting, and sat down to business. He’d asked us to bring our financing statements so he could look at them to come up with an offer. We gave them to him (no NDA required – we didn’t even know, or care, what an NDA was) and he started going through them. We always had very clean financials because we took it seriously so he quickly sized up our income statement and balance sheet. He asked us a few confirmatory questions, including how much salary we were each getting paid, separate from any distributions from the business, which was $100,000 / year each.
He turned over a piece of paper and scribbled an offer on it. It was 40,000 shares of Sage stock, options for another 40,000 shares of Sage stock, the cash and working capital on the balance sheet (which was about $250,000), salaries of 100k for year 1, 110k for year 2, and 120k for year 3, and 10% of the profits of our group going forward. I’m 99% sure that was the offer, although Dave might remember something different, so it’ll be interesting to see if he weighs in here and corrects us.
Len explained that was their formula for doing deals – 2x multiple of Net Income + balance sheet cash + a three year employment deal. At the time, Sage stock was around $6 / share so it was like a $500,000 offer for the business, half with cash that we’d already earned but had tied up in the business, but upside in the stock and the options. Len made the point that the stock and the options had a lot of upside.
By this point I think Len could have offered us $1 for the business and we would have taken it. We were both totally burned out running the company, had never really thought about the business, were excited about the idea of being able to sell it, and entranced by what was going on around us. Remember that I was very depressed (although I used up all my energy not showing it) and I’m sure Dave was totally worn out from dealing with me. I knew I liked Len from lunch and fell in love with him in that meeting, a love which endures to this day.
Len didn’t propose this as a “bid/ask” type offer – it was a very soft, straightforward “take it or leave it” offer – and it was clear that they were doing lots and lots of transactions and if we weren’t interested, that was fine and they’d quickly move on.
Suddenly Jerry Poch came in the room. In contrast to Len’s calm fatherly approach, Jerry was awesomely full of fire, power, and energy. He was loud, aggressive, and enthusiastic. He knew about us, even though we hadn’t met yet, told us how excited he was to be talking to us, and mentioned how the Galvin’s thought we were great and hoped we could do a deal together. And, before I knew it, he was gone, off to the next thing.
I remember meekly telling Len to send us an offer. I remember shaking hands and vaguely felt like we’d just agreed to a deal. We said our goodbyes, Dave and I left the office, and went to our car for the three hour drive back to Boston.
to be continued…
Do you remember your first board meeting? I do. Well, I sort of do, kind of, maybe.
Danielle Morrill of Mattermark memorialized her first board meeting on the web in her post Post Series A Life: Reflecting on Our First Board Meeting and What It’s Like Working with Brad. It’s a detailed view of her expectations leading up to the first board meeting we had along with the blow by blow from her perspective of the board meeting.
I have two simple pieces of feedback to Danielle, Kevin, and Andy about the board meeting. First, bring the rest of the leadership team the next time so we have a room full of the team for most of the meeting. Second, you did great – I love the style of board meeting we had.
We didn’t have board meetings at Feld Technologies – we didn’t really have a board. There were three owners – me, Dave Jilk, and my dad. Dave and I had a monthly offsite where we went away for a day and an overnight somewhere within driving distance of Boston. We did this eight to ten times a year and these were some of the most powerful and useful working days, and personal days, we had together. Once a year my dad would join us for a long weekend somewhere where we hung out, talked about the business, and drove around New England.
My first real board meeting was at NetGenesis. I remember the place – an MIT classroom. I remember the attendees – Rajat Bhargava, Eric Richard, Matt Cutler, Matthew Gray, and Will Herman. The chalkboard was black, the chalk was white and dusty. Will and I had each invested $25,000 for a total of 20% of the company. It was 1994. The meeting was around a wooden MIT classroom table that looked like it was from 1894. I don’t remember much of the meeting, except we wrote lots of lots of things on the chalkboard. There were no PowerPoint slides.
I remember my first board meeting for a company I joined as an outside board member. This company was SBT Accounting Systems, based in San Rafael, California. I flew to San Francisco from Boston, stayed overnight in the city, and drove over the Golden Gate Bridge. I’d only been to San Rafael once before, presumably to interview for the board position under the auspices of spending the day at the company. I was nervous because I had no idea what to expect. I showed up a little early, was ushered into the very large board room, and fed breakfast of bagels, pastries, fruit, and coffee. For some reason, I remember eating so much that I was full before the meeting started. SBT always had outstanding, freshly ground coffee filtered through Melitta cone filters which meant that I often drank way too much coffee. Unlike my NetGenesis board meetings, and the few others that I had started attending like ThinkFish’s, this one was formal. Everyone took their place at the table, with blue board books in front of them, and “the show” began. After a number of years of faithful service, I left that board, but I learned a lot and remember the time on that board as helpful to forming my view of an ideal board meeting.
My book, Startup Boards: Getting the Most Out of Your Board of Directors, covers what I’ve learned over the ensuing hundreds of first board meetings, and thousands of board meetings, I’ve participated in. While the book was hard to write, and at some points I feared that it would be excruciatingly “boring” to read, the feedback has been positive, especially from entrepreneurs and CEOs like Danielle who are having their first “real board meeting.”
Just remember – keep it real, not fake. Be yourself. And own the meeting.
There are lots of blogs and anecdotes on (a) how to build a successful SaaS company and (b) what a successful SaaS company looks like. Yesterday’s post by Neeraj Agrawal from Battery Ventures titled The SaaS Adventure is another great one as he describes his (and presumably Battery’s) T2D3 approach.
If you want to follow these posts more closely on a daily basis, I encourage you to subscribe to the Mattermark Daily newsletter. Or take a look at the VCs I follow in my Feedly VC channel.
I was at a board meeting recently and heard something I’ve not heard before from a late stage investor. He described what his firm called the 40% rule for a healthy software company, including business SaaS companies. These are for SaaS companies at scale – assume at least $50 million in revenue – but my Illusion of Product/Market Fit for SaaS Companies correlates nicely with it once you hit about $1m of MRR.
The 40% rule is that your growth rate + your profit should add up to 40%. So, if you are growing at 20%, you should be generating a profit of 20%. If you are growing at 40%, you should be generating a 0% profit. If you are growing at 50%, you can lose 10%. If you are doing better than the 40% rule, that’s awesome.
Now, growth rate is easy in a SaaS-based business. Just do year-over-year growth rate of monthly MRR. You can do total revenue, but make sure you do MRR also to make sure you don’t have weird things going on in your GAAP accounting, especially if you have one time services revenue in the mix. It’s always worth backtesting this with YoY growth of gross margin just to make sure your COGS are scaling appropriately with your revenue growth, regardless of whether you are on AWS, another cloud provider, or running bare metal in data centers.
Profit is harder to define. Are we talking about EBITDA, Operating Income, Net Income, Free Cash Flow, Cash Flow or something else. I prefer to use EBITDA here as the baseline and then back test with the other percentages. If you are running on AWS or the cloud, this should be pretty simple and consistent. However, if you are running your own infrastructure, your EBITDA, Operating Income and Free Cash Flow will diverge from your Net Income and Cash Flow because of equipment purchases, debt to finance them, or lease expense. So you have to be precise here with which number you are using and “it’ll depend” based on how your SaaS infrastructure works.
While the punch line is that you can lose money if you are growing faster, the minimum point of happiness is 40% annual growth rate. Now, some people will focus on MRR growth rate, others ARR growth rate, and yet others on weird permutations of year of year growth rate by month. Others will focus on the same strange permutations for GAAP revenue to justify growth rate. Regardless, you need a baseline, and I’ve always found simply doing year-over-year MRR growth rate to be the easiest / cleanest, but I always make sure I know what is going on underneath this number by using the other calculations.
I often hear – from sub-scale SaaS companies, “we can get profitable right away if we slow down our growth rate.” And – that’s often a true statement, but you will end up being sub-scale for a much longer time when you end up with a 20% growth rate and a 20% profit. So – if you are going to raise VC money, get focused on the T2D3 approach to get to scale, then start focusing on the 40% rule.
tl;dr: As a small company, focus on two things with big companies: “1. What can we, the small company do, to make the big company successful? 2. What can I do, as a leader of a small company, do to help the people I’m working with at the big company be successful within the big company?”
I was on the phone yesterday with the head of corp dev for a very large tech company. He and I had never talked before so it was an intro meeting, although brokered by a long term colleague at that company. It’s a tech company we’ve had many interactions at many levels with over the years – some good, some bad, some complex, and some perplexing. Over a long period of time, these interactions, and many others that I’ve had with other big companies, have shaped my view on interacting with large tech companies.
When I started investing in 1994, I was involved with a few large companies. My first company (Feld Technologies) was one of the first Microsoft Solution Providers (Dwayne Walker, are you still out there somewhere?) At the beginning I was still working for AmeriData when I started investing. AmeriData was a public company, a voracious acquirer (we acquired 40 companies in three years), and a very fast growing business (they were less than $50 million in revenue when they acquired Feld Technologies and over $2 billion in revenue three years later when GE acquired them.) For a short time I was connected into GE via their acquisition of AmeriData (I still have my GE business card with the “meatball logo” on it.) During the same time, I started working as an affiliate to Softbank which was a large Japanese company acquiring minority and majority interests in lots of US companies. By the time I co-founded what became Mobius Venture Capital, Softbank (our sponsor – at the time we were called Softbank Venture Capital) was the key investor in Yahoo, E*trade, and a number of other large US-based Internet companies.
I used to think that these large companies had a clear view on how to help small companies. I was seduced by Microsoft’s Solution Provider program into thinking that Microsoft had the long-term interest of Feld Technologies (and then subsequent companies that I invested in, including ePartners, Gold Systems, and NewsGator) at heart. I participated in a number of meetings with Yahoo in the late 1990s as a member of the Softbank team and listened to the vision of what Yahoo wanted to do to help the ecosystem. I spouted all kinds of garbage and nonsense about what we were doing as part of the broader Softbank ecosystem to help advance the cause of Softbank while at the same time helping startups everywhere, especially the ones we had invested in. I had the notion that whenever I ended up in a meeting in GE, I could get GE to do something with one of the companies I was an investor in to help them out. When I invested in the Feld Group, we even set up an initiative to help startups getting connected into the very large Feld Group clients, which included companies like Southwest Airlines, Delta, Home Depot, First Data, and Burlington Northern.
For over a decade, I heard and made happy talk from two directions – that of the investor in a startup and that of the partner of a big company that was looking to work with startups. That we were building an ecosystem. That we’d do all kinds of vague and unspecified things together in the name of innovation. Many drinks were had, many conversations were enjoyed, and many plans were hatched. And very, very little got done.
Around 2004, after the dust on the mess that was my world post-Internet bubble settled and I shifted into a mode where I grinded it out at Mobius until we started Foundry Group in 2007, I decided I was thinking about it completely wrong. I came to these conversations wondering what the big company could do. Sure, I considered the skills and capabilities of the startup, but I was always trying to figure out and anticipate how the big company could help the startup.
Wrong, wrong, wrong, wrong, wrong.
My first adjustment was realizing that whenever I counted on a big company to do something to help a startup, I generally was disappointed. Often, even if the big company wasn’t trying to harm or limit the small company, they often did. This is what causes so many VCs to be wary of corporate investors, especially ones who come to the table with strings attached to a financial investment. But I saw it in all of the partnership dynamics, product roadmaps, build vs. buy decisions, shifting leadership and goals, and conflicting big company product teams. It’s not that the big company couldn’t do something to help a startup, it is just that the startup shouldn’t count on it as a critical input into its success.
Then I realized that the big company has no fundamental obligation to the startup. For a while, I carried around a purist thought of mutual innovation. I got involved in huge investment efforts on small companies to try to satisfy the needs of a big company in the context of a partnership. I’m not talking about a sales situation – separate that out – but rather a long-term business partnership, joint development, or technology partnership. In these cases, the large company puts up no money, but people engage to work with the small company. And the small company puts huge effort into the project for free with the hope of a payoff at the end. The opportunity cost for the big company is tiny while the opportunity cost, and often the direct costs, for the small company is enormous. In hindsight this is a clear imbalance. It’s easy to fix and align the parties, either through money flowing from the big company to the small company, or via clear rules of engagement between the two, but if you assume the big company has no fundamental obligations to a startup, you can’t get hurt too badly.
The turning point for me was a specific time I experienced a large company totally fuck over a long-term partner that had gone all in on their relationship. This large company benefited enormously – both directly (via product sales) and indirectly (via market reputation and customer love) from the small company over a period of several years. But, one day, the large company decided to do something that drastically undermined the business of the small company, and no level of effort could generate a discussion between the two companies about it or a path forward that was supportive of the small company.
I realized that was a consistent pattern in my world. Large companies have whatever agenda they have. They have no responsibility to the small company beyond whatever legal contract exists, which often is heavily weighted in favor of the large company. Strategies change. Executives change. The macro changes. Exogenous forces, that the small company can do absolutely nothing about, regularly cause havoc for the large company.
Rather than be mad, hate the large company, feel like a victim, or behave like an abused spouse or child that sticks around and keeps coming back for more, accept that you are fully responsible for your own destiny. And that instead of expecting something from the big company, you should be focusing on doing specific things that help the big company while advancing your goal as a small company.
It was subtle to me at the time, but totally obvious to me now. In the conversation I had yesterday, I gave some direct, constructive feedback on situations where startups I’m an investor in had felt abused, mistreated, or deceived by the big company. But I was clear that none of these were fundamentally issues for the big company. They hadn’t done anything illegal, but they had damaged their reputation with me and with many VCs and entrepreneurs I knew. I was willing to give feedback from my perspective, but I had absolutely no expectation that the company would do anything about the past or behave differently in the future.
This corp dev leader was gracious. He listened, accepted the feedback constructively, suggested that the reputational dynamic mattered a lot to him and the company, and acknowledged that the only way to improve was to keep trying. I said I was always happy to start with a completely clean slate and try again. But for me, this doesn’t mean having false hopes and expectations that something magical will happen. Instead, I start from the focus with every engagement point of “what can we, the small company, do to help you, the big company, be successful.” If I can’t figure that out in an unambiguous way that we, the small company, can afford to try, then it’s not worth the engagement.
JFK’s words, “Ask not what your country can do for you – ask what you can do for your country” echo in my mind. Modify it slightly as startup: “Ask not what big company can do for you – ask what you can do for big company.“
I hear some version of this one all the time.
- “We will never need another financing.”
- “This financing will get us to cash flow breakeven.”
- “This is our last financing before we become profitable.”
It’s probably bullshit. There are so many reasons companies raise more money in the future that even making an assertion like this is generally nonsensical. But even if you, as the founder, believe it, you are still probably deluding yourself.
Now, there are points in time where a company doesn’t have to raise any more money. I’m on the board of several significant companies that are profitable and generating meaningful free cash flow. They don’t need to raise any more money unless they want to. And, there are a few reasons they might want to, but we’ll get to that later in the post.
There are also companies, like my first one (Feld Technologies) that bootstrapped and never raised any money. Well – almost no money. We funded the business with $10 (for ten shares of stock) and my dad personally guaranteed a $20,000 line of credit with his bank. We promptly spent the $20,000 on our first few months of operations, realized there was no more where that was coming from, fired everyone, paid back the line of credit over the next six months from our very modest positive cash flow, and then made a profit – and had positive cash flow – every month for the rest of the seven years of the business up until the day we sold the company.
But I’m not talking about bootstrapped companies. I’m taking about angel and VC backed companies. You know, the ones that generally lose money for a while before they make any money. And need money to fund their operations.
Imagine being an investor and being approached by a business SaaS company that has raised $5 million, has $100k / month of revenue, has been growing at about 5% per month, and is doing a $10 million round. “This is the last financing we’ll ever need” is the lead in statement. My first question is “how fast do you want to grow year over year for the next few years?” When the number comes back over 100%, my next question is “Do your customers pay monthly or annually, up front or in arrears.” Unless you are getting paid annually upfront, it’s highly unlikely that your cash coming in is going to outpace your cash going on on a monthly basis for a while. It’s simple math – give it a shot if you want. Sure, every now and then something magical happens (very high price point, very low cost of customer acquisition, zero churn), but that’s a serious edge case.
Now things are working nicely for you and you are growing quickly after raising that $10 million, but you have a competitor that is chasing you from below and a giant public company who is suddenly attacking you from the top. You decide you need to add a direct sales force to augment the self-service / low-touch sales model you’ve been using. Yup – that’ll be more money. Or you realize that you have massive technical debt because you’ve underinvested in scaling and your AWS bills are now increasing non-linearly with your revenue all of a sudden because of the way you’ve architected things. Or you have a major outage and decide you need some redundant infrastructure. I could come up with 100 more items.
You want to do an acquisition, but the seller wants some cash. Your revenue growth flattens out for a few quarters but you didn’t get ahead of the cost dynamic. There is a macro downturn and 25% of your customers vaporize (Don’t think this happens? Ask one of your friends who was a CEO of an Internet company in 2001.)
Where there is a wonderful fantasy about never needing to raise more money, and it does occasionally turn into a reality, I recommend you not lead with it when you are out raising money. It simply undermines your credibility.
Interviewing Lucy Sanders at Entrepreneurs Unplugged on 1/28/15
Lucy Sanders, the founder/CEO of the National Center for Women & Information Technology is a remarkable person. I’ve worked with Lucy since 2005 and she’s done more advancing the cause of engaging women in IT, computer science, and entrepreneurship than anyone I know.
As a bonus, she – and NCWIT – are based in Boulder. I like to refer to them as a gem of CU Boulder that is hidden in plain site.
Next Wednesday, as part of the Entrepreneurs Unplugged interview series I’ve been helping host for the past few years, Jill Dupre and I will interview Lucy at the ATLAS Center in Room 100.
I promise you that it will be a special one. Lucy started her career as a young woman at Bell Labs in the 1970s. She was one of the only ones. When she retired from Avaya Labs in 2001, she was CTO, R&D Vice President and Bell Labs Fellow and had about 600 people reporting to her. Her journey up to this point was amazing, but she was just getting started. What she’s done in the last decade as the CEO of NCWIT is amazing.
My work with Lucy has been one of the most satisfying non-profit experiences I’ve been involved in. In addition, I’ve learned an incredible amount from her about the dynamics of women in technology, business, and entrepreneurship. She’s had a dramatic impact on my thinking and behavior and I’d love to share some of her magic with you.
Register here and come join us on Wednesday, January 28, 2015 for 6:00-7:30 PM.
“We have product/market fit.”
“We are searching for product/market fit.”
“We are raising this financing to find product/market fit.”
“Our customer traction demonstrates product/market fit.”
Product/market fit. It’s a wonderful phrase, thanks to Marc Andreessen, Sean Ellis, Steve Blank, and Eric Ries. But it also one of the most overused, and inappropriately used, phrases that I hear with SaaS companies on a daily basis.
I was in a meeting a month ago with a company I’m on the board of where product/market fit was asserted. I sat quietly for a moment and then stated as clearly as I could that the company didn’t have product/market fit, they had the illusion of product/market fit. A long conversation ensued which resulted in me pondering this illusion and trying to put some parameters around it.
But first, some history.
There’s a fun post from Ben Horowitz in 2010 titled The Revenge of the Fat Guy that weaves in comments from Fred Wilson about product/market fit where Fred argues in his post Being Fat Is Not Healthy. While ostensibly it’s a post about lean vs. fat startups, it really is about discovering product/market fit and it gives a good history lesson on the thinking circa 2010 on this issue. Ben eventually states, and then explains, four product/market fit myths.
- Myth #1: Product market fit is always a discrete, big bang event
- Myth #2: It’s patently obvious when you have product market fit
- Myth #3: Once you achieve product market fit, you can’t lose it.
- Myth #4: Once you have product-market fit, you don’t have to sweat the competition.
As I rolled this around in my head, I started to realize that part of the illusion of product/market fit is that there’s a belief that once you have it, you never lose it (myth #3). There’s also the belief that there’s a magic moment where you have it and declare it (myth #1). Worse, there’s the belief that it’s obvious when you have it (myth #2). And tragically, a lot of companies believe when they have it, they don’t have to worry about anyone else because they’ve won (myth #4).
I’ve experienced the downside of each of these myths many times. I’ve seen companies have to rediscover product/market fit after getting to a $500k MRR (monthly recurring revenue). I’ve been involved in companies that thought they owned the market at a $2m MRR only to have a new competitor come out of no where and beat the crap out of them. I watched companies at a $4m MRR enter new markets and struggle mightily to discover product/market fit for these new markets. Or worse, I’ve seen a new product release that was late completely toast product/market fit and force a company to hang on to customers any way possible while rushing to fix what was broken.
The illusion of product/market fit pops up at multiple points in time. So I started thinking about heuristics for these points in time and came up with MRR as a parameter to explore. Suddenly, the illusion problem came into focus for me based on MRR, with clear transitions happening up to a $1m MRR. While I’m going to keep exploring this, I have a hypothesis now about the dynamics around product/market fit in SaaS companies that I’m playing around with. Feel free to tear it apart.
When you have $0 of MRR, you have no product/market fit. Ok – that was easy. You are working on a product and searching for your first customer.
From $1 to $10k MRR, you have the illusion of product/market fit. You finally found someone to pay you for your shitty MVP, but you’ve got a long way to go before you truly have product/market fit. Do not pour on the gas at this point. Stay calm and keep doing what you are doing.
$10k to $100k MRR is a super exciting time. You’ve got a semblance of product/market fit. You are starting to learn what your customers will pay you for. You feel like things are actually cranking. You probably have one or two salespeople and one of your founders – maybe your CEO – is still the head of sales. If you try to raise a Series A, the process is straightforward. It’s easy to believe you’ve got it figured it out here. This is the point at which myth’s #1 and #2 usually kick you in the ass. If you aren’t growing a compounded 10% each month, you don’t have product market/fit yet. If you are growing faster than that, you have found something.
Going from $100k to $500k MRR is a product/market fit sweet spot. You are starting to build a sales organization, have visibility in the market in your segment, and might even have customers coming to you on a regular basis. This is where myth #3 bops you on the head. You think you’ve got it and it’ll keep scaling, but you hire the wrong VP Sales, you focus on the wrong metrics, or you end up struggling to renew your customers when the first annual renewal cycle hits. You get confused about negative churn and conflate upsells with growth with churn. Lots of companies stall here – some due to self-inflicted pain; others due to the illusion of product/market fit.
If you can blast through the $500k MRR mark and march to $1m MRR, you’ve found product/market fit. You are now at the magical point some people call “Initial Scale.” Cool – you’ve got a business.
Now, your value is going to be determined by your growth rate. At any point in time, if you are growing > 100% year-over-year you will be highly valued – think at least 10x revenue, but I won’t tell you whether it’s trailing or forward, as that’ll shift around based on the public markets. And, the faster you are growing, the more discontinuous (e.g. higher multiple, but not linear) your valuation will be.
If your growth rate is between 50% and 100% and holding steady, that’s good and you’ll see a nice, big, healthy valuation. But if it’s declining, watch out for that magic 50% year-over-year mark. It’s like a trip wire that will send off all kinds of weird alarm bells. Once you decline below 20%, you better make sure your existing investors are going to be ready to step up to finance you, or else start the rapid march to profitability, which likely generates even slower growth.
Myth #3 and myth #4 show up all the time at MRR’s > $1m. You disrupted someone a few years ago which is what caused you to discover product/market fit. Don’t be confused about the world – someone else is gunning for you now that you are the big player in whatever segment you are in.
Every time you work on something new, whether it’s a new feature, a new product, or a new product line, recognize that you are searching for incremental product/market fit. The search is a continuous and never ending quest. Don’t confuse illusion with reality.
I just saw my first proposal for a Coding School Rollup. As you are probably aware, 2014 saw the explosion of coding schools all over the US. These are typically four to 12 week programs. Some are full-time, others are part-time. Many are immersive and include internships. A few are longer than 12 weeks.
I know several people who have gone through the with great success and gone on to have excellent software development jobs. It’s a powerful model that university education has generally missed on. In fact, I know a few companies that put computer science grads through these types of programs as an on boarding process. I’m a big fan of coding schools.
When I saw the proposal, I immediately thought of the web consulting rollups of 1999. Do you remember US Web, iXL, Scient, and Viant? Companies were being bought (and valued) at 10x forward revenue only to be valued at between 0.5x and 1.0x revenue several years later. I’d argue the 0.5x and 1.0x revenue were the correct valuations since these are generally 5% to 10% net income businesses that are 30% – 40% gross margin and heavily dependent on (a) transitory labor and (b) favorable supply/demand conditions.
But let’s go back a little further in time. Anyone remember the web hosting rollup? Or the ASP rollup? I was in the middle of that with Interliant (I was a co-founder) – we bought 20+ companies, at one point has an almost $3 billion market cap (on $200 million of revenue – recognize the multiple), but went bankrupt in 2002. A few companies got bought before the whole Internet-bubble thing fell apart, and we almost managed to get bought (for around $500 million, but that’s another story for another day.)
Or the ISP rollup before that? Yeah – Verio was the big winner there (and they overlapped with the web hosting rollup since they evolved into that) and their timing was epic being bought by NTT for $5 billion in cash just before everything blew up. I will forever be in awe of the exit execution and timing there by the board and investors (some of whom are friends.)
Or the systems integration rollup of the 1990s. I was involved in that also. My first company, Feld Technologies, was bought by AmeriData, which bought 40 companies in three years. We were bought for a more reasonable 1x revenue (and about 4x pre-tax income) when the value of the AmeriData stock, options, and cash we took out were factored in. GE Capital bought AmeriData for $500 million two years after Feld Technologies was acquired, so that was a great exit, but there were plenty of other system integration rollups that ended up in the dust bin.
Office supply consolidation? Anyone remember that one? I wasn’t involved but some of the players ended up in the systems integration rollup game.
My good friend Phil Weiser often says to me “history doesn’t repeat itself, but it does rhyme” which I always thought was a Mark Twain quote but apparently there’s some confusion about that in the world of Wikiquotes.
In this case, Coding School Rollup definitely rhymes with all the rest. And for those clever entrepreneurs and investors who try to use the word “consolidation” instead of “rollup”, don’t bother, we already tried that. Consolidation and rollup rhyme also (well – actually they are synonyms.)