Entrepreneurs should have a framework for thinking about how to achieve the sort of scale that justifies a $100m+ exit – and that’s what this post is about. It’s also a result of a number of recent discussions and other posts:
- active planning cycles in many of Silverton’s portfolio companies
- growth targets and revenue scale discussions in those same companies
- reading Fred Wilson’s post on the dearth of start-up exits above $100m http://kipm.cc/qtwwas
- thinking about the details & drivers of past acquisitions of my companies (for example).
We need more companies that have a vision for building real businesses that scale to produce more $100m+ exits (not just $100m+ valuations). As an investor, I’m generally less interested in the sort of pre-product or talent-based acquisitions that have become popular at places like Google, Twitter and Facebook because it takes the team out of the game and keeps their vision — the one that I invested in — from being realized. I believe that a $25m-$30m annual run-rate means that the company has a long-term perspective and executed well enough to have options: stay independent and (likely) profitable, be an attractive acquisition target or even consider an IPO.
But let’s talk about acquisitions. For acquisition targets with revenue, acquirers tend to value acquisitions as a multiple of revenue that increases based on how strategic the business is to the acquirer and the potential leverage of the business model for the acquirer.
For example, for a business with lower strategic value to the acquirer, multiples tend to be 1x – 3x forward 12-month revenue. For businesses that have less business model leverage (such as low-margin, services-based company that requires a significant human component to scale), the multiple could even be less than 1x forward 12-month revenue or, where possible, simply valued as a multiple of EBITDA.
For businesses that are highly strategic to the acquirer, multiples go up significantly. 3Com paid an ~11x multiple when they acquired TippingPoint because they wanted to get back into the large-enterprise IT space and wanted to do that via a high-margin security product. TippingPoint’s cutomers were exclusively in the global 2000 and we had a world-class security product. TippingPoint was at a ~$38m annual run rate and therefore had sufficient traction to prove that customers were repeat buyers and referenceable. BroadJump achieved around $50m in revenue in three years with about as much in backlog.
Once your company clears the $25m+ annual revenue bar and an acquirer has assessed the strategic value of your business, the following criteria will drive that acquirer’s valuation analysis:
- revenue concentration risk. if you company achieves revenue scale through (to be extreme) a single, $6.25 million dollar deal each quarter (aka “elephant hunting”), the revenue concentration risk will discount your multiple. More transactional businesses where many smaller deals make up your revenue drives a higher multiple because losing any one deal won’t de-rail your quarter.
- revenue consistency. Hitting your revenue target one quarter and missing the next will obviously discount your appeal (and multiple) to acquirers.
- time to scale. As a general guideline, if a company achieves $25m in revenue in less than 4 years, it’s a defacto a high-growth company with good execution. Conversely, if your company has been around 8 years and has yet to achieve such critical mass, both investors and acquirers will (at least) wonder what’s wrong with the business.
Given the above, if your company is a reasonably strategic acquisition target, executing well, with at least a $25m revenue run rate should deliver an exit over the $100m mark because your multiple should be more than 4x the current annual revenue run rate.
Let’s assume we’re talking about a software product company. Whether you price and sell your product on a monthly basis, you can certainly do the math to understand the revenue it delivers on a per-month basis. Therefore, the very first observation is that your product’s selling price has a huge impact on how complex it will be to scale your business. A product that delivers $100 per month will require nearly 21,000 customers to achieve $25m annually; a $10,000 per month product will take (only!) 208 customers. For what it’s worth, I think the most resilient, scalable software businesses charge somewhere in between these two monthly goal posts.
May 2012 UPDATE: recently, I came across Jason Cohen’s post that discusses “Which is better: Many customers at low price-point or few at high price?” The discussion swirled around the merits of selling more units (i.e. maximizing reach) versus selling more expensive units (i.e. maximizing per-unit profitability). A lot of what makes Jason’s post a good (and fun) read is that he’s discussing the issues inherent in high-growth versus life-style businesses. Full disclosure: as an investor, I really only care about high-growth businesses.
Starting from ZERO-revenue, your start-up will progress through several phases on your way to $25m annually…which is $6.25m quarterly…which is about $2.1m per month. As the business passes through these phases, more and more of the business is understood and infrastructure to scale is put in place.
The five phases of revenue scale & what they mean:
Phase One: $0 — the first sale or two
- the company starts to prove it can build a complete product
- it proves that you can twist someone’s (mom? dad?) arm to become a “customer”
- it proves that you’re not unrealistically priced (although you may be leaving money on the table)
- phase one is the beginning of measuring conversion, activation and on-going activity rates
Phase Two: getting to the first dozen sales
- entering this phase, the the company has achieved some degree of product-market fit but it is still learning something new with each sales transaction
- it proves the company can stick to their product and sales plan but says nothing of how good those plans will be in the long term
- the company can to begin to characterize the cost to acquire a customer…but not yet able to characterize cost to serve this market. cost to serve = cost to acquire + support + keep active (and therefore remain the customer)
- in phase two, the company has yet to prove that it can really scale sales and the sales motion is most likely “brute force” with little repeatability
Phase Three: getting to $1m per year
- entering this phase, the company has generally proven product market fit and, consequently, the list of next “critical” features to add will be a mile long thanks to customer input
- it proves the company has started to scale sales and characterize cost-to-serve at this level:
- the company has a defined and repeatable “sales motion:” a fully direct sales force, lead gen + an ISR (inside sales rep) team, or touchless via leads and web-based transactions.
- data-driven understanding of where to invest to grow sales and revenue
- the customer or buyer is well understood… And therefore messaging should be mature at this point
- the company should have knowledge of market trends such as seasonality and other buying behavior such as multiple decision makers and sales cycle lengths
- it proves that the company is measuring and improving conversion, activation and on-going activity rates as part of daily business.
- phase three is the first meaningful revenue milestone for a start-up and its investors.
Phase Four: getting to $1m quarter
- Entering this phase, the company has reasonably proved that you have a scale-able business (versus being able to scale small sales process in Phase Three)
- it proves that the product is differentiated enough to beat competition consistently
- it proves that you can maintain reference-ability and keep customers (since getting here will typically take longer than a year…which is usually the maximum amount of time between customer re-commits)
- it proves some financial discipline and that there is leverage in the business model (ie you don’t have to perpetually spend a dollar to make a dollar in revenue)
- in phase four, the company is typically leaving the “early stage” and maturing into the “growth” phase; profitability is usually possible around Phase Four; and while profitability may be possible, maintaining it will challenge rapid, sustained growth at this level
Phase Five: getting to $6.33m per quarter
- entering this phase…
- the company likely has more than one product in market;
- the company has likely expanded the opportunity in existing accounts beyond the initial “deal;”
- the company has continued to beat the competition in competitive situations;
- the company has continued to scale the sales team and process to an even more mature state and know what it will take to get to $100m in annual revenue
- in phase five, the company is unquestionably a “growth-stage” business and, in general, the company should be sustainably profitable.
These five phases are at least one swag at the “stair steps” to growing a start-up from zero to $25m in annual revenue; scaling beyond $25m up is never easy but the creative requirements and range of unknown problems have generally been addressed by the time you get to $25m.
Finally, it’s interesting to remember that a clear path (or achievement) of at least $100m in annual has been the most common lower bar for IPOs for quite awhile now (although the window has slammed shut pretty recently). If you’re able to achieve $25m, I sincerely believe that you will have executed your way to a range of options for raising future capital, running a profitable stand-alone business, being an attractive acquisition target, or even driving toward an IPO. Having those options available is the definition of success.