Growth vs. Profitability and Venture Returns

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There has been a lot of good material written in the last few months about the impact of the topsy turvy fundraising market and the importance for entrepreneurs to shift their focus from growth to profitability. Some of the better posts over the last few months include Joseph Floyd‘s TechCrunch article and Bill Gurley’s The Road to Recap.

I agree with this sentiment to some extent, and have been preaching it with my entrepreneurs for many quarters as well.  I fear, though, that the pendulum is at risk of swinging too far the other way. That is, entrepreneurs are not appreciating or understanding the true value of growth and thus taking the slow road to building a big company. Right now, it’s fashionable to humblebrag about your startup that was a “15 year overnight success”. The problem is that the slow road to success doesn’t typically result in “venture returns”. And the entire VC-backed fundraising model is predicated on generating venture returns.

So What Are “Venture Returns”?

In order for a venture capital fund to be considered a success, they need to deliver on one of two metrics: 1. a cash on cash investment multiple of greater than 3 times invested capital, or 2. a net internal rate of return (IRR) of greater than 15%. You can quibble around the edges, but these are basic truisms of our business that have held true for decades. The reason for these performance milestones are related to the fact that the money is tied up for many years (i.e., is not liquid), and is considered riskier than many other types of investments. Thus, an illiquidity premium and a risk premium are required.

For a portfolio of investments to achieve 3x invested capital, though, the winning investments must achieve something like 10x or better. In any portfolio, you will have mostly losers – investments where you lose all your money or perhaps get your money back after many years of hard work. But a few large winners of more than 10x your money will make the entire portfolio a success. Fred Wilson wrote an excellent retrospective on USV’s first fund, Losing Money, where he cites the fact that they lost all their money in 40% of his portfolio companies in one of the best fund performing funds in the history of venture capital. Yet, they had five companies produce outcomes that were better than 20x, which drove their outstanding results.

What Does It Take To Achieve Venture Returns?

For a company to achieve a 10x or 20x or better return on invested capital, it needs to grow very, very fast.  To bring this to life, take a look at the table below. It represents a profile of three startup company examples that start at $1 million in revenue at “year 1” (note – to achieve its first in revenue often takes 2-3 years from inception). If you model out three different growth rates – 100%, 50% and 25% –  for the subsequent six years, then the fast growing company has a shot at achieving venture returns. It will grow to $64 million in revenue and, assuming a 6x revenue multiple (reasonable assumption for a company growing that quickly at that scale), it would be worth nearly $400 million. Assuming the company required something like $20-30 million in capital over the life of its growth – perhaps accumulated across two to three rounds of financing – and assuming the position of early investors is a post money valuation of $40M (again, reasonable assumptions based on my experience), then a 10x outcome is achieved.

Screenshot 2016-05-16 09.42.28

Lastly, if the third company is growing at only 25% YoY, your firm will lose money–a lot of money. These companies, because they’re slow growers, maybe only be worth 2x revenue and so worth $7.6M, only 20 cents in return on each invested dollar in capital. Think about that for a minute – six years in a row of 100% growth, executed perfectly, and you get to 10x. But if you achieve “only” 50% growth over six years, which is still outstanding performance by almost any other metric, and have a revenue multiple of 4x (lower than the 100% growing company for obvious reasons), you have a company worth only $45 million in value and investors basically get their money back.

Now obviously this is a simplified example – growth rates change over time, often starting faster and slowing over time as markets mature and the base numbers you’re trying to grow from get larger. But the point is pretty clear:  there’s a reason venture capitalists and entrepreneurs are so focused on growth. To generate venture returns, VCs need companies to consistently grow north of 100% year over year. And if a few companies in a portfolio don’t achieve this, then no one generates venture returns. And if no one generates venture returns, the whole system breaks down.

This example also uncovers a structural tension between the VC and the entrepreneur. VCs are naturally going to push entrepreneurs to grow faster in order to be that one portfolio company that achieves the 10x result that makes their fund a success. The entrepreneur is going to be more cautious to grow at the right pace, without burning too much capital or burning out customers or employees.

So, yes, let’s make sure we’re building real companies that are generating real value, and over time, real profits. But let’s not forget that to get there, our companies need to grow very, very fast over a consistent period of time. Remember that the next time someone tells you to slow things down.

The Search for Product-Market Fit

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Every year around this time, I get asked by First Growth Venture Network to do a tight, 10-minute presentation on the Search for Product-Market Fit as an introduction into a panel on the same topic, drawing from material from my HBS class, Launching Technology Ventures.

This year, I was joined on the panel by Beth Ferreira and Zach Weinberg, both of whom know a lot about the topic.  They both have a tremendous amount of experience searching for product-market fit from (in the case of Beth) Fab.com, Etsy and (in the case of Zach) Flatiron Health, Google and Invite Media.

Below are the slides I shared, which hopefully will be useful to folks. I find that I have to update the slides each year with good thinking from many people, as well as new experiences and thoughts I have from teaching and living the material.

Not captured in the slides is the issue of investor-founder fit. At the presentation, I told the story of two entrepreneurs of mobile consumer start ups – one who received funding from a “growth-focused” seed investors and one from an “engagement-focused” seed investor.

The entrepreneur with the growth-focused hit every engagement milestone across hundreds of thousands of users, but couldn’t raise the series A because their investor didn’t feel like their growth rate was fast enough – something they weren’t even aiming for! Without the financial support of their seed investor, the company was unable to raise their series A and sadly had to shut down.

The entrepreneur with the engagement-focused investor iterated and iterated against fewer than 1000 users, improving the product – and the associated key performance indicators – thoughtfully and methodically. This entrepreneur impressed their engagement-focused investor so much with their learning and experimentation process that they raised a terrific series A – pre-emptively.

The moral of the story? It’s not just about optimizing your search for product-market fit. It’s also about making sure you have seed investors that are aligned with the way in which you go about your journey.

Here are the slides – enjoy (and feedback welcome!):


Fgvn 3 31-2016 search for pmf from Jeffrey Bussgang

 

Advice to Grads: Join A Winning Startup (v. 2016)

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Around this time of year, many students are focused on finding a job in Startup Land and building their careers. If you have your own idea and no one can talk you out of it, that’s awesome. But for most undergraduates and graduate students, they have no idea how to get plugged in to the startup community. I gave some advice in my post, Seeking a Job in Startup Land, on the process for selecting a startup that is a good fit, but I didn’t name specific companies who I think are emerging winners and thus good places to begin your career.

For many years, I have been keeping an updated list of interesting, scaling start ups that are well-regarded and hiring (private or recently public) to share with the students in my HBS class to point them in the direction of high quality, fast growing companies worth exploring. Andy Rachleff at Stanford / Wealthfront does the same in the fall (here’s their Oct 2015 list), although it is lighter on East Coast companies. Last year, I open sourced the list and with graduation season coming, I thought I would share an updated version, again organized by geography. Note that this is my own imperfect point of view with imperfect data (also informed with a sprinkling of Mattermark data and CB Insights; here is the latter’s full list of the, as of this writing, 154 unicorns, which is another interesting filter).

Full disclosure: Flybridge portfolio companies are hyperlinked. Feedback welcome!  I’m sure I made many mistakes and omissions.

Boston:

  • Private: Acacia, Acquia, Acronis, Actifio, AdAgility, Affirmed Networks, Anaqua, Applause, Attivio, BevSpot, Bit9, BitSight, CarGurus, ClearSky Data, Cloudlock, Data Robot, DataXu, Digital Lumens, Draft Kings, Drift, Drizly, Dyn, Ellevation, Evertrue, FlyWire, Fuze, HourlyNerd, Infinidat, Iora Health, Jana, Jibo, Kenshoo, Kyruus, Localytics, Lola, LovePop, M.Gemi, Nasuni, OwnerIQ, OnShape, OpenBay, Panorama Education, PillPack, Pixability, Placester, Promoboxx, Rethink Robotics, Savingstar, Simplisafe, Simplivity, Sonos, Tamr, Toast,Valore Books, Veracode, Virgin Health, VMTurbo, Zerto
  • Public: Akamai, CyberArk, Demandware, Hubspot, iRobot, Kayak/Priceline, LogMeIn, Rapid7, Trip Advisor, Wayfair

NYC:

  • Private: 1st Dibs, Adore.me, Alfred, Amino, Andela, Appnexus, BetterCloud, Betterment, Birchbox, Bloomberg, Boxed, Blue Apron, BuzzFeed, Casper, CB Insights, ClassPass, Codecademy, Compass, Contently, DataDog, DataMinr, Digital Ocean, Fan Duel, Floord, Fundera, General Assembly, Handy, Harry’s, IEX, Integral Ad Science, Jet.com, KeyMe, Kickstarter, Knewton, Mark43, MediaMath, Message.ai, Moat, MongoDB, Namely, Newscred, Oscar Health, Outbrain, Payoneer, PlaceIQ, Policy Genius, RadioDash, Rent the Runway, Sailthru, SeatGeek, Shapeways, Spotify, Sprinklr, Stack Exchange, tracx, Vaultive, Warby Parker, WeWork, Yext, YouNow, ZocDoc
  • Public: Etsy, Match.com, OnDeck, Shutterstock

SF/SValley:

  • Private: 23AndMe, Airbnb, Anaplan, Angellist, App Annie, App Dynamics, Automattic, Beepi, BloomReach, Checkr, Cloudbees, Cloudera, Cloudflare, Coinbase, Collective Health, Coupa, Coursera, CreditKarma, DataStax, Docker, Docusign, DoorDash, DoubleDutch, Drawbridge, Dropbox, Earnest, Eventbrite, Evolent Health, FundBox, Funding Circle, Gigster, Gigya, GitHub, GlassDoor, Gusto, HackerRank, Houzz, Instacart, Jasper, Jawbone, JustFab, Lattice Engines, Lumosity, Lyft, MasterClass, Mattermark, MixPanel, Monetate, NerdWallet, Nextdoor, Nutanix, Okta, OfferUp, Optimizely, Palantir, Pinterest, Plaid, Plastiq, PlexChat, Postmates, Quizlet, Quora, Shazam, Signifyd, Slack, Slice, SoFi, SpaceX, StitchFix, Stripe, Sumo Logic, Survey Monkey, Theorem LP, Thumbtack, Twilio, Uber, UpWork, Wallapop, Wanelo, WealthFront, Wish, Zumper, ZScaler, Zuora
  • Public: Atlassian, Box, Castlight Health, FireEye, Fitbit, Horton Works, Lending Club, LinkedIn, New Relic, Palo Alto Networks, ServiceNow, Splunk, Square, Tableau, Tesla, Twitter, Workday, Yelp, Zendesk

Israel (often with HQ or business operations in the US – either BOS, NY or SF):

  • Private: Argus, Fiverr, Forter, Freightos, Fundbox, Hola, IronSource, Kaltura, Kaminario, Moovit, ObserveIT, Outbrain, Playbuzz, Riskified, Sisense, SundaySky, Taboola, tracx, Valens, Wochit, Wibbitz
  • Public: CyberArk, Mobileye, Wix

London: Bla bla car, CityMapper, Duedil, FarFetch, Funding Circle, GoCardless, King, Purple Bricks, Shazam, TransferWise, Vouched For

LA: AirPush, Auction.com, Cornerstone on Demand, Dollar Shave Club, Honest Company, JustFab, Network of One, OpenX, Ring, Riot Games, Rubicon Project, SnapChat, SpaceX, Telesign, Tinder/Match.com, TrueCar, Zefr, ZestFinance, ZipRecruiter

SEA: Apptio, Avalara, Julep, Juno, Koru, Peach, Porch, Pro, Refin

CO: LogRhythm, Rally, Sympoz, Webroot, Welltok

UT: AtTask, Domo, Health Catalyst, Hirevue, Inside Sales, Instructure, Plurasight, Qualtrics

CHI: AvantCredit, BucketFeet, Fooda, Groupon, Iris Mobile, Narrative Sciences, Raise, SpotHero, SproutSocial, Uptake

DC: 2U, Cvent, Opower, Optoro, Sonatype, Vox Media, WeddingWire

ATL: Kabbage, MailChimp, Yik Yak

– See more at: http://www.bostonvcblog.typepad.com/#sthash.sc44tsAz.dpuf

Why Every Company Needs a Growth Manager

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(this post was originally published in Harvard Business Review and is co-authored with Nadav Benbarak of Okta.)

Growing revenue and profits is a core objective of most companies, and it is the responsibility of every function to contribute to the pursuit of this goal. Yet, in recent years technology startups have embraced a new role, Growth Manager — alternatively Growth Hacker, Growth PM, or Head of Growth — that focuses on it exclusively. By viewing product development and marketing as integrated functions, not silos, leading tech companies like Facebook and Pinterest are rethinking their approach to driving growth and achieving breakthrough results.

Yet, the Growth Manager role remains poorly understood, especially outside Silicon Valley. As part of an entrepreneurial research effort for Harvard Business School, we interviewed more than a dozen Growth Managers at fast-growing startups and explored what they are doing to design a growth function within an organization.

The Growth Manager function typically lives at the intersection of marketing and product development, and is focused on customer and user acquisition, activation, retention, and upsell. The Growth Manager usually reports either to the CEO, the vice president of Product Management, or the vice president of Marketing. They work cross-functionally with engineering, design, analytics, product management, operations, and marketing to design and execute growth initiatives.

As for responsibilities, the Growth Manager’s job has three core components: first, to define the company’s growth plan, second, to coordinate and execute growth programs, and third, to optimize the revenue funnel.

But before any of these things can take place, the Growth Manager needs to make sure the right data infrastructure is in place.

Data is the fuel of the growth function and growth teams invest a significant share of their resources to create the infrastructure that enables analysis of user behavior, scientific experimentation, and targeted promotions. While many growth teams have special requirements that compel them to build their own custom data infrastructure, many choose to work with commercially available SaaS products. These include everything from analytics tools like Adobe Analytics and Google Analytics, to A/B testing tools like Oracle’s Maxymiser and Optimizely.

Growth Managers are typically responsible for selecting and integrating these products into the company’s analytics framework and working either on their own or in partnership with the analytics team to provide dashboards and testing tools as services across the organization.

Once data is available, the Growth Manager must help the company define its growth objective, typically by answering two core questions. First, at which layers of the funnel should growth initiatives be focused? For instance, should resources go to user acquisition or to combatting churn? Second, the Growth Manager needs to help the company to quantify and understand progress against goals. This task is accomplished through the selection of key performance indicators, and the development of reports on these metrics for consumption across the organization.

Growth Managers also provide customer insight, by blending data with a deep understanding of user needs, habits, and perceptions developed through targeted interviews, usability studies, and customer feedback. Growth Managers utilize the data they have to answer some of the troubling “whys” that a company may have. For instance: Why are users dropping out of the sign up experience? Why don’t users come back to the application after the initial download? Why aren’t users responding to special offers? These insights are then fed back into the product team to help prioritize product priorities, which impacts the product roadmap, as discussed below.

Furthermore, the Growth Manager is responsible for prioritizing growth initiatives and product changes. Ideas for initiatives to create growth originate in virtually all functions in the organization. The Growth Manager is the catcher and champion for product requests from outside the growth team. Further, the Growth Manager must implement a framework for prioritizing growth-specific product improvements, and organizing the testing rhythm.

Sean Ellis, founder of Growthhackers.com and former vice president of marketing at LogMeIn, proposes a simple framework for prioritizing project ideas via ranking on three core dimensions:

  1. The impact of the change if it is successful
  2. Confidence that the test will yield a successful result
  3. Cost to execute the test.

Taken together, these three elements can help to negotiate priority across the pool of ideas.

With a clearly defined growth objective, and a prioritized roadmap of ideas to test, a Growth Manager turns their attention to designing and implementing tests. If the test is to be conducted within the product, the Growth Manager leads a product development process to implement the change. The process often begins with a Product Requirements Document (PRD) or a summary slide presentation that articulates the product changes needed. Next, the Growth Manager works with a cross functional team including engineering, analytics, design, marketing, and product marketing to execute the test.

So what makes a good Growth Manager?

If data is the fuel of growth, then analytics is its engine. The Growth Manager must master statistical reasoning, understand how to design effective experiments, and develop a quantitative intuition for interpreting user experience data. Effective Growth Managers are conversant with data analysis and the best tools for retrieving, manipulating, and visualizing data including tools like MySQL, Excel, R, and Tableau.

Growth Managers also need to be fluent in the full spectrum of acquisition channels at their disposal. James Currier, founder of Ooga Labs, identifies three general types of acquisition channels:

  • Owned Media: Email, Facebook, Craigslist, Twitter, Pinterest, Apps
  • Paid: Ads (Mobile, Web, Video, TV, Radio, SEM, Affiliate), Sponsorships
  • Earned Media: SEO, PR, Word of Mouth

Each channel has its own advantages, trade-offs, and idiosyncrasies. An intimate and specific knowledge of the channels that are most effective in reaching a product’s target audience is critical.

The Growth Manager also needs creativity, strategic thinking, and of course leadership. The latter is particularly important since the Growth Manager must align all market-facing functions to a shared growth objective without direct authority, and must build a growth team whose culture is suited to the challenging and experimental nature of the work.

Experience at numerous growing tech firms confirms that Growth Managers are getting results across all parts of the user journey and at all levels of the funnel.

By comparing behavior of retained users versus those users who churned, the early Facebook growth team determined that a key driver of new user retention was finding and connecting with at least 10 friends within the first two weeks after signup. With this insight in hand, Facebook developed features to allow users to quickly see and connect with friends who were already using the service.

The growth team at Pinterest was able to increase new user activation by more than 20% with an improved flow for new users. By changing the on-boarding experience — from a text-intensive explanation of the service, followed by a generic feed of the most popular content, to a visual explanation and personalized content feed based on a survey of user interests — the team was able to better explain the value proposition and train the user, which ultimately led to better conversion.

Expect the Growth Manager to become a standard function in the coming years. As with many organizational innovations, what begins in startups migrates to larger organizations that wish to operate in an entrepreneurial fashion.

Sentenai

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Today, we are announcing co-leading a $1.8m seed investment in Sentenai, an exciting machine learning company based in Boston, alongside our friends at Founder Collective, Project11 as well as a new local seed fund, Hyperplane.

Sentenai is one of those companies attacking a complex problem deep in the bowels of IT infrastructure. The company has developed a way to vastly simplify data infrastructure and database schema development through automated intelligent systems that use behavioral and historical data streams to help companies make better decisions. Their solution allows companies to save valuable time and resources by outsourcing some of the “muck work” of data engineering and eliminating the need to develop a full stack data management infrastructure.

You always hear venture capitalists talk about the two things that compel them to make these crazy seed investments in de novo companies: (1) The Team, and (2) The Market. Not surprisingly, both of these factors were major drivers for us in this case, but particularly because we are passionate about machine learning (a few of our thoughts on the topic are here, here and here) and its potential impact to disrupt how we live, work and play in the coming years.

The Team

We are excited to be in business with co-founders Rohit Gupta and Brendan Kohler. I first met Rohit when he was helping run Techstars Boston, where I’m a small personal investor. He is an MIT guy who came to Techstars after a few stints at startups (and even as a VC associate). As a former Techstars leader, Rohit is very savvy about company-building, having seen so many case studies of startups play out in such a compressed period of time. His co-founder, Brendan, is the technical brains behind Sentenai. After graduating from Georgia Tech and serving as an engineer and programmer at multiple companies, he became a researcher at Yale in the area of distributed systems. While there, he helped start IoT company Seldera, which was later acquired by Ameresco. It was his work at Seldera and Ameresco, as well as advising other companies on how to optimize their data engineering, that inspired Sentenai as he saw the complexities of big data and the cloud play out. He is also an early enthusiast and thought leader in Haskell, a functional programming language that promises to be a exciting new environment for machine learning application development.

The Market 

As I wrote recently in announcing our fourth fund, in today’s startup world, the bar is very high for entrepreneurs who have a choice of investors (and the best ones have choices).  VCs, therefore, need to have a strong investment thesis such that when they come across a great team and a great market working on a problem that is consistent with the investment thesis, it makes sense for both sides.

This “meeting of the minds” was clearly the case with Sentenai. We have been early proponents of the growth and applications in Big Data and Machine Learning. Literally 15 minutes into Rohit and Brendan’s pitch, I was pulling out some of our own slides that we have written about full stack analytics and comparing notes about our mutual observations about machine learning and the impact of another order of magnitude of additional data becoming available to enterprises in the coming years. We were also able to get the team quickly in front of some of the top technical minds in the field by exposing them to the CTOs of some of our best machine learning companies, like DataXu (machine learning applied to programmatic advertising), ZestFinance (machine learning applied to loan underwriting decisions) and Tracx machine learning applied to social media marketing). Entrepreneurs expect their VCs to be passionate about the area that they’re dedicating their lives to and this is certainly one of those cases.

Creating companies from scratch is very, very difficult but if you can work with great teams pursuing a market with a lot of secular trends in your favor, at least you have a fighting chance.

New Year, New Fund

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As a former entrepreneur, I have always viewed venture capital as a service business. That’s a funny line for many because, historically, VCs are viewed (and at times reviled) as judges or overlords. When we started Flybridge over thirteen years ago, we developed a firm mission statement that we would treat early stage founders as our valued customers and have lived by this mission throughout our history.

With our fourth fund, launched last year, we are thrilled to continue pursuing our mission of serving brilliant founders during the critical, formative stages of creating their world-changing startups. As part of our work leading into the new fund, we went on a listening tour – talking to founders about what they want and need from their venture capital partners.  We heard a consistent set of themes:  treat them with respect, bring real expertise to the table, and have an investment approach that is consistent with the new world of the capital-efficient startup.

Over the last few years, the needs of founders have changed dramatically. The advent of the cloud, open source development tools and lean startup practices have led to a different evolutionary pattern for startups. They need very little capital to get started and run value-creating experiments, yet require a lot of capital to scale. That’s great news for early stage investors such as ourselves, because it means our entrepreneurs can get more runway with our early stage dollars.  It also means they love our approach as an activist seed investor – supportive throughout the company’s entire lifecycle and fully engaged despite the small dollars – not a “spray and pray” passive investor.

What has not changed is that the best founders want experienced guidance, support and value-add, but not interference from their investor partners. And with all the blogs, books, courses and case studies out there about entrepreneurship, the bar for delivering value-add has gotten even higher.  In our experience, great entrepreneurs don’t want to be hatched, incubated, promoted or optioned. They want a VC to be a company-building partner to coach them throughout all the stages of growth and an investment partner who has a deep understanding of the market opportunity they are targeting. That’s the firm we have tried to build at Flybridge, and we’re proud of what we’ve created and the amazing entrepreneurs we’ve had the opportunity to work with to build large, valuable companies.

So what opportunities are we focused on with our new fund? A number of years ago, we identified a few core investment themes which we still love, including:

  • The advent of the cloud as the next application platform, in combination with the rise of the grassroots developer as the driver of IT decision-making – our “developer-driven” investment thesis – which includes MongoDB, Crashlytics and Firebase, among others.
  • The explosion of data, leading us to be awash in information but starving for insight, leading to a massive opportunity for machine learning-based applications to emerge, applying “programmatic thinking” to numerous business problems, similar to what DataXu, Mattermark and ZestFinance are doing, among others.

A few emerging themes that we are excited about going forward include:

  • The next generation approach to enterprise computing, which is “outside in”, resulting in IT requiring new security models and a “control plane” paradigm to monitor, manage, scale and secure the disparate cloud applications and infrastructure – examples in our portfolio include BetterCloud, BitSight and NS1.
  • The rise of the “urban millennial”, a savvy, Net native consumer who views her smartphone as the remote control for her life – examples include Omni and Raden.
  • The globalization of startup talent yet the magnetic appeal of the US, resulting in many founders coming to the East Coast from all over the world. Israel has been a particularly exciting source of entrepreneurial talent in the areas that we focus (e.g., cloud, big data, security, machine learning) and we have increased time and energy sourcing deals from there, building off our work at tracx.

The new fund is smaller and more focused. We expect to partner with 20-25 companies, as compared to the 45 in our third fund.  Our average commitment per company is now in the $4-8m range, when allocating enough in reserves to support companies during their growth years.  Our geographical focus continues to be centered around our offices in New York City and Boston. Our team is small and senior – David and Victoria in NY and Chip with me in Boston, our new venture partner David Galper in Tel Aviv, alongside a group of over a dozen advisors who provide subject matter expertise and value add for our companies. Matt is leaving us to join Wellington Management Company and enter the world of late stage investing. We wish him well in his new endeavors.

We had an exciting 2015 – we made eight new investments out of the new fund and have a ninth that is closing this month (see our fun Year in Review):  Jibo, NS1, Omni Storage, Raden, Redox, SmackHigh and two stealth companies. Based on the inspiring people we are privileged to invest in, 2016 is already shaping up to be another exciting year!

Impact Entrepreneurship

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Paul Graham sparked a furious debate over the last few days about inequality with his blog post, Economic Inequality. He points out that the focus of the dialog should shift from inequality to combating poverty and providing more economic opportunity. The power of entrepreneurship, mixed with technological disruption, is creating an "acceleration of productivity" that is leading to rapid, massive wealth creation. Paul's essay argues that we should celebrate this, not seek to suppress it, and instead focus on inequality and social mobility.
 
I like that Graham is sparking dialog on this important topic. He puts himself "out there", even if it means being exposed to some withering critiques. 
 
His essay caused me to step back and reflect on the fact that I am seeing more entrepreneurs inspired to harness the power of some of the forces he describes – entrepreneurship, technology, innovation and shockingly fast productivity – to make a positive societal impact. I would like to see this trend continue.  I'd like to see more Impact Entrepreneurs (a concept I first saw coined in an article in Wired Magazine by Adam Levene) not just wealth-creating entrepreneurs. Impact entrepreneurs are inspired to direct their entrepreneurial energy and skill to make a difference, help a group in society, right a wrong or turn around an injustice. Not just build the next Candy Crush Saga.
 
Don't get me wrong – I love wealth-focused entrepreneurs, too. As a venture capitalist, investing in and supporting entrepreneurs focused on turning Flybridge's seed and Series A investments into something very valuable is my day job. But if we want to unleash the full power of entrepreneurship and technological innovation to better society, more entrepreneurs need to direct their energy to truly making an impact. This effort can take a few forms.  Some examples and trends are:
  • Mission-Driven, Double Bottom Line - Double bottom line companies measure their success on both financial performance and social impact. They are typically mission-driven companies with founders who are passionate about the mission for its own sake rather than financially driven where the company's focus is a means to an end. One of our portfolio companies (sprung out of Paul Graham's Y-Combinator), Codecademy, aspires to teach the world to code for free. The founders are focused on helping millions of people learn to code so that they can improve their job prospects and move up the income ladder. A company I co-founded back in 2000, Upromise, is focused on helping families save money for college, a necessary ticket to the American Dream. At its peak, Upromise helped over 10 million families save over $30 billion. Both of these companies are mission-driven, bottom-line for profit companies that raised lots of venture capital money, hired great people and built businesses focused on generating profits. There are many others like them, particularly in the world of education, health care and financial services. 
  • Impact Investing – A new class of investors is emerging at the intersection of financially-driven investments and social initiatives called impact investing. I am seeing impact investing funds popping up all over the world (e.g., one from Israel came into my inbox this morning). Deval Patrick, former Governor of Massachusetts, recently joined Bain Capital to start a new impact investing fund to find a sustainable, middle ground between profitable investments and social responsibility. The field is still unproven and there are many questions to be sorted out (e.g., should the investment return target be similar to "regular" investing or consciously lower?), but this notion has led folks to talk about “triple bottom lines" for firms:  financial, social, and environmental.
  • Public Entrepreneurship - Another powerful trend is directing entrepreneurial skills and efforts to innovate in the public sector. At Harvard Business School, Professor Mitch Weiss teaches a class called Public Entrepreneurship that focuses on this area. The notion is that entrepreneurs can work with civic leaders to make a difference in the world through technology, social change, and/or political transparency. Public Entrepreneurship can be for profit or not for profit. Not for profit examples include President Obama's Open Government Initiative, which has included making massive amounts of government data available to the public in machine readable form. Google's ambitious Sidewalk Labs is a for profit effort in this area, focused on applying technology to solve urban problems. The thesis of many public entrepreneurial efforts is that if both the government and the private sector can cooperate across silos, sharing information and tools to innovate together, we can materially improve the infrastructure and welfare of our communities. 
  • Social Entrepreneurship (aka Non-Profits That Act Like For Profits) - Social entrepreneurs are non-profits that draw on business techniques to address social issues, but explicitly in a not-for-profit structure. EdX, an ambitious joint venture created by MIT and Harvard, is an an example of a non-profit that acts like a for profit. EdX hires top engineers and marketers focused on building an online learning platform that teaches college-level courses worldwide for free, radically expanding global accessibility to high quality education. Another example is Google.org, whose mission is to develop products that give nonprofits the technology or the funds they need to implement change. Since 2010, they have raised over $20 million to fight human trafficking and child abuse, which was given to multiple organizations that are ready to use the money quickly and effectively. 
Each of these examples represents relatively new models for blending innovation, technology and entrepreneurship to achieve a social good.  There are really interesting hybrid models forming, which is why Mark Zuckerberg did not create a charitable fund when he created his multi-billion dollar initiative, directing his wealth to social impact. 
 
To further this trend, perhaps Y Combinator, Techstars and other accelerators should be creating a social entrepreneurship track. And more business schools should be creating public/social entrepreneurship courses to inspire young entrepreneurs to take their passion for social change and find ways to create scalable, positive impact.

Human progress is often the result of multi-disciplinarian efforts. I am optimistic that the trends Paul Graham points to – and is in the midst of helping accelerate – are going to ultimately have a very positive impact on society at all levels. But it will take some inspired entrepreneurs to get us there.

Analyzing Boston’s Reindeer (Not Unicorns)

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A few years ago, I did an analysis on the Boston-based companies that were worth more than $500 million in value, which I called Boston Unicorns. One of the (somewhat depressing) conclusions I made at the time was "there have been no multi-billion dollar valued tech companies founded in Boston in the last 13 years."

With the news that Hubspot has hit $2 billion in market capitalization, I figured it was time to update the analysis. Happily, I found a more encouraging picture, both in terms of the performance of some of the Boston-based public companies and the pipeline of candidates that might elevate into this level of extraordinary value creation.

I felt compelled to move away from the oft-used unicorn label and I really just wanted to focus on multi-billion dollar companies because these represent the future anchor companies that Boston so desperately needs, as identified by this recent MIT study on Growing Innovative Companies to Scale that I participated in. Because it is the holiday season, and because I was able to find nine of them, I'll coin a new label:  Reindeer (pop quiz for my readers: can you name all nine of Santa's reindeer? I'm Jewish, so I confess that I had to look that one up). By my definition, Reindeer are tech companies founded since 2000 that have created more than $2 billion in market value. They're mythical creatures, just like unicorns, but very special when found.

Public Reindeer:  Nine

To get a sense of the future anchor companies in the Boston region, let's first look at the public companies. Two years ago, I pointed out that there were only three companies that had achieved > $1 billion in value in the tech sector founded since 2000 (i.e., excluding life science companies). Happily, there are now five companies founded since 2000 that have achieved > $2 billion in value and another four founded since 1990. Those companies can be seen in the chart below (complete with Christmas colors that would make Starbucks proud), reading left to right in terms of total market capitalization:  Demandware, Fleetmatics, Hubspot, Vistaprint, Wayfair, athenahealth, Nuance, Akamai and the new king of the Boston tech scene (with EMC's demise), TripAdvisor.

MarketCap2

Contrary to popular myth, big business to consumer (B2C) companies can be created in Boston as four of the nine Reindeers are B2C. It is also encouraging to note that 2015 was a pretty good performance year for these companies. Seven of the nine companies saw price gains (as of 12/15) ranging from 6% (athenahealth) to 134% (Wayfair). Only two of the nine companies saw their value decrease: Demandware (11% decline) and Akamai (18% decline). Pretty good performance as a whole compared to other tech stocks that have gotten pretty beat up (e.g., Yelp is down 49% YTD, Box is down 41%, Hortonworks is down 24%).

Reindeer Pipleline:  Ninety-Nine

The next piece of analysis is to look at the high-flying private companies and examine the pipeline of companies that could become reindeer in the coming few years.

In order to do this, I used data from my friends at Mattermark (my firm, Flybridge, is an investor) to look at all the companies that have raised over $25 million in total capital in the last 10 years and whose last round was greater than $10 million (thereby filtering out down rounds/sideways situations). I was pleased to find a robust 99 companies that met those criteria in Boston. Of those 99 future reindeer candidates, 53 are from the tech sector, including 11 companies that have raised over $100 million in private capital:

2006-2015

Of those 11 companies, only one is a B2C company: DraftKings. The others are all B2B, including a few perennial IPO watch list companies who are believed to be unicorns (i.e., private valuations > $1 billion) like Acquia, Actifio, Affirmed, Veracode and Simplivity. Amazingly, three tech companies who have raised > $100 million were founded since 2011: the stealthy Altiostar Networks, DraftKings and OnShape.

Bottom Line

The conclusion of this analysis:  the Boston ecosystem is looking pretty robust, with nine solid anchor tech companies who seem to be performing well and over 50 private companies that have a shot at becoming future anchor companies in the years ahead.  So keep your eyes on the skies this Christmas Eve and you may see a few Boston reindeer overhead (meanwhile, I'll be at the movies and eating Chinese Food).

Thanks to Nicholas Shanman for his help with this analysis.

The Secret Weapon to Scaling: Sales Operations

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AA-sales-potential

I was speaking at an event last night and met a young woman at a large public tech company that was thinking of moving into startup land. She wanted to know whether her skills would be valued in a smaller, growth company. I asked her what role she was currently playing and my eyes widened when she replied, "sales operations". "Holy crap!" I exclaimed, "You'll be the most valuable hire a growth stage company could ever make." When the people around us looked puzzled, I realized that not everyone appreciates that sales operations is the secret weapon to scaling start ups.

One of the largest friction points to rapid scaling is the sales force. Very few companies have a business model that enables frictionless revenue growth because of their successful implementation of a freemium model – e.g., Bettercloud, Cloudflare, Dropbox, MongoDB – and even those that do eventually hire a sales team to move up the ladder on deal size and improve upsell, cross-sell and renewal rates. When you begin to scale a sales force, you desperately need to create a sales operations function.  Here's why:

  • You need to hire, train and make productive a lot of new salespeople – fast. Your sales directors and VPs find it hard to take the time to sit with internal and external recruiters and write job descriptions, screen candidates and develop the systematic training and monitoring and coaching programs for new sales recruits. The difference between ramping a productive salesperson in 3 months versus 6 months could be life or death for a scaling startup. That's the role of sales operations.
  • Your VP of Sales is a great leader, but not a great operator.  Most VPs of sales are strong leaders of people, recruiters and individual "rain makers". But they don't typically love staring at spreadsheets, analyzing metrics and working out optimal compensation systems that align incentives with strategy. That's the role of sales operations.
  • Sales and marketing alignment is important – but hard to execute in the trenches. The sales directors and VPs are too busy chasing deals and coaching their reps in the field to be back in headquarters walking marketing through the latest in competitive intelligence. The field staff struggles to be patient enough to explain and identify what sales tools are lacking as well as tracking what happened to certain cohorts of leads to improve lead generation. And wrangling over the latest in pricing and packaging schemes is never fun – and not something you want your sales team distracted by. That's the role of sales operations.
  • The insights from your sales CRM system is strategic, but cumbersome. Having an in-house whiz at salesforce.com/SugarCRM/NetSuite is required to develop those fancy pipeline reports, prepare for the weekly sales calls as well as report to the executive team and the board on a weekly, monthly and quarterly basis a snapshot of what is happening in the field across all territories and all sales teams. That's the role of sales operations.
  • You want to invest in technologies to make sales efficient, without slowing down sales during technology implementation. Sales organizations are full of technology that need to be mastered – CRM, dialer, email platform, analytics tools – and asking each sales rep to develop proficiency in each tool and provide the IT team with feedback on how to optimally configure each tool is a distraction for them. That's the role of sales operations.

The best sales operations leaders allow the sales team to spend more time selling and less time worrying about reporting, cross-functional coordination and operational management. Sometimes known as the Chief Revenue Officer's chief of staff, the mole for the CEO to figure out what's really going on in sales, the executive who prepares all the board reports on sales – whatever you want to call it, that role is the absolute secret weapon that every company needs to rapidly scale sales.

As an aside, here are a few job descriptions recently posted for directors of sales operations at rapidly scaling startups that I liked on LinkedIn to help bring the position to life:

Your LTV Math is Wrong

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There has been a lot of good stuff written over the years on the topic of calculating customer lifetime value (LTV). Thus, it amazes me how many times I discover faulty thinking when I talk to entrepreneurs regarding their LTV math. One portfolio company executive confessed to me last week that he knows he is doing it wrong but he just didn't have the time to research the best way to do the LTV calculation.

Since I see a few common patterns of mistakes, I thought I'd add to the LTV literature and point out the top three reasons many investors roll their eyes when they see entrepreneurs present inflated, poorly constructed LTVs:

1) Your churn rate is understated

One important component to an LTV calculation is the churn rate or cancellation rate. Many blogs suggest you simply divide 1 by your monthly churn rate to get to a number of months of duration that you can expect to collect revenues from your customer. Thus, if your average monthly churn rate is "c", the number of months of revenue you will receive over the lifetime of a customer is 1/c.

The problem is that many early-stage companies have no idea what their average, long-term churn rate really is because they are simply too young. When they have 6 month or 12 month or even 18 month cohorts, they extrapolate from those cohorts and come up with an absurd time period for their customers to stick around generating revenue. For example, if you have a 2% monthly churn rate in your first year, then some folks will extrapolate their monthly revenues out 50 months. A monthly churn rate of 1%? Then multiply that monthly revenue by 100.

As Jason Cohen points out, it's just not realistic that in a wildly competitive, dynamic technology market, a company can expect to hold on to its customer on average for 8-10 years. And, in my experience, you are so hyper-focused on satisfying and servicing your early customers that extrapolating your early churn rate just isn't going to be accurate.

To fix this potential issue, I recommend you pick a fixed cap number of months – conservatively 36, or three years – and recalibrate your LTV math accordingly. Your new expected months of revenue (N) would now = [1-(1-c)^36]/c. For example, if your churn rate is 1%/month, instead of assuming 100 months of revenue, you calculate 30 months.  Anything beyond 36 months just doesn't seem credible – and shouldn't even matter that much when you think about the next issue – a start-up's cost of capital.

2) Your cost of capital is too low

Ask an entrepreneur about their cost of capital and you'll likely get a blank stare. Cost of capital is the rate of return that an investor who provides capital expects from investing that capital. Today, the United States government has a cost of capital of nearly zero – for example, it can borrow money for 10 years and pay only 2% interest. 2% per year is the expected return that an investor in US treasuries requires because the risk of holding an IOU from the US government is so low.

For a start-up to raise capital, it must sell equity to venture capitalists or other investors that expect an annual return more like 30-40% in exchange for the high risk that the company will never be able to pay back the investor and the investment will be written down to zero. Thus, the cost of capital for a start-up (and the dilution a founder faces in exchange for that capital) is very high. Therefore, back end loaded cash flows are not nearly as valuable for a start-up as front end loaded cash flows.

That's a bit of context as to why start-ups need to highly discount future cash flows when calculating their LTV. I suggest 3%/month which results in a roughly 30% annual cost of capital. Thus, if you are receiving $100 in recurring revenue, you should value next month's $100 in revenue as $97 and month 2 as $94. In practice, combining this point with the one above, take your number of months of revenue (say, 30) and use the 3%/month discount rate to calculate the value of the months of revenue = [1-(1-3%)^30]/3% = 20 months of revenue – 1/5th what you would have calculated if you had simply used 1%/month churn rate with no time limit and no discount rate!

3) You forgot about Gross Margin – and you're probably overstating them.

I recently received a board deck from one of my portfolio companies which treated revenue as the numerator in their LTV calculation. Entrepreneurs sometimes forget that a dollar of revenue isn't worth a dollar in incremental contribution. Instead, there is real cost to produce this revenue:  a cost of service, processing, data, storage, media, overhead whatever.

Many early stage companies don't yet have experienced CFOs who can help them with precise gross margin calculations, so they assume a gross margin that is too high. SaaS companies think "mature SaaS company margins are 80%" so I'll just use that. But you are not mature. Your executive team spends more time selling and servicing than you account for. Your engineers spend more time servicing customers over time and addressing issues and bugs and feature requests than you account for. Thus, your COGS (cost of goods) are understated and your gross margin is overstated. Salesforce.com has a gross margin of 75% with their scale of $6 billion in annual revenue. Can yours really be the same or even 5-10 percentage points better? And are you sure your gross margin calculation is factoring in all variable costs not related to customer acquisition or are some costs sneaking "below the line" into, say, SG&A?

To fix this one, the rule of thumb I suggest you use is to discount an additional 10% points beyond whatever your finance head says your gross margin is. Thus, if you think your gross margin is 70%, assume for LTV calculation purposes 60%. So, in the example above, instead of summing up $100 revenue over 20 months (factoring in a shorter time horizon and a higher cost of capital), you would sum up $60 over 20 months.  Add all three factors together, and instead of multiplying $100 in monthly revenue by 100x for an LTV of $10,000, you would be multiplying $60 in monthly contribution margin by 20x for an LTV of $1,200.

Conclusion

All of these factors – time realism, appropriate cost of capital and accurate gross margins – discount your LTV as compared to simpler methods. Sorry, but that is the reality of LTV math. If you have a business with strong network effects, there can be a reason to believe that your metrics will meaningfully improve over time. But another reality of LTV math is that absent strong network effects or other large benefits of scale, many times your metrics get worse with scale. I cover this phenomenon in another blog post and so will simply say:  make sure you don't overstate early metrics with rosy extrapolations.

A mentor of mine is fond of saying that every business plan contains the same word in relation to its forecasts:  "conservative". It is better to be truly conservative – or, dare I say, accurate – rather than letting a savvy, cynical investor do it for you.