On startups burn rates • Board Observers Bill Gurley gave an interview a few weeks ago in the WSJ where he sounded alarm on the very high cash burn rates of big startups these days. It triggered an immense debate as he was immediately echoed by Fred Wilson, this “Winter is coming” post from Techcrunch post along with deeper commentary from Mark Suster or Danielle Morill. The trade-offs between profitability and growth is one of the most fundamental and (generally) misunderstood business topic in the startup ecosystem. Here I’ll explain why there is no “right” amount of burn for a company, and I’ll try to give you some frameworks you can use for thinking about this problem. Frameworks The first item is to remember that you should take all advice as directionally good guidance, but every business is different. What are the frameworks you can use to determine the optimal burn rate for your company? The milestone play The “milestone play” consists in getting your company to a point at which you can raise money at a higher valuation.
Pricing A Follow-On Venture Investment Today on MBA Mondays, I am going to walk you through some math that our team does when looking at a venture investment in a company that is starting to scale its business. Let's assume we have a portfolio company. I will call it fit.sy. So now the VC firm (us) needs to figure out what is a fair price. - fit.sy is on track to generate $10mm in gross transactions in 2011 - they operate on an all-in "take rate" of 9% so their net revenue in 2011 will be $900k - they will have operating costs in 2011 of $1.5mm and they will lose $600k this year - they plan to triple gross transactions in 2012 to $30mm and grow to $150mm in gross transactions by 2014 - they plan to do this while ramping operating costs to $3mm in 2012 and to $7mm in 2014 We lay all of those number out in a spreadsheet and then look for some multiples to apply to them to get to a sense of value. I've observed these multiples over a long time, going back to eBay and Mercado Libre a decade or more ago.
Determining Valuation Multiples Last week on MBA Mondays, I talked about valuing an internet marketplace business. In that post, I talked about using 1x gross marketplace transactions and 20x EBITDA as multiples to determine value. In the comments, I was asked about multiples for other sectors. That's a good question so I figured I'd show how to calculate multiples for various sectors. For this exercise we will focus on the software as a services (SAAS) sector. The first thing you need to do is find a universe of publicly traded companies to use for your model. The next thing you do is create a spreadsheet with a bunch of companies on it. Please don't get too caught up in the numbers in the spreadsheet. For each company, I collected revenues and EBITDA for 2011 and 2012 and current values for market cap, cash and debt. I then put all the numbers down and used formulas in the spreadsheet to calculate enterprise value which is market value minus cash plus debt. The results of this exercise are as follows:
Always have 18 months of cash in the bank tech I was once told by an experienced entrepreneur (I can’t remember who) to always have at least 18 months of cash in the bank. The logic behind this is: 1) as a rule of thumb it takes 3 months to raise money, 2) building/marketing/selling technology always takes longer than you think. More adventurous entrepreneurs might argue 18 months is too conservative. The question of when to raise money is one of the few times that entrepreneurs and early-stage investors have somewhat divergent economic interests.
Capital And Success In a post early last week I asserted this: Access to capital and raising a boatload of it is rarely the thing that wins the market. And then later in the week I saw this tweet And then this one These tweets are about the competition between our portfolio company DuckDuckGo and another search engine called Blekko. Blekko has raised $60mm to date and DuckDuckGo has raised $3mm (and never spent it). In that post last week, I also asserted this: Product execution, network effects, go to market strategies, and a few other things are what allows companies to win the market It is what you build, how you go to market with it, and how you monetize it that will determine your success.
Ten Realities of Taking Venture Capital Money If you take venture capital money... 1) You increase the chances that you may not be CEO of your own company one day--and that also might be the best thing for its long term success. 2) You are signing up to sell the company one day--to another company or to the public market, but definitely to someone. 3) You will almost certainly take more venture capital money after that. 4) You will almost certainly go cashflow negative, increasing the risk that your company will fail. 5) You now have the responsibility to report the progress of the company to others--and to consider their opinions and feedback. 6) You have prioritized growth and your company will be bigger next year than it is now. 7) Some of the people working for and with you now will not be suitable for a growth phase and will have to leave. 8) There are smaller exit opportunities you will not be able to take because your capital structure makes them financially unattractive.
Revenue Multiples And Growth When you say “the stock is trading at 20x revenues” people rightly shake their head and say “that is nuts.” I got a lot of tweets like that in reaction to my comments about the Uber valuation in the LeWeb breakfast chat. However, what people fail to realize is these things happen in a moment in time and that stocks won’t trade at 20x revenues forever. Let’s take a fictional company that has $1bn in revenues in 2014 and goes public at $20bn, 20x revenues. Let’s say it will double revenues in 2015, then grow 60% in 2016, and 40% in 2017, and 30% in 2018. So here are the revenue numbers So, let’s now look at profits, since valuations are ultimately a function of profits, not revenues. Let’s say this fictional company is breakeven in 2014, but expects to make 10% EBITDA margins in 2015, growing to 25% EBITDA margins by 2018. Let’s say this fictional company’s stock will go up 10% a year each year until 2018. So here are the Revenue and EBITDA multiples that fall out of this thought exercise
Ten Good Reasons to Take Venture Capital Money Following up on my post from Monday that rang like "reasons not to take VC money" here are some reasons you should: 1) You really like the investor and believe they can add more value than you give up in equity. 2) You are growing, and if you don't raise, you won't be able to build the infrastructure required not to come apart at the seams. 3) You have the team in place or identified to build the product, you've done your homework by talking to customers that it is, in fact, the right product, and you're the best person to lead the effort, but you can't fund the build of the product yourself. 4) You've identified the best team, and while they're asking for reasonable startup salaries, you can't afford to hire them quite yet. 5) You've figured out how to get a sales funnel going, the flywheel is turning, you've got positive ROI on incremental salespeople or customer acquisition dollars and now you want to put gas on the fire.
The importance of optionality - StartupCFO It seems like there is no end to the supply of venture capital these days. Funding rounds are getting larger. The time between funding rounds is getting shorter. For the most part this is all good. As a general rule, my advice to founders and CEOs is: raise what you can, when you can. But…it’s important to be mindful of the path that you go down by raising more and more capital. CBinsights recently reported a huge increase in the number of companies that have raised $3M *before* their Series A. ee, this trend is not specific to 2014. Maybe it’s just semantics, but in my books a company that has raised multiple millions of $ is definitely post ‘seed’. Back when I was a seed VC my view was that my seed investments were not even companies. The importance of optionality Strategy is ultimately about choices: what you choose to do and as a result, what you choose not to do. Today’s technology markets are more dynamic and more competitive than ever. Putting this into practice…