Thanks to Jeff Erickson at Carta and Elyse Kent at Access for help on this post.

Introduction

In the mid 1900s, the idea of giving equity to compensate employees was effectively unheard of, yet today it is a standard practice for almost all publicly listed companies and tech startups. Granting equity to employees comes with some upsides:

• Allows you to reduce your short term cash needs (reducing salary in place of equity)
• Builds a culture of shared success and ownership
• Helps to compete for top talent with the promise of a share in a potentially large outcome
• Helps to drive retention (employees are less likely to leave if they are vested in the future of a company)

There are two major types of option plans with major differences in tax treatments — Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs). ISOs tend to be more tax advantageous and common — some of these terms will be discussed below, at a high level on the tax front:

• When you exercise NSOs: the difference between the strike price of your shares and their current market value is treated as ordinary income, and you pay income tax on the gain now
• When you exercise ISOs: you don’t pay standard income tax now (although the difference between the strike price of your shares and their current market value does count towards the Alternative Minimum Tax calculation which can have income tax implications for you if you qualify) and instead, you pay capital gains tax when you sell the shares (which comes with a lower tax rate if you have held the shares for longer than a year). Needless to say, if you have been granted ISOs, AMT is a critical factor in thinking through your exercise or hold strategy.

Beyond the tax implications, the other major factor for employees in deciding whether to exercise their stock options is that they need to front the cash to exercise the options (i.e. they need to pay the strike price of the options x the number of options).

For the rest of this piece, we will assume we are talking about ISO allocations (although many of the same principles apply to NSOs).

There are three key components to an ISO options allocation:

1) Vesting schedule

• The most standard vesting schedules involve 4-year flatline monthly vesting (i.e. you “earn” 1/48th of your equity allocation each month) with a 1 year “cliff” (i.e. if you leave within your first 12 months you sacrifice all of your options).
• Most options plans account for “accelerated vesting” in the event of a liquidity event — i.e. your options will vest over 4 years, but if we sell the company in 2 years, you will have the 4 years worth of options converted to shares pre-purchase despite the fact the last 2 years worth are yet to vest. The reason for this is that you don’t want to penalize your employees on a successful early outcome that they helped to drive toward. That said, depending on your contract, alternatives may include you carrying over your vesting schedule to the acquiring company or your sacrificing of the outstanding non-vesting options.

2) Options Value and Strike Price:

In setting the amount of options that might be suitable for a grant, the key factors will be the following:

• What is the current share value? This is the current “best value” of the company (based on a recent funding round or other benchmark comps for companies at your stage and profile, etc). This is the best estimate at the present value of each share.
• What is the strike price of the options? This is the “fair value” of the common shares (often set through a third party 409a valuation, which is often lower than the share price of preferred shares set by an external fundraising as those shares have preferred status which gives them a different value). This will be the price the employee must pay to exercise the options into shares. As you get later in funding rounds and closer to an IPO, the gap between the strike price of options granted to employees and the price set by 409As and funding rounds begins to narrow (options in the early stages are higher risk and therefore more likely to be worth less).
• What value of options to give to the employee? The value of a single option is the difference between the strike price and the current value (so if the current value is $3 and the strike price is $0.50, each option in terms of present value is worth $2.50).

3) Rules for exercising:

• The rules for an employee exercising their options can be very relevant to them. In general, employees can exercise any “vested” options whenever they want
• One major area I see of difference in options plans is the rules for exercising once an employee leaves — some plans require employees to exercise vested options within 1–3 months after leaving the company or they will be forfeited (this can place more “golden handcuffs” on employees because of the tax implications mentioned previously); other plans may permit much longer timelines for employees to exercise options after they have left.

That is about as far as we will get into the structure and financial and tax implications in this piece — suffice to say, you should be aware of them.

General Rules of Thumb

Angel to Series A stage companies (1–10 FTE)

For your first key hires to the company, you will likely find it difficult to use any kind of formula for options and equity. Getting someone to join your dream before it is much of anything and has limited external validation or set equity value can be challenging, and is more of an art than a science.

The reality is that when things are so early and risky, you are not seducing someone to join your team based on the value of the equity today, but rather their share of a dream tomorrow. As a result, in the early days of a company’s development, you may need to communicate about options as a % of the total company (e.g. a senior hire might be 2–5% of outstanding equity, a junior hire might be say 0.1% or less).

In the table below are some very general rules of thumb on typical early employee grant values as a % of the overall company’s fully diluted equity. Ultimately, the way you compensate your employees with options in the early days will vary based on how your company is performing and the status of your funding, the industry you are in, and the importance of the person/role to the company.

Some resources that might be helpful for benchmarks:

• Holloway compensation guide has some good benchmarks (link)
• Option Impact is a paid tool you can use to get more thorough benchmarks too (link)
• Comparably has a useful calculator for looking up equity based on role and funding stage (link)

Employee roles, levels and titles at this early stage are likely more fluid and less formal than the below table might suggest.

Series B+ stage companies

Once the company has raised enough funding to signal business viability and a clearer enterprise value, and you have a bigger team (say 30+ FTE), you will likely make a shift in your options strategy and begin to communicate options not in terms of a % of the company, but rather in terms of the dollar value of the options granted (the recruitment of senior executives might still involve a discussion in terms of % of the company)

Some things that can be useful to do to determine the right dollar value of option grants to give to employees (remember that the value of the grant will be the options value less their strike price):

• Develop an options grant framework that is not based on a percentage of company ownership but rather as a proportion to employee salary — the below is an example framework that might be useful for setting the options bands at each level based on average salaries at those levels
• You should also think about the overall employee option pool available and how best it might be shared among the key hires you need to make
• You want to finally also consider market benchmarks

E.g. if you have a VP on a $120,000 base salary, they would get 0.5x or $60,000 worth of options value. If your company is worth $20m with 10m shares outstanding and the current share price is therefore $2 per share, your VP would therefore get a 30,000 option grant ($60k / $2)

• You can create brackets of equity value for each employee level — Level 6 (C Suite), Level 5 (VP), Level 4 (Director), Level 3 (Manager), Level 2 (Individual Contributor), Level 1 (Associate)
• Moving up between the levels will generally take 12 to 24 months depending on performance. You may even introduce sublevels within the levels to provide employees a sense of progression
• It can be helpful to set a formula for the options grant based on the salary level of the employee too.
• For example, “A new Director has a salary of $100,000. They should get approximately 0.25x that in equity ($25,000). Current share price is valued at $2 so the Director should perhaps get a grant of 25,000 shares at a strike price of $1.00.”

Here’s an example of how to communicate this to an employee:

“We are granting you a salary of $100K plus 25,000 shares at a $1 strike price. The value of these options today is $2 (based on this analysis of comps and past funding valuations). The strike price is already a significant discount over the price per share paid by investors in the previous funding round. The value of these options will only grow depending on the success we as a team have in growing the organization, as we plan to do along with our investor support. For example — if we sell the company for $100M (4x current valuation), your options will be worth $100K; if we sell the company for $500m (20x current valuation), your options will be worth $500K”

Other thoughts

1) You can offer employees two compensation options

Some companies choose to offer employees two compensation options — 1) high salary and no/low options and 2) lower salary and higher options. Some companies like to do this to let the employee decide what they prefer for their own financial security needs and wellbeing. Some companies don’t like to do this as they want all employees to be more vested in growing the company or because cash is important to preserve.

2) It is best to avoid option ranges or “bands” for role levels and rather have static figures

Bands tend to have two potential flaws — 1) the person negotiating compensation on behalf of the company doesn’t understand the value of the equity and so, for ease, gravitates to the top of the band off the bat unnecessarily; or 2) the recipient finds out they’re at the low end of a band and then becomes disgruntled — you need to assume that employees will talk and will find out what each other are on. At a minimum, you will want to have the more junior roles (Levels 1–3) standardized and the senior roles can be more flexible. You want to avoid negotiating with junior new hires. Setting a fair and competitive compensation program upfront that is formulaic and standing behind it is much more advisable than opening negotiations on an individual basis. Junior roles should not get differentiated pay as a baseline — only differentiated pay based on performance in the form of a bonus.

3) Different departments may have different baselines

You might consider suggesting different % levels between departments/functions. For example — depending on the nature of the company, a VP of Marketing may be more or less valuable than a VP of Engineering.

4) Step ups between employment levels

As a general rule, you should structure each employment level to have approximately 2x the baseline grant of options to the level immediately below it. This provides some room and flexibility for you to insert more “sublevels” in between the existing levels as the company grows.

5) Create a system that revisits compensation only 1–2x a year

Do employee reviews and band resets either annually or biannually through a formalized process. Align the compensation reviews with your performance reviews.

6) It is advisable to put together an employee guide for understanding equity

The process will seem well thought out, clearer and formulaic with a guide and many employees will not understand how to value their intangible equity. It will make people more comfortable with the program. The guide should help them to be able to put an estimated value on the options grant today as well as what those shares will be worth in potentially scenario outcomes for the company.

7) There are some tools out there for benchmarks

You may want to find benchmarks for the options pool that are more specific to your geographical region and/or industry.

Good Resources

• Fred Wilson’s blog post here (link) is a little outdated but a good starting point
• First Round Capital has a great overview (link)
• Holloway’s compensation guide has some good benchmarks (link) and Option Impact is a paid tool you can use to get more thorough benchmarks too (link)
• Index Europe also has a good overview and report on options but is EU focused (link) — they suggest C Suite 0.8–1.5% (COOs can sometimes reach 2%, CTOs commonly 1%); VP 0.3–0.8% (0.2–0.7% at Series B)
• AngleList has a good summary of key options terms (link)
• Carta has a good explanation of the tax treatments of ISOs and NSOs under income tax, AMT, and capital gains tax scenarios (link)

For your employees, here are a few reads from Carta:

• How to evaluate equity in a job offer
• How are stock options taxed?
• What to know about equity when you leave a company
• Employee Shareholder Bill of Rights

Founder Guide: Employee Options was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

Demystifying the challenges to hiring your first sales person

Image: Phillip Lemmons on Shotzr images

Introduction

Hiring your first salesperson is challenging. A big reason for this is the complexity of sales quota and compensation. Setting compensation for most other roles you hire for tends to be more straightforward — you determine a salary based on market benchmarks, maybe include a smaller annual bonus of some form, and then allocate some vesting options and perks.

When hiring salespeople however, you will typically be looking to structure a performance-based compensation package which brings into play a whole suite of new, and often complicated, questions such as:

• What performance metric should I use as a basis for quota? Should it be number of customers acquired, total revenue, net revenue, other? Should it only factor for the first year contract value or ongoing value / renewals? Should quota be net of churn or simply gross? etc
• Once I have a metric, how should I set their specific quota target? How long of a ramp up period should I factor for?
• How much compensation should I put into the variable versus base salary components?
• How should I structure the variable commission payout? How should I pay out commission in relation to that quota? Should I pay out on a percentage of quota basis or based on hard caps? Should I use accelerators?

This chapter in the Founder Guide Series seeks to answer these questions with some basic rules of thumb. There are many factors to consider in setting up your sales compensation scheme and many businesses will pose exceptions to the rules. Ultimately, the structure that is the right fit for you should be determined with the nature of your business, your sales objectives, and the types of behaviors you want to incentivize from the team in mind. That said, hopefully this guide is a good starting point for that process.

General Rules of Thumb

Following are some general rules of thumb for early stage startup founders when approaching the sales compensation process.

It is important to note upfront that you should view your compensation structure as fluid. Things change, teams grow, and go-to-market strategies adapt, so you will likely be constantly reviewing and modifying your compensation structure over time. Making changes in the middle of a quota period is not advisable — always try to be transparent with the team and attempt to communicate any changes as far in advance as possible.

1) What Metric Should I Use as the Basis for Quota?

For most SaaS companies, the quota system is most logically based on achieving monthly revenue goals (MRR or monthly recurring revenue). Each Account Executive has a monthly MRR target that will correlate to the commission they receive for the month. For companies focused on larger and lumpier enterprise sales with longer sales cycles, this quota may be quarterly- or annual-based and set on Annual Recurring Revenue targets (not MRR).

It is important to note that while a revenue-based quota is most common, this is not always the case and in some cases you may deviate from this to incentivize the right behaviors.

For example, when I was with the company OurDeal (a Groupon-type company in Australia), we initially compensated salespeople based on gross revenue (or Gross Merchandise Value — GMV), but then later pivoted to compensating based on net revenue (the total proportion of the GMV that was recognized as revenue to OurDeal). This was because we not only wanted to incentivize our salespeople to go out and bring in deals that secured top line GMV, but also on the commission rates they negotiated for those deals. At the end of the day, a $100,000 GMV deal at a 10% commission rate was a worse financial outcome to OurDeal ($10,000 net) than a $50,000 GMV deal at a 30% commission rate ($15,000 net). So we wanted to incentivize our team to think about the net revenue impact and not simply total GMV.

It is important to note that some companies may prioritize other things above MRR in the earlier days of their evolution, such as acquiring customers or landing key marquee customers, in which case you might elect to structure a compensation scheme based on this objective. For example, in the very early days at my last company Kanopy, when we were focused almost solely on landing customers to get our foot in the door (for later land-and-expand opportunities) and get logos (to build our credibility and reputation in market), we set quota for our team based on number of new customers, not on a revenue target. We classified customers and would give extra points for landing larger, marquee customers than smaller ones.

That said, as mentioned, revenue-based targets are most standard and we will move forward through the rest of this piece on the assumption you are running with that.

In general, shorter term goals are better than longer term (weekly versus monthly versus quarterly versus annual) to stay on top of sales and identify problems early, as well as motivate nearer term, stable performance (and not end of quarter “fluffing”).

2) How Should I set the Quota Amount for Each Salesperson?

In setting quota, there are two major factors you want to keep in mind. The first is that you want to set a MRR quota that is realistic and attainable — something that approximately 60% of your reps should hit.

Use your best rep as an example of what “good” reps can do. Analyze historical sales and pipeline data, conversion rates, and closing percentages to work your way to a sales quota amount that you think makes sense for 60% of reps to hit. You probably won’t get this right at first, but over time and by continuously reviewing the assumptions with more reps, you will get more accurate.

The second key factor to keep in mind is that you want to try to achieve a healthy, balanced relationship between an Account Executive’s On-Target-Earnings (OTE) and their quota targets. OTE is the total compensation that a rep will take home (base salary plus total commissions) should they hit each of their quota targets perfectly.

Ideally, the total OTE of your reps should be approximately 20x the MRR quota. For example, if an Account Executive’s MRR quota each month is $5,000, then this would equate to them having an OTE of $100,000. Looking at this equation another way, you ideally want your reps to be bringing in ARR each year at a rate of approximately 7x their OTE (i.e. hitting $5,000 MRR per month will mean a rep brings in $720,000 in ARR across the year, this is ~7x the OTE of a rep at $100,000).

If you are seeing a ARR/OTE ratio that is higher than this — awesome, hire more salespeople! If you are seeing an ARR/OTE ratio lower than this — don’t stress, but it it could be a signal that the sales efficiency of the model you are employing right now is not optimized — maybe you need more time to find product market fit, maybe you need to think about whether you can achieve the same sales quota with more junior/lower cost sales reps, maybe you haven’t fully defined your ideal customer profile for your reps properly, maybe you need to rejig pricing, maybe you need to fully rethink the sales model (e.g. switch to more inbound or self-serve sales), etc. At the end of the day, you need to compete for sales reps on the open market and the OTE you will need to offer to get good reps will be ultimately set by the market.

At my last company Kanopy, we were bootstrapping growth and trying to build a sales team in San Francisco competing with the likes of Facebook and Salesforce, who were paying top dollar OTE for sales reps. A healthy ARR/OTE equation would have been difficult to achieve as a result. Our response was to hire much younger sales reps (1–2 years out of college) and invest heavily in a robust training program to get them to fully ramped Account Executive status as fast as possible. Other companies faced with this situation chose to build remote sales teams or set up a secondary office for customer-facing roles in another city.

In sum, the trick here is to understand market OTE rates for reps, think about what a realistic MRR quota is, and hope that the two align to be a healthy OTE/quota ratio. It is a beautiful moment when you find a sweet spot where these factors align!

It is important to note that a quota discount is standard for new sales team members to account for their ramp up period. I tend to see a 3-month ramp up as the most common in the market, but this depends on your business and the time it takes to train your salespeople and them kickstarted with the customer sales cycle. You may for example give a 100% discount on quota for month 1 (so a salesperson is guaranteed to get paid out), a 50% discount for month 2, and a 25% discount for month 3 — as a simple example

3) How Much Compensation Should I Put into the Variable Versus Base Salary Components?

So you now know your rep’s OTE and MRR target. Now the question becomes, how should I split that OTE between base salary and variable commission?

As a general rule, variable compensation (performance based salary pegged to hitting quota targets) is important to ensure you are incentivizing and rewarding sales performance. Much motivation theory will challenge how important it is (versus other factors such as autonomy, mastery and purpose) but let’s move on the assumption that we agree it’s important.

Sales reps at some companies can be purely 100% commission-based (e.g. many real estate agents, recruitment consultants, hair dressers, etc are paid purely on commission), but this is pretty uncommon for tech startups. In general, most companies shoot for a 50/50 split between base compensation and commission — i.e. if you think that a rep should be taking home a OTE of $100,000 if they meet their quotas throughout the year, then you would structure a $50,000 base salary with on-target bonuses that add up to another $50,000 (i.e. if the rep is held to a monthly MRR target, this would meant that the rep would get $4,166 in base pay and $4,166 in added bonus each month if they hit quota).

That said, you may want to over-index more on equity options and/or base compensation in the earlier days if you are expecting your first sales reps to take a leap of faith in joining your company, play a greater role in the broader team and not just be a standard sales rep, and help you to experiment to find product market fit. In this case you might structure compensation to be more 70/30 or 80/20, or keep it at 50/50 but provide a guaranteed base level of bonus each quota period for the near term.

As another general rule, the more the sales role is outbound focused (versus simply fielding inbound leads), the more it makes sense for a higher percentage of total OTE to be variable bonus. This is because all of the sales process is in the sales rep’s control, whereas with an inbound sales model, they are partly beholden to the performance of the marketing operation in delivering quality leads.

The main idea here is that the sales rep must know exactly what their MRR quota is and how much they get paid based for hitting that goal. The next question logically becomes — well what happens if they fall short of or exceed that goal?

4) How Should I Structure the Variable Bonus Payout?

In its most simplistic form, the variable commission payout (or bonus) is paid out as a formula of the percent of the quota the rep hits. Using the example from above, if the rep hit 120% of their quota, they would be paid $4,999 ($4,166 x 1.2). If they hit 80% of their quota, they would be paid $3,332 ($4,166 x 0.8).

There are two ways to make this more complicated. The first way is through “caps”, which put limits on commission payments by either 1) not paying out anything if a rep doesn’t hit a base amount of quota (e.g. if the rep hits <70% of target, they get nothing. The bonus only gets paid out if their hit at least 70% of target); or 2) putting a cap on how much bonus a rep can make in a quota period (e.g. you only get paid a bonus until a max of hitting 200% of quota — i.e. $8,322 or $4,166 x 2.0. Any additional sales beyond this are not paid out). In general, we don’t believe in capping commissions and they can complicate things and create perverse behaviors

The second way to complicate the bonus structure is through “accelerators”. An accelerator increases the bonus that is paid to a rep the more they exceed their quota. For example — you might provide a 1.2x accelerator on sales made in excess of 100% quota and a 1.5x accelerator on sales in excess of 200% quota. So if the rep had a monthly quota target of $5,000 but brought in $12,000 of MRR, they would get $11,665 in total bonus, calculated as:

• $4,166 (for hitting the $5,000 quota), plus
• $4,999 (for the next $5,000 of sales closed — the 1.2x accelerator applied to the standard bonus rate for the next $5,000 MRR secured), plus
• $2,500 (for the additional $2,000 of MRR of sales in excess of $10,000, with a 2x applied to the standard bonus rate)

Some Other Tips and Parting Thoughts

1) Simplicity is key

You want a simple compensation structure that is easy to understand and track in real time. This is most critical. If a sales rep can’t understand the structure and easily ascertain in realtime how they are performing mid period, things will quickly get problematic. There is always a temptation to structure a quota that is based on hitting many metrics — try to focus it on one metric only.

2) Communication with the sales team is important

If you are rolling out a new compensation structure in the early days of your sales motion, it is advisable to communicate to the team that you are still figuring out the optimal sales incentive structure and to manage their expectations that it could change in the future.

Building trust and communicating clearly on this is important with the team. The team needs to trust you — tell them that you are shooting for them to receive a certain OTE that is fair if they perform, but are still figuring out the right quota structure that makes sense. This should be enough.

3) You need to be careful of sales “discounting”

You can try to factor discounting into the compensation scheme to effectively disincentivize it, but we advise against this. Ideally, you put in place processes outside of the compensation system to avoid steep discounting to be given to customers by sales reps (such as manager approval processes for discounts that are more than 10%, or clear set rules).

4) You need to be careful of “bad sales”

Sometimes there is a temptation to account for churn in a sales reps quota through a “claw back”. For example, you might want to calculate MRR quota as new sales made in a month LESS MRR associated with accounts that churned in their first 3 months. The objective here would be to steer your sales reps toward “good sales” and away from “bad sales”. Because if you don’t account for churn, you might have a rep signing up customers based on unrealistic promises for what your product can do and getting paid out bonuses for those sales, while you see many of those customers churn soon after.

Again — we advise against this. At the end of the day, you are trusting your sales reps to do the right thing. Take churn seriously but keep it out of the commission scheme. Churn can ultimately be caused by many things — a reps activities (i.e. “bad sales”), not directing the rep to the right customers, poor handovers to the implementation and customer success teams, poor product execution, etc. If you see an atypical level of churn in the accounts of a particular rep, take them aside and have a conversation about it. Maybe put them on a warning and monitor them more closely in the following months.

Also — you might want to stage your bonus payments if dealing with multi-year contracts where customers are not guaranteed for the whole time. For example, a large, well-known company recently had a big issue with churn. The company rolled out a sales compensation plan where all reps would get 10% of total contract value for deals they sold to customers. The sales reps started selling large multi-year deals and seeing huge bonus payouts upfront. But as customers were onboarded, many were saw the product fall far short of the big promises the sales reps had made, and many customers churned in Year 1 breaking the contract. So customers were frustrated, the company got a bad name in market, and the company didn’t see the revenue materialize; yet the reps were swimming in large bonuses. So for these large contract situations where revenue is not guaranteed, staging bonus payments out per certain milestones can be important.

5) You may consider factoring for cash-based payments in the bonus structure

Paying your reps out only when cash is received from customers, and not when contracts are signed, may help with problems like the one outlined above and also align everyone’s interests to the company’s healthy (prioritizing cashflow, avoiding bad debts). Reps might hate the cash-first approach, but they’ll appreciate why you’re doing it. You should probably only go down this route if you need to — ideally the contracts with customers should be strong, your product delivers, accounts chases down late payments, and you don’t have your reps wasting time chasing payments.

One other alternative is that you may pay out reps based on contract value signed but offer an extra bonus for cash upfront deals. This will make pulling in cashflow upfront from customer top of mind in your reps.

6) You want performance to be transparent and “live”

Sales reps are best motivated when they can get a live update on their progress toward their goal. If they don’t know where they stand mid-period against their quota, they are likely to quickly become frustrated and demotivated.

Being fully transparent on sales can work really well. At my last company Kanopy, we had a big whiteboard in the middle of the main meeting room in the office where we would track the weekly sales progress for each sales rep against their quota. This created a healthy level of pressure, accountability, and competitiveness, and also encouraged all-team celebrations for big sales wins. It made the reps hungry!

Good resources

• “Compensating the Salesforce” (by David Cichelli) — The book has 40 sample plans in it and is the best I have seen on the topic
• HBR “Does Your Company Have the Right Number of Salespeople?” (source)
• First Round “A Counterintuitive System for Startup Compensation” (source)

Originally published at https://www.accessvp.com on September 23, 2020.

Founder Guide: How to Set Sales Quota and Compensation? was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

by Tom Humphrey, Kirk Holland, and Tyler Knox

Image: Nancy Taylor on Shotzr images

Introduction

Last week, I was approached by the founders of a portfolio company who mentioned they were thinking about bringing on an advisor. They had met an awesome person of high profile who was interested in helping them on their journey and offered the potential for a lot of help.

But they had a few simple questions — how do you go about bringing on an advisor? What should you be looking for in that relationship? How do you set up the right expectations? And how might an advisor typically be compensated?

This is actually a pretty common situation for many founders, so we thought it may be helpful to bring together some of the best wisdom we could on the topic. In reality, there are a couple of ways you can approach the relationship and some simple tips that may help to get it right.

“ The best advisers, helpers and friends, always are not those who tell us how to act in special cases, but who give us, out of themselves, the ardent spirit and desire to act right, and leave us then, even through many blunders, to find out what our own form of right action is. “ — Phillips Brooks

Types of Advisor Relationships

For starters, it is helpful to think of the possibilities of an advisor relationship in terms of a sliding scale of engagement, from an informal mentor at one end of the spectrum to a formal board member or observer at the other. Of course, these are not so much absolutes as dimensions, and there are many differing ways of formulating an advisory relationship.

1) The Mentor

This is the model that most accelerators employ — e.g. Techstars typically pools 40–60 mentors around the 10 companies in their programs to provide general industry and functional mentorship. Think of this as a heightened social relationship for general and typically irregular advice or mentorship. The relationship is more akin to a monthly or quarterly phone call or coffee chat with someone whose counsel you trust, whether it be from personal experience or industry expertise. There is typically no formal structure or agreement, nor compensation involved.

Generally speaking, it is advisable to start any advisory relationship here first and get a good feel for each other and the “advisory fit” before considering other options.

2) The Consultant

You can think of this as an extension of the mentor “coffee chat” arrangement. Perhaps you have an existing mentor relationship that you would like to take further. One option is to consider bringing that person onboard on a contractual basis, effectively as a consultant.

This consultative arrangement works best when you have:

• A well-defined project or scope of work to be done (with clearly defined deliverables)
• The person has the skill set and time availability to deliver on that
• You are not necessarily in need of a long term ongoing relationship

At my last company, Kanopy, we brought on a consultant to help design our customer support processes, another one to help with setting up our business analytics function, and another to help with a product management project. We ultimately went on to hire that last person to be our Chief Product Officer and no doubt the ability to test the relationship through the contract arrangement was a great way to ensure there was a good fit there.

Compensation for consultative arrangements is typically monetary based — often set as an hourly fee, monthly retainer, or set project package.

3) The Advisor

In this situation, you are bringing on someone who you want to be more involved in your company and on a regular, ongoing basis. Most commonly — the relationship might be to support the CEO or executive team with general leadership or team building support, developing a certain functional capability (e..g. Marketing, sales, customer success), or providing key industry insights / customer introductions.

This relationship will typically be formally established through a simple written agreement specifying their role and compensation. In the early stages of a startup, compensation is almost always in the form of equity; only in rare circumstances will such a role involve monetary compensation. If you start a light touch advisor relationship, and notice that the person is adding more value than expected and is indispensable, level them up to a larger advisory role and match it with a larger equity stake.

4) The Independent Board Member (or Observer)

An independent board member is ultimately a “souped up” advisor. Most companies will typically have a formalized board by the time they hit their Seed or Series A round. The board is responsible for higher-level company administrative and strategic decision making (e.g. M&A, financing, budgeting) as well as the general supervision of the CEO. The board will commonly provide founders and management strategic input, support with attracting key talent hires, give fundraising advice, help to make useful connections, and more.

For most early ventures, it’s likely that the board will simply consist of the founder(s) and maybe an early angel or VC investor or two. Sometimes an independent board member might be considered as well.

Independent board members are almost standard in public companies, are very common in later stage companies, especially as they near IPO, and are not uncommon in Series A+ companies.

An independent board member is an individual you elect to your board who is not affiliated with the executive team or major investor base. Often independent board members are brought on to help fill a gap or build a needed strength on the team — they may bring a key and unique perspective to the table (whether that be a key functional perspective such as finance; or a key industry perspective) or they may play a key role in supporting the team (such as leadership mentor). As a board member, they will accept the legal fiduciary responsibilities of being part of your board.

Observers are distinct from board members. They are individuals who may attend board meetings in person but do not have a right to vote on key decisions. Often, board observer status might be given to a non-lead angel or investor who has invested a sizable amount in a round. It is a way to capitalize on the relationship with the person and have them involved in the “team” without the full board responsibilities and powers.

This guide is focused on the latter two — advisors and independent board members. Note — from here on in when talking about “advisors”, we are referring to “advisors and independent board members”.

When does an advisor make sense?

Advisors can be assets to your venture. They will commonly have recent and relevant “ been there, done that “ operating experience that can help you make better decisions.

In thinking about potential advisory support, it is often a good starting point to think about 1) what are your key weaknesses and blindspots as a founder and team? , and 2) what are the critical competencies or knowledge areas you need to be successful? — and figure out where there is overlap.

At the end of the day, advisors can wear a lot of hats, but the most common are:

1) Functional support: they are an expert at (insert sales, marketing, product management, etc) and will help you build that function yourself. In other words, the advisor is filling a gap or role not currently being executed by someone on your team

2) Industry expertise / customer relationships: they bring extensive industry experience and a wealth of information on customers and/or a rolodex of customer relationships for introductions. Such advisors can be especially helpful when targeting technically complex and big enterprise industries (e.g. pharmaceuticals, insurance, utilities, etc). For some areas (especially healthcare) you may need high profile experts as advisors purely for credibility

3) Emotional / leader coach: they support the founder with leadership coaching or emotional guidance. CEO’s often feel the pressure of being squeezed between two pyramids — the investors on top pushing down and the employee below pushing up. Sometimes, there are things a CEO might not feel comfortable sharing or talking about with either of those groups, and so an advisor can be helpful as a trusted and objective sounding board for questions. Oftentimes, an investor can play that role, but not always

4) Team / Hiring advisor: they are well connected into a functional area or industry and can help you recruit and build your team and attract key hires

Specific functional advising is probably less common, as at some point, you will actually want to hire for those functional skills internally. General leadership and industry expert advisors tend to be more common and always needed.

How to build you advisors?

Think like a coach

You should think about your advisor and board composition like a coach might approach player selection for each game. Every stage of your business (seed, Series A, Series B) is a new game, and the optimal players to put on the field might differ overtime.

This is not a marriage. At the end of the day, advisors are there to drive value for you and your company, and if that value starts to fade, don’t hesitate to replace an advisor. The best way to manage this, without being awkward or having to cancel equity agreements, is to keep your advisory agreements short (say, 1 or 2 years in length) so that when those agreements end, you can either choose to “re-up” or let the relationship fade (send them to “the bench”!).

Your set of advisors is often dubbed your “advisory board”. This can be a little confusing as advisory boards do not act like your “board of directors” — they generally do not meet as a group and are just a notional concept applied to the set of people you select as your advisors.

Leverage your network

This may seem frankly obvious, but your own network could already be filled with potential advisors and it is best to start there. Ask people you know and trust for recommendations too — , Founder CEO of Accompany, says “When I started out, I would ask the people I knew who their best and brightest contacts were for X — where X was maybe sales or software engineering. Then I’d ask for intros. I met and met and met and met people. If I felt chemistry, I followed up. If we ran out of things to talk about after talking one or two times, I didn’t pursue. If there was more density, I took note. “ You need to invest to cultivate the relationship.

Identify and shoot for your “reach” picks

You may be hesitant to reach out cold to accomplished CEOs, investors, or others, but don’t. You have nothing to lose in seeking to connect and oftentimes you’ll find that people who have “made it” are actually seeking out opportunities exactly like this. Track down their Twitter, LinkedIn, and Medium to get a window into their expertise, communication style, and personality which can make your approach more meaningful.

Use how these individuals respond as a metric to evaluate their potential. If they’re receptive and actually eager to help, that’s great. If they seem cold or blow you off, it’s likely not a good fit anyway. While getting the big names on board is great, you also need them to commit.

Do not skip due diligence

You should treat an advisor as if they were a new hire. Vet them thoroughly — consider your casual coffee chats as “interviews”, plan on catching up a few times before jumping into a conversation about an advisory relationship, and do some reference checks. Be sure to inquire if there are any conflicts of interest that might exist too.

What kind of relationship are you looking for? Every advisor relationship is different but if you are seeking an engaged relationship, then you want to be challenged and not just have the advisor clocking the punch card. Phin Barnes says, “define your relationship this way: you’ll tell them what you’re thinking or planning to do, and their job is to back you into a corner and make you fight your way out.”

You want to walk away from each conversation with either a new idea or having a pre-existing one challenged. Ultimately, you want to make sure you have the right chemistry, such that you walk away from each conversation wishing you could have spent more time together.

Write a job description

This is super important and often overlooked. More commonly than not, advisor relationships are formed more casually with barely even a handshake. I strongly suggest in all situations that you write up a short job description for the advisor role, which covers both 1) the commitment you hope to get from them (e.g. “you will spend 5 hours per month with us” or “we will set up a call once per month for an hour”) as well as 2) the role you hope they will play (e.g. “you will help with sales strategy and go to market design” or “you will help introduce us to key contacts in the industry”) — to make sure you are fully aligned on what you hope to get out of this relationship and set the right expectations.

This doesn’t have to be written up in formal letterhead (email is fine) but being written down and documented is, in my view, important. You want to hold the advisor accountable.

Beware of red flags

There are some common things that can be red flags in the process of setting up an advisory relationship:

• If the person offers up the idea of being an advisor for compensation in the first interaction or early conversations — I always find it concerning when someone pushes the idea of a compensatory relationship in general, especially when early. In general, I like it when the founder is extending the invitation to join as an advisor
• If the person has numerous other advisory relationships at play — it might be worth asking them “do you have any other advisor roles currently?”. If they respond “yes, I have these 15 other advisor positions” that is definitely a red flag for their potential commitment level.
• Confusing the need for an advisor with the need for an employee. I.e. you might think “I need an expert sales advisor” when in reality you need a VP of Sales on the team. Functional advising tends to be lower value add in general and certainly lower value than real team members!

How to compensate advisors?

Compensation is a really important and difficult part of this process.

Revisiting our early relationship scale, if you are setting up a mentor “coffee chat” relationship, you do not need to typically compensate the individual. If it is a more serious advisor relationship then some general advice is as follows:

• Skin in the game can be great: as a general rule, I find advisor relationships work well where the advisor both invests in the company in tandem with getting a sidecar advisor agreement for additional shares. This is a great way to ensure the advisor is committed to the cause
• Be careful when granting equity: there is no hard and fast rule on how much equity stake an advisor might get. A general rule of thumb for a Seed to Series A company might be 0.1% of the company (for a standard advisor) up to 1% (for a big name, game-changer advisor). When looking at an independent board member relationship, you may need to bump this up more (perhaps to swing between 0.5–2%) — given the person is accepted greater fiduciary responsibilities. The later stages you go, the less equity (as a % of company) would be given to an advisor. You should always be very cautious when giving away equity.
• Use a vesting schedule: it is standard practice to set up an advisory relationship with a vesting schedule so that the equity is earning over time in conjunction with the value added from the advisory services. A 2 or 3 year monthly vesting schedule with a 1 year cliff might be ideal — so that you have the first year buffer to make sure the relationship works, as well as the trailing monthly vesting to ensure equity is commensurate with the relationship
• Supplement out of pocket expenses: you typically will reimburse an advisor or independent board member for out of pocket expenses (e.g. costs associated with meeting with you or attending meetings). It is very unusual to pay cash compensation in the early stages of a company’s evolution

Other resources

• First Round’s “A Field Guide to Identifying and Integrating Independent Board Members” (source)
• Failory’s “Guide to Startup Advisors: Find Them, Reach Them & Secure Them” (source)
• Matt Munson on “How to find great advisors for your startup (and avoid the shit ones)” (source)
• NFX’s “A Founder’s Guide To Taking Advice” (source)
• Samaipata Ventures’“10 tips to turn your startup board into a secret weapon” (source)
• First Round’s “7 Tactics to Get the Most Out of Your Startup’s Advisors” (source)
• Techcrunch’s “What you need to know about startup boards” (source)
• Silicon Valley Bank’s “How to build a startup advisory board” (source)

Originally published at https://www.accessvp.com on September 15, 2020.

Founder Guide: How to go about Advisors and Independent Board Members? was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

by Tom Humphrey and Emily Yuan

Introduction

It is interesting to reflect on how pricing has developed over time. In early civilization, people would trade, barter, and auction items for sale in person and information asymmetry was pronounced (no search engines to find comparative products or reviews). Pricing was always customized through a process of negotiation. Today, most companies offer standard pricing on their websites (except for enterprise sales where you will commonly see the “contact us for pricing” option) and consumers have significantly greater access to transparent information on products and competitors.

Pricing is a very effective value driver. A Deloitte study found that pricing is the most impactful lever on profitability — a 1% improvement in a company’s average price has an approx. 2–4x bigger impact on overall profitability than a 1% increase in sales volume or a 1% reduction in fixed or variable costs.

Source: Wall Street Journal/Deloitte

This is not to suggest that everyone should just go and raise prices. Pricing is hard to get right, especially for early stage tech companies with limited past purchasing behavior, only the earliest signals of market feedback, and immense pressure to drive early customer adoption.

“I’m always urging founders to raise prices, raise prices, raise prices… it is a great way to flesh out whether you actually do have moat… [and] companies that charge more can better fund both their distribution efforts and ongoing R&D efforts” — Marc Andreessen in High Growth Handbook

Pricing is also contextual, and must fit like a puzzle piece into your overall schema of market, product, and business model. People always talk about product-market fit, but I believe product-market-business model fit is a much better definition of the core elements that must to come to together to to set the stage for growth. It is pointless having an amazing product that is priced perfectly for customers at $1 / year and ready to scale aggressively in a large market… if your business model to successfully deliver on the product will cost $2 / year per customer. All moving parts must fit.

The below graphic shows how the “product-market-business model fit” equation can express itself through the dominant go to market business models that orientate around self-serve, inside sales, field sales, and channel sales.

Setting yourself up early with the right methodologies and processes for thinking about pricing is a good idea. Common pricing pitfalls made by early stage startups are (a good discussion on this topic):

• Basing prices off of competitors, research, and existing market conditions instead of from talking to customers and ascertaining actual customer value
• Setting prices in stone and not continually reviewing and adjusting them over time
• Setting prices too low to attract early customers and never raising them over time (it can be easier to drop prices over time than to raise them later)
• Offering features for free (or lumping them in with an existing package) even when it is clear customers will pay extra for them
• Building pricing structures that are too complicated to understand, with the objective of trying to cater to a multitude of individual use cases

It is also important to note that within startups, there are often conflicting viewpoints to navigate — sales might want to keep pricing lower to maintain sales momentum, while finance might be pushing for higher pricing without necessarily having full visibility into the coalface.

The Basics of Pricing Strategy

Fundamentally, there are five core pricing approaches that companies incorporate into their pricing strategy, some more common than others:

1. Value based pricing

Setting a price based on how much the value the customer believes or perceives your product is delivering. This is the most common and accepted approach to thinking about pricing, and you may have heard advice along the lines of “compete on quality, not price” or to “work backwards from the customer’s willingness to pay”. This is obviously the standard approach of enterprise B2B companies, who often craft custom pricing for customers based on the ways in which the customer plans to use the product — often the approach if to try to ascertain what factor is the key driver of customer perceived value (amount of data, seats, features, modules, etc) and price the product based on that.

2. Cost plus pricing

Calculating the costs for building your product or delivering your service and then marking that up for a profit margin. This has been a common approach in many large infrastructure industries such as construction and aerospace as well as professional services businesses such as consulting, where the materials and labor involved are a large part of the cost and there is a lot of customization involved. Another newer and slightly nuanced take on cost plus pricing might be the dynamic pricing employed by Lyft and Uber — “surge pricing” is effectively just adjusting the price the consumer must pay as a function of the cost of the service (the higher cost of getting the driver in peak periods) plus the standard mark up

3. Competitive pricing

Charging a price based on what your competitors are charging and how your product compares relatively. This is a common pricing model in “commodity markets” where there is limited product differentiation — you might notice how when your local gas station drops fuel prices, the one down the road soon follows suit. This can also often be the pricing strategy for a company entering a market where there are established incumbents who charge high prices and the new entrant’s strategy is to compete predominantly on cost efficiencies. SpaceX, for example, charged into the aerospace industry with the promise of building rockets (through improved production methods) for the government at a cost of $80–90 million versus the United Launch Alliance’s average cost of $400 million. “Price bundling” is a common way to build pricing leverage over competitors, offering larger discounts for purchasing product bundles

4. Price skimming

Setting a high price to land your first customers, and then iteratively lowering it as the market evolves, competition enters, you reduce production costs through scale, and/or you satisfy the highest value customers and need to extend to more price-sensitive segments. Price skimming might make sense where there are high production costs that need to be recovered before scale is hit, there are enough buyers willing to buy the product at the higher price, and/or the higher price might be a market signal for quality. Oftentimes, luxury brands might enter a market like this, and then later set up a separate sub-brand to extend themselves into other parts of the market with greater distribution (think Ralph Lauren and Polo). Peloton and Tesla are also good examples too — they both set high prices for their early products, gained premium brand positioning and secured market share with high net worth households. Now they have created lower priced products to extend further into the market.

5. Penetration pricing

Setting a low price to enter a competitive (or blue ocean) market and gain market share and then raising it later once you have more market dominance. This has been a common approach in recent years particularly in markets considered “land grabs” or “winner take all”, where rapid customer adoption has been deemed critical to success. Fierce penetration pricing and discounting has defined many recent consumer marketplaces, such Uber / Lyft, Doordash / GrubHub / Postmates, Rover / DogVacay, etc.

Somewhat of a subset of the penetration pricing model is the “razor and blades” pricing model of the traditional shaving companies. The idea was sell the core razor cheap (often at a loss) to encourage the purchase, lock the consumer in to your “platform”, then monetize on the high margin blades sold on a recurring basis thereafter (almost like a subscription).

The right approach for you depends ultimately on the nature of your industry and business, what your objectives are, and who your customers are. For companies in the early days, your key objective might be:

• Maximizing revenue (which might guide you to value based pricing)
• Gaining rapid market share (which might guide you to penetration pricing)
• Securing your first publicly reference-able customers (which might guide you to competitive pricing and optimizing on value delivery and sacrificing revenue for the short term to ensure early customer success)
• Landing key customers to later expand (which might lead you to some initial price discounting with a roadmap to growing)

That said, value based pricing is the most commonly accepted approach and is, in general, a logical framework for most companies.

How to do “Value Based Pricing”?

The objective of value based pricing is to ascertain as best you can the customer’s perceived value from your product and “willingness to pay”, and then use that to inform your pricing plan (as well as product roadmap, with the view to building features to grow that value).

Value-based pricing is a good approach as it orientates your company around the customer and toward building feature differentiation that grows value.

Remember that the key here is setting your pricing based on customer perceived value, which is not necessarily actual value. Funnily enough, pricing (in a virtuous, reinforcing cycle) actually ends up being a major input into customer perceived value — when you walk into a liquor store, you automatically think the $30 bottle of wine is more valuable than the $10 bottle.

The most effective thing you can do is to not simply try to set a price that closely aligns to customers’ willingness to pay, but to actually peg your pricing model to a key value metric, such that your customers’ ROI is baked into the pricing model itself. Much more on this topic below.

So how to execute on “value based pricing” –

Step 1: Do Your Customer Discovery

Among all of the other questions you might do in talking to early customers for your idea validation, you will want to cover some on pricing too. Van Wesendorp developed a 4-question “pricing sensitivity meter” for researching pricing:

• “At what price would you think product is a bargain — a great buy for the money
• At what price would you begin to think product is getting expensive, but you still might consider it?
• At what price would you begin to think product is too expensive to consider?
• At what price would you begin to think product is so inexpensive that you would question the quality and not consider it?”

In addition to these, some other good questions to ask may include:

• What is the last software solution you bought? Tell me about that evaluation process.
• If I told you that I have a solution for [insert pain point], would you be interested? Why?
• What is your budget for a solution in [insert your product category, such as BI/analytics, security, collaboration tools etc]? Where does that budget come from?
• Who would be involved in the purchase decision-making process?

In working through this process, you need to remember that actions speak louder than words and often people might say one thing but do another. The price a customer says they will pay is never as powerful as the price they actually do pay.

Step 2: Test Pricing on Early Customers

• Build hypotheses around what you think you can charge certain customers for your product then test it with some early customers (say 5–10 to get a meaningful sample)
• Deliver the pricing over the phone / in person if you can (versus an email), so you can gauge the reactions. If they’re adverse to the price, ask open-ended questions that expose the root causes of their anxiety, and then re-evaluate
• Make sure you have done the job of communicating the product value before you discuss pricing

What you want to learn from these meetings and early deals:

• Your upper bound — the highest price range that the market will allow you to charge for your current product. There is a tendency to want to close deals at any cost in the early days, and you might feel uncomfortable pushing for a high price but remember the objective here is to learn how far they will go, if you have done a good job at communicating the value the customer most likely won’t balk, and you can always scale back on the pricing offered at first through tactics such as “let me see if I can chat to my colleague about a discount” or “if we can do a 2 year deal, I could probably reduce that” or “we are an early stage start-up still figuring out of our optimal pricing — what can we do on price to make this work for you?”
• Your anchor — the thing that the customer will typically compare your product against as the alternative or replacement option. Ideally you can set your anchor to something the customer understands — e.g. “our software replaces the need for a HR administrator, who typically makes around $75k per year”. Ideally your anchor is something of high enough value to justify the pricing you propose
• Your messaging — the key words and features that signal the value of your product and that customers want to hear. For example, Weebly initially marketed itself as being “free and easy”, but that insulated in the market the idea of being “cheap and low value”. Over time, Weebly adapted their messaging to be “create a site as unique as you are”, which better aligned to the perceived customer value proposition (even if being free was a real driver)
• Your ideal customers — the key profile factors (size, budget, etc) and trigger elements (specific events, timing, etc) that make for an ideal customer

Step 3: Build Customer Personas

Customer personas are representations you use to profile segments of your customer base. They help you to understand your customers and better tailor your products and pricing to them. Personas can be based on qualitative features (job titles, interests) or quantitative measures (customer acquisition cost, price sensitivity, size).

You want to be specific with your personas — for example instead of saying we sell to “software developers”, you might say we sell to “developers who use Python and have teams of 10–50 people”. This is not to say you can’t sell to people outside of those highly specific personas — this is more just guiding the core people for whom you will design your key messaging, go-to-market and pricing.

Some of the key factors you want to understand on your personas:

• Who are they? Define their background, demographics and presumed personality
• What are their motivations? What are their goals and challenges, and how can your product help them reach their goals and overcome challenges?
• Why wouldn’t they want to use your product? What issues would they have with it?

Patrick Campbell, CEO of Profitwell, has a great section on customer segmentation in his article here.

You may keep these personas more for internal use (to guide how you think about your marketing and product etc) or you may even orientate your packages and pricing directly around them. An example of this is Cloud Campaign, who has structured its pricing packages around freelancers, studios, agencies, and enterprise in its market.

Some Pricing Tips

1) Peg pricing to your main “value metric”

There is a great article on this topic here from Patrick Campbell, CEO of Profitwell. His key point — in the beginning, don’t worry too much about getting the price exactly optimized and just get it in the right ballpark (am I a $10 product, $100 product, $500 product, etc). You will be able to optimize the price with more refinement later. What is most important to get right upfront is 1) the value metric you use to set pricing, and 2) your ideal customer profiles and segments.

Pricing based on a value metric (vs. a flat tiered monthly fee) allows you to essentially have infinite price points, best align customer pricing to product value, and grow with your customers. This optimizes both your market and revenue potential. Value metrics help growth (your revenue grows with customer usage) and churn (if customers consume less, they pay less and are less likely to churn). Companies using value metrics are typically growing at double the rate with half the churn and 2x the expansion revenue when compared to companies that charge a flat fee/pricing tiers.

There are many great examples value metric pricing out there, e.g. Stripe (2.9% of value and $.30 per transaction), Slack and Salesforce ($x per user), Hubspot and Pardot (number of contacts), etc.

To give you a personal example — at my last company, Kanopy, we entered a market where existing incumbents sold large content packages to colleges for a large fixed subscription price, meaning customers had to build the business case upfront to justify the purchase (will this be used? how much so? will it be worth it?). We flipped the pricing model on its head with an innovative cost-per-use model with no upfront payment and usage-driven monthly billing — which meant that 1) customers didn’t need to craft the business case upfront (“we will only charge you if you get value, and you are guaranteed this exact ROI”) and 2) our entire company was orientated around delivering end use value, because if we didn’t, we didn’t get paid!

2) Remember that recurring revenue is premium

Whether your product is a technology solution, a service or project-based, the first step to your pricing is determining the right revenue model. The two primary revenue models are recurring and transactional.

Recurring revenue is where a business has continuous, repeatable revenue based on an ongoing service. Much pricing we see today is recurring, such as Netflix, Spotify, Amazon Prime, etc. For consumer platforms, this revenue is often called subscription revenue. For B2B companies, it is often called “SaaS” or Software as a Service revenue (almost all B2B startups today shoot for SaaS revenue). More interesting recently has been the invention of the “RaaS” model for large capital goods businesses — rather than sell a large capital item for a one time fee, rent it on an ongoing basis with a maintenance and servicing package included.

Transactional revenue, on the other hand, involves a one time payment for a good or service through a transactional purchasing process. Transactional pricing makes more sense when customers make large but infrequent purchases or the product is completely different for each purchase (e.g. at Whole Foods, I might buy toothpaste today but avocados tomorrow). Other common examples include Airbnb (where you transact each time to make a booking for a property), Sephora (where you add things to your cart before purchase), or Ticketmaster (where you buy tickets for individual events).

Recurring revenue is the model most prized pricing model by investors. “Companies with SaaS software models averaged a 6x revenue multiple, twice as high as the 3x revenue multiple that perpetual software companies average”. On April 23, 2012, Adobe moved from a non recurring revenue-based product model to a recurring revenue-based subscription model when it announced Adobe Creative Cloud. This change resulted in a 35% decrease in revenue the following year. However, according to Harvard Business Review, “in April 2016 Adobe’s stock price had nearly tripled from its value four years earlier.”

Another more recent example is Apple — Apple’s Q2 2020 earnings per share were up 18% on a year earlier yet their share price is up 115%. I.e. their market cap doubled despite earnings seeing modest growth. Obviously many market forces can be at play, but no doubt a big factor is the growth in the % of revenue that has switched from transaction purchases (of apple products) to recurring (icloud, appletv, apple care, apple pay, apple store share of app subscriptions, etc). Scott Galloway has dubbed this approach of Apple “rundling” — a mixture of bundling products and services into a recurring revenue model. Apple’s average price-to-earnings over the past decade has been about 14, lagging other high-growth companies with recurring revenue and reflecting its singular dependence on iPhones sales. Salesforce.com and Netflix, which rely on recurring revenue, are trading at over 95 and 85 PE respectively.

Why is this the case? Recurring revenue models are attractive because they have more predictable revenue streams and customer behaviors (such as churn), are less prone to seasonal fluctuations and instability, and typically require lower ongoing costs through better expense management and not having to continually engage customers to re-buy.

Many of the leading companies in verticals today have managed to turn traditionally transactional businesses into recurring, even in markets that might have seemed ill suited to recurring beforehand. For example — I used to buy Microsoft Office as a one time software package for my computer and now am nudged toward an annual subscription which follows me to all my devices. I once bought music on iTunes, and now pay $9.99 per month to Spotify. The purchasing of ski tickets was typically transactional for a single day or week and bought at resorts, until Vail Resorts came along and invented the yearly Epic Pass. Peloton turned the purchasing of a bike into an added content subscription package. Shaving was a transactional business too with Gillete, until Dollar Shave Club came along and began a monthly razor subscription.

It is also important to note that some companies that are essentially transactional have elements of recurring in the sense that ways in which consumers engage with the product is much more predictable and reliable, thereby delivering the key benefits of a recurring model. Think Uber and Paypal, where they make revenue off of individual transactions, yet consumer purchases are very frequent and significantly more predictable. Or to a slightly lesser degree, Airbnb, where the average consumer would spend much more regularly and predictably (given the breadth of supply and use cases served) than with your average hotel chain.

3) Play to the “goldilocks principle”

Named after the famous fable where Goldilocks, faced with three bowls of porridge, found one to be too hot, one too cold, but the third just perfectly down the line, the goldilocks theory of marketing implies that it is best to offer customers three pricing packages to choose from (a high, low, and middle version). The reasoning being that:

• Customer psychology will naturally guide customers toward the middle priced option as that seems most balanced and “average” (so you want to make that an attractive one)
• It provides more flexibility to segment and land customers which will have different budgets and pricing expectations along
• It provides the context for future conversations around upsell by clearly outlining different product packages and tiered options

Apple has always been a great follower of the Goldilocks gospel –

There are many levers to pull on to separate package versions, such as limits on users or data, different features, etc. Ideally you want your packages to be simple to understand and logically set up in terms of the tiering to align the upsell conversations with customers with their natural points of growth and product ROI.

4) Surpass the “endowment effect”

People tend to overvalue things that they already have, making it more often than not harder to to convert people from a competitor than to get them to buy something new. This is commonly called “switching costs”. Depending on how large the switching costs are, you may need to consider reorienting your pricing strategy when a prospect is using a competitive solution (giving the first month free, waiving implementation costs, etc). For example, mobile carriers will often pay out your existing device contract to switch from a competitive carrier.

5) Encourage upfront annual contracts and payments

When visiting the pricing pages of most leading SAAS companies, you will see a familiar toggle offering annual or monthly pricing, typically affording a discount in the range of 20–30% for paying annually.

The value of doing this is twofold. First — cash is king. It is such a simple rule, but the cheapest cash to any startup is cash from customers, much cheaper than cash from investors or debtors. Second — you will (most likely) see lower churn rates with a higher rate of yearly billing adoption (as customers, beyond being locked in, will have more time to adopt and implement your product). Some data suggests that companies with 75%+ of customers on annual contracts see ~2.6% churn versus ~10.4% churn for companies with no customers on annual contracts.

When you get to a level of mature market dominance, you might even find yourself in a position to do away with monthly pricing options altogether, like Salesforce (only offers annual billing today).

6) Consider longer term contracts

Even if it is not possible to charge your customers annually, and monthly is the only viable billing option, you may want to consider whether you can sign customers up for 1-year or longer contracts while billing them monthly. This won’t impact your cashflow but might impact your retention rates, give a stronger sense of forward looking projections, and give your success team more time to get customers to a point of comfort to reduce early activation failures. This is Salesforce’s standard approach — they will generally lock you in for 1 or 2 year contracts, while bill you monthly for the service.

Note, forcing customers into longer term contracts should never be viewed as a replacement for delivering on a great product/pricing promise to customers; it should purely be considered a strategy for enhancing your customer relationships.

7) Deliver pricing effectively

When engaging a customer in an inside or field sales conversation, always qualify before you quantify. The customer must earn their way to the price, do not offer it upfront. Push a customer to a demo first — you must use this to both understand the customer’s specific situation and challenges (listen) and position the value of your product in the best possible way in light of that (present). Get the customer to verbally agree on the value of the product in meeting their needs to then set the stage for a pricing conversation: “Based on everything we have discussed, would you like to move forward?”

Price always comes at the end. There will be times where the customer is pushy and you need to deliver a price. In this situation it is best to deliver a price range. For example: “well we offer some different package options and it depends on your needs — we have some smaller customers on the basic version at around $20K and some larger customers pay over $100k per year for our premium product.” Ranges are helpful so you don’t anchor the discussion too early. It is much better to deliver pricing over the phone than in writing.

Don’t jump to discounts; instead try to foster empathy. Don’t be afraid to admit being a young company and that you are still trying to learn from customers. Maybe ask what their concerns are with the price and how it could work for them.

8) Track pricing feedback

Use your CRM system or a simple google doc to collect important feedback on your customer conversations. Have a “loss” type field (to record why the customer declined the product — e.g. went with a competitor, pricing too high, wrong timing, went quiet, etc) and if the pricing was the factor then record the feedback on that. You may also want to track the customer journey in the sales process — what was their specific situation or point of interaction that was the catalyst for purchase.

When do free trial / freemium models work?

Saas companies of the past used to solely offer “demos” or “free trials” to lure in leads, but the freemium model has become increasingly popular over the past decade. You see this model in services such as Dropbox, Tinder, LinkedIn, Spotify, Slack, Zoom, and The New York Times to name a few. Even in other verticals, the freemium model has prevailed — take gaming, where most of the more popular games of today such as Fortnite are completely free to play and the monetization is strategically designed through in app purchases and upgrades.

The Freemium model ultimately shifts us from a time-based paywall (free trials) to a feature- or functionality-based paywall (freemium). Freemium particularly makes sense where a couple of factors exist:

First — there are strong network effects and viral benefits to your product, where people are likely to refer and share things virally with non-users (which you want to support) and/or the value of the product grows with the scale of users. If a product generates more value with more people using it — such as in viral products like Calendly or Zoom — freemium is a good way to go. Freemium products that grow with virality can also drive incredibly low CAC for users onto which you build an upsell or inbound sales model. This is often called a “bottoms-up adoption” approach. You want to see users be evangelists of your product for freemium products to work.

Second — your product is structured in a way that there are very logical in-product “stage gates” which create highly emotional impulses to upsell. A good example of this is Linkedin, who’s greatest pinch points are at the point where you want to send a message to a non-connection or do advanced searching.

For Slack, their most effective stage gates were around team features and the length of message archiving, a great way to segment out enterprises. For Zoom, their most effective stage gate is the 40 minute call limit which is a great way to segment out professionals. For Spotify, their stage gate is advertisements and the ability to create and store playlists.

Third, the feature differences between free and paid are simple to understand. Dropbox does a great job at this — free until 2GB of storage, then you must pay. LinkedIn, on the other hand, actually does a pretty poor job at this — the specific additional features that come with premium are somewhat unclear and the lines between packages are fairly blurred.

Fourth, the value of the features to the free user are compelling enough to encourage them to sign up, but not so valuable to cannibalize conversions to paid. A good example of getting this was the New York Times, who back in 2011 gave users 20 free articles a month. They soon realized they were giving too much away for free (and were seeing low conversion rates to paid), so cut this down to 5. On the other hand — it can be dangerous to cut back on features that are core to the product’s value from the free version as the user might not see any of the value and have a bad experience — you may as a result of this see a low conversion to paid and a lot of churn from the free version.

Getting the balance right is critical. You want to track your conversions closely and test different strategies. If you are operating in a small market, you may want to shoot for a higher conversion rate (say 5–10%); if you are operating in a massive market, you might be comfortable with a lower (2–3% conversion rate).

Fifth, the people you are targeting as your Ideal Customer Profile will respond well to a freemium model. If you have an enterprise-grade product and are targeting senior people at large companies, freemium likely won’t make sense given 1) a consultative sales conversation is in general a more logical approach, to understand their needs and customize a demo and pitch to them; 2) such people are time poor and are less likely to “play around” on a free version of a product; and 3) often implementing your product requires more customization and a bigger implementation lift, so a free product version will unlikely give an adequate experience with the product that you are hoping to convey.

Finally, your cost to successfully implement and serve the freemium users is low such that you are not significantly eating into your overall margins. Or, in the case of Spotify, you might actually find an alternative way to monetize the freemium to cover the costs — Spotify’s free version is supported through ad revenue. If your product requires personal handholding to successfully get customers set up and onboarded, freemium will be difficult.

That said, David Sacks would tell you that “I usually recommend that SaaS companies go with the Free Trial approach because it’s easier to implement in the product and coordinate with sales and marketing efforts”. Key drawbacks of freemium can include:

• The free version can become your biggest competitor — there might be less urgency to buy if the free version is working. With a free trial, buying urgency is built in via the time limit of the trial
• A lot of product management goes into creating and maintaining a functionality-based paywall — with a free trial, you are only building one product
• Paid marketing is much more complicated — it can be harder to ascertain marketing ROI when it can take months to convert users to paid

A recent Openview survey of 150 companies explored how free trials stacked up versus freemium models. They found that freemium generally opens up a business’s top-of-funnel much more, with typical freemium tools generating 33% more free accounts for every website visitor. However, unlike a never-ending freemium product experience, free trials drive urgency to purchase, made clear in the median conversion from free to paid being higher. If a business is laser-focused on maximizing conversion and near-term revenue, free trial might be a more logical option. That said, freemium products convert customers without sales 25% more often than a free trial model so tend to be more cost effective.

Case Studies

Atlassian

Tying your pricing and sales model together

Atlassian entered the project management market with Jira in 2002. At the time there were incumbents who were defined by hybrid on prem and cloud solutions (Atlassian went all in on cloud only, which made their product development and management costs lower), fixed high price license options, and expensive field salesforces.

Atlassian, mostly by necessity (the team was bootstrapping and based out of Australia), dedicated to launch with no sales force and instead a very low cost (all options were under $5K as that was the max limit for most credit cards) and self-serve model with frictionless sign up. In turned out this model worked well, especially with the audience they were marketing too (devs) who seemed to respond better being sold to by a product and not a human.

Atlassian also switched the model from fixed licenses to user-based pricing. This allowed them to get broad market adoption with small teams into the funnel of their product and grow with them as they matured into enterprise. It turned out that in this space, broad product adoption was important to become the dominant “UI experience”. There are real “UI switching costs” in many markets — think how hard it is switching from IOS to Android or Mac to Windows — and this was one of them.

Finally, Atlassian in addition to the above, launched aggressive pricing campaigns in early days. They launched a 5-day campaign for Jira at $5 for all teams under 5 users, with all profits going to charity. In 5 days, they raised over $100k.

Slack

When freemium wins over free trial

Interestingly, Atlassian was on the other side of the table when it came to their team collaboration tool, Hipchat. Hipchat was first to the market and was growing very nicely. Atlassian set a simple pricing structure of $2/user and operated a free trial model followed by a forced credit card upgrade.

Slack on the other hand came into the market with a new freemium model — a completely free version of their product for all with a paid version set at $10/user. Even though their paid version was 5x the cost of Hipchat, this model won out at the end of the day. Why? Because –

• For every paid user, there were a lot of free users not using the competitive products (so it blocked out the competition)
• The product was very prone to virality, so those using the free version could easily refer others to join and adopt at a much higher rate and lower CAC
• It ensured that the Slack interface was the dominant experience in the market that users became accustomed too (creating “UI switching costs”) — Slack even made strong pushes into the college market to acquire users whilst they were students, so when they entered the work world they would take that love for product with them
• It gave an extended amount of time for Slack to invest in converting free users to paid (through direct sales or self serve product workflows), whilst Hipchat only had the short trial period to convert users after which they were lost.

Slack is also a great example of customer validation. Slack notoriously started out completely free for its early adopters (with no priced version at all). This allowed it to build a customer base and monitor usage to learn how users engaged with the product and where the key sources of value were. The team spent time talking to customers and reviewing usage data to ascertain the true sources of customer value. When they eventually “turned” on pricing for customers, they became a $1m revenue business overnight.

Salesforce

When a freemium version doesn’t make sense

Salesforce was one of the first, and is by far the most popular, cloud based enterprise-level CRM. When Salesforce was first conceived, nearly all software was on-prem, resulting in longer set-ups and less accessibility. Thus, when they launched in 2000, they had to also educate and convince users to try the cloud.

Salesforce initially launched with a freemium model where companies would be able have 5 free users, and as they grew from there, could add users at a relatively steep price of $50/user/month. This helped them to get smaller teams and startups into their funnel which would convert with their business scale.

However, overtime Salesforce has shifted away from freemium and their lowest pricing tier for startups under 10 people — their “Essentials” product — sells for $25/user/mo. This shift was likely driven by a couple of factors:

• Salesforce software doesn’t experience the same network effects across companies and between people, and thus, would not have benefited from the virality aspect that Slack did
• Implementing Salesforce is a “heavy lift” and often involves sales and customer success on the Salesforce side as well as customer resources for the data importing, configuration, feature customization, etc — this makes it harder to parse out features for a lite, self-serve version
• At this point, Salesforce has achieved market dominance (have 20% fo the CRM market) and no longer needs to price so aggressively for market share and awareness

Calendly

Launching yourself into a market

Calendly runs on a freemium model that, much like Slack, leverages the simplicity of the platform to allow the tool to easily be distributed among a user’s connections. The platform went into beta testing with over 10k users, more than most launched products and which kickstarted their growth.

Once they launched and had users, they were easily able to add a paid premium version later that instantly converted some customers. The virality, ability to share, and ease of use of Calendy has made it a perfect candidate for the freemium model, as the core feature of the product being the sharing of calendars and meeting invitations at a high daily cadence with others made it a perfect candidate for virality and organic growth.

Individuals using Calendly can try out all of the features for 14 days, and then are reduced to the free version (with more feature restrictions) unless they choose to upgrade to a Premium ($8/user/month) or Pro ($12/user/month) version.

Zoom

Entering a crowded marketplace

Zoom is a textbook example of execution on freemium. A big reason for their logic in launching with freemium was that they were entering a competitive market. In an article, Founder CEO Eric Yuan said, “we really want to get the customers to test our product. This market is extremely crowded. It’s really hard to tell customers. ‘You’ve got to try Zoom.’ Without a freemium product, I think you’re going to lose the opportunity to let many users test your products.”

Once they had users trying their product (because it was free), their next job was to delight. Yuan said, “We make our freemium work so well. We give most of our features for free and one-to-one is no limitation. That’s why almost every day there are so many users coming to our website, free users. If they like our product, very soon they are going to pay for the subscription.”

Superhuman

Playing the luxury or exclusivity card

To provide a counter example to those above, Superhuman is a fascinating case study as it runs in the face of many common theories of business — i.e. make your pricing transparent (Superhuman’s pricing, which is today approx. $30/mo, is completely opaque and unlisted), let your users self-serve where possible to keep sales costs low (Superhuman manually onboards every user with a personalized demo call), offer free trial or freemium options for lead gen (Superhuman offers neither, and you must “sign up” for the waitlist to be let in), don’t compete with free (Superhuman entered a market where they are taking on big incumbents such as Google and Microsoft who’s products (Gmail, Outlook) are completely free). Superhuman has charged at a competitive market and is choosing to compete on features and branding, not price.

If you visit Superhuman’s website today, you will not see any pricing or free trial options but rather a simple feature to enter your email to request access. In the early days, the only way to get access was to be “referred” into Superhuman by an existing user, with your acceptance more likely the more referrals you received. By stage gating access, Superhuman has created a sense of exclusivity and desire for entry much like the role of a bouncer outside the nightclub.

Superhuman is also fortunate to benefit hugely from organic and viral growth — all users’ emails are capped off with the tagline of “sent via superhuman”, and when the average person sends and receives 121 emails per day, that starts to add up. What is particularly smart with this strategy is that 1) their core target market of venture capitalists and startup leaders also happen to be an audience that is very likely to be in receipt of these emails (i.e. their target audience is dense in the organic referral audience); and 2) they have tied their branding to a highly attractive and aspirational goal — who doesn’t want to be “superhuman”?!

Good Reads

• Patrick Campbell of Profitwell’s article on pricing here — some other tips he talks of not outlined in depth here include — 1) Case studies boost willingness to pay quite a bit; 2) You should experiment with your pricing in some manner every quarter; 3) Should you end your price in 9s or 0s? Depends on your price point; 4) Don’t discount over 20%; 5) Value propositions matter oh so much; 6) You should localize your pricing to the currency and willingness to pay of the prospect’s region
• Openview has a great set of resources here — 1) a good list of pricing resources and thought pieces (Openview); 2) a resource on how to approach customer segmentation (Openview); 3) “3 Famous Freemium SaaS Strategies (And Why They’re So Good)” (Openview); 4) “7 Reasons Why Companies Fail with Freemium (And How to Actually Succeed)” (Openview)
• Julien Lehr has a good piece with 9 pricing strategy tips (Lehr)
• Great perspective on sales tactics in field sales (First Round)
• Good review of general value based pricing theory (Sequoia)
• Good perspective on how to conduct buyer persona research (Hubspot)
• Good review of when freemium works (HBR)
• “Freemium vs Free Trial: Which is Better for SaaS Startups?” by David Sacks
• Lenny Rachitsky’s “How today’s fastest-growing B2B businesses turned their early users into paying customers — Issue 36” (source) —his key highlights:

1. “100% of companies ended up building a sales team, including every bottom-up driven business
2. Founder-led sales is how most companies kick-started growth
3. You don’t need to launch with a paid plan if you are going bottom-up. Seven of the twenty-five companies I looked at (including Segment, Figma, and Airtable) had no paid plans when they launched. They then worked with their power-users to figure out what the paid plans should be.
4. You can adjust your sales strategy down the road — Zoom and Amplitude started sales-driven and later became bottom-up-driven. Box and New Relic did the reverse.
5. Nearly company offered a free plan from the outset — usually a freemium tier, and occasionally a trial period.
6. There are four options for charging B2B users: a flat monthly fee, a per-seat monthly fee, a usage-based fee, or a transaction fee. Most of the companies I looked at charge a monthly per-seat fee, and sometimes include multiple changes (per-seat + flat monthly fee, or usage-based + flat monthly fee).
7. Sales-driven companies love blue logos”

Originally published at https://www.accessvp.com on September 3, 2020.

Founder Guide: How to Price Your Product? was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

by Tom Humphrey and Willa Sobel

The State of Play

The demands of digitally-reliant consumers and a post COVID-19 world are ensuring that the ecommerce industry is gearing up for major disruption in the coming years.

Before exploring where we are heading, it is important to understand where we are. In 2019, total retail sales topped $25 trillion globally growing steadily around 4% each year the past half decade. Of this, the US accounted for $5.5 trillion which was (pre-covid) expected to grow by 2.8% to $5.6 trillion in 2020. COVID has naturally thrown a wrench into the mix. Due to the pandemic’s significant demand shock, store closures, and stay-at-home orders, total US retail spending is now expected to decline around 10.5% to $4.9 trillion in 2020.

Ecommerce has gradually been chipping away as a share of total retail sales over the years, increasing from 8.9% of all sales in 2017 ($450 billion) to 11% in 2019 ($601 billion). If one were to focus solely on the sale of “general merchandise”, 2019 was actually a milestone year with total online sales exceeding physical sales for the first year ever. COVID has also had the impact of speeding up the transition to online sales, and in 2020 approximately 14.5% of all goods sold in the US are expected to be web-transacted, an alltime high, the biggest share increase of any year and a 2.5% gain in market share of sales above original pre-COVID forecasts.

That said, and despite the growth of Amazon, the US is well behind other countries, most notably China. In 2017, while 9% of retail sales in the US was conducted online, China saw 23%, the UK at 19% and South Korea at 16%. India is well behind at 2.2%, which combined with a 1.4 billion population is perhaps why everyone is jumping in so aggressively on Jio.

China has seen huge innovation in the ecommerce space over the past decade with JD.com, Alibaba, Tencent, and Pinduoduo (the company that you’ve never heard of that is actually listed on the NASDAQ and is the fastest company ever to hit a US $100B valuation, reaching that achievement less than 5 years after its founding). So obviously a lot of room for continued growth.

In 2017, ecommerce accounted for 23% of all retail sales in China versus only 9% in the US

Given the shift to ecommerce was already well underway, the effects for physical retail are likely to be lasting. How things shake out from here with covid is uncertain and largely depends on the course of the pandemic, regulatory responses in terms of stay at home orders and retail restrictions, and new technologies to enable safe shopping. In the short term, luxury and discretionary purchases or those related to travel and outdoor activities will continue to be hurt more than purchases of necessity such as groceries and purchases for home use and entertainment. Even french luxury conglomerate LVMH shifted normal supply chain operations to produce hand sanitizer during global shortages. Supply chains (production, manufacturing and shipping) will continue to be severely disrupted.

Beyond the shift to ecommerce, another big theme has been consolidation. Amazon, Walmart, and Shopify are industry powerhouses and continue to rapidly innovate to compete and grow. Much of the ecommerce market today is directly attributable to Amazon, which is growing at above-market rates and is expected to account for 38% of all online sales in 2020. No doubt the desire for reliable delivery, improving turnarounds of click-and-collect fulfillment, and the expansion of goods offered into groceries and other lines is driving this. The top 10 online retailers in the US now have approximately 60% market share. Although, with recent moves by congress and administration to break up big tech, Amazon may well be laying low for a while.

Key Themes

A couple of key trends are looking to define the ecommerce industry moving forward and, as you know, all great things come in sevens…

1/ Mobile purchasing will grow rapidly through technology enhancements such as Augmented Reality (AR).

Mobile sales have increased as a share of US ecommerce sales from 34.5% in 2017 to 49.2% in 2020. Yet despite this, conversion rates on mobile are less than half than on desktop. Many companies are shifting to be “mobile first” in their approach with new technologies such as accelerated mobile pages and progressive web apps affording improved shopping opportunities and faster loading.

Recent enhancements in AR are breaking down one of the biggest barriers to e- purchasing today — the inability to “try things on”. This factor, combined with the promise of “free returns”, means that consumers often make erroneous purchases, leading to significantly higher return rates. Approximately 8–10% of instore purchases are returned compared to over 20% for ecommerce, driving a significant cost line for online retailers. By affording consumers the ability to visualize their purchases in their home or on their bodies, AR will increasingly close that gap. For example, Warby Parker and Sunki now allows consumers to try on glasses virtually online pre-purchase (overlaying the glasses to your computer’s video). Threekit and Seekxr are two examples of companies spearheading the AR initiative for other ecommerce companies.

2/ The rise of vCommerce (or voice powered commerce) and digital voice assistants.

There are expected to be 8 billion digital voice assistant enabled devices in the market by 2023, and the smart speaker market is projected to hit $36 billion by 2025 (up from $12 billion in 2019). VCommerce conversational chatbots are rapidly improving and increasing their share of retail sales, yet have not taken off as fast as was initially expected, largely due to consumer concerns over privacy and the need for enhancements to overcome errors (some quite funny!). The rise of vCommerce is also expected to have a major impact on SEO as the focus switches to emphasize optimization for voice over search results.

3/ Artificial Intelligence and automation will significantly streamline workflows and enhance personalization.

Personalization in online retail is nothing new — already by 2014, upwards of 73% of retailers offered some form of basic website personalization leveraging location data and curating a targeted consumer experience, but strategies are rapidly getting more sophisticated. Perhaps no company encapsulates the opportunity for the use of data, AI, and personalization in the retail process more than Stitch Fix, the personal styling company that curates and ships personalized outfits based on mass data analysis of preferences and behaviors. Some areas where AI and automation is enhancing the ecommerce value chain include:

• Product merchandising — supporting relevant product assortment and “customer-centric search” to improve conversions, automatically preloading storefronts for major events, real-time pricing adjustments and “flash sales”
• Marketing — optimizing messaging and channel mix and automating the engagement of customers based on known profile and behavior, streamlining tracking and reporting
• Inventory — automating inventory alerts and the scheduling of reordering, analyzing sales to identify product development opportunities, warehouse robotics
• Support — assisting customers with their questions instantaneously to improve NPS and reduce support costs (as much as 85% of interactions will be moderated without human presence in 2020)
• Fraud — identifying and flagging / cancelling high-risk orders (e.g. NS8 in Nevada recently raised a $123m series C to reduce fraud through behavioral analytics)

4/ Brands will grow their Direct-to-Consumer channel and transition to social media platforms for retailing.

A number of factors have been driving major brands to look to grow their direct to consumer sales channels — 1) the growing threat of retailer private labels (now expected to account for almost 20% of all consumable sales), 2) the shift to ecommerce and mobile sales (in 2015, it was reported that 70% of shoppers made mobile purchases, which has only grown since), 3) the desire to own the customer relationships and data, 4) the proven success of DTC companies such as Dollar Shave Club and Warby Parker, and 5) more recently covid (which has slashed retail channels and forced brands to seek sale elsewhere).

In addition, this spring, Facebook announced Facebook Shops, a way for users to seamlessly purchase items from their favorite businesses directly on Facebook and Instagram, which will only serve to dramatically increase the possibilities for DTC. Perhaps one of the most interesting differences between the ecommerce shopping experience in China versus that in the rest of the world is the role of social features in the process. In China, the biggest ecommerce companies are heavily integrated into social media and messaging (e.g. Pinduoduo is built almost entirely on Tencent’s WeChat platform) and strong social elements are married with the purchasing experience (e.g. on Pinduoduo, consumers can see what their friends are buying, join buying groups, and even play games that connect to the purchasing behavior… think Farmville meets Facebook meets Groupon meets Amazon).

With this move by Facebook, a new digitally native Gen Z population, and the blueprint of China’s market, we are likely to see growth in “social-selling” in the US.

Some of the key areas of opportunity that DTC affords to brands over traditional retail through the direct customer relationship include:

5/ New innovations in shipping, logistics and fulfillment will be a key focus.

With Amazon pushing the envelope and offering standard one day shipping, consumer expectations are heightening and moving closer toward same-day (same-hour?) delivery. Combined with a high return rate, covid, and recent government tariffs, pressure is mounting on supply chains and shipping costs. Amazon’s shipping and fulfillment costs alone totalled $78 billion in 2019 or 28% of their total sales. Innovation here is key to keep costs in check and meet service expectations. Some initiatives companies are taking include 1) structuring incentives to better align customer purchasing behavior to optimized logistics (free shipping thresholds, lower shipping for longer delivery times, etc); 2) multi location inventory warehousing to reduce transportation costs and time; 3) buy online and pick up in store options; 4) technology experiments such as drone delivery (In 2016, the U.S congress legalized the commercial use of unmanned aerial vehicles (UAV) and Amazon launched its Prime Air program in early 2020) and self-driving delivery robots (e.g. Starship technologies); 5) greater connectivity between the systems of retailers and brands to provide visibility over broader inventory and support activities such as “drop shipping”; etc.

6/ Point to point solutions will continue to be developed to enhance key components of operations to “level up” to Amazon.

What has been proven over the years is that very large companies can be built by attacking singular “picks and shovels” problems in large commercial value chains. For example -

“during the gold rush, it wasn’t the miners that made the real money. It was the toolmakers, the workers that manufactured the implements necessary for the droves of miners to strike it rich. We remember Levi Strauss & Co but few rarely can recall top gold miners of the time. The toolmakers made riches; the vast majority of the miners went home empty handed.”

Whether it be Bolt and NS8 for the check out process and fraud detection, Afterpay or Affirm for “buy now, pay later” payment options, ROKT for relevant recommendations at purchase, ShipBob for Amazon level shipping logistics, Happy Returns or Loop Returns for an optimized returns process, Recurly for recurring subscription payments, or otherwise — the size of the market, the ability to market through the marketplaces of shopify and other platforms, and the significant impact that marginal moves of the needle on any ecommerce metric can have, makes the opportunity for point-to-point, “picks and shovels” solutions to be successful.

That said, key players in the space will start to diversify product offerings and leverage customer relationships into new opportunity areas driving some consolidation — for example, Yotpo (which just raised their $75 million Series E) now offers a product suite spanning SMS communication, loyalty programs, reviews and ratings, and visual marketing.

7/ With a recent emphasis on sustainability and ethical commerce, brands will increasingly prioritize the environmental integrity of their products as a source of competitive advantage.

Brand sustainability has been important in recent years, but not critical. But that is beginning to change as it turns out Gen Z and Millennials really care. Companies such as Packhelp are helping to ease brands’ carbon footprint through ecological packaging. Further, DHL GoGreen and DPD Total Zero offer climate neutral shipping solutions to help ease the burden on companies. Brands have begun to innovate different ways to integrate sustainability into their business model whether it be reforming their return policy, repurposing their packaging materials, or sourcing from ethical manufacturing. Online retailers are incorporating sustainability into their mission statements more regularly today

We are in exciting times for the space and it will be interesting to see how things pan out. One thing is for certain — the future will be significantly shaped the depth and longevity of covid.

Facebook Shops, Amazon, and the Future of Ecommerce in America was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

by Tom Humphrey and Dylan Burton

State of Play in Fitness

The announcement last week of Lululemon’s $500m purchase of Mirror , a home fitness start-up that sells a $1,495 wall-mounted machine for streaming workout classes, has once again thrown fitness tech back into the spotlight.

At the start of 2020, fitness tech was poised for strong growth. The fitness industry itself had grown in recent years, with boutique studio membership increasing by 121 percent between 2013 and 2017 and the $80 billion traditional gym market growing at 4% per year. However, digital fitness saw 10x that growth rate (40%) over the same period.

No company has signaled the digital fitness revolution more so than Peloton, which IPO’ed in September 2019. The success and cult-like following of Peloton has spurred an influx of new connected fitness products as the overall industry has adapted to shifting consumer preferences for flexibility and convenience. Beyond the out-of-studio workout experience, we have also seen significant growth in subscription fitness commerce and wellness/mindfulness apps.

Then… a global pandemic came along and kicked things into 5th gear for the tech side of space. A disruptive force to many industries, COVID-19 has rapidly accelerated the adoption of fitness technology as big box gyms and boutique studios have shuttered their doors. Peloton’s most recent quarterly report showed a 66 percent increase in sales, while Tonal and Hydrow saw their sales triple and usage reach all-time highs. On the mental health side — meditation app Headspace saw a 100 percent demand spike during the pandemic. Wearable fitness data, which had begun to gain early traction through corporate wellness programs pre-pandemic, is also now being piloted for the potential early detection of COVID-19 (by Fitbit, Garmin and the like).

An April 2020 survey from Harrison Co suggested that $10 billion of market share may have shifted from in-person to at-home fitness offerings purely due to COVID, even as gyms and studios begin to re-open.

What next?

So what next? With what we have seen and some of the changing signals of consumer preferences emerging, we see a few key thematic trends that we think will continue to characterize the fitness industry over the coming years:

1. Continued shift from at studio to virtual / at home fitness — The recent explosive growth of digital fitness is expected to continue to drive a $7 billion market in 2017 to a $27 billion market by 2022 . Negative consumer sentiment towards a quick return to in-person fitness and improved accessibility to digital fitness brands may drive this growth to even higher levels. Recent national polls indicate that only 30 percent of gym users would be comfortable returning to the gym in the next 2 to 3 months, with 33 percent saying they may not return until 2021 or later. Connected fitness equipment brands thus have a substantial window of opportunity to reach a more mainstream audience despite their generally hefty upfront price tags. The majority of these brands now offer interest-free financing plans to help would-be buyers digest this cost, while Peloton CEO John Foley recently hinted at plans to lower the company’s price point to “low-end gym chain” levels over the next one to two years. Expect others to follow suit as part of a massive continuing shift towards virtual at-home fitness offerings.
2. There will likely be significant consolidation among fitness apps and services. The fitness app space is getting crowded. This has been amplified during the pandemic, as new players have spun into the market and many have offered extended free trials to new users and/or additional services to existing customers. Fitness franchises have also begun to enter the fray — Planet Fitness (with iFit), Anytime Fitness (with Wellbeats) and others have entered the digital sphere to weather the storm. Customer acquisition and retention is getting more difficult in direct to consumer, which is resulting in two things. First, many players are switching to B2B2C models targeting employers and healthcare carriers in particular for their go to market. Driving end user adoption through targeted marketing will still be critical, but removing a payment barrier to consumers will help. Such B2B2C models will also necessitate developing more formulaic approaches for assessing ROI to the B2B clients, whether cost, clinical or otherwise. We have already seen a number of companies making the shift, such as Aaptiv, Peerfit, and ClassPass, who have started partnering with corporations to expand the wellness offerings in their benefits packages. Second, it is likely we will see near term consolidation and a shift from point-to-point solutions to a more holistic consumer-centric approach to thinking about wellness — mental, nutritional, and physical. We have already seen this with Peleton moving into Yoga and Tread classes. This will be further bolstered by the shift to B2B2C distribution model as well, as enterprises prefer to consolidate their offerings to employees and members. As for the streaming platforms, with the hustle for the title of the “Netflix of fitness,” no doubt Netflix itself will make an aggressive move into the space.
3. The most successful platforms will be those that develop a strong sense of community. The world of fitness is one of cultness in the physical world (think of the following that builds around a popular coach at your local SoulCycle) and that will carry over to the digital world. The ability to make users feel like part of a group has been a strength of Peloton, Strava, Zwift, and others. Features such as active Facebook groups and live leaderboards have driven personalization and social competitiveness and kept members feeling engaged and “ together, but alone “ when working out from home. This desire for connection has no doubt been even further engrained with the social isolation of COVID.
4. AI and VR/AR will continue to heighten the opportunities for how people engage with fitness. Pre-COVID, rapid development in these areas was creating new fitness experiences and methods for remote workouts. The gamification element of Zwift and apps such as Supernatural and Beat Saber offered a fun new remote exercise option, while Black Box VR even opened a virtual reality gym . The application of computer vision and AI motion tracking in a fitness context also shows great potential in the areas of personal training and physical therapy. Existing apps in this space charge considerably less (especially with insurance or employer coverage) than the in person, oft cost-prohibitive, alternative, and come with the added benefit of a healthy social distancing.
5. Fitness data will play a bigger role in monitoring health and customizing fitness plans. With the growing penetration of wearables and the scope and quality of their data collection, so too does the potential for what can be done with the data grow. The aforementioned trials with wearable data for early detection of COVID-19 is one example of this. The first wave of wearable technology to date has been focused on fitness data capture and critical alerts; the next wave will focus on the customization of health, nutrition, and fitness plans based on the data. In an unregulated market, such data would inevitably feed into the way that insurance premiums were structured as it does in other insurance verticals such as auto (Metromile), home (Flyreel), or cyber (At Bay , Measured Insurance). However healthcare carriers are legally prohibited from discriminating against consumers based on “pre-existing conditions”, so personal health data cannot play a role in the underwriting process (it can in the underwriting of life insurance, and companies such as John Hancock offer policies based on wearable data and how many push ups you can do). But that is not to say it can’t play a role in the health management of consumers. Remote patient monitoring (in short, the clinical monitoring of patients remotely through the capture of vitals through wearables) has begun to gain steam in both the medicare and private insurance realms and will no doubt only continue to expand. No doubt we will see health insurers playing a greater role in the monitoring and customized support of member wellness in the coming years. We can expect increased adoption of existing opt-in programs such as Apple’s “Earn with Watch” program as well as the emergence of new data-sharing partnerships. In addition, we are likely to see the expansion of smart devices and wearable tech with new technologies emerging in prosthetics, exoskeletons, etc.

The era of flexible, connected fitness is here to stay. An already growing trend, the coronavirus pandemic has only served to force adoption and accelerate growth. It will be interesting to see the coming years play out.

Originally published at https://www.accessvp.com on July 8, 2020.

Future of Fitness Tech and reflections on Mirror’s $500m exit to Lululemon was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

We are delighted with the team of 7 we have pulled together thus far — all from very different locations across the country and varied passions and backgrounds — who are working on various projects with the Access team.

The venture interns for 2020 include:

Willa Sobel

My name is Willa Sobel and I am a rising junior at the University of Michigan Ross School of Business, with a specialization in Entrepreneurship and a minor in Art History. At Access Ventures, I am taking a deep dive into the ecosystems of e-commerce and education technology, which plays a lot to my passions. I am the Founder and Editor-in-Chief of the Michigan Journal for the Business of Fashion (MASH Magazine), a digital publication that explores the rapidly changing global markets in retail, e-commerce, supply chain and consumer trends. For the past few years, I have worked as a Teaching Fellow for the Breakthrough Collaborative, a middle school program serving Denver metro students on the Kent Denver School campus. I am thrilled to work with the Access Ventures team, gaining valuable hands-on analyst experience, collaborating with portfolio company founders, and learning how venture funds develop and pursue investment strategies. I have also so far helped one portfolio company with a project, helping them to put together a fundraising pitch deck.

Alazar Michael
Hey, my name is Alazar Michael and I’m from Denver, Colorado. I attended Denver East High School, graduating with the class of 2019. While in high school I involved myself in many sports including tennis and track and field. I was also a member of DECA business club which introduced me to the business world and led me to apply to the Leeds School of Business at the University of Colorado Boulder. While attending CU Boulder, I strive to learn everything surrounding business, specifically finance, as I’m majoring in finance and accounting with a minor in economics, while at the same time taking on internships along the way. With all the experiences I hope to gain, I plan on starting my career in investment banking, private equity, or hedge fund. At Access so far, I have dived into the proptech industry and am putting together an investment memo for the market. Access has been fairly active in the space to date with investments in TurboTenant and Taskeasy, to name a few.

Luis Villareal
Hi Everyone. My name is Luis and I have over seven years of business experience in the process and energy industries. In my last role as an engineering project manager at one of the world’s largest cement companies, I built a strong background in project valuation, risk management, decision-making and cross-functional collaboration. Inspired by my passion to drive innovation, I returned to school to pursue my MBA at the University of Colorado Boulder. While at CU, I have focused on high-growth ventures and gained experience in finance and market intelligence. I am enjoying working with Access Ventures this Summer and the exceptional group of founders in their portfolio. My focus for research will be mainly in the healthcare and fintech industries, but I am also assisting a number of portfolio companies on bespoke projects — for example, I am helping one company with scenario planning on their forecast model. In my free time, I enjoy playing baseball, skiing and Colorado’s great outdoors.

Dylan Burton
Hi there, I’m Dylan. I am a 2nd year MBA student at the University of Colorado, a native of Maryland, and an undergrad alumnus of the University of South Carolina. Over the past 7 years, I have worked in various management roles in the live events industry, most recently with a security contractor for the athletics department at Colorado State University. My passions include travel, craft beer, hiking, sports, and fitness — and one of my projects so far at Access has been putting together a market map and investment perspective on the fitness industry, which has been heavily disrupted by COVID providing unique opportunities. I am also working on some research around the future of work, which is a big focus area for Access. In these unprecedented times, I am grateful for family, friends, and the great outdoors of Colorado, as well as the great opportunity to work with Access!

Emily Yuan
Hi everyone! My name is Emily, I’m a rising sophomore studying Management Sciences & Engineering and Computer Science at Stanford, and am currently located right outside DC. I love both finance and entrepreneurship and am involved in a couple of the investing and entrepreneurship clubs at school. In the past, I’ve written a book called “Beyond a Bake Sale” on how students can get started with a social venture, and I am still part of a nonprofit I founded in high school, Paper Bridges, which supports orphans and vulnerable children around the world. In my free time, I love hiking, baking, and working on side projects with my friends! I’m very excited to join the team at Access.

William Walsh
Hi, I’m Will. I’m from NJ and am a rising sophomore at UPenn studying systems engineering. I’m interested in understanding how businesses can operate efficiently and learning the merits of business models. I’ve investigated these topics within value-oriented investing communities (generally focusing on larger companies) and I’m excited to explore early-stage companies with this same mindset with Access! Currently, I’m looking into the rapidly changing construction tech and logistics industries, two spaces ripe for disruption from new entrants. In construction, startups are helping modernize the least efficient sector of America’s economy, presenting a massive secular opportunity for new efficiency-creating services. Within logistics, technology platforms are helping bring economies of scale to the smallest customers. I am really excited to have been offered the opportunity to work with Access.

Tyler Knox
Hello, I’m Tyler Knox, one of the venture interns with Access this summer! Originally hailing from upstate NY, I am a recent graduate of the University of Pennsylvania, where I studied Management and Legal Studies at the Wharton School. At Access thus far, I have had the opportunity to dive into the complex and intriguing world of cybersecurity. I have been working on a market map of the industry while also putting together a thought leadership article on Access’ perspective on the trajectory of cybersecurity in the years ahead. It’s been a blast to learn more about an emerging industry while also getting exposed to the thought process behind identifying promising ventures. I’m looking forward to working on even more exciting projects while working with Access over the next few months!

Originally published at https://www.accessvp.com on July 7, 2020.

Announcing the Access 2020 Summer Venture Interns was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

The State of Play in Healthcare

The U.S. healthcare system is on life support and the novel coronavirus is not to blame. In 2018, the U.S. spent on average $11,172 per person or $3.6 trillion on healthcare — a staggering 17.7% share of GDP and more than twice the average OECD country .

America is investing into healthcare more than double what other developed countries are on a per capita basis, yet it sits at 46th in the world for average life expectancy (right behind Cuba and Estonia) and has experienced an incredibly lacklustre performance through COVID-19 (currently still crowns #1 in the world for both cases and deaths and saw significant shortcomings on hospital beds, ventilators, protective gear, and more). The chart below tells a compelling story — from 1998 to 2018, whilst general inflation rose 56% overall and many goods and services have seen declining prices and efficiencies, the price of hospital services have risen over 200% and other medical services 120%. Mix in an aging population, 40 million freshly unemployed Americans, a shortage of clinicians, and rapidly rising pharmaceutical prices and the outlook is pretty bleak.

How did this happen? There are many things we could point at, but one overarching theme upon which blame is often cast is the fee for service model.

The US healthcare system was designed to be provider-centric — i.e. physicians and healthcare professionals get reimbursed for procedures (or health services) performed rather than value (or health outcomes) delivered. Fee-for-service programs traditionally revolve around the practice of high-cost reactive medicine and have been a big driver of excessive services, uneven care delivery and health inflation — neither patients nor providers are financially accountable.

US regulatory agencies have acknowledged the inadequacy of the situation and have been supporting a transition to value-based care — a model that is patient-centered and emphasizes and incentivizes better health outcomes at a reduced cost, not more services at a higher cost. Unfortunately, progress toward this has been incredibly slow and health institutions are now in a predicament. Most health institutions are being severely affected by the fee for service model during this pandemic — they are facing budget crises as this model is structured to reward high cost procedures that are not being performed at this time. All these organizations are cancelling elective procedures as well as their in person routine doctor visits. Some of them have even been forced to cut pay and lay off workers, while others wonder if they will bounce back from this at all. At a time when we need all available capacity at our disposal, this situation is troublesome.

Key Predictions for 2025

So, how do we fix a healthcare system that is so broken? The answer, to a large degree, is digital health.

Digital health will be a critical driver in the shift to value-based care and drive progress toward, according to the American Medical Association , the 4 objectives of the system — improved patient experience, better health outcomes, reduced costs and increase in provider’s satisfaction. The first wave of digital health tech (software based, not medicals or devices) has focused predominantly around companies that took mainly analog processes on paper and slides and switched them to a more accessible digital format — the core EHRs leading the charge. The coming wave of digital health will be more focused on the delivery of preventive care, the fluid sharing of patients’ records and data, great accessibility, patient tracking and early intervention, etc.

With that in mind, here are some of our core predictions for digital health for the next 3–5 years:

1. Virtual health services will see substantial growth — The pandemic accelerated the demand for telehealth services by forcing adoption and putting its benefits on full display. A survey from McKinsey & Co. suggests that adoption is gaining momentum — 46% of consumers are now using telehealth services versus 11% in 2019, and 76% of the participants surveyed said that they would be interested in using them in the future.
2. Mobile health will revamp healthcare — “ An apple (and android) a day keeps the doctor away “ has never been more relevant! In a time of an aging population where 6 out of 10 Americans suffer a chronic condition , preventive care will drive the future of healthcare. Remote patient monitoring (RPM) devices will power the transformation because they can track a patient’s health condition outside the doctor’s office and allow early intervention for potential problems.
3. Artificial Intelligence will boost productivity and extend the efficiency of care delivery — In 2017, the US spent $812 billion or $2,500 per person on healthcare administrative costs , a huge burden to the healthcare system. Combined with a growing shortage of clinicians and nurses, this will raise the role of AI in driving efficiencies, reinventing clinical workflows, improving the quality and delivery of care, and extending the number of patients any one caregiver can see. Not only that, but AI/ML have the massive potential to revolutionize healthcare with frontier of science applications. For instance, has built the world’s largest library of clinical data and is utilizing data-driven precision medicine (via AI/ML) to accelerate cancer research. Another example would be Kaia Health and Exer AI, two companies that use computer vision and AI to make therapy, physical rehab and exercise cheaper and more accessible. Their software analyzes motions and movements from thousands of athletes and their product provides real-time feedback to perfect your movements.
4. Health carriers will increase investments in digital health and direct care solutions — There has been a cultural shift in the industry and healthcare carriers are playing a more active role in care delivery as they seek to bolster their member offerings with solutions that improve patient outcomes at lower cost. Carriers are now increasingly collaborating with providers, investors and digital health firms to reorientate around preventative, not reactive, care. For instance, UnitedHealth acquired Vivify Health, a remote patient monitoring start-up, this past October 2019, providing them with early intervention capabilities. UnitedHealth is also offering a virtual health service for members where they can talk to a doctor 24/7 by phone or video. And, the success of Livongo has provided a roadmap for app-based, carrier-distributed care models and many others are following.
5. The tech giants will significantly extend their reach into healthcare — The “Big Four” (a.k.a. Amazon, Apple, Google and Microsoft) have been signaling high interest in healthcare. This makes sense — when you are that size and looking to satiate shareholder expectations for continued growth, few opportunities left are big enough to move the needle (fintech is another you see getting a lot of attention). Also, they are fairly well-positioned given they own the key rails to consumers. They will be strategic in how they approach the space and play to their capabilities — for example, Amazon is leveraging their e-commerce and logistics services to extend into prescription drug delivery. Apple is honing in on clinical research through data collection from its wearables, and the Apple watch will likely start incorporating more functionalities such as glucose and blood pressure monitoring, sleep tracking and food logging. Google, on the other hand, is utilizing their AI/ML technology ‘DeepVariant’ to drive genomic sequencing and precision medicine (similar to Tempus Health). And finally, Microsoft is offering their cloud service platform Azure to health systems as a pathway to collect and utilize data from multiple sources, while maintaining patient privacy and confidentiality (as discussed above with their new platform service Connected Consumer Healthcare).

The pandemic has not only unveiled the shortcomings of healthcare in America, but magnified them. The opportunity to fundamentally improve our care delivery model is now no longer important, but critical.

Originally published at https://www.accessvp.com on June 26, 2020.

Predictions for Digital Health and the Transformation of a Broken System was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

Photo credit — Mark Chaves on Shotzr Photos

WFH — the 3 letter acronym for “work from home” that almost had no meaning 3 months ago, yet is now common lexicon.

CEOs and founders will be facing challenging decisions in the coming weeks and months regarding if, when, and how they reopen their offices and how they structure their teams moving forward. This has certainly been on the minds of a number of our portfolio leaders, and in the past few weeks, Facebook made headlines for announcing that up to 50% of its workforce would be remote in 5 to 10 years, Google told all employees that can work remotely to plan on doing so through to 2021, and Twitter went a step further in telling employees they can work from home indefinitely. At the same time, other companies have begun to reopen their offices and encourage employees to return — Apple being one of those.

We — Tom and Nick — found ourselves on a call recently which tracked itself toward a healthy debate on the future of work and the benefits and costs of a remote work model. We decided to settle the score with what you see here — a two-part piece that presents the for and against arguments on remote work. We hope you enjoy!

The Argument for Remote Work (by Tom)

The concept of the “Future of Work” was already in common parlance pre-COVID. Now, in our post-pandemic world, it is almost awkward when the phrase doesn’t come up in a founder pitch.

The concept is a somewhat vague and encapsulates a number of things — the changing nature of communication (Zoom, Slack), new methods for collaboration (Jira, Notion), an emerging gig and freelancer economy underscored by new marketplace models (Uber, Instacart), and, inevitably the rise of remote work, amongst other things.

While for many of us, remote work has been underscored by the pandemic, the reality is that its trend was well underway pre-COVID. Many people view COVID through a lens of disruption and commonly ask, “ when will things return to normal?”. Others, myself included, view COVID through a lens of acceleration, and rather tend to ask “ what will be the new normal? “. COVID has not created telemedicine, on-demand fitness, remote collaboration, online education, etc, it has simply doubled down on it, and so too with remote work.

In 2018, 5% of total US workers worked from home, up from 4% in 2010. If you remove those working in agriculture and mining, construction, manufacturing, retail or transport and warehousing — industries in which workers would likely be required to be in person — then this increases to about 7.7% (up from 6.6%). While this is not a trend moving at mach speed, it is a trend nonetheless, and there are also other studies that suggest the growth has been greater than this.

So why does the shift to remote work make sense?

1. Reduces Employee Health Risk

The most obvious and timely point to make here in a world defined by 6 foot social distancing is that offices are a petri dish for illness. If COVID has taught us one thing, it’s that there is a high correlation between risk of illness and social density. And this is not simply about pandemics; think back to how every flu season would wreak carnage through the office. How every sneeze, cough, and stomach bug would wipe out half the team. According to a survey Indeed ran in 2018, 50% of remote employees said working from home reduced their sick days and 56% said it reduced their absences 🤢.

There is also a lot of evidence to suggest that cutting out the work commute is good for one’s health. First, and to state the obvious, less commuting equals less traffic accidents. Second, in many studies (including one recently at UCLA and CSULB) researchers found that vehicle-miles traveled has the highest correlation to obesity of all lifestyle factors, including physical activity 🏃‍♀️. Finally, reducing commuting time frees up more time for exercise, and remote workers workout on average for 18% longer per week than commuters.

2. Increases Productivity

Every day, 151 million Americans commute to work. The average commute is 26.6 minutes, which factoring for both routes, equates to almost 1 hour every day, 4.5 hours per week, and 213 hours per year, simply moving between home and office. For many, it’s even worse — one in 6 workers commutes over 45 minutes each way per day.

And this has been gradually getting worse — the average commute in 2010 was 25.2 minutes. Population growth, especially in the biggest cities, is surely not helping as anyone who lives in Oakland and works in San Francisco proper will tell you 🌉.

Giving this time back to employees is huge. A March 2020 survey by Airtasker found that,

“ remote employees worked 1.4 more days every month, or 16.8 more days every year, than those who worked in an office “.

But it is not only the commute time that is saved through remote work, there is also the time lost to office “distractions”. Forging relationships with colleagues is very important, but the average office worker spends 66 minutes per day talking to colleagues about non-work related topics versus 29 minutes for the average remote worker. Assuming a daily half hour is enough time to keep work relationships healthy and the additional 37 mins is invested in awkward chit chat and unfortunate hallway run-ins, this would give back 148 hours of time to each worker per annum ⏱️.

The reality is that the cost of distraction in open plan offices is high. A study from the University of California Irvine recently found that it takes an average of 23 minutes and 15 seconds to get back to a task once you have been distracted from it.

3. Provides Access to a Broader and More Diverse Talent Pool

Putting a job ad out there for a “ UX designer, based in Denver” will inevitably be more limiting in terms of the volume and quality of applications than an ad for “ UX designer, live wherever you are”. In addition, many cities suffer from low diversity and simply tapping into the local talent pool might make it hard to meet the diversity goals you have for your team. The impact of diversity on culture and innovation within an organization is well documented 💡.

4. Increases Employee Satisfaction

If I was given $1 every time I heard someone say “ you know what, I’m actually kind of enjoying working from home” these past few months, I would be a wealthy man. In fact, a 2020 survey of 3,500 remote workers found 97% of them would recommend it — that is a pretty attractive NPS score 🤗.

The act of commuting is known to be the greatest driver of human unhappiness. Convincing evidence exists that connects long commutes to obesity, neck pain, loneliness, divorce, stress, and insomnia. A recent Swedish study found that people are 40% more likely to divorce if one partner has a 45 minute or longer commute 🚗.

There are also large cost savings to working remote. A recent Airtasker survey found that the average worker spent $4,523 per annum simply on fuel related to the office commute. In addition, remote workers save an additional $45 per annum on car maintenance and likely save money on coffees and meals, depending on office policies (which in many cases have become quite flamboyant). And while these benefits are to the employee, they soon measurably impact the employer — 1 in 4 workers say they have quit a job previously due purely to commute.

Finally, and moving beyond the commute into perhaps the biggest point I’d like to make here, facilitating your team members to live in the location that is optimal to them and their personality also increases well being and satisfaction. The Washington Post had an interesting piece recently that discussed Gallup data comparing where people lived versus where they want to live. What that found was that whilst most Americans live in big cities, they don’t actually want to be there. So what are they doing there? Likely the requirement to be there for the job is a big factor.

“whilst most Americans live in big cities, they don’t actually want to be there”

While the last 2 centuries have been defined by rapid urbanization — the shift from agrarian to industrial society and growth of cities — this century will likely be defined by a reversal process of “ de-urbanization “, as people realize they can sustain, through the empowerment of technology and social change, a big city job whilst living the small town life 🚌.

5. Reduces Company Costs

For your typical company, wages are the greatest cost line and hover around 20–30% of gross revenue. The ability to tap into lower cost staffing markets can therefore have a big impact on the bottom line. Let’s use an example — say you are a San Francisco based company and currently have a 100 person on location workforce which you pay on average $96,000 pa (a total $9.6M wages expense). You decide to move to a hybrid remote model and now have 50% (or 50) of your workers in other locations such as Denver. Well the good news is that Denver salaries are 19% lower on average, so you have just cut out $912,000 in annual costs (or 10% of your total salaries expense). Not bad 💸.

Another big cost line is rent. Average office rent in San Francisco is approximately $13,032 per employee. Back to your 100 person company — should you move all 100 workers to be fully remote (both those in San Francisco and other Denver-like locations), you are now also saving $1.3 million pa in rent.

There are likely other less obvious gains to be made. If we have achieved a healthier, happier, and more productive workforce per the comments above, we are likely also enjoying lower costs associated with staff churn and recruitment too.

6. Provides Greater Business Flexibility

10pm in San Francisco is 9am in Abu Dhabi. Your ability to manage a customer-facing operation (sales, support, etc) through a single office becomes significantly more difficult as you go global 🌐. Having a distributed team with an on-ground presence in different regions can allow you to better deliver across time zones and markets and deliver the kind of support you need.

7. Helps the environment

Today in America, 77% of all workers drive to an office alone, 9% carpool, 5% take the bus, and under 3% walk. Unfortunately, whilst remote workers have crept up, so too has the percentage of people driving to work alone.

While we have all suffered in many ways under COVID these past few months, our world has actually thrived 🌲. Oil futures have gone negative and air pollution is at historic lows. A lot of this has been underpinned by the removal of the work commute from the daily ritual. Remote working, literally, might actually be the answer for climate change.

8. Companies have proven it can be done

Companies like Buffer, Stack Overflow, Toptal, Auth0, Zapier, InVision and the like have shown that it’s possible to build successful, larger scale companies with fully remote workforces. The tools for remote collaboration today are strong and are only getting better, and anyone who thinks that tangibles such as ping pong tables and free lunch are required to build culture are wrong 🏓.

In Sum

We hope you enjoyed part one, the argument for remote work. Would love hear the thoughts, personal experiences and perspectives of anyone on the topic, so please share. Stay tuned for Nick’s follow up from the anti-remote corner next week!

Originally published at https://www.accessvp.com on June 10, 2020.

Our Brave New (remote) World: #WFH (part 1) was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

The State of the Startup and Venture Ecosystem in Colorado 2020 — Access Ventures

Calling the Colorado startup ecosystem our home turf, we on the Access Ventures team often get asked by out-of-towners, “how is the venture scene in Colorado?” or hear comments like “it seems like there is a lot of activity out there.” Fortunately, a lot has been going on but unfortunately, I’ve never really had a strong, factual response in these situations. This post seeks to paint what I hope to be a fairly thorough picture of the current state of the Colorado startup and venture community heading into 2020… if for no other reason than to self-servingly help me better engage in such a conversation!

A rapidly growing ecosystem

Significant lift in venture dollars

2019 was a big year for Colorado startups. In total, $2.5B of venture dollars was invested into the centennial state, a big 1.5x lift on 2018 ($1.6B) and 2.3x bump on 2016 ($1B).

This growth in capital invested surpassed most other major investment states and far exceeded the national baseline, which saw a slight overall decline in total VC dollars on 2018 and a lower 1.8x rise on 2016.

Huge growth in deal volume

Perhaps more impressive than the increase in investment dollars is the rise in actual deal volume. Since 2013, Colorado has seen an 8.5% average annual increase (CAGR) in the number of companies getting funded per annum. This is in fact, by a significant margin, the fastest growth of any major venture state in the country (states with 100+ annual deals — 23 in total), and almost 4x the national growth rate in deals over the same time period.

With this rapid growth in activity, Colorado now accounts for over 4% of national venture deals, up from 2% in 2006. The mountain region now accounts for over 8% of nationwide investments, whilst California has declined from accounting for 42% to 34% of deals during the same time period.

Increasing deal sizes

Increased deal sizes are inline with national themes, there has also been a shift in the size and profile of deals happening in Colorado over this time. The average seed deal in Colorado was $1.8M in 2019 versus $400K in 2006. Series A, B, and C deals averaged $6M, $23M, and $31M retrospectively, all effectively doubling in size since 2006 as well.

In 2016, 40% of investment rounds were <$500K; that number was down to 27% by 2019, reflecting a maturing market with bigger and later-stage deals taking place in the State.

On average, Bay Area companies tend to raise more money at each stage of the fundraising evolution — seed, Series A, etc.

However, the size of the rounds is largely meaningless — bigger rounds don’t signify or correlate strongly to companies with greater promise or bigger exits. In fact, a primary driver of larger early-stage rounds in the Bay Area is actually quite simply the higher cost base there. $1M raised by a Bay Area company is worth $1.31M to a Denver company in terms of purchasing power parity (the lower cost to achieve the same business investments in staff, office space, etc), meaning companies in Colorado can (and should) be raising less to achieve the same outcomes for investment through pure capital efficiency.

What is obviously more important than the size of rounds is the outcomes achieved for the stakeholders involved. And the reality here is that 1) big exits are capable of, and actually are, taking place in the mountain region and 2) those exits are in general occurring more efficiently — on average, the data suggests that by the time founders have hit their Series C, they have suffered ~4.2% extra in dilution in the Bay Area versus Colorado (i.e. the larger round sizes, even despite the larger on average first stage pre-money valuations, means they have suffered more equity dilution by this point).

Bigger exits are taking place

Over recent years, Colorado and the mountain region more broadly has also been seeing solid growth in exits — both by number and size. In fact, in 2019, companies in the mountain region exited for an average of $429M (n=38 known exit values) versus $235M (n=183) in the Bay Area. A statistic like this is a little misleading and can be very skewed by a few large or small outlying outcomes, and I hesitate in sharing it. To be clear, the only takeaway here should be that big exits are capable of happening in places like Colorado outside the Bay Area; definitely not to suggest that bigger exits happen on average in Colorado.

The region has also seen a steady rise in the number of exits over the years.

10 years ago, it would have been difficult to point toward many major tech exits in the State, let alone unicorns. Yet, if my numbers are correct, 4 new Colorado companies joined the unicorn league tables in 2019 alone — Guild, Ibotta, Evercommerce, and Ping Identity.

The key drivers of growth

A couple of factors are at play in fueling this impressive growth in the centennial state startup ecosystem:

First — no doubt a big driver of growth has been underlying population growth. From 2015–2018, the population of Colorado grew over 5%, making it the 7th fastest-growing state in the country with more than double the national growth rate. Colorado has effectively been seeing over 250,000 people move into the state each year, driving average net migration of well over 100,000 people per annum. The mountain region, in general, has been the fastest region of growth in the country with 5 of the top 10 states.

Equally important is the profile of this population growth, which has been largely younger, educated, and skilled labor. 71% of over 15-year-old migrants to Colorado are aged between 15 and 39 when that age segment only accounts for 43% of the existing base of residents.

In addition — 79% of these migrants who are over 25 have some form of college education. According to a Linkedin report for 2019, Denver was the second city in the country for “net labor migration” (calculated as (1) # of members that moved to Denver minus (2) # of members that left, divided by (3) starting base of members).

In sum — the people coming in are young, educated, and on Linkedin.

Second — perhaps in part attracted by this dynamic and in part causing it, serious coastal tech companies have either moved, set up or growth operations in Colorado in recent years. Slack, Facebook, Salesforce, and others have opened Denver tech hubs.

According to a report from Cushman & Wakefield covering the 89 largest tech companies in the Bay Area (that have 100,000+ SF), 58 have opened an office in the Denver region in recent years and taken up 1M square footage of office space. Today, approximately 7.4% of all employment in the city is in tech (the US average is 4.9%), which is an almost 1% lift on 2018.

For an exploration on why these companies are looking at Colorado for primary or secondary offices, read another piece I wrote on the topic here.

Third — the last decade has also seen the development of fairly robust early-stage support infrastructure for Colorado startups. “Incubation institutions” in the state — including accelerators, angel groups, incubators, etc — have doubled in number in the last 10 years, and the State being home to the likes of institutions such as Techstars no doubt helps.

Areas for improvement

Despite the above, there is certainly room for improvement in the Colorado ecosystem:

Growth in funding — for one, local funding has not kept up with the pace of growth in fundable startups. This is feedback you will receive from many founders you speak to here, and is certainly played out in the data too. For example:

Local venture assets under management compared to venture dollars invested is the lowest of any state in the country.

The state also has the highest invested deal volume per local investor of any state in the country too.

Finally, the state also has one of the lowest local venture communities per capita in the country.

In sum — whilst Colorado has seen significant development in the tech and startup community, it has seen less development on the investment side of the equation. The importance of investor proximity and localization increases the earlier companies are in their lifecycle, and the continued development of the investment community will be important for the continued growth of the startup ecosystem.

Other areas of improvement — there are certainly other areas of improvement of the ecosystem. Looking at the lessons of other thriving ecosystems, some things that will be important for Colorado’s continued growth will be:

1. Expanding the talent funnel — Colorado will need to continue to attract young, educated talent from outside the State to migrate in to supplement its talent flow from the local educational system. Don’t get me wrong, the local colleges are fantastic, however Colorado does not have the same breadth and volume of colleges and student flow as say a Boston or Chicago has. Fortunately, the attractiveness of Colorado has meant that to date, it has been able to seduce that talent in. Hopefully, the local colleges will keep extending themselves in key areas of high skills demand such as computer science, robotics, engineering, data science, etc.
2. Building stable tech stalwarts — Seattle’s tech ecosystem has been largely built on the shoulders of Microsoft and Amazon. Those companies both attract talent to the city as well as provide the perfect training ground for future founders and operators. Colorado has started to see some of its own promising titans of tech emerge as well as the growth of large secondary offices for the Silicon Valley majors, but this trend will need to continue.
3. Growing diversity — finally, the diversity of the community will also be important to the continued growth of the ecosystem. It is well-documented that a significant share of America’s innovation has been driven by immigrants and people of all backgrounds. Reimagining the future requires being openminded and exposed to difference.

For those of you who made it this far, congrats and thanks for reading. Overall, 2019 has been an awesome year. These are some exciting times for the startup ecosystem of Colorado and I, for one, am pumped for what’s to come in 2020! Feel free to reach out with any questions or to discuss.

Originally published at https://www.accessvp.com on March 5, 2020.

The State of the Startup and Venture Ecosystem in Colorado 2020 — Access Ventures was originally published in access ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.