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Questions to ask your investors
Hopefully you will be in the enviable position of selecting your VC. If that’s your situation, you should interview your VC just as they are interviewing you. Avoid asking the generic ‘how will you add value’ question and instead focus on these big topics:
How have you helped current or prior portfolio companies? This question should replace the generic ‘how will you add value’ question (generic questions receive generic answers). Your focus should be to understand specific examples of the VC helping its current and prior portfolio companies. Every portfolio company will have had different needs and there will be times when a particular VC’s core strengths weren’t applicable, and other times were the VC added a ton of value. Look for an honest VC that highlights both situations. For instance at BSV, we have built complex financial models for our companies and we’ve been instrumental in assisting with raising capital and going through M&A. We have been unsuccessful referring great personnel to our companies.
Can I call some of the CEO’s of your portfolio companies? You should ask to speak with more than one CEO and be allowed to pick who you want to talk with. This is the best way to learn what about a particular VC. A good VC will not introduce you to their portfolio companies until they’re certain they’re close to a deal with you because they want to use their founders’ time only when necessary. When you’re a portfolio company, you’ll ultimately appreciate the VC’s discretion here.
How do you see the Company growing to an exit? This is a critical question in making sure you and the VC are on the same page. For instance, if your goal is to grow the business over the next 8 years and IPO, but the VC’s goal is to exit via M&A in the next 3 to 4 years, there’s a serious misalignment there. It’s also important to understand the VC’s philosophy: does he/she want to raise and invest a lot of money trying to build a big business? Or does the VC prefer to grow at a more reasonable rate with less risk? Maybe they have a preference to achieve profitability sooner than later, even though the return in the end may be lower. These are very different philosophies requiring a different timeline, mindset, and volume of capital so you need to make sure you’re in agreement. In case you’re curious, our philosophy is more conservative.
Do you do follow on investments? It’s important to know what the size of the follow on is: is it 10% or 100%? At BSV it’s 100%+, but make no mistake, an entrepreneur has to earn that follow-on as we will not throw good money after bad. It’s not automatic, and that’s important to know.
Who will sit on my board? Make sure the person you’ve been talking to and have built rapport with is the same person who will sit on your board. Watch out for the switcheroo which can occur at larger funds, and spend as little time as you can talking to Associates. Indeed one of the benefits of dealing with smaller funds like BSV is that you’re generally talking to a decision maker from day 1, not an associate.
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What to do with VC emails
If you’re a startup on angelist, crunchbase, or have had any kind of publicity, chances are good that VC are emailing you about raising money. Here are some tips to maximize the benefit of these inquiries:
Emails from decision makers are good. Knowing principals, managing directors, and original founders at venture funds is a good thing. These individuals are real decision makers, won’t waste your time or theirs, and should try to ascertain fit quickly. If they reach out and you have the time for a call or are fundraising, take it.
Emails from associates. More than likely, you’re going to get an email from an associate. Unless you’re raising, feel free to ignore this. The job of an associate is to get on the phone with as many startups as possible so they will waste your time just to stay busy in front of their boss. It’s not out of line to politely ask to be connected with a principal. If the associate wont push you up promptly, he’s just fishing.
Don’t feel the need to respond or take calls. Even if you’re emailed by Vinod Khosla (well known venture investor), don’t feel pressured to take the call, especially if you’re very busy or not raising any time soon. Believe me, we’ll email you in a few months. Another acceptable deferral is to intro them to one of your board members, and let that board member handle the communication. Using your board is very effective way to save your time while also building familiarity with a venture firm.
Beware of those fishing for information. Before taking a call with a VC, make sure he doesn’t have competitors in his portfolio. If he does, then it’s likely he’s wasting your time just tying to get intel. Feel free to be up front and ask that question directly.
Don’t ask one really annoying question. Responding with “so what value are you going to add” is like a job interview where you’re asked “so what are your strengths?” It’s a bullshit question that’s going to get a bullshit answer, and at worst you’ll turn off the really good VC who will view this question as arrogant. Finding out about the value-add of an investor is best done by asking for reference calls to other companies in their portfolio during your raise.
Save the email address. If you don’t respond, no problem. Do save the email address though and reach out to that person when you are about to raise.
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Don’t worry about competitors
Many entrepreneurs we speak to obsess over what their competitors are doing. They dig for information like how large the competitor is and how much money the competitor has raised. While it’s good to know where you are in the market relative to peers, overly concerning yourself with what your competition is counter-productive. Below are a few things you should stop doing in regards to competitors:
Stop worrying every time a competitor raises money. Especially if you’re in a new market. A lot of that money your competitor just raised will inevitably go to building the market, which is a positive for you. If your competitor is throwing a lot of dollars at marketing to make customers aware they exist, savvy customers will often research alternatives which means they’ll inevitably find you as well. So long as you have a great solution, your competitors marketing spend will actually result in new business for you.
Additionally, the more money your competitors have raised, the less acquirable they are. For instance, one of our portfolio companies has a competitor that raised $50mm+ at a nine figure valuation. This makes them unacquirable by all but the largest of entities or they have to IPO. Our portfolio company however has raised less than $6mm and the last valuation is in the teens. This means when it’s time for M&A, because we’ve raised less money at reasonable valuations, there is a far larger universe of acquirers that can scoop us up for $30mm+ and we’ll be excited about it, whereas a $30mm acquisition for the competitor is completely off the table.
Stop worrying about competitors’ revenue. Let’s say you happen to find out a competitor is doing $100mm in revenue but you’re much newer and younger, only doing $1mm. How does that piece of information change the way you do business? The answer is it doesn’t. You still need to get up every day and build the best business you can, no matter where your competitors are, so stop trying to figure out how many employees they have or how much revenue they generate.
Focus on the right questions. The real focus should be on the questions that matter: ‘are you losing customers to competitors?’ and ‘are you beating out your competitors for new clients?’ and ‘are you offering a superior solution?’ These questions are far more important than what a competitor’s market share, revenue, or employee count is. Remember the story of eBay: at the time it was still young and Benchmark had invested $6mm in it, The Economist estimated that there were more than 150 online auction sites on the Web. One of those was far ahead of the rest, backed by Kleiner Perkins, and was already a public company with a market capitalization of about $175 million. eBay beat everyone because they focused on building the best solution they could and grew responsibly, focusing on profitability versus making a bonfire with their cash just to build market share.
In summary, it’s valuable to understand where your competitors are, but it really won’t and shouldn’t change the way you run your business, so don’t obsess over it.
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As the list of sureties go, add ‘getting sued’ alongside death and taxes. Unfortunately you can and will be sued for anything at any time. It’s not a matter of if, it’s a matter of when. Below are the times I’ve seen companies most vulnerable to a suit:
You just raised a big round. Next time you raise a big round, think twice about announcing it to the world. Making the raise public lets everyone know that you have money and inevitably, the haters will hear about it. People you’ve fired in the past are especially prone to finding a reason to sue you once they know you have new money.
You’re about to sell the business. This is arguably the point at which you’re most vulnerable because even if you have insurance, it doesn’t matter. A potential acquirer is going to say “make this go away, tomorrow,” and many acquirers will pass all together, even if it’s an asset sale. Filing a claim with your insurer is going to take many months (sometimes 10+) so you’re almost always going to be forced to settle. If you’re selling the business, tell as few people as possible and do everything you can to make sure past employees or former business associates do not find out.
You just fired someone. If you don’t already have EPL insurance, get it. Nobody is good at hiring and inevitably you’re going to hire someone that you need to fire (you should adopt a hire slow, first fast mantra, but that’s another article). No matter how amicable the firing was, there is risk that the person will come back and sue you: all it takes is them falling on hard times and a lawyer taking their case on contingency of which many of them do.
A competitor thinks you’re infringing. Even if you’re not infringing on someone’s patent, copyright, or trademark, if a competitor thinks you are and a lawyer is willing to take the case, you could get sued. The good news about suits like this are they’re less common because they are very expensive to litigate: we’ve seen plaintiffs spend upwards of $150k and spend 10 months in court trying to establish infringement. Nonetheless, if you’ve got the budget to patent some of your most important IP, it may be worth it not so you can go sue competitors, but so that you can easily play defense when they try and sue you.
You’re sideways with your banker. Boutique investment banks sue their former clients all the time. This will happen when you’ve hired a small investment bank to run a process for you, they fail, your raise money on your own or sell the business on your own at some point, and now the banker believes they’re due a fee because you’re within the ‘tail period’. I am very averse to hiring boutique banks but if you do, make sure they only get paid on intros they make directly.
I’ve come to believe that it’s not about avoiding getting sued, it’s about avoiding getting sued multiple times and handling each suit quickly and cost effectively. Do what you can to minimize the risk at all times and always be conscious of it. Of course, this article is not nor is it to be construed as legal advice, I’m not your attorney, and you should seek the advice of counsel for all matters.
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SaaS valuations are strong
SaaS multiples look great and made a nice comeback from Q4 2018: of the 72 SaaS companies we follow, the average public SaaS business is trading at 10.51x revenue while the median is 8.94x. Interestingly, the gap between the average and median has never been larger for the time period shown, meaning more attractive SaaS companies are being rewarded with big premiums. The data is below.
Negative EBITDA, positive cash flow. The median SaaS business had trailing twelve month revenue of $419mm, EBITDA of -$-mm, but positive cash flow of $52mm thanks to deferred revenue and up-front collections on annual contracts. Indeed so long as you’re growing (the median annual growth rate is a strong 39%), investors will overlook negative EBITDA especially if the business is cash flow positive after working capital changes.
The trend is still on. The chart in the picture shows median revenue multiples we’ve collected since Q4 2014. During that period, the median SaaS multiple has ranged from 4.60x to 9.32x with an average of 6.90x.
SaaS margins are still terrible. Investors and founders love saying “SaaS margins are great.” They’re not. They’re horrible. The median EBITDA margin for the companies above was -2% and the average was -2%. Fixed costs for SaaS are terribly high and worse yet those fixed costs are mostly people, meaning the only way to materially cut costs is layoffs. If you’ve ever fired someone, you know cutting costs by cutting people is not easy and hurts the culture and morale of remaining members.
Premium gets a premium. Premium SaaS businesses trade at premium multiples. In the data set, 54 companies trade at greater than 10x revenue, 29 trade at greater than 15x, and 15 trade at greater than 20x.
Growth is strong. The median of 39% is strong given the size of these companies ($419mm of median revenue).
SaaS businesses are healthy. There is almost no debt on these businesses as banks don’t like ‘asset-lite’ businesses like software. Additionally, these companies have $211mm of cash on the balance sheet on median, plenty relative to annual burn (recall EBITDA is -$8mm). The number of years of cash on the balance sheet is less important given that these businesses are generally cash flow positive (median of $52mm), and indeed only 8 out of the 72 have negative cash flow. Note that 38 out of the 72 have negative EBITDA, but again that’s acceptable so long as the growth is there and cash flow overall is positive.
Recent IPO’s are killing it. Five of the latest SaaS IPO’s (Docusign, Smartsheet, Z-Scaler, Zuora PageDuty,) are trading at an average valuation of 23x revenue. It shows that now is a great time to come to market whether you’re raising money or selling the business. Survey Monkey, the latest company to IPO, is trading at a much lower 9.54x, but that’s in large part due to its nearly flat growth.
So what’s this data mean for a fast growing private SaaS business? Public multiples and trends guide what’s happening in the private markets: i) as compensation for illiquidity, size, and lack of profitability, prudent investors will look to invest in your private SaaS business somewhere below the median unless your growth rate is demonstrably higher than 39% YOY; ii) financing will continue to come from equity, less so from debt, although we’ve seen banks like Bridge Bank get more aggressive and lenders like Lighter Capital get more creative; iii) and burning cash is still acceptable on an EBITDA basis, so long as free cash flow is positive or moving in the right direction.
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Tell investors everything
If you’re not communicating with your investors regularly (at least monthly), you should be. Here’s why:
The more info you share, the fewer questions you’ll answer. I can attest to this personally. At BSV we have a lot of investors and one thing I feared was getting weekly sets of random questions from all of them, crippling my productivity. To prevent this from happening, I share a weekly update with my investors talking about our portfolio, opportunities we’re looking at, the Fund’s financials (monthly), etc. As a result, I never get lists of questions because our investors feel well informed.
They can help you. Talk about the bad as much as you talk about the good because you never know how your investors can help. Trying to find a contact at a big enterprise client? Maybe one of your investors knows the CEO. Looking for a new attorney or accountant? Your investors know someone, I promise. Need a killer VP of Sales? You get the idea.
One day you’ll need them to help you. Investors are much more inclined to help you when you’ve been transparent and forthcoming with information. By help, I’m not talking about advice, I’m talking about money. The path of a startup is almost never up and to the right even though entrepreneurs always think it will be. There could come a point where you need a small cash infusion to chase after a new hot marketing channel you’ve found, build a product feature, bridge to a financing, or even make payroll. Smaller amounts of this sort (sub $500k) can often come from some of your smaller investors and in some cases they may be the only option, so keeping them informed is critical.
It can prevent you from being sued. If you share bad news as well as good news, investors are a lot more inclined to believe the good news when it happens and truly bad news, like revenue falling significantly or the company shutting down, won’t be a surprise. When investors feel surprised, they tend to sue, whereas when they’re informed the whole time, they can see you’ve been working hard and will be more inclined to understand failures.
Amendments and votes will be much easier. In all likelihood you will need a majority or supermajority of your current investors to make amendments to the operating agreement/certificate of incorporation. This happens any time you raise money, issue more shares, do M&A, or a variety of other major strategic initiatives. Getting the majority of each class is much easier when investors have been apprised of what’s going on since day 1. When you leave investors in the dark, they may use a re-opening of the agreement to play hard ball asking for better terms themselves or in a worst case, hold the company hostage in exchange for better terms.
All the benefits aside, you should be sharing information with all your investors and be as transparent as possible because it’s the right thing to do. Don’t ever forget who believed in you and who entrusted you with their money, so do right by them and keep them informed of what’s happening.
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A great VC story
eBoys by Randall Stross is a classic. It chronicles the early days of one of the finest venture funds ever: Benchmark. Below are some of the excerpts I found most valuable.
“When Benchmark invested $6.7mm in eBay in 1997, the auction company’s valuation was put at $20 million. By the next spring, the company was valued at more than $21 billion; the value of Benchmark’s stake had grown 100,000 percent in less than two years’ time, making it the Valley’s best performing venture investment ever.” Page xv
“John Doerr for example excelled at promoting the visibility of John Doerr, but he evinced no ability or wish to raise up his partners to the same prominence he enjoyed, (and after hearing so much about Doerr, what entrepreneur who approached his firm, Kleiner Perkins, wanted to be deflected to one of the other partners, an unknown not-Doerr?). Benchmark partners had selected one another on the basis of perceived ability to subordinate individual ego to the larger interests of the collective.” Page xviii
“Two met with the entrepreneur that night; the others met with him the next day. At the end of day two Benchmark and Mohr Davidow made an offer.” Page xxi
“Obtaining the opportunity to invest in a cash burning company that had only just launched its service and had yet to sign a single significant customer was not an instant win at Benchmark. One partner summed up the situation: ‘the good news is we won. The bad news is we won.’” Page xxi
“Eighteen months after Benchmark invested and seven months after Critical Path’s IPO, its trading price gave it a market capitalization of $2.9 billion. Benchmark’s investment was now worth 87 times the original sum.” Page xxii
On cold calling: “We have no fear. If we could find God’s phone number, we’d call him.” Page 6
“He also left out the way he and his colleagues had to project an aura of success for years before it actually existed, the way credit card debt and second mortgages had to tide the business over in the interim.” Page 6
“In year two, Beirne convinced Ramsey and their first associate, Alan Seiler, to abandon the low rent contingency fee model and instead adopt a high rent retainer fee model, the one that the elite search firms used. To be a success, one must act the part, and a retainer fee was the way to communicate that one’s services were in demand. That was the theory. It was not easy however to remain confident when Ramsey Beirne’s revenue dropped to zero – and remained there. Beirne was barely able to keep his colleagues from abandoning the experiment as the months went by and their personal savings evaporated. Finally, six months later they got their first retainer.” Page 7
“The founders held off installing voicemail. The phone was to be answered, promptly, by a human – even in the after hours.” Page 8
“’Hi we’re Ramsey Beirne, the leading retained executive search firm in high technology.’ If said with sufficient force, it would not be questioned. And if a client laughed at the audacity, Beirne and his colleagues would reply ‘we brought in the COO of Central Point. We built the whole management team.’ The prospect probably never heard of Central Point, but it must have been an important client for Ramsey to lay claim to it the way that it did.” Page 8
“a client would be willing to hear a pitch from Ramseu Beirne the next morning at 8:30, then Beirne would call back and ask that it be moved to 7:30, just to show that his blood was Type A.” Page 8
“’I have nothing to sell you today – let’s take that off the table and just talk,’ he would say. ‘My goal is to earn the right to have a relationship with you, and I know it’s my responsibility to earn that right.’ He had removed anything uncouth in his appearance that would provide an excuse to be turned away. He didn’t display the know it all arrogance seen in many who have coasted through the most selective colleges, nor was he handicapped by a parvenu’s tendency to try to bluster his way to status parity by talking incessantly.” Page 9
On collecting receivables: “Office lore had Beirne leaving a voicemail and saying ‘Joe. David Beirne here. Here’s the deal. I want my fucking money Federal Expressed over fucking night right now. This is the most unprofessional bullshit I’ve ever heard goddamn it. You’re better than that, and you know you’re better than that. So stop playing this fucking game and get it done.’ After he hung up the story went, he looked over at colleagues whose mouths were agape and said ‘that was the right thing to do, right, guys? I mean, this guy owes us money.’ The others reassured him but steeled themselves for the repercussions when Beirne’s message was picked up. The CEO called back. ‘David I wanted to turn that into a tape. That’s an unbelievable message.’ He said he had transferred Beirne’s message to his own collections department saying ‘this guy is how we should be collecting our friggin money.’ The check arrived as promised via FedEx the next day.” Page 10
“The Benchmark boys would make his career transition instantaneous. They believe in equal partnerships and were not going to ask him to go through a let’s get to better acquainted probationary trial. He would be a fully enfranchised partner, with an equal share, on his first day.” Page 14
“Of the fifteen hundred proposals that came in, about five hundred of those seemed interesting enough to warrant a meeting with one partner. Two hundred one second meetings, and half of those received additional review.” Page 25
“Arthur Rock, the senior dean of American venture capitalists and an early investor in Intel, always insisted whenever his venture firm put money into a startup that the entrepreneur co-invest one third of his total net worth, whether it be large or small.” Page 34
“Kagle was a little worried that eBay had offered her only 6 percent equity, lower than the 10 percent that had come to be the Valley standard in recruiting a seasoned CEO.” Page 58
“The collective value of a typical venture capital portfolio will go down before it goes up – the pattern is called the J curve – because the companies that are not going to survive die before the best performers begin to shine and pull the value of the portfolio up with them.” Page 75
“In eBay’s case, at the time it was still sitting in the nest and Benchmark had invested in it, The Economist estimated that there were more than 150 online auction sites on the Web. One of those was far ahead of the rest, backed by Kleiner Perkins, and was already a public company with a market capitalization of about $175 million.” Page 76
“after two years in the saddle, he’d expect to be a director at 8 companies. That would be what his Benchmark partners considered the maximum number of directorships he could hold without diluting the quality of service to the entrepreneurs.” Page 144
“The company’s dire financial situation, with sizable liabilities, meant that Benchmark’s capital would be financing an existing balance sheet, rather than financing growth. That was not the case with the other first round investments. ‘If you put in half of what we’re on the hook for, it goes to do these two acquisitions and Yahoo and he’s out of money again. I think it’s either walk away or do a the big financing at lower cost. I don’t think the turn-over-a-few-more –cards-on-the-cheap works.’” Page 163
“The art framing business was ripe for consolidation because competitors were not solely interested in making the greatest amount of money, as he was.” Page 170
“’I’d love to kill it and I’d hate to kill it.’ And Rachleff then said “you know that emotion is exactly the emotion you feel when it’s time to shut it down.’” Page 191
“Webvan faced a choice: owning fewer customers, who shopped more frequently, or more customers, who shopped less frequently, and the strongest base of customers to have would be the former group.” Page 198
“we’ve been on the boards of hundreds of small companies, and the ones that focus, statistically, win at a much higher rate than the ones that try to do two or three things at once.” Page 201
“He showed sides that illustrated the volatility of Yahoo’s and Amazon’s stock. In the month of June, Yahoo’s market cap had jumped by $4 billion. Do you think Yahoo was actually a really different company on Jun 30 than it was on Jun 1? Probably not. The few number of shares circulating intensified the trading activity. Only 3.5 million shares, or 10 percent, were in the hands of the public.” Page 208
“Three weeks ago the stock was at $18. Now we’re at $82.50. It’s just like what we said: it’s real volatile. Don’t get crazed. Don’t go buying Porsches or your resort home. We’ve got to focus on the long term.” Page 210
“What’s it like recruiting when the stock price is so high? Really hard. The options offered to new employees were certain to be valueless, as they would depend on the stock ascending still higher. I mean, it’s at such a ridiculous level, there’s going to be a big fall here. The question is sort of when and how.” Page 215
“Very few of benchmark’s startup investments had gone bust. Of 73 investments made by July 1999, only three had gone out of business. It seemed that venture investing was less exposed to the risk of failure, fundamentally different. Or had the ready supply of follow on capital – in private and public markets – merely prolonged artificially the lives of companies that would have soon perished were it not for the extraordinary infusions of capital?” Page 293
“One of the best ways to have a nice Silicon Valley company is to keep your headcount as low as possible as long as possible.” Page 301
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SMB focus is challenging
We’ve always believed there is a valuation discount for SaaS businesses that focus exclusively on SMB customers. To see if this is true, we compared publicly traded SaaS companies that focus on SMB customers to those that focus on enterprise customers. Specifically, we wanted to see if SaaS companies with an SMB customer base trade at a valuation discount to those focused on enterprise clients. Our findings are below, and they surprised us.
SMB only is rare. Of the 81 SaaS businesses we monitor, there are only 4 pure play SMB companies. Conversely, there are 37 companies that focus strictly on enterprise customers and 32 companies that focus on both. This has led us to conclude it is very challenging to become a large, successful publicly traded company by focusing on SMB alone.
SMB trades at a premium. While we only found 4 SMB focused companies, their median revenue multiple was a strong 12.0x while for enterprise it was only 6.8x. This really surprised us as we’ve always believed SMB customers are worth less than enterprise. It’s likely because the YOY growth of these SMB focused businesses (53% median) is more prolific than their enterprise focused counterparts (36% median). We’re not surprised that SMB grows faster since the sales cycles are shorter and there are many more SMB’s than there are enterprises in any given market.
Enterprise is ubiquitous. Of the 81 companies we researched, 76 of them serve enterprise customers. This leads us to believe the probability of building a big successful SaaS businesses improves for those SaaS co’s that do serve enterprise customers whereas focusing on SMB only is a hard road since there are only 4 publicly traded SMB focused companies.
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Non-recurring revenue is important
Everyone loves recurring revenue and rightly so: it’s far more valuable than one-time revenue to VC and acquirers. But, don’t forsake one-time revenue. Whether it’s for services, onboarding, licensing, or some other one-time event, revenue of this type is incredibly valuable especially at early stages. There are three big reasons it’s valuable:
It’s a Source of Cash. The most obvious reason one-time revenue is valuable is that it’s a source of cash to fund overhead. Indeed while a VC or acquirer may not ascribe a multiple to that revenue stream, they’ll absolutely look at it as “financing” for the core business. While the business is still burning money, one-time revenue is as important as recurring revenue as a source of cash.
It Preserves Founder Equity. The less obvious reason one-time revenue is valuable is that it prevents a founder from having to raise more cash, and the less cash you raise, the more equity you preserve.
It Can Make You Sticky. Too many companies today focus on building products that are low/no touch. Their idea is to build a product that’s so good, the customer never has to call you for anything. On paper that sounds amazing but in practice, it’s not practical as the customer wants customer service. It’s about not just being a product, but a solution. Solutions include the product but also encompass a level of touch with the client, and companies that touch their clients often with consulting, services, or ancillary needs tend to have way less churn.
Indeed, some of the best SaaS businesses in the world generate a lot of services/one-time revenue as it’s a valuable source of cash and makes the product stickier. The list below shows that at the time they went public, the 82 SaaS companies below on median generated 17% of their revenue from non-SaaS sources and 21% on average. It’s material.
Even though it’s not as sexy as recurring revenue, don’t forsake onetime revenue. For the reasons above, it can be every bit as important as recurring revenue, especially while you’re burning cash.
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Hiring software sales reps
We had a good conversation with one of our SaaS companies where we discussed sales rep efficiency. The Company has two seasoned reps which are generating a respectable 2.6x and 3.2x as much bookings as we pay them. In other words, if we are paying the reps $100k all-in (includes base, commission, bonus, and benefits), they’re generating new bookings of $260k and $320k per year. Certainly that’s decent performance and these are good reps, but ideally we’d like to see a seasoned, strong rep generating 4.0x their compensation and if they’re really good, 5.0x their compensation. The economics of a sales rep can make or break a business. Below are some additional thoughts to keep in mind:
Hiring is the way to growth. Hiring sales reps is the only reliable way to grow for a business focused on enterprise customers. It’s dangerous to assume growth happens magically, for instance assuming the average contract value will improve because you’re going to add more features or the sales cycle will shrink as the market becomes more aware of you. Stay conservative and assume the only way to grow revenue is the addition of reps, not gradual increases in contract size or other miracles.
Add 1 to 3 reps. When you model out your cash need for the year, assume your VP of Sales can add reps at a reasonable pace: at most 1 a quarter for very seasoned reps and up to 3 a quarter for the less experienced. The more complex the sales cycle, the harder it will be to find reps that are a good fit. Assume reps will need time to ramp, generally 3 to 6 months depending on the length and complexity of the sales cycle.
Failure is high. The rule of thumb is that for every 5 reps you hire, 2 are going to be a waste of time and resources, 1 will be a stud that hits quota, and 2 will be below quota but worth keeping and still economic (generating revenue that is 2x to 3x their compensation). Going 3 for 5 is actually fantastic, but you’ll go through a lot brain damage to get there.
1:8 ratio. For every 8 reps you hire, go ahead and assume you need a VP of Sales or sales manager. You do not need a VP of Sales until you hire 5 to 8 sales reps – while you’re small, the sales reps should report directly to you.
Leads first. Don’t hire reps unless you’ve got the leads and your existing reps are at capacity. Poor leads or a lack of enough qualified leads is a great way to kill morale and waste a lot of time and money. That said, every rep at every level should do some outbounding.
Hire once reps are good enough. Once a rep is generating revenue that is at least 2x to 3x their compensation, if you have enough cash and leads, you should be hiring the next rep or even two. There’s no need to wait for each rep to achieve the magical 4x to 5x unless you think they can do it (many never do).
Growing the enterprise sales team is the best way to forecast growing your topline. Depending on larger contract sizes, shorter sales cycles, random upgrades with no historical basis, and other slights of hand is a good way to miss projections and even worse, run out of cash.
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