6 key similarities in our top performing companies

Each quarter we pull the Arthur Ventures team together for an all-day offsite where we go through every company we’ve funded in detail and rank them across a handful of categories to help inform where we want to deploy additional capital and better understand where we expect future returns to come from for our limited partners.

Its always been a highlight of the quarter for me, but now its really getting fun because we are deep enough into the fund where we can clearly see companies breaking away from the pack and hopefully headed for special outcomes.

Coming out of this last meeting I analyzed the traits of our top performers and noticed some similarities that were present in each of the companies.  Not some of them, but every single one.

I could write a separate post on each one of these, but I thought it’d be fun to cover the highlights.

Disclaimer before we hit the list – our investment focus at Arthur Ventures is 100% B2B Software + 100% outside Silicon Valley…

Product-focused founder/CEO
More specifically, a MANIACAL focus on product.  In the first investment I led at AV, I was incredibly fortunate to co-invest with a very successful partner at a world-class firm and when I asked him about his best investments he said that his best performing companies were led by founder/CEO’s that had a maniacal focus on product.  At the time I didn’t really get it, but now I totally do.  Over the last few years I’ve observed product-obsessed founders attract the highest levels of talent, have the ability to see where the market is going and possess deep long-term beliefs that better position them to withstand short term struggles.  Its has been a true x-factor for the companies.

Turning customers into a community
Turning your customers into brand evangelists is one thing, but creating a system by which customers directly benefit from interaction with each other to the point of near dependence on one-another is a whole new level of competitive advantage.  Some ways we’ve seen this happen is through rich user forums, contribution of data back to the core product for continuous improvement, job boards for help with projects, user-led meet ups and company-led user conferences.  This is the most powerful force in our top performers.

Tripling down on the go-to-market that works
From a revenue standpoint, our top performers generally go from $1M – $10M in ARR within 8’ish quarters post our initial investment.  On that march, those companies tripled down on what got them to $1M ARR in the first place. If they were an inbound model, they didn’t go heavy on outbound.  If they were high price point, they didn’t introduce freemium.  You get the idea.  The rebuttal of this is that what gets you to $10M ARR won’t get you to $100M ARR.  I totally agree and each of these businesses are now into new go-to-market channels, but they are doing so at a time where they have really good data on their own economics, an established brand and a lot of cash in the bank.

Investing in recruiting early
We have observed a strong positive correlation between hiring internal recruiters early (first one around 15-20 employees) and revenue growth.  One of our best companies has 4+ recruiters on staff.  It is a very high leverage point for the executive team early on.  Having somebody do initial screens, be constantly present at community tech events and instill a strong recruiting/onboarding process early on is incredibly valuable.

Emotionally mature and present board members
Boards are always interesting.  Multiply dozens of companies in a portfolio by 5’ish board members and you get a lot of people.  You get a lot of people together and you see fascinating things.  Good and bad.  The founders of our top performers have done a really good job pulling together quality boards over the course of multiple rounds of financings.  The key characteristics of these boards is that they have a very high level of active participation (i.e., in person whenever possible with multiple interaction points between meetings) and emotional maturity.  They don’t try to run the founders’ business for them or try to show everyone how smart they are.  They provide a supportive environment that enables the founders to do their best work.

Low Burn
Our top performers each burned materially less than $5M to get to $10M+ in arr.  They weren’t hoarding cash at the expense of growth.  They weren’t being reserved people outside of Silicon Valley.  They simply never lost the scrappiness that got them their first million in revenue.

There is no silver bullet to building a great company and different approaches are needed for different products and markets.  Self-awareness of ones own unique situation is important, but hopefully you can pull a few nuggets from this to help on your journey.

When founders bootstrap for too long

The strongest Series A rounds (raise how much you want from who you want at what you want) most consistently occur when founders bootstrap their startup to initial traction ($1-$2M ARR) with strong growth (consistently 10% MoM).

Its damn hard to do, but when founders are able to pull this off its sort of a magical time period and in my opinion they deserve every second of it.

For the first time you can feel the business clicking and you’re starting to see how this thing could actually be as big if not bigger than you imagined.  You’re getting inbound emails from VC firms that want to talk because they are ‘big fans’ of your company.  Best of all, you’re better understanding how your startup is being valued off a revenue multiple and as you continue to grow at the rates you have been you continue to be worth more every month.

Through some triangulation of wanting to push the pedal down to accelerate growth even faster, wanting to de-risk their startup to some degree having had a lot of close calls getting here and wanting to raise their profile for recruiting, many founders choose to raise their Series A here.

Others, feeling like their growth rate is showing no signs of slowing down and getting an understanding of valuation math, decide to march on with the expectation of raising their Series A down the road (“When I grow 100% again I’ll be at $4M ARR next year!”).

The problem is that for nearly all bootstrapped businesses, cash constraints start to catch up with you around the $2M ARR mark.  To keep growth rates at the same levels you’ve been experiencing you simply need more people across product/sales/support/etc. than you have the cash to hire.

Your $2M ARR startup that grew over 100% last year ends up growing 50% this year and 33% the year after that.  The result isn’t a $4M ARR business next year, but two years from now.

Unfortunately what makes for an incredible accomplishment also results in very disappointing financing conversations.

What was a fast growing $2M ARR startup that may have been able to get financed in the $15-$20M range ends up being a $4M ARR startup that gets offers in the exact same range and often times from firms with private equity-like terms.  At the highest level their revenue multiple contracted in accordance with the slow down in their top-line growth.

To the $4M ARR founder, this seems unfathomable, but I’ve probably seen 10 examples of this exact scenario this year.

These conversations always leave me sick to my stomach for the founders given the blood sweat and tears they’ve put into building their business.

All I can say is that they bootstrapped for too long.

 

 

How VCs get a false sense of security with their investments

Over the last 4 years as a VC I’ve been consistently surprised by how often VCs get a false sense of security with the investments they’ve made.

Having seen other companies succeed in seemingly similar situations to their ‘own’ companies, they develop the feeling of being safer than they really are in the investment.

They take edge cases and use them to rationalize a situation they are in without taking the time to understand the details on what made the edge case, well….an edge case, and why it probably doesn’t apply to them.

The issue here isn’t just with the VC’s internal thought process, but that they rationalize it for the entrepreneur as well, which just perpetuates things.

This has certainly happened at Arthur Ventures and I know from first-hand conversations that each of the great firms we have co-invested with have been there too.

As an early stage VC, here are four examples where I see this happen most often:

The proven entrepreneur will ‘figure it out’
Proven entrepreneurs are great.  Some have had multiple grand successes.  However, many have also raised way too much money right out of the gates with essentially zero traction based on nothing but their reputation.  It has worked before, but often times the company never gains enough traction to warrant their overpriced valuation.  When this happens, expect a VC to overlook the facts and say the proven entrepreneur will once again ‘figure it out’.

The business won’t get valued off a revenue multiple
Some markets have repeatedly demonstrated that large outcomes can occur in the absence of material revenue (social, open source, life sciences, etc.).  When working with companies outside of these sort of markets with some sort of ‘proprietary’ technology, it is really easy to overlook and rationalize glaring revenue misses by the uniqueness of what is being ‘built’.  When this happens, expect a VC to say that this isn’t the sort of business that will get valued off a revenue multiple at exit.

Revenue in one market is more valuable than another
Some markets are just harder to sell into than others. Healthcare is a great example.  There are something like 6,000 hospitals in the country while there are millions of small/medium sized businesses.  It is inherently harder acquire 1 hospital than it is 1 small/medium sized business.  When companies in these more challenging markets are doing well, you’ll never hear about how hard it is to sell into their market.  However, when they are not, expect the VC to rationalize the long sales cycle and repeated unimpressive financial results by saying that revenue in this challenging market is more valuable than another.

A company’s market is a ‘land grab’ right now
There are special times when a macro-event occurs that causes a market to suddenly open up and become what many call a ‘land grab’.  I see this the most with compliance software reacting to recent regulation (think electronic medical records, etc.).  However, this term is used way too loosely by both entrepreneurs and VCs, usually right after a big financing round, as an excuse to sustain a burn rate that is not supported by any sort of productivity ratios.  When a startup is burning a clearly inappropriate amount of cash, expect a VC to say that their market is a ‘land grab’ right now.

All of this rationalizing of situations and getting a false sense of security comes from a good place.  VCs and entrepreneurs never work together with the goal of losing.  They always want to win.

However, sometimes the less safe you feel, the more successful you end up being.

What lack of VC conviction looks like

A pretty interesting part of being a VC is having a front row seat to observe the approach of other VCs that want to invest in your portfolio companies.

I’m not talking about tire kickers here.  I’m talking about VCs that have genuine interest.

The stronger the portfolio company is performing, the more interesting this gets as VCs put on their ‘A game’ to make the best impression possible.

Every VC thinks their ‘A game’ is well, an A, but what has been pretty fascinating to me is how many VCs fall short in the eyes of entrepreneurs.

When this happens the most common word I hear from the entrepreneurs we work with is that it seems like the VC lacks ‘conviction’.

But what does a lack of conviction look like?  How can you, as an entrepreneur, spot it yourself?

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None of the above is meant to demean the importance of financial analysis or insinuate that it isn’t Ok to ask questions.

What its meant to shine a light on is:

  • The VCs that show conviction to entrepreneurs show up prepared, focus on talking about the future and then validate that historical metrics support the story.
  • The VCs that lack conviction have the founder educate them, make sure the historical metrics meet their investment requirements and then see if there is a vision.

Its no surprise that the VCs with the best reputations very often fit squarely into the conviction category and understand that there is more to building a big business than financial formulas.

 

How the tech market volatility really impacts SaaS entrepreneurs outside the valley

 

If you’ve spent about 10 minutes on Twitter or Techcrunch over the last two weeks you’ve likely read 10+ opinions about what the hell is going on the tech market and how it impacts entrepreneurs.  Terms like multiple compression, down rounds, cap table clean up, etc. are getting tossed around left and right.  They sound scary and you may not even know what some of them even mean.

It seems like the sky is falling right?

Coming off a full week in SF to attend SaaStr, I can tell you that virtually every conversation I had over the course of 4 days, whether it be with another VC or an entrepreneur, included some negative tone on the market and how bad things are going to get.  You couldn’t escape it.

None of this really surprised me.

What surprised me is the incredible amount of optimism I left the valley with about the opportunity for entrepreneurs outside of it.

I was pretty optimistic going in as Q1 2016 is going to be a great quarter for Arthur Ventures entrepreneurs.  We have multiple companies under term sheet for follow-on financing in good rounds from coastal firms.  So I knew good companies were still getting funded.

But my optimism was really driven up when I heard the specific market concerns and realized almost all of it is stuff that entrepreneurs outside the valley have been dealing with for years!

Follow along here….

What you’re hearing: Seed capital is drying up and more entrepreneurs are going to have to bootstrap to initial traction.
Likely impact to you:  Minimal.
Why: Bootstrapping to initial traction has been the blueprint for the majority of the successful companies outside the valley for years!  The inherent lack of seed capital in most cities outside the valley has forced entrepreneurs to build a business that isn’t dependent on capital.

What you’re hearing: There will be a focus on sustainable business models.
Likely impact to you:  Minimal.
Why: Same vein as the bootstrapping comment above.  Non-sustainable business models typically = pre-revenue.  Pre-revenue companies have been hard to get funded outside the valley for years.  So chances are, you’re building a business that has a real revenue model.

What you’re hearing: The bar is very high to get funded.
Likely impact to you:  Minimal.
Why: Has it ever really been low for you?

What you’re hearing:  Drops in revenue multiples mean that companies will need to grow significantly to raise an up-round.
Likely impact to you:  Medium.
Why: The drop in multiples is very real (great read here) but it is important to understand the key drivers.  The first is the valuation entry point.  Almost all of the analysis here is based on valley-based entry point.  Entry points outside of the valley, even for good companies, have stayed pretty reasonable over the past few years.  The second is growth until the next round.  The reality is that for Series A companies outside the valley that raised at $1M ARR, they’ve needed to grow 3x then 2-3x in their two years post funding to raise a strong B.  If you do that and you get your business to $7M – $10M ARR, you will be able to afford multiple compression.  Your next round might not hit the levels you expected, but it 100% will not be a down round.  If you are unable to hit that sort of revenue growth, you would have had a luckluster B round anyway.

What you’re hearing: It will take longer to raise money
Likely impact to you:  High.
Why: Anytime there is this much dialogue about market uncertainty investors will always be a bit more cautious.  While a lot of the comments above play to your favor, it is definitely prudent to expect a raise to take 2-3 more months that it likely would have over the past few years.

So pulling it all together – in today’s market, entrepreneurs need to build businesses like seed capital won’t be plentifully available, they need to have a sustainable business model, the bar will be high to get funded, they will have to have strong growth to raise an up round and it will probably take longer to get funded.

Sort of sounds like your life for the last 5 years right?

Plan.  Be thoughtful.

But keep building businesses that matter.  Don’t lose that chip on your shoulder.

And don’t let short-term volatility impact your long-term outlook.

The founder/CEO struggle of articulating long-term strategy & vision to the entire company

Much is said and written about the challenges founder/CEOs face when trying to turn their idea into a product into a team into a high-growth company.

Hiring, firing, building an executive team, finding a repeatable sales process, controlling churn etc. all while maintaining a great culture, but one of the most overlooked pieces that I see virtually every one of our founder/CEOs struggle with is effectively communicating the long-term strategy and vision to their team.

This isn’t very challenging when the team is 10, 20 or even 30 people.  Up to this point, you as the founder/CEO are taking great pride in personally interviewing every candidate before they get an offer.  You’re finding people that are mission driven about what you’re building.  They have real passion for the core problem you’re setting out to fix.  They identify themselves as working at your company.

Your employees ‘get it’.  They know what you’re doing and why.

If things at your company are going well, chances are you’ll surpass 50 people within a couple years and you’ll be on track to surpass 150 employees within 3 years.

It is in this phase where effectively articulating the strategy and long-term vision can start to fall apart.

The founder/CEOs realize they can’t interview every employee before they get an offer so they must rely on people they’ve hired to hire new people.  You’ll find people who are mission driven, but they will be fewer than before.  Several will understand the problem you’re setting out to fix, but maybe not as deeply as the initial core team.  Employees will start to have less identification with the broader company and more identification within their specific team (not ‘I work at ABC Inc’ but ‘I work in Account Management at ABC Inc’).

It is during this phase that it is absolutely critical that you build your speaking and presentation skills to ensure you are able to clearly articulate your strategy and vision to the entire company.  To people you employ that you may not have even met yet.  To team members that might be 3 layers down from you now.  Not only is this key for culture and employee retention, but it bleeds into every fabric of your business.  The more employees understand and identify with what you’re doing, they better your company will perform.

I find this important to call out because I have seen it obsessed on (in a good way) by executives in large companies and virtually ignored by founder/CEOs in rapidly growing companies.

OK – the preaching is over.  Time to give some guidance on traps to avoid, suggestions on how to get better and ways to practice.

Traps to avoid

  • ‘I’m a better writer than speaker, so I just send company emails’. Thoughtful founder/CEO emails are great, but as you get big you have to be able to deliver it in person.  People want a real connection.  They want to see the in person passion.
  • ‘I’ve raised a bunch of venture capital, so I must be good at this.’ Not quite.  Financial performance, metrics, market size, etc. all play a big role in funding, but they are less visible (especially in private companies) to employees down the org chart and sometimes less meaningful.
  • ‘We are growing so fast that this doesn’t really matter.’ Growth will slow at some point my friend.  When this happens you want a team that already understands what you’re doing and why, not play catch up.

Suggestions on how to get better

  • Find a peer coach.  Ask those in your network (VCs, board members, friends at other companies) who the best public speaker they know is.  Ideally its another founder/CEO, but doesn’t have to be.  Get a connection, meet them, try to use them as a coach. For example, at Arthur Ventures, we are happy to have founders spend time with my partner Doug. The guys is a pure expert in giving an effective employee all hands.  Its been built on 20+ years of experience of giving these talks to teams of 50 – 2,000.
  • Find a speech coach.  They may not be a fellow entrepreneur, but they can give tips/feedback on all sorts of helpful stuff.  Are your sentence too long.  Are you pausing enough between sentences.  Are you pausing too long.  Are you repeating the same words over and over.  Are you making eye contact.  How to emphasize words, etc.
  • Research.  Nowadays its fairly easy to find videos of CEOs of large companies giving an all-hands talk.  Watch them.  What is resonating, what isn’t.  What are their tactics.  Whether you like what you see or not, you can get some ideas on what may/may not be helpful to you.
  • Practice Practice Practice.  When I worked at Microsoft I was blown away by how much time executives practiced their talks.  It makes sense, there are few opportunities a year to do so.  Say what you want about Steve Ballmer, but at every annual company meeting he’d tell everyone it was the most important day of the year for him.  The one he practiced the most for and that was the most nerve-racking for him.

Ways to practice

  • With any coaches you get.  If you get a peer coach and/or a speech coach, absolutely leverage them for multiple dry runs.
  • With your investors.  They have great insight into your long-term vision and can be a great sounding board.  Just make sure they don’t interrupt you🙂
  • With your leadership team.  Next to you, they know what will resonate with the employees.  Its also important to make sure they are equally bought into the vision you’re delivering.

In the craziness of growing a company, it is easy to overlook all of this as not a critical priority.  Don’t make that mistake.  It only gets exasperated as the company grows.  If addressed early and thoughtfully, the ability of a founder/CEO to articulate vision and strategy to their team can turn into a real competitive advantage as you scale.

 

 

How your startup actually gets acquired

You hear it all the time in startup circles.  Founders, investors, advisors and writers are all guilty of saying it at one point or another.

Some variation of: ‘This company will get acquired by [Google, Salesforce, Facebook, Microsoft, Apple, Oracle, SAP, etc.].  They will just have to have it and will swoop in to buy it.’

Really?

I’m pretty sure that’s not how this whole thing works so I’m confused why I keep hearing it.

The only explanation I can think of, other than people trying to reassure themselves about decisions they are making, is that there is a broad lack of understanding on how acquisitions actually happen.

I’m talking big time, multi-hundred million dollar acquisitions.  That’s the goal right?  Not acquihires.  Not feature buys.

I can’t recall the exact number of M&A situations I’ve been around in my career, but across 10 years of being a VC, in Corporate Development at Microsoft and as an investment banking analyst I’ve seen enough to confidently share a few myths and facts about how startups actually get acquired.

  • Myth: If your startup is in the same ecosystem of a big company, then the big company can be considered a likely acquirer.
  • Fact: It simply isn’t enough to be in the same ecosystem. Ecosystems are massive.  Your startup usually must be doing one of two things in a material manner: 1.) delivering joint value to the same set of customers (i.e., very active integration, products work better together) or 2.) be taking away customers from the acquirer (customers literally choosing you instead of them).  If neither of these are happening, there is a high likelihood your startup is not on the mind of the acquirer.
  • Myth: Acquisitions happen quickly.
  • Fact: The time between getting ‘the phone call’ and the initial offer can be short, but often times it takes years of relationship building to just get the phone call. Trust, value alignment and joint strategic direction are critical to big acquisitions, especially when the CEO of the company being acquired will have a leadership role with the acquirer.  This stuff doesn’t just happen overnight.
  • Myth: The Corp Dev team decides what companies to acquire.
  • Fact: I’ll be brief because Paul Graham has already done a great job covering this, but in almost all cases Corp Dev are purely focused on executing the deal when told. You want to build relationships with the actual business unit leaders that have P&L responsibility and will be leading the business once integrated.  They drive what happens because they are the ones who live with it after.
  • Myth: How much money I am losing doesn’t matter. Its all about revenue growth and momentum.
  • Fact: Revenue growth and momentum are huge drivers of getting acquired, but how much money you’re losing matters way more than people think. The business unit leader, the one calling the shots, is going to absorb your P&L when they acquire you, but chances are their own end of year targets they are accountable aren’t going to change as a result of the acquisition.  Sometimes CFOs give their business unit leaders what is called ‘P&L relief’ on acquisitions, which basically means the business leader can remove the losses of the acquired company from their end of year results, but its not that common.  Don’t think this is a big deal?  Tell that to the Exec buying you who has worked 20+ years to get in their current role.  They kind of want to stay there and missing end of year targets is a great way to have a short stay.
  • Myth: My chances of getting acquired increase a lot after someone else in my space gets acquired.
  • Fact: It really depends on how big your category is.  There are some strong examples of material acquisitions happening after an acquirers competitor makes a purchase (Microsoft buying aQuantive after missing out on Doubleclick, Apple buying Quattro Wireless after missing out on AdMob, Oracle buying Taleo after SAP bought SucessFactors), but usually it doesn’t extend past the top 2 or 3 players in a space.  So I guess your odds might increase a bit if another player in your space gets bought, but you better be next or it might be a long slog.  Besides, who wants to be second or third anyway?

Are there edge cases to these myths/facts, of course.  Acquisitions happen in all sort of weird ways, but if you really want to be smart about who might be an acquirer of you startup ask yourself these questions while your building: What companies do I have strong customer overlap with?  What companies am I taking customers from?  How senior is my relationship at that company?  How strong is that relationship?  Is the financial health of my business make me more or less attractive to them?

By answering those questions you’ll probably learn a lot about who you true set of acquirers may be and how attractive your business actually is.


Paul’s post on Corp Dev – http://paulgraham.com/corpdev.html