None of you asked, but we did it anyway. We spoke with 18 specialist VCs and did a look-back on the deals Alpha VP has seen in the last three years to give you, our loyal ComedySeller fans, a unique insight into valuations in the private market.
We looked at six common industry verticals that VCs invest in: Enterprise SaaS, E-Commerce, FinTech, Healthcare IT, Real Estate Tech and Logistics.
First, we analyzed public company comparables in each of those industries. Then we compared that data with the 18 VCs’ opinions and Alpha VP’s aggregated deal flow.
Let’s dive into the public companies first. Industry standard, as a way to compare public companies with unprofitable private companies, is to use Enterprise Value (“EV”) / Revenue to discuss valuation. For private companies, that ratio is presented as Pre-Money Valuation / Revenue. To get a sense of growth and profitability, we also looked at 3-year Compound Annual Growth Rates (“CAGRs”) and Gross Margins (“GM”).
Now, here is where it gets interesting. The graph below brings over the public data from above and shows it in relation to the private market. The private market data points are an average of those 18 expert VCs’ thoughts and Alpha’s aggregated deals in each vertical. We had, on average, three VC opinions on each vertical. Then, we added Alpha’s deals as another data point and averaged it into the VC opinions.
If you are still with me, it is only going to get better from here. We are about to take a closer look at each industry. And I am going to keep the same order throughout the rest of this post, so if you just want to get the inside scoop on FinTech, skip over the next few paragraphs.
Enterprise SaaS companies, as mentioned above, see similar valuations in the private and public markets. 12x EV / Revenue is the top end of the reasonable range VCs will pay. In terms of line items VCs focus on when evaluating an Enterprise SaaS deal, they put more weight on Gross Margin than they put on Gross Revenue. This is because VCs believe healthy margins are more of a differentiator and give them a better sense of how the companies will scale.
Many VCs use “the rule of 40”, when evaluating deals in this space. The rule says that growth rate plus margins must be at least 40%. If you are growing at 20%, you should be generating a profit of 20%. If you’re growing at 50%, you could have -10% margins. Notice top line revenue isn’t part of that equation.
For key performance indicators (“KPIs”), LTV / CAC was by far the most important KPI expert VCs look at. For an in-depth look at LTV / CAC, check out the ComedySeller’s post here! To go even deeper into Enterprise SaaS companies and what they trade at, if that is even possible after reading this thorough analysis, there are a lot of resources available. Check out BVPs Emerging Cloud Index, which currently trades at 11x. Also, Tomasz Tunguz and Christoph Janz have insightful posts on this topic. Christoph’s 2018 SaaS Funding Napkin is below.
E-Commerce companies are typically valued as a multiple of Gross Merchandise Volume (“GMV”). GMV is the $5 you spend for new toothpaste on Amazon. Amazon’s “take rate” is what they actually make from your $5 after they do their revenue share with the merchant. VCs look for take rates of ~20%.
For KPIs, VCs search for companies with Contribution Margins equal to 3x their cost of customer acquisition (“CAC”) within 12-18 months. Next they focus on churn, as merchants always follow the customers.
FinTech valuation discussions got quite heated, and the valuation range ended up fairly wide, from 6-15x Pre-Money Valuation / Revenue. Early Stage, Seed and Series A deals trade towards the top end of the range, at 10-12x. Payment networks and acquirers trade at 4-6x revenues. Digital / Network companies trade at 9x+. For online brokers, look to pay ~5x and for exchanges, closer to 9-10x. Some of the larger, public companies, like Visa / Mastercard trade well above the range, from 16-18x.
When looking through FinTech companies’ Income Statements, sales and transaction volume come first. Scale is more important than margins when VCs take a first look. Further, there is a strong focus on quality of revenues. That means a truly recurring SaaS FinTech revenue business would be valued at a higher multiple than a business that has a services component, since services-heavy businesses typically have lower gross margins and are less scalable.
In terms of KPIs, churn is first, followed closely by LTV / CAC.
Wow. Thank you for still reading. Here is your mid-post reward!
If you still need to take a break, go stand up, call your high school English teacher, and tell her you are sorry for complaining that Atlas Shrugged was too long and Ayn Rand isn’t the most boring author you’ve read.
Healthcare IT valuation discussions were also quite detailed. At a high level, the industry trades at 4-5x. Medical Devices come in towards the top of that range, at 4.5x. Information Services trade at 2.8x, Home Care companies, 1.4x, and Diagnostics at 1.1x.
For companies in this industry, Operating Margin is most important line item VCs look at. For KPIs, it is utilization. What is the company’s Daily Active User (“DAUs”) count? What is the retention and churn on those users? VCs look for different hurdles depending on the stage of the company and its business model. We are seeing a significant shift in Healthcare IT business models that reflects companies striving for lower churn. According to Rock Health, 61% of companies that started out with a B2C model switched to a B2B or B2B2C model.
Exits came up the most in conversation with Healthcare VCs. Most companies that are built around some aspect of workflow automation see exits of $100-150 million. In order to get a higher exit, north of $500 million, companies need to show some patient engagement component.
Real Estate Technology companies, similar to Enterprise SaaS, cover quite a few different industries. Ranges for valuation are between 3-7x for the sector. Property management software companies trade in the middle, at 5x. Mortgage data technology companies come in at 4.4x, and companies attacking the real estate sharing economy trade at 3.9x. The focus for VCs is on profitability, and real estate technology was the only industry where EBITDA came up in conversation.
In order to develop a competitive moat, VCs focus on where companies play in the regulatory environment. For exits, keep in mind that balance sheets are thin for construction companies. Further, technology is outside the wheelhouse for REITs. In order to sell for $500 million+, companies in this space need a true, proven ROI for its customers.
Logistics companies, as mentioned above, trade at the lowest revenue multiples, at a range of 1-3x.
The logistics world is a pricing war, and it is difficult for pure logistics companies to maintain more than ~10% net margins. Companies in this industry focus more on increasing margins than top-line growth. Logistics is an old school, fragmented industry that is slow to adopt new technology.
Alright, all done with the industry deep dives! To close out the conversations with the VCs, we asked them if they thought valuations will be higher or lower in 2021. Now, here is a very helpful set of quotes we got back in response to that question. We saw a nearly perfect split of VCs sharing that valuations are on the rise, valuations will decrease and valuations will stay the same.
“Prices will be higher ~15% higher, assuming there isn’t a major correction in private asset values or economic downturn.”
“Valuations have been consistently getting more expensive, and we are at the peak. Valuations will start to come down, especially for those that do not have a profitable core business model. I would say about 20% lower.”
“Valuations, on a multiple basis, will stay the same. Meaning they will continue to trade in line with public comps.”
In summary (finally), look for expert VCs leading rounds. They understand the intricacies of how to value companies in their respective industries, and hopefully can add significant value post-investment. Give valuation some additional thought when a corporate venture capital firm is a part of the round. In every year from 2012 to 2017, the average deal value of deals with corporate venture capital involvement was ~3x the average deal value of those deals without it.
Different industries have different valuation triggers. It may not always make sense to value revenue above all else, as margins and profitability could play a larger role in certain industries.
When evaluating a potential new deal, always pull together a competitive company analysis. That can include public and private comps, if you have them logged in your deal flow sheet or can find reputable sources online. And think about the exit landscape, which is vitally important when considering how much you should pay for a deal. What does the recent M&A landscape look like? What did its public peers trade at when they initially IPO’d?
If you want a copy of the presentation I walked through at the conference, send me a note!
Just like your United Airlines’ pilot continuously says for three hours while you are waiting impatiently on the tarmac, Quick Response (QR) codes are just about to take off.
QR codes are similar to barcodes, which are used by retailers to track inventory and price products at the point of sale. The difference is that QR codes can hold a lot more data and are consumer facing. You don’t need a fancy scanner, as QR codes can be accessed by any phone with a camera.
Barcodes are one-dimensional and can’t hold more than 20 numerical digits. QR codes are two-dimensional matrix barcodes and can hold alphanumeric characters. Picture boring, back-office Toby Flenderson vs. client-facing Michael Scott with an amazing memory.
What do QR Codes enable?
They enable everything from online to offline marketplaces to augmented reality.
Just like Kevin Federline, innovation in the QR code world follows the money. For Kevin, it was an emotionally unstable but wildly successful pop star. For QR codes, it’s performance marketing.
It is difficult to monitor the performance of offline marketing. If you run TV and print ads at the same time, how do you know which one is more effective? And if you don’t live in a small town and your billboard isn’t just up there to seek justice for an unsolved murder, how do you know if your three billboards are working?
QR codes give marketers a new way to assess consumers’ interaction between offline and online media. It allows companies to attribute performance marketing in the physical world. For you sales managers out there, you can even figure out which one of your sales representatives is doing the best job, by giving them unique QR codes behind specific company promotions.
Let’s take a look at Japan and China:
QR codes are in its early days in the U.S., but they have been mainstream for years in Japan and China. Those countries have been using their cellphone cameras to bypass URLs for a long time.
QR codes were trademarked by Denso Wave, a subsidiary of Toyota, in 1994. QR codes were created for dynamic car parts inventory management. In 2000, the broad applications were recognized, and its use became quite popular in Japanese and Chinese marketing. Crazy that the company that owns the trademark for QR codes is also on pace to set the record for most recalls by an automaker.
QR codes are used everywhere in China. I think the U.S. has some time before our churches also collect tithes through QR codes.
Some pretty cool QR code applications (and a picture of a panda, so keep reading):
When you scan a QR code, it can link you to digital content as well as perform an action for you. Many QR codes perform simple actions, like launch a website on your internet browser.
Others have gotten quite advance. Firms have QR codes on their website, where their contact information automatically saves into your contact manager if you scan it. If Patrick Bateman were around today, he’d probably throw a QR code on his business cards.
You can have a QR code send a tweet when scanned, or for those of you who still have the app, check you in on Foursquare. QR codes can even enroll you in an event.
Bands can put QR Codes on a CD cover that links to a band's website, allowing you to purchase concert tickets. And, if you miss Limewire, QR codes could even give you free mp3 downloads.
Advertisers are having fun innovating with the QR code in mind. Including QR codes on large billboards, and I guess in zoos, is now very common across China.
Since I am on an Angry Bird kick, they killed it with their QR code, which links you to their download page.
I don’t play the game, but two ComedySeller references in two weeks must be doing wonders for their top line. And, if you are curious if the strategy of continuously referencing companies until someone from said company sees the post and pays me for ad space works, then you are not alone.
Obviously with any large scale innovation and confusion, scammers are quick to jump on board. Scammers are using QR codes to flood smartphones with disguised malware downloads. So, don’t just go wildly snapping pics of QR codes. Our lawyers want to let you know ComedySeller is not responsible for any malware problems.
The next generation of barcodes will hold even more information. Experts predict that an Internet connection will soon not even be necessary. The content will be effectively embedded in the code. Imagine scanning a digital code to manifest physical reality. I’ll leave you with that.
You can do everything on a Super App. Super Apps provide an integrated experience to major online hubs, bypassing individual company websites, and is composed of many apps within an umbrella app.
Let’s focus on WeChat, China’s premier Super App. You can order food delivery or book a flight and a doctor’s appointment within the app. You can even pay traffic fines on the app, which is helpful for this guy...
WeChat has over 1 billion monthly active users and their app accounts for 29% of all time spent on mobile devices. 90% of all messaging app users in China use it. Not quite as monopolistic as The Federation of Quebec Maple Syrup Producers (FQMSP for future reference) who produces 94% of Canadian maple syrup, but it’s close.
WeChat used some unique marketing strategies to hit those numbers. 700 million people watch the New Year’s Celebration on China’s central TV network, CCTV. WeChat ran commercials that prompted new and current WeChat users to shake their phones to win over $80 million. In one night, over 20 million users shook their phones over 11 billion times. Shake Weight’s attempt at this strategy didn’t go quite as well.
Super Apps are easy. Why try to remember 20 different app passwords that have to contain different uppercase letters, numbers and the astrological sign of your maternal grandmother, when you can just open WeChat?
WeChat, and other Super Apps like Line in Japan, have created a self-sustaining conglomerate with development platforms for mini apps. Those are platforms for web developers to create applications within WeChat's app. Picture Inception for web developers, but it’s legal.
And they are going after the entire value chain, sharing powerful incentives for individual low-income consumers, with free messaging, and for large businesses, who use chat services similar to Slack. This makes these companies difficult to displace.
The rapid adoption of these apps has been on the consumer side. Consumers don’t view smartphones as expensive phones, they see them as cheap computers. And consumers in emerging markets, who typically have lower disposable incomes, are strongly in favor of these no-cost communication options instead of expensive SMS options.
This Super App model doesn’t work everywhere, and most likely will never work in the U.S. Countries like China, Japan and those in the MENA region skipped the PC and went straight to mobile. This encouraged a complete redesign of consumer applications. For consumers in these regions, smartphones and the Internet were, and still are, one and the same experience.
In the U.S. people gradually moved from the Internet browser on desktops to phones, and we expected phones to be a continuation of that experience. The U.S. still isn’t completely comfortable going all in on mobile. According to Euromonitor International, U.S. consumers aren’t expected to make more purchases through mobile phones than through computers until 2021. China crossed that barrier in 2015.
The App Store launched in 2008 with 552 apps. Crazy that only ~10 years ago you couldn’t save eggs from green-colored pigs using flying birds on your smartphone. When the app store launched, the applications were relatively simple and had a single focus. Within a few months after the launch, AIM was the #2 most downloaded app. Unfortunately, using “brb, mom needs computer. HAGS!” as my out of office e-mail for summer vacation wasn’t as well received as it was on AIM.
Unlike early U.S. apps, Super Apps utilize every single aspect of a smartphone. WeChat and Line were designed for messaging first, and they took advantage of the microphone with voice messaging and the accelerometer with things like WeChat’s shaking the phone example above.
Super Apps won’t work in the U.S. for two main reasons. The big guys like Google, Facebook and Apple weren’t designed to go after the market this way from the beginning. By the time these companies had the cash and brand to do it, there were already other companies designed specifically for “finance for clueless millennials” that were quickly gaining market share.
Second, even if those companies figured it out, anti-trust regulations in the U.S. wouldn’t let it happen anyway. In China, antitrust laws were put in place to limit foreign companies’ influence in China, not to promote more competition.
Christopher Chen wrote a good piece on this idea, sharing that instead of Super Apps in the U.S., we will have super-connectors. Tech giants like Airbnb won’t be able to provide the same seamless experience all within their app, but they will link you to the relevant page you are looking for. They started with home sharing, and are now partnered with companies like Resy for restaurant booking and heading towards an all in one trip platform.
Super Apps are an interesting phenomenon that came on the heels of once in a generation technological change. There will continue to be more innovation within these apps, and it will be interesting to see who pops up as the leading players in other developing countries. And tech giants like Amazon and Facebook will continue to be jealous of the monopolistic success of these Super Apps, and look to create a U.S. friendly version of it.
The U.S. spends a lot of time in an office, with the average worker coming in at 8.7 hours a day and entrepreneurs, on average, clocking in well more than 60 hours in a week. With changing skills and roles in the workforce, we are seeing the traditional workspace changing. And, ever since Fifth Harmony showed us how cool it was to not go to work, more people are working from home.
In the U.S., 43% of the workforce has spent at least some time working remotely, and that number has steadily increased throughout recent years. Why shouldn’t it increase? Working from home is great. Your schedule is more flexible, you have the ability to travel, avoid office politics and maybe even exercise regularly. But, just like Akon in the early 2000’s, it could be quite lonely. For those of you counting at home, that’s two subpar and obscure music references in eight sentences. Other downsides of not being in a shared office are the lack of collaboration and distractions at home.
The biggest reported struggle of remote work is the lack of community. Company culture is hard to develop if people aren’t physically present and interacting face-to-face. That said, there are some companies that made it work, like InVision or Elastic whose workforces were fully distributed from day one.
If you don’t work from home, you are probably thinking, “how do I convince my boss to let me do it?”
Buffer conducted a study called the State of Remote Work that provides a great case study. The hyperlink is included in the title, but just open it in a new tab for now, and read the rest of my post first. Sure, their paper has more statistics and is “coherent” and “readable”. But, this is also pretty good.
Explain to your boss that Buffer, a fully distributed team with no office, allows everyone to work where they are the happiest. Even employees who want to work in an RV. And they have an employee retention rate of 91%. So, they either are doing something right, or Elizabeth Holmes is in charge of how they showcase their numbers.
China’s largest travel agency also tried this idea out on 250 workers, where half worked from home and half stayed in the office. The Company saved $2,000 per-employee annually and there was a 13% rise in productivity from the remote workers, with them working 9.5% longer during the test period. It also reduced staff turnover, since 50% less people left the company.
Before you go all-in with the work from home pitch. It is important to note the downsides. In the travel agency case, the work from home employees, despite the increase in productivity, took twice as long to be promoted as their office-based colleagues. It could just be out of sight out of mind.
This was an interesting disconnect for me, because when you can’t see someone all day long, the only thing you have to evaluate is their work. Managers can’t evaluate employees based on “Was she here at 8am sharp?” or “Did he take too many ping pong breaks?” and “Are those ping pong breaks even helping? I saw his backhand on Friday and there’s still barely any topspin.”
All you have is the ability to judge what a person actually did today. And since it was proven that there was a 13% rise in productivity from the remote workers, shouldn’t that correlate with more promotions?
I don’t have the answer to this disconnect, but that’s the ComedySeller for ya, you leave the blog with more questions than answers. Like, “Wow, he’s really still doing this?” and “Should we stop telling him this is “funny”? Maybe it’s our fault.”
So, by now you have probably convinced your boss to let you try it out. First of all congrats, and you’re welcome. Now how do you make the most of it?
Start with your work from home set-up. If you have the opportunity to work from home, fill your home with Natural Light. Always helps take the edge off at the end of a long day. Also, introducing sunlight helps. Maybe even buy yourself a nice plant.
Next is self-discipline. Tim Ferris share that he values “self-discipline, but creating systems that make it next to impossible to misbehave is more reliable than self-control.” Create a system where there is a clear separation for what is work and what is relaxation. Don’t mix the two. Some things are better separate. Looking at you Cranberry juice. No one wants your cran-apple, cran-orange, cran-banana juice. Even if it’s just 5 minutes of going out to get a coffee before you start your day, that can help make sure you are leaving your home space and returning to your workspace.
If you need to procrastinate, procrastinate productively. The worst feeling is procrastinating by scrolling through Instagram for 45 minutes and you’re left feeling guilty and angry. Procrastinating productively is based on a simple concept. Completely disengage from work. It really doesn’t matter what it is, as long as it has nothing to do with work. Get out of your workspace. And stick to that set amount of time. If you’ve given yourself a 20 minute break, then take that 20 minutes.
If you need to be out of your home, but not in the office, check out Breathr or Spacious. And if you really want to get away from the office, RemoteYear could be a great option.
By the end of 2020, Gen Z will comprise 36% of the global workforce. Gen Z grew up in an internet-centric society and are more inclined to seek remote or flexible working arrangements, rather than pursue traditional corporate roles. How you and your business adapt to these office and employee changes is up to you.
Entrepreneurs have many choices as they set out to raise their first round of funding. Time is money, and taking the wrong kind of money at the wrong time can be crippling. So can spending your time writing a blog, but, when in Rome.
Here is comprehensive overview of four common choices for an entrepreneur’s first round of funding: SAFE, Convertible Note, Equity and Bootstrapping. I guess you can speak with a lawyer-type to learn more, but this should be sufficient.
A SAFE (Simple Agreement for Future Equity) is a convertible security that is not debt. It was created by Y Combinator to simplify Seed investment. It acts as a warrant to purchase stock in a future priced round. Simple, and aptly named. Like naming a comedy blog about business the ComedySeller. Some will say it’s lazy. Others would have written an ending to this joke.
A SAFE is only five pages long. And since it is not debt, there is no interest rate and no maturity date. The only thing it does is allow investors the opportunity to convert into the next round. It converts whenever you raise any amount of equity, which gives entrepreneurs less control.
One workaround is by raising common stock from friends and family, which doesn’t trigger a conversion. So, with one easy step you can both bridge to the next round without conversion and test how much your loved ones truly believe your company is going to change the world.
If you are a good negotiator, you can finalize a SAFE without a valuation cap. Also, contrary to popular belief, you don’t have to offer a discount to the next round.
Even with these terms, founders can end up with more dilution of their ownership percentage than anticipated, like your $4 Gin & Tonic at the local “intern bar” that when you think about how much alcohol is in it, isn’t actually that good of a deal. Founders end up raising numerous successive mini equity rounds using the SAFE format or traditional convertible notes. And, the appeal of more capital often overtakes the little thought that goes into the potential impact of these notes on future valuation and therefore dilution implications.
If you raise a SAFE for the right reasons, it makes sense. It is quick, cheap and anything that comes out of Y Combinator is apparently gold. Don’t raise a SAFE to postpone pricing equity until your valuation is higher or to stall until you find a lead investor to price the round on more attractive terms.
A Convertible Note is debt and is structured similarly to a loan. Which means it has an interest rate and maturity date. These are more complex than a SAFE with how, when and if it converts. Convertible debt can carry an interest rate ranging from a 2% - 8% (most falling around 5%).
These notes allow you to convert into the current round of stock or a future financing. It is only triggered when a qualifying transaction takes place, which is set in the agreement or when both parties agree on the conversion. Once you reach the date of maturity, an entrepreneur can either pay back the principle plus interest (if the company has enough cash to do that), or convert the debt into equity.
This complexity may pose a threat to your company’s continued operations by creating cash flow pressures, like interest and principal payments that you may not be in a position to satisfy. They may also prevent your company from gaining future financing via a suddenly expanded capitalization table after a forced conversion.
Multiple series of notes, either SAFEs or Convertible Notes, can create dilution waterfalls and hamper future priced rounds, as large portions of the pie have already been carved out to founders, converted note holders and Series A investors. In these cases, the only valuations that makes sense for a Series B lead investor may force the Ringo Starr of fundraising rounds, the down round.
Equity deserves another few blog posts in itself. Unfortunately, equity isn’t always valued correctly. A priced equity round is an offering and sale of newly-created stock in your company at an agreed upon price per share. Once stock is sold, investors are part owners of your company. The decision to bring in part owners, and choosing where you and your significant other are going to dinner tonight, are big ones to make and shouldn’t be done lightly.
Priced equity rounds permanently alter the capitalization of the company by adding those new stockholders. Given this permanence and the inherent complexity, many deal documents are required for stock transactions, which is time consuming and expensive.
However, doing this work provides you with a more thorough view of your business and financial model, so you can have realistic valuation discussions with potential investors. It will enable you to lay out concrete near-term goals for your company and decide what financial resources are required to launch and scale.
The problem with raising money is that it typically doesn’t come for free. Raising money increases the risk profile of your company. If you are fortunate enough to be in a position where bootstrapping is a feasible option, there are many benefits that come with it.
Bootstrapping forces you to figure out how to make money earlier on, which means you are less likely to run into a cash-issue down the line. Without funding, you only deal with customers. And your employees I guess. That means no investors or board to report to and pretend to listen to. Having said that, there are many VCs who are quite helpful as you are looking to hire and scale your business.
And, once you reach a certain scale and are still bootstrapped, it can turn out to be a strong asset and a major component of your brand.
In summary, there are advantages to each initial funding strategy. All I am saying is do the math. Look at what happens to your cap table when the notes you raise actually convert into equity. If you keep kicking the can on setting a valuation on your business, you could end up pretty diluted, like Seed investors in Uber after their 18th round.
Let's talk about Edge Computing. It is a way to streamline the flow of data from IoT devices and provide real-time local data analysis. Edge computing is done at or near the source of the data, instead of sending data across long routes to data centers or clouds.
With data being processed at the edge of the network, you can do more analytics on the devices themselves. We are at a point where almost everything that can be centralized has been centralized. So, the real opportunities for the next generation of cloud computing lie at the edge.
Edge computing triages the data locally, therefore some of it is processed locally, reducing the backhaul traffic to the central data center or cloud. It can help reduce connectivity costs by sending only the information that matters, instead of raw streams of sensor data. It’s like hypothetically not showing up to any college classes except for the midterm and final reviews. Except, that’s still just as expensive.
We now know we can trust Facebook and Amazon with our personal data. So, the natural next step is to give them access and control over everything in our house, like our refrigerators. Edge computing also brings future proofing to these systems by allowing over-the-air updates for the device software and the list of local commands it can run. If Amazon starts to make Alexa-enabled refrigerators, that refrigerator can be updated without anyone coming to your house. We’re living the dream.
Your voice assistants, like Google Home, Alexa, and I guess Cortana, typically need to resolve your requests in the cloud. The device has to process your speech, send a representation of it to the cloud, process it in the cloud and send it back. Edge computing will help reduce that lag time to almost zero. Since there isn’t a large, constant data transfer taking place, latency will decrease wherever edge computing is being used.
Bandwidth issues will also decrease. If you have a smart security camera, you can upload all of that data to the cloud. But, if you manage a network of 40 security cameras, you can run into a bandwidth issue. Edge computing will allow you to only push your “important” footage to the cloud, like boomerangs of you and your friends striking a silly pose because you’re unpredictable and fun.
To give you a sense of scale, by 2020, it’s expected that there will be more than 5.6 billion smart sensors and connected IoT devices across the globe. If you give it another three years, the IoT market is expected to reach $724 billion by 2023.
Edge computing has significant applications for corporations as well.
For example, oil rigs in the ocean have thousands of sensors, which constantly produce large amounts of data. But, a vast majority of that data doesn’t need to be sent over a network as soon as it is produced. With edge computing, the oil rig can compile the data and send daily reports to the cloud for long-term storage. This dramatically reduces the amount of data needed to be transferred, which cuts down on costs and time for all parties.
Those applications are less interesting than the benefits of asking Alexa to order your bacon, egg and cheese while lying in bed, hungover in your pajamas. But, there’s more money in oil.
There is a lot of talk about how edge computing is going to be great for privacy, but I don’t buy it. Until I stop getting ads for Peloton when I open Instagram 30 seconds after a “biker” mentions how life changing getting one was in a meeting, it isn’t worth talking about. Try it out for yourself, say the word Peloton three times out loud right now and click your heels, and I am willing to bet you’re going to be seeing an ad for Peloton pretty soon. ComedySeller is getting interactive!
And think about who is spreading that news that this will be better for privacy… Google, Microsoft and Amazon. As comedian and camping-hater Jim Gaffigan said, they say you should play dead if you come across a bear in the woods. Who came up with that? Probably the bears.
To be fair, it will mean that there will be less data in a corporate data center or cloud environment, so theoretically there is less data to be vulnerable if any of those gets compromised. But the edge devices themselves can be more vulnerable.
Lastly, there is a new layer called fog computing that comes along with edge. It refers to the network connections between edge devices and the cloud. I know, boo on the name choice. Edge refers more specifically to the computational processes being done close to the edge devices. So, fog includes edge computing, and fog would also incorporate the network needed to get processed data to its final destination.
Your two acronyms of the day are:
Lifetime Value (“LTV”): the net value of an average customer to your business over the estimated life of their relationship with your company.
Customer Acquisition Cost (“CAC”): the average amount of capital you need to spend on sales, marketing and related expenses to acquire a new customer.
Together they form a ratio aptly called LTV / CAC, which is considered to be the golden metric. This ratio has everything – it combines purchase frequency, average order value, and customer lifetime to figure what each customer is really worth to a brand. Plus it’s a 5-star recruit for basketball and football, while maintaining solid grades and still makes time for community service.
Calculating your LTV / CAC ratio is a great way to see if your company is positioned for sustainable growth. Like most metrics, your LTV / CAC is highly context specific, and a solid value will vary depending on your product, brand and industry. Therefore it is calculated in different ways.
SaaS companies measure LTV by:
Average Monthly Revenue per Customer ($) X Customer Lifetime (typically in months) X gross margin (%)
Or, you can take average monthly revenue per customer divided by monthly churn.
E-commerce companies calculate LTV by:
Average Order Value ($) X Repeat Sales X Average Months of Retention X Gross Margin (%)
The retention rate is perhaps the most critical component. The longer customers stick with you, the higher their LTV is, because you can expect to receive payments for a longer time. There’s a great blog post about it being cheaper to upsell a customer and keep them for longer, than it is to gain a new customer. This is why it is so important to build a product that customers want and like to use.
CAC is a standard calculation, where you take your total sales and marketing expenses divided by the number of new customers acquired. But, that doesn’t stop companies from stretching the truth and showing CAC in ways that are so, let’s use the word interesting, that they forget the metric they were talking about halfway through explaining it to you.
Do you ever wonder why some companies offer referral fees to test out their product? It is because they know their average CAC, and whatever they are giving both the referrer and referee, is still less than that number they are willing to spend to acquire a new user. When the New England Patriots pay referees before a big game, they know that it costs less than the value generated by another Super Bowl ring. I am prepared for, and accept, a few unsubscribes from Patriots fans. That was worth it.
Let’s look at an example. An e-Commerce company spends $10,000 on an ad campaign and acquires 1,000 new customers. The average revenue per customer is $50 and the direct costs of filling each order are $30. The company retains 75% of its customers per year.
That means the contribution margin per customer is $20. And the LTV is $80, which is $20 / (1 – 75%). The CAC is $10. So, your golden ratio is 8:1. Not a bad ad campaign for a made up e-Commerce company using an arbitrary pricing strategy.
An LTV / CAC Ratio of 1:1 means you lose money the more you sell. A good benchmark for an LTV / CAC ratio is 3:1. Let me know when we set the record for most times using "LTV / CAC" in a blog post. I think we’re close!
If you hit 4:1 or higher, you could be looking at a great business model. You’d think that if your ratio is 5:1 or higher that you would be sitting pretty, but that would be too easy and VCs wouldn’t have anything to critique. Experts believe at that ratio, you could be growing faster and are likely under-investing in marketing.
What can you do with this ratio? Some companies look at this number, analyze it and decide how much they want to spend to acquire the average user. Other Ubers, sorry, I mean other companies, spend well more than they can afford to acquire users. They maintain that spend by raising additional venture capital. But, raising capital can only take you so far, and those companies at some point need to either increase LTV or decrease CAC.
Companies use this ratio to determine if a customer is worth more than what it costs to sell to them. A healthy LTV / CAC ratio is what gets investors comfortable enough to invest in a SaaS company that is losing money, because it is clear how they plan to become profitable.
Understanding this ratio in detail helps companies understand when, where and how much to invest in sales and marketing. You can figure out how many sales people you can afford to hire and how to effectively manage spend. And, it allows you to figure out which customers and products are the most profitable.
The more work you do in terms of segmentation, by customer type and marketing channel, the more actionable the data will be. You may find out it makes more sense to target SMBs instead of enterprise customers. Or, that a brand loyalty campaign targeting millennials may not be the right move.
Peter Thiel shared that LTV / CAC ratios should be used to take data and make it actionable, but don't treat them as gospel. While an impressive ratio is, well, impressive, the best founders don’t use that number as a vanity metric. Rather, they use it as a tool to demonstrate their complete understanding of their company’s unit economics and how they are prepared for growth.
This ratio is definitely important, otherwise why would it be covered on the ComedySeller. But, be on the lookout for companies that are playing with the numbers and how it is calculated, and more importantly, companies that are not using that ratio to drive business decisions.
This ratio, if calculated correctly, is a true indicator of sustainability of a company. A 5:1 LTC / CAC ratio shows that if a company can predictably and repeatedly turn x into 5x, assuming no crazy fixed costs, then it is a viable business.
Quick explanation of the cartoon above: Pareto says that 20% of your input generates 80% of your results. Peter says that competent employees will continue to be promoted, but at some point will be promoted into positions for which they are incompetent. Taylor talks about inflation rates and Newton about physics.
The question is: do you even need to know about a rule in order to perform well with that rule? If you're still not with me. Anyone can put an LTV / CAC number in their pitch deck, and you don't have to know what it truly means for you to have one. But, it'd be a lot cooler if you did.
Can a single survey question serve as a useful predictor of growth for a company?
Yes, yes it can. How likely is it that you would recommend our company/product/service to a friend or colleague?
That question is used to calculate a company’s Net Promoter Score (NPS). The NPS question is answered on a 0-to-10 Likert-type scale (remember high school?), with 10 being “definitely likely”. “Promoters” are those who give ratings of nine or ten to the question. The “passively satisfied” are a seven or an eight. And the “detractors” score from zero to six.
You calculate NPS by taking the % of promoters (number of respondents who ranked 9 or 10, divided by total number of respondents) minus % of detractors (percentage of those who chose ≤ 6). It essentially only counts your mom’s and your ex-girlfriend’s ratings of you. And, it cuts out the high school acquaintances you occasionally see on the street and smile at, but hope they never actually strike up a conversation.
It took Frederick Reichheld two years of dedicated research to zero in on this one question and how to score it, which he published in the HBS Review in 2003. It is a long read, but it is one of the most interesting pre-YouTube (launched in 2005) pieces of content I have seen on the internet.
By limiting the promoter designation to only the most enthusiastic customers, not just those who choose above a 5, the scale avoids the “grade inflation” that often infects traditional customer-satisfaction assessments and Economics 101 classes across the U.S., where fresh baked cookies and a call from an eager mother can throw off the curve.
Customers just above neutral are considered satisfied, but those customers don’t help your score. That’s not enough. The idea is that the only path to profitable growth lies in a company’s ability to get its loyal customers to become, in effect, its marketing department.
Take Tesla, who consistently tops the leader board with an NPS of 96. I got a text from a friend who test drove a Tesla and said it was the most incredible experience he’s had. I said Watt, you haven’t even purchased the product yet, and you are already helping the company sell? It’s game over once they make the purchase. And because of that, Tesla doesn’t have to advertise.
Comcast sits at the bottom, with an NPS of -5. That’s not a typo. That is a negative 5. If you are shocked, give Comcast customer service a call today and email me tonight when / if you get off the line. Amazon has an NPS of 62, and in light of the recent HQ2 debacle, Amazon has stopped reporting its NPS score. They’ll probably wait until after Prime Day to report it again. Nike is at 32, and after arguably the most famous shoe incident in college basketball history, I expect that number to continue to drop quite quickly.
Let’s take a step back. What is the goal of customer surveys? You want to measure your customer’s satisfaction and dissatisfaction in a cost-effective way and then use that data to improve your growth and retention.
What Reichheld did was substitute a single question for the complex black box of typical customer satisfaction surveys. Those surveys are complicated, yield low response rates and provide ambiguous implications that are difficult for operating managers to act on.
The Net Promoter Score works, because it allows you to keep it simple. Too many of today’s satisfaction survey processes yield complex information that’s months out of date by the time it reaches the managers on the front line. The NPS number and its underlying data gets you to action more quickly. A customer feedback program should be viewed as an operating management tool, not as pure market research.
The question itself works because it shows how many customers, and which ones, are putting their reputation on the line for your product. Granted, doing so is more valuable to some than others, like Peyton Manning endorsing Papa Johns. Come on Peyton, there’s no way you enjoy that.
Reichheld chose this exact question because traditional customer satisfaction statistics lack a consistently demonstrable connection with company growth. In some cases, there is an inverse relationship. For example, K-mart experienced a significant increase in the company’s American Consumer Satisfaction Index in the early 2000’s, which was accompanied by a sharp decrease in sales as it slid into bankruptcy. I promise that will be the most out of date statistic I'll use in this blog.
To get to this wording, Reichheld tested out 14 different questions. He tied survey responses from individual customers to their actual behavior, including repeat purchases and referral patterns over time. “How likely is it that you would recommend Company X to a friend or colleague?” blew away all other questions in terms of statistical correlation with repeat purchases and referrals. The second and third contenders were “How strongly do you agree that Company X deserves your loyalty?” and “How satisfied are you with Company X’s overall performance?”
The standard NPS question doesn’t always work for all industries. In database software companies, for example, senior executives select the vendors. So, it doesn’t make sense to ask users of the system whether they would recommend the system to a friend or colleague, as they had no choice in the matter. For those industries, try using phrases that understand if the Company “sets the standard of excellence” or “deserves your loyalty”.
It would be nice to expand the universe of what NPS was used for… How’s your son? He’s like a 55. It’s not that I wouldn’t recommend him. But, something happened at school last week. And you know, we’re just cautiously optimistic for the college application season.
When analyzing a company’s NPS, obviously the higher the number the better. It is important to look at a company’s NPS relative to its competition. NPS and its trends are a great leading indicator that the company is not only focused on its users, but is improving its value proposition over time.
As an investor, look out for funky ways of showing NPS. Like only showing percentages of promoters, not including detractors. Also look into how they are showing the number choices, especially on mobile. As the layout of the number choices has led to scores that can differ by 20 points depending on if you put 10 at the top and scroll down to 0, or vice versa. Experts (yes there are multiple experts on a one-question survey) recommend doing a 50/50 split on phone screens.
I’ll take this time to congratulate the ComedySeller for its impressive NPS of 95! Thanks to all eight of you who filled out our real NPS survey. I know it was anonymous, but I took the liberty of unsubscribing Aunt Carol, who brought the average down, and coincidentally is no longer known as the “cool Aunt”. Good luck at Thanksgiving Aunt Carol. Can’t wait to review your turkey.
If you liked this post, recommend it to a friend. If you didn’t, let me know here.
Venture Capital investment into U.S. based companies hit $100 billion in 2018, and the industry is only getting bigger. But, we expect a lot to change.
Keep in mind that this post is the aggregated thoughts of 25 VC partners and my own. So, in line with the VC industry, I expect 5% of these predictions to be spot on and 95% to be wildly off.
Thank you again to all of the VCs that helped me put this together! Here are a few of their logos below, as well as 12 others who wished to remain anonymous.
There are four key areas I am going to discuss:
Shifting Fund Structures
The “2 and 20” model: In order to keep diversity in the profession, including socio-economic status, management fees will stick around for emerging managers and first-time funds. But, should a firm on their 12th fund be collecting $20 million a year in management fees? We are starting to see some innovation with Greylock’s economics being budget-based, not based off of a set fee. SOSV generates income from sponsorships and operations, so they have given rebates to their LPs, and some years they have not charged a fee.
Tokenization: VC is notorious for long lock-ups. The tokenization of funds and assets will reduce compliance and transactional costs and enhance fund liquidity. This means that founding teams won’t have to wait for a traditional M&A-style liquidity event. But, with liquidity will come volatility. This could lead to lower exit multiples on individual portfolio companies, but will also offer more non-zero outcomes for companies than the traditional model offers. Companies like Republic are using tokenization to give more investors access to deal flow.
GEN Y in the decision maker’s seat: This could lead to an increase in double bottom line funds, as the decision makers have different values in deploying capital. Impact and profit used to be separate, but we will see the two continue to blend. This could lead to different diligence processes and more impact studies being done.
Fund size: We will see more capital going to fewer funds as capital is increasingly becoming a commodity. Traditional Series A firms like Andreessen Horowitz and Sequoia will continue to get larger and play later stage in response to Softbank.
Investor landscape: Corporate VC involvement has gone from being present in 29% of deals in 2012 to 45% of deals in 2017. Strategic investors are typically not valuation sensitive, as we have seen the average deal value of corporate VC deals is ~3x the average deal value of all VC deals each year.
We are going to see increased participation from global investors as venture capital is in its early days around the world and is still becoming an asset class in many countries.
Other differentiated models: We will see more formalized social networks of entrepreneurs helping each other, especially on the education front. People know much more about how to start a company than they did 10 years ago through Youtube videos, Techcrunch and blogs. Village Capital has its entrepreneurs pick the start-ups in their class that continue to get funding. Revenue based financing could also start to gain more traction. Earnest Capital sets a return cap at a multiple of their initial investment (typically 3-5x) and gets there through a profit sharing agreement with the companies they invest in.
Technology Empowered VC
Computers are good at narrow intelligence. But, they are bad at general intelligence, as they can't tell you why they are doing what they are doing. Therefore, AI will help VCs, not completely replace them. AI will be used to evaluate the potential success of a founding team and idea at the earliest stage. Once the data proves to be valuable, it will be turned into a real forecasting model.
Some VC funds will create their own solution in house, including Peakspan and SignalFire. Others will purchase solutions from 3rd parties, which could be other VC firms selling their own (unlikely if it actually works) or start-ups that will pop up to attack the space.
Some of these solutions just aggregate simple growth triggers. For example, giving notifications when someone changes their role from Founder to Co-founder Linkedin. Other solutions are much more complex.
Generalist vs. Specialist VC: The top-decile funds will institutionalize into the best generalist funds. Later stage funds will act more as pure capital sources, taking less board seats and lessening their involvement. The overspecialization of VC funds was an interesting point of contention amongst the VCs I spoke with. Some believe that overspecialization is a product of having so much capital in the space that it is just a way to differentiate themselves between investors. Others and I think it is a product of more ex-operators starting funds and the fact that technology is now disrupting every industry.
Industries VCs are investing in: We surveyed over 100 VCs on this question. Here are a few industries VCs plan to deploy the most capital into from their next fund:
Other notable answers:
Expanding Silicon Valley Mindset
Silicon Valley will no longer be a geography, it is a mindset. California’s market share of VC investment is slowly shrinking, as is Silicon Valley’s. California maintains a dominant lead with over 51% of all of the early VC funding in the U.S. in 2017, which is down from 55% in 2016.
Market share of the U.S. will decrease as well. The share of what the U.S. represents relative to Global VC on a deal value dollar basis went from 81% in 2005 to 54% in 2017.
India, Latin America and Southeast Asia are the top emerging markets that will attract more capital. It will be exciting to watch places without legacy systems or infrastructure grow. Many emerging markets have skipped the PC and went straight to mobile, changing the mobile application development experience. The financial ecosystem will be notably different than the U.S. with the rise of mobile payments and banking the unbanked, like in China and India. And transportation and mobility will be upended, as they are re-inventing and transforming the public bus commute, and using drones and hyperloop logistical situations.
I am excited to see the effects AI, data and an increasingly global investor base will have on the venture industry. And, I am most interested in the changes in VC fund structure. VCs and LPs will challenge the standard 2 and 20 fee structure, tokenization will have major liquidity, timing and cost effects, and differentiated investing models will gain scale.
If you would like a downloadable copy of my summary presentation (which includes additional data and examples of VC funds and companies who are at the forefront of innovation), or if you have any questions about anything you have read, please email me at firstname.lastname@example.org.
5G networks are coming, and the technology is going to lead to major changes. To set the stage, 5G is expected to be more than 257 times faster than the average speed of the fastest LTE network in the U.S.
5G isn’t just about speed. It will bring more capacity to mobile networks. You know when you are at a rough Mets game (which happens a lot) and Instagram won’t load, because everyone else at the game is also on their phone? The extra capacity 5G brings to the table will allow everyone at the game to scroll through and comment on as many photos of cats doing cute things as they want.
Capacity is a worldwide issue. As more people around the world continue to get smartphones, it will be important for mobile operators to accommodate that growing network usage. Many developing nations have skipped the PC all together and are going straight to mobile. 5G will help carriers keep up with that demand.
5G allows for network slicing to take place. This is big. Network slicing means that you can customize speed, quality and coverage for certain areas or users. You can sell truck drivers dedicated capacity for a few mile radius near a specific warehouse. Or, if you are worried about not being able to post a "story" at your next music festival, concert operators can take a short-term lease of a network slice that optimizes for connectivity.
Each of these layers can be individually designed, deployed and controlled depending on the needs or usage of a specific group. We may not notice this as much on the consumer side, but the enterprise applications are substantial. And if that means Amazon can deliver your new aromatherapy diffuser in hours instead of two days, isn’t it all worth it?
There are technical solutions that already exist that have network slicing-like features, such as Differentiated Services that classify and manage different types of IP traffic. And Virtual Private Network, that separate and isolate traffic across the Internet using techniques like IP tunneling. But, they each have their issues, such as Differentiated Services not being able to perform traffic isolation, making it difficult for hospitals to use given hospitals' security measures. No holistic end-to-end solution exists aside from 5G.
The applications of 5G expand to the IOT industry as a whole, especially self-driving cars. It is the next big step to complete autonomy for cars, as they will be able to communicate with the environment in near real-time. A focus on low latency and high security levels are ideal for the autonomous vehicle, which should also be what airports focus on, but we aren't that lucky yet.
Virtual and augmented reality will also see major updates. Phones will now be meant to be used with VR headsets. VR and AR applications will require low latency, and the consistent speeds of 5G will give users access to a virtual world whenever they want. Which will make it that much more fun to walk around Times Square with tourists who are somehow further distracted.
The most exciting aspect of 5G is that we don’t yet know what applications will become possible. For example, Netflix could not have existed on the broadband of the early 2000’s. (If anyone from Netflix is reading this, I expect to get compensated for marketing if I bring you up in one more post). 5G will make applications on both the consumer and enterprise level faster and higher quality, and it is bound to lead to new software we didn’t know was possible.
This will take some time. 4G phones in the U.S. appeared in 2010, and Snapchat and Uber didn’t become widespread until 2012 and 2013, respectively. Experts believe that 5G is still in its early days, and game changing 5G applications will start to come to market in 2022.
I am a 25 year-old venture capitalist and amateur stand-up comedian living in NYC.