In the initial days of your SaaS startup, when you are doing user development, you may find that your product will help both SMB (Small Medium Business) users as well at Enterprise users.
There’s a tendency to then focus more on the “customer” development than the user. Assuming you have spent enough time on the user, there is a serious possibility of getting distracted from your mission by doing “both” at the same time.
Here is a dichotomy for entrepreneurs – Knowing that the milestone of Monthly Recurring Revenue (sans Churn) is the most important metric for SaaS companies, many entrepreneurs try to take the “relatively” easy route to try and get more larger enterprise deals for their product, if that’s what they know.
I have found that most entrepreneurs with an enterprise background end up finding 5-10 early customers who are willing to pay for a good product, but in the bargain they end up flexing their enterprise sales” muscle instead of building the “SMB marketing” muscle.
There is nothing wrong with choosing either market, but there is a big enough difference between both.
The enterprise SaaS market will end up with longer sales cycles (even if you know the decision makers), larger deals and request for integration with many existing tools and processes.
The SMB SaaS market will end up with smaller individual sales, an inbound marketing driven “self service” approach to vending and a extreme focus on seamless “on boarding” of users (sans training).
Many entrepreneurs also convince themselves that they can do both at the same time.
Which cannot be farther from the truth.
So, the question I usually get asked is “Which one do investors prefer“?
The answer is either one, since investors care about quality and quantity of revenue, but above all they also care about empirical evidence that they money they invest in will generate the consistency in the business for the chosen model.
Inconsistencies kill fund raising cycles.
So, if you chose to say you will build an enterprise sales model, you need to show your financial, product, hiring and operational model to support that type of business.
If, however you say your company will build a try and buy model for SMB sales online, with minimal or zero human touch from your side, driven by digital marketing, you need to show evidence that you can do that over a 3-6 month (or more) period.
I have seen many entrepreneurs confuse any revenue with good revenue. Consistency matters.
You have to show investors that you have done what you want to do.
Empirical evidence trumps theories.
So, my suggestion is to pick a model, stick to it for some time, before you decide to pivot if that does not work for you. Before you raise money, showing that the model you are choosing is one you have relevant expertise and knowledge in running is going to be critical.
The question “What do you want to be when you grow up” is a pain to answer for kids as it is for startup entrepreneurs. Most times you just dont know. Sometimes you ask other people in the hope that it will lead to an answer that you can co-opt. Other times it is not clear yet (unlike with kids) if you will ever grow up.
Even if you dont want to grow up, I’d still recommend you spend some time putting together milestones that matter to your company for an 18-24 month period from when you start so you know what you are shooting for.
The milestones fall into many buckets, but they should answer the question:
“If you hit the milestones you set out for your company, would you be much more valuable as a startup than you are now”?
The relative sense of “much more valuable” indicates that this is very different for each company, founder, market and type of startup. Most entrepreneurs who are focused on B2B bemoan that they are measured to revenue metrics, compared to their B2C counterparts who usually are measured on user growth (or engagement).
Regardless of what you are measured on, the key is to ensure that you document the most important metrics that will move the value of your startup.
So, to set milestones, the first step is to agree on metrics to measure, and then the date by when they will be achieved.
Here are some examples.
1. Revenue metrics. Regardless of what the new “temporary” trend might be, revenue and profit trumps all. In the early stages of your company, profit will be an illusion, so I would focus a lot on revenue growth. How quickly you grow revenue and have reduced churn, better predictability and more diversity gives an investor more confidence in your business. If you need to have one metric alone in place I’d recommend a revenue growth metric. As in most things, quality and quantity of your revenue metric matter.
2. Absolute # of customers / users metric: In some cases, when the revenue is not significant initially (for example you are in the razor blades and razors model of a business) then I’d focus on growth in # of customers. Again, like the previous metric, quality and quantity both matter. If you are an enterprise software business, getting the initial key marquee customers matters more than any customer. In B2C, this is widely followed with startups tracking # of users, MAU, DAU, or engaged users, or a proxy for # of users (# of snaps sent for example).
3. # of employees: This used to be a metric people tracked, but I am not sure this really matters as much in terms of growth. I’d focus more on the quality and profile of employees alone, instead of a growth in # of employees,. If, however you are in a consulting or services business and this metric drives revenue, by all means this becomes important to track.
There are many more metrics you could track, but the key question you have to answer is “Will this metric(s) drive my startup’s value higher. You can also track metrics that are a proxy for the metrics I listed above. This is so that you can communicate it externally and get people excited about it, instead of having to share a revenue metric.
In some cases, (like Uber for example) the # of rides as a proxy for revenue might be tracked.
Then the next part after you select the metric, (typically one is preferred) is to draw a line in the sand for those metrics –
What would those numbers be and by when would you achieve them.
This part is the “setting milestones”. It has to come with a “sell by date” or “achievement date”.
Simply setting metrics alone, without the date of achievement is typically useless.
The important next steps is to break down the milestone into smaller more achievable milestones during your progress (monthly, quarterly, etc.). This is so you can communicate with your team and have them all rally behind the milestone.
When working on customer development, many B2B startups quickly realize that their user is different from their customer. This usually happens because the price of the product is more than what the user can pay for on their credit card, or if the user wants to use the product for “work” and needs to have it approved by their manager (the economic buyer or the customer).
When I ask the question “Who is your customer”? to a startup, the answers range from a) Size of the company (Enterprise, SMB or Mid-Sized) to organizations within the company (Marketing teams, Engineering teams or Sales teams) to titles within an organization (Event planner, Release manager, etc).
When you are initially doing customer development, the user pain and problem matters more than the customer value proposition. If you do not solve a problem for a person (s), you dont have a product at all, even if your value proposition is useful to a larger organization.
The best way to do the initial user development is to practice ethnography. Spending as much time with users is key. Watching and learning from users is more important than interviewing them is what most entrepreneurs learn quickly.
The next step in your user development process is to document your “day in the life of your user”. This is the process of understanding what you user goes through on a “typical day”. I would highly recommend “chunking” the day into 15 min increments from 8 to 6, instead of 1 hour or 30 minute increments. You should get 40 segments in the users day. Put these segments in your first column. Then have 3 columns together – one for what the user “does” during those 15 min, a second column for categorizing the work into buckets that are relevant for your startup versus not relevant and third for priority of that task to the user.
Typically you will need to watch and observe about 15-20 users before you detect patterns. What most entrepreneurs realize quickly is that if the startups is not tacking the most high priority problems for the user, and instead is only # 5 or lower on the users priority list of pain points, then getting “traction” is slow and long. Growth is stunted.
The second observation I have is that the categories that the user prioritizes over what the startup prioritizes are indicative of the lack of empathy that the entrepreneur has for the users job. The best case situation is if you have been in that role – so you can scratch your own itch, but if not, what I have seen is that there is a cognitive dissonance between what the users categorizes as things for a project versus things for building network, versus meetings for example.
Finally, if you can map the users day in the life, and even if you dont tackle the top 3 problems for the user, you will find that the top 3 offer you opportunities to market to the user by helping address their biggest other pain points – this is typically done by content, tools and other products that will help you establish credibility with your user. Which gives you an opportunity to build a longer term relationship with the user.
As many entrepreneurs start their customer development workshops at their accelerator programs, they quickly realize that “Cold calling” potential users to get feedback does not work, any more especially for B2B users. In 99% of the cases, most of our participants at the Microsoft Accelerator found out that they got voicemail, with no responses, over the last 4 cohorts.
Most accelerator programs tell you to call potential users, who are not your “friends and family” to prevent many cognitive biases. The first couple of weeks is spent by most entrepreneurs trying to identify potential users and spending time trying to get them to validate the problem. This is the most uncomfortable time for most entrepreneurs.
It is an absolutely important part of the development of your company, but the caveat is that many entrepreneurs find out that cold calling does not work any more. Most Americans are unlikely to pick up the phone from unrecognized numbers.
In fact, when you try to do it in B2B situations, and call the potential user’s work number, at their desk, it is worse. The number of times you go directly to voicemail is about 999 out of 1000. “Smile and Dial” is truly the most frustrating part of your customer development.
The situation is so bad that many entrepreneurs sometimes falsely believe after their customer development phase that no one truly has the problem.
Most people dont want to beinterrupted, and dislike having a synchronous discussion with a stranger.
So, what are the alternatives to cold calling and what can you change.
First, you can change the “interruption” and align it with their routine, then you can remove the “synchronous” portion and make it “asynchronous” and third you can change the “stranger” to acquaintance.
1. To remove the interruption, the best is to put your feedback gathering into the flow of the problem. So, like native ads, you have to insert yourself into the normal course of the problem surfacing for your users. The best way to start this effort is to do a “Day in the life” scenario mapping of your potential user. I would typically do it in 30 min increments.
Find out when the problem surfaces and what the “Triggers” are for users. What I have found is that you can leverage moments of downtime to target your message and bring out the pain. For example if you are selling keyword optimization services to SEO marketers, answer questions on Quora or LinkedIn Groups about these services so they are aware of the problem. Or ask a question on an active forum (something WhatsApp did) about the problem you are trying to tackle.
2. Email seems to work, to make the conversation asynchronous. If targeted, specific and brings value to your user before you make the request or have a call to action, it is powerful. Typically you’d want the email to be highly personalized (look at the users recent Twitter or social media feed) to start the conversation with highly relevant topical points, before asking for advice.
3. To remove the stranger problem, dig your well before you are thirsty. In fact, use social media (Twitter and LinkedIn groups work very well, as do Quora and SlideShare) to build “acquaintance” relationships well before you need them.
Finally, make it easy for people to give you feedback. Before they are willing to commit time to giving you feedback make them believe they will get value from your interaction as well.
I’d love to know what’s worked for you. Drop me a note on Twitter, if you have found a better way to engage users during customer development.
When I talk to entrepreneurs who are developers and they don’t have a hustler (sales person) on board, they ask me if they should outsource their sales function. I usually advice them never to outsource startup sales efforts. They then look to find partners who they can work with. The main reason they want to do this is because they find the entire process of hiring, managing and growing their sales team revolting.
Some of them talk about possible “channel” sales efforts via partners or larger companies in their domain who can help, who they would like to approach.
When I tell them about the potential costs, commissions and the customer relationship efforts that are involved, they take a second look at their direct sales efforts. I thought I’d document that for many of the other entrepreneurs who have the same question.
There are 5 models of partnerships I have encountered so far in my career. I will outline these models and list their pros and cons. While I cant say which model will work for you, and there may be other models as well, I think understanding the landscape will help you figure out which one makes sense in your situation.
First off, most channel or indirect sales models assume that the partner has an existing relationship with the startup’s customer. After all you are trying to shorten your sales cycle by using the partner’s strength.
Lets now look at these different models.
1. Co selling partnerships: These agreements tend to have a low to medium level of commitment from both the partner and the startup. If a sales person from the partner is going to meet the client, and are in active discussions on a deal and they feel like bringing your solution will help them win the opportunity, they will look at trying to position your product as well. In this case, you will have to go on the sales call with the sales person at the partner. The advantage of this partnership is that you typically dont have to do the initial “opening of the doors”. The “paper” or contract is typically separate as well. This means there will be 2 separate agreements for the customer to sign.
Pros: Since there is no commitment (most times) from both parties towards a quota or target, the discount you offer to the partner is low (typically starts at 20% and can go up to 30%). Also, since you can have a direct relationship with the customer, you can control the relationship going forward. Be sure to ensure that there are lower levels of “pass through” revenue you have to pay to the partner after year one.
Cons: There is no commitment to sell by the partner so you cant quite depend on this channel to deliver consistently. The customer also tends to get confused about the single person who will responsible for their success (the bad term usually used is one throat to choke).
2. Reseller agreements (sometimes called VAR or Value Added Resellers) : This partnership is medium to higher level of commitment. The partner will either resell your product on their paper or include your “quote” in their contract. You will hence have to train and manage their sales professionals.
Pros: There is a quota commitment in most cases, so you can be sure that sales people are motivated to sell, but you want to be sure that there are some downsides if they dont hit the commitments, else all this is a co selling agreement structured on the partner’s paper.
Cons: Since there are commitments, you will pay a much higher commission % – typically 40 – 60% are standard. Some partners may ask you for more. You will still have to train and do the lead generation to bring their sales folks into deals. Typically when you sign an agreement, even if you bring the partner into a new customer, they might ask you for the commission that they technically dont deserve.
3. OEM associations: When your product (or module) becomes part of another product and is integrated in such a way as to cause sales of your product each time the other product is sold, have an OEM (Original Equipment Manufacturer) association. These are typically for run time modules of developer products or a contact management product within a CRM system as an example.
Pros: Since your product is part of another product, you will typically be sold each time the other product is sold. In most cases this guarantees revenues and commits the partner to certain revenue goals.
Cons: Since your product is part of a module, you dont have the end customer relationship. Most OEM products also tend to generate smaller % of sales. Don’t be surprised if the final product is sold by the partner for a significantly more cost that what they pay you. Typically I have seen 10% of the final cost of the product paid out to the module.
There are 2 other models that I dont have much experience with, so I will let you give you an overview and try and address them in a future post.
4. Certified agent alliances: These are loose agency models (typical in affiliate sales) where the solo sales person who maybe has a few clients will try and sell for you. Since you have to recruit and manage each sales person yourself, these will be hard to scale. The only advantage is that the sales person is not an employees, so their base salary costs dont hit your books. This also means they are less committed to your product.
5. Distributor agreements: When your product is sold in a different geography where you need a local partner to stock (for hardware) or help educate local re-sellers, then distributors can help you with education, local tax and integration and identifying resellers. They can help you navigate a local market, but since they stock and manage multiple products for that region, getting their attention to focus on your product tends to be rather hard.
Channel partnership Framework
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Most every entrepreneur does things initially that don’t scale, and that’s okay to start. Pretty soon they realize that the things that made them successful enough to get initial sales and customers wont work for them to reach the next level at their startup.
One of the most frustrating things for the entrepreneur is when they run out of folks “in the network” who they can sell to. After having sold to their ex colleagues, friends, etc., their network dries up. No longer is it possible to sell via the network to sustain the growth.
That’s when they realize they have to build a sustainable sales process and organization to grow the business and increase revenues.
They then encounter 3 most frustrating things as they try to recruit sales people, define the sales process and grow their sales muscle.
1. How to hire the right sales people who are motivated by commissions alone?
First, realize that the market tends to be fairly well balanced. It follows consistent demand and supply constraints. Most good sales people have many folks chasing them to work in their company, similar to good engineers. If you wont expect an engineer to work for stock options alone, then expecting a sales person to work for commission alone is something you should be able to relate to.
The problem I hear from many entrepreneurs is that they are unable to determine if the sales person would actually close any deals, so they are unwilling to make a commitment to the sales person. Well, that’s the chicken and egg problem for sure, which means that person who’s more in demand will not make the compromises. Most likely, you the entrepreneur will end up finding some small amount of money to pay as base salary to give the sales person a start to get going. The best sales people are smart about risk and reward. If they see the opportunity to make more money by forgoing their base salary but get a much higher commission, they will.
2. How do they share the details of the “sales process” that they have perfected with the nuances that make the new sales people successful quickly?
As an entrepreneur and the initial sales person, you understand the sales process for your product the best. You have likely sold to many potential prospects and have addressed many objections and handled the toughest questions. So, it is best for you to detail the steps of your sales process to on-board the new sales person. It is best if you do it in a 2 step method.
a) First you can tell – take the sales person through the steps in your sales process via examples. How you sold to the first 5 prospects is more important than how the ideal sales should happen. Take them through the detailed steps in the number of meetings, the different people you met and what questions came up at each stage.
b) Follow this up by showing them – go on the first 5-10 sales calls together so they can learn from your initial pitch, the questions, etc. Show them how you demo, how to position the product, handle pricing questions etc. This also helps you build a bond with the sales person so they can be honest with you later when it comes time to ask the difficult questions.
3. How can they determine if the sales person is on the right track?
Initially you have to be on all / most of the sales calls after you hire a new sales person. Hopefully you have hired someone ambitious and mature, so they will be able to then build a sales organization for you instead of you having to hire a new VP of sales above them. The Tell and Show approach works best for sales people, is my experience.
Use this time to determine and evaluate the sales person – are they able to build relationships with the prospects? Are they able to handle questions effectively? Are they following through on their commitments? Are they able to keep activity level high consistently?
The other thing you should do is to take your average sale cycle time – lets say that is 8 weeks from introduction to close. Double that and evaluate the sales persons ability to close deals in that time period. The reason is that the first cycle time is usually the period of extreme learning. It is rare to get a sales person that will shorten the sales cycle right away unless they come with connections in the industry who have the problem you set out to solve.
Yesterday I was at Chicago running a workshop for TechStars alumni (about 12 companies) on SaaS sales. The companies were largely B2B, selling to mid-sized or larger organizations. Most were trying to go beyond the founder being the primary sales person and were getting ready to build out their sales team. One or two of them even had a couple of sales people on board.
The section of sales compensation generated the most questions. Obviously most of the entrepreneurs were founders who did not have a background in sales, so they were curious as to why it was so complicated. Most were used to paying out salary + bonus or more likely salary + stock options for their engineering staff.
Sales compensation does not have to be complicated, but it can be made to appear so. Obviously it starts out fairly simple – most sales people like cash and are motivated by cash more than anything else. Entrepreneurs should like sales people that are motivated by making as much short term money as possible.
On Target Earnings (OTE) is the term we use for total compensation for sales people. OTE comprises of Base salary (fixed, paid monthly or every other week), which is typically between 40-60% of the OTE and Commission, which is variable making up the remaining amount.Sometimes a bonus is added to the mix to achieve certain objectives the company has – for example, an objective that is important, but does not generate revenue – getting reference customers or supporting a marketing program.
OTE = Base Salary + Commission (+) Optional Bonus
The question, specifically was about when and at what conditions is the commission paid?
1. Early in enterprise software, most companies paid commissions on bookings. When the purchase order has been signed by the customer, the sales person gets paid. That’s usually good for perpetual license deals, where the customer pays an upfront fee for the software and amortizes it over the life of the usage. Since most customers who could afford this were large, the possibility of them defaulting the payment was rare, so it made sense. Most large enterprise software companies did this.
2. Thanks to monthly recurring revenue (sometimes billed and recognized monthly and other times billed annually and still other times billed for 2/3 years), most SaaS companies started to pay commissions on recognized revenue. This aligned the interests of the company with the sales person.
3. Still other companies actually only paid out commissions on income. That is when the money hit the bank. This ensured that the sales person would ensure the customer would actually pay the money, but then puts the sales person in a position to be responsible for some non-revenue generating tasks.
4. Some companies pay out commissions on contribution margin achievement. So, software (high margin) would get X% margins, but services (lower margin) would get less than software margins. VSOE regulations prohibit vendors for arbitrarily charging different customers, different prices (or inconsistent price discrimination as it was known) so this practice is rarely followed.
5. Finally some startups pay their commissions on implementation. This is typical in companies where there is a lot of services to get a customer up and running. Typically, if a customer takes 3-4 (or longer) months to get the software working thanks to customization, then most companies would prefer to pay their sales people after the customer has successfully implemented.
Regardless of when you choose to pay your commissions to your sales reps, the method cant change as often as you’d wish, since it confuses sales people and creates a lot of angst.
I would stick to one method and keep it consistent. Realize though, that the later you choose to pay the commission (closer to implementation) the more time the sales person spends on non new sales opportunity related tasks. The earlier you choose to pay the commission the less the incentive for the sales person to see the customer be successful.
Many #developer founders struggle with their pitch to anyone but their customers. Too technical and they end up losing 90% of their audience, like investors or potential employees not in the engineering team. Too high-level and everyone thinks they are hand waving.
The problem is fairly acute in B2B companies overall – if your product is aimed at a very technical audience – for example finance managers, statisticians, or climatologists, then you will end up getting “into the details”, in your overview pitch.
The right level of presentation is very hard to get right. It almost seems likes a “Goldilocks presentation” – not too technical, which most people wont get and neither too fluffy – which many dismiss as “does not get the problem right”.
The simple answer is to keep it on the right side of technical. From my experience it is better to be specific and articulate than come off as condescending or “hand wavy”.
The good thing is that this also will ensure that if some folks in the audience dont get it, they are probably not the right target for you.
So, the question is what is the right level of technical? The answer wont be easy, but the best thing to do is to A/B test your positioning with the soft audiences first.
The most important part to remember is that it is not only investors who are the audience you are initially trying to get on board.
Sometimes senior executives in your potential customer base have a problem relating to very technical presentations, as well.
If your customers dont get your pitch – again either because it is too technical or too fluffy, then I’d recommend you revisit the lucidity of your presentation.
Let me give a specific example of one startup we are helping now. They target a very new and a developer audience. Most of what they end up doing is “Educating” their audience.
When they talk to potential customers at the right level in the organization, the bells toll, but in many cases when they describe their problem statement to folks higher in the org of their target customer base, things get difficult.
Here is what I recommend:
Most people understand the BEFORE and AFTER story the best for representing technical products.
If you have to explain a trend you might want to articulate that quickly, but I’d focus a lot on sharing what the “CURRENT” problem is – which is the BEFORE situation.
For example. The pitch they were using was to show code screen shots of deployment tools and how their product was much better. That went well with some developers, but they were unable to sell that to the managers who needed to understand how it will help developers.
Most managers, when they did not understand it clearly enough, dismissed the tool as “nice to have”.
Here is a better “framing” of the problem in my mind.
1) Your developers need to understand agile methodology since they are being asked to ship products quicker and in incremental fashion instead of once every 6 months.
2) Developers like the agile methodology but your systems are built for the waterfall approach
3) If you use the tools like abc and def which were built for the waterfall methodology, the compromises they will show up in more outages, more defects and slower release cycles.
This helps put a context to the person listening to the pitch even if they are not using the tool daily.
You will still have to tailor your “standard” pitch so it appeals to the audience, but this is at the “right level”. Again, you want to keep testing, until you can get head nods quickly, within the first 1-3 minutes.
That’s when you know you have the pitch “Just right”.
There are 2 schools of thought that most people assume are contradictory.
First that, people buy from other people – so folks buy because they like the other person and if they like the person they will buy anything (or everything from that person).
The other school of thought is that people want to buy from a trusted brand, so even if the individual goes away the business remains to support what they bought.
Actually they are both true.
People dont just buy from other people, they buy from people they like.
Which brings me to the demo day pitch. If you dont create an emotional connect with your audience quickly enough (first 30 seconds) you are likely to be perceived as wooden, robotic or impersonal.
The best entrepreneurs realize they are saleswomen and show-women first and CEO’s next. That does not mean they are “watch your pocket near them”, sales people.
One of the things I learned very early in my sales career was that you need to appeal to the “heart, mind and the wallet”. That means, you have to emotionally connect with your buyer, then appeal to their brain, by solving the problem they have and finally ensuring they are willing to part with money to solve that problem.
Hopefully if you solve a problem that they have, then parting with money is an automatic, but if you dont appeal to them emotionally (or to their heart), then they will likely try and make the decision purely on the merits of your product, company, website, etc.
That’s not necessarily a bad thing for some people, but if the emotional connect does not exist, then they will look for reasons to not want to do the deal, if it does not meet any of their criteria (or “features”).
The first thing your audience at the demo day is trying to do is answer the question – “Is this worth my time, or should I go back to looking at my smartphone and get distracted for a few minutes”?
The best way to answer the question is to appeal to them with a problem they likely have themselves or ensure they know someone with this problem.
After that they are evaluating if the problem is large enough – market.
The last thing they try to assess is if you are the right team to solve it.
Surprisingly all this happens in seconds if not minutes.
I have seen many investors decide in the first 60 seconds if they want to “Work with the person” and then do their “due diligence” over the next few weeks, months or quarters to consummate the deal.
So the best thing you can do for yourself and your startup is to tell a personal story that appeals to your audience, with something they can relate to.
See to their heart first, then the mind and finally their wallet.
Almost every company I have talked to in the last 2 weeks ( total of about 12 startups) has a question around valuation multiples they should expect for their company. While many are concerned about dilution and loss of control, I think the bigger worry should be the high bar of flawless execution priced into valuations.
Basically the way it works is that the higher the valuation multiple (to your revenue, forward-looking growth or execution to date), the less room you have for errors. The higher the valuation, the more flawless your execution needs to be. Else you will be either replaced as the founding CEO, or face a lower valuation in your next round (called down round, and cause cramming).
I had a chance to talk to about 20 founders who recently raised money in the last 5 weeks. All of them, except 3 have raised money in the US, and of the remaining 18-19, 7 have raised money outside the Silicon Valley.
Most investors (seed or institutional) are always looking for a “low” valuation. Few may be looking for a “fair” valuation at the early stage. Often, it is impossible to determine what the valuation of a company is or how much the multiple on their metrics should be.
The “easier” (relatively speaking) valuation multiples are determined on your revenue, if you have any, profit (still rare) or other metrics that you can sell your investors on (e.g. user growth in the case of social networks for example, when you are not yet making money).
The tougher “nice to have” valuation multiples are on the management team, market size, etc. These negotiations are always harder than those on metrics.
So what metrics matter? According to the 20 folks I spoke with, they all fell into – revenue,expected growth (what the investors believed they would be in 12, 18 or 24 months) and growth to date (execution).
Step 1: The range of the valuation multiple would be determined for most of these by an arbitrary “market size” number and many quoted “angel list” averages as a good starting point.
Step 2: Then the investors would dive into their current revenues (12 of the companies are making some money). The range for multiple of revenue ranged from 5 X (in India) to 30X (at the high end, Silicon Valley, YC company). Interesting that non of my surveyed companies had more than 30X multiple on their valuation, even though, I have heard via anecdotal evidence again, that there companies getting more.
Step 3: The startup then goes through an exercise of growth projections, and obviously, the higher the growth, the more the valuation multiple. The best way to think about this is via a rule of thumb – for every 10 additional percentage points in growth month-on-month, folks are asking for a 1.1X increase in valuation multiple. So someone growing at 20% M-o-M is asking for 2.2X increase in their multiple, above and beyond their revenue multiple.]
Step 4: Looking at past revenue growth, over the last 6-12 months (if applicable). Many founders are pointing to the past growth purely as a sign of good execution, but not an indicator of future growth numbers. Most founders I talked to believe they will grow faster with the money than without, which the investors discount, since they believe they are providing that fuel.
Step 5: Finally, most cited the use of a well rounded management team and recent competitive “whisper numbers” around startups in the same “space” as benchmark metrics for valuation multiples.
I must caution that most of this is anecdotal and not very scientific, but a good rule of thumb.
What I am telling the entrepreneurs at our accelerators is to make sure they factor in “average” valuation multiples for their projections, but execute so they can get the best.
I’d love your input if you have recently raised money. Let me know in your comments if you’d like to have a discussion (via email or on Slack is preferred).
