Re-imagining the Rule of 40 for Early Stage Startups: The 70% Growth Efficiency Heuristic

  • On February 9th, 2017

  • by Sundeep Peechu

It’s been a fascinating period for startups. For a few years, as founders, all you heard was the mantra of “grow at all costs.” Thankfully, sanity is back, and with it has arrived a ruthless focus on efficiency and a new set of principles for evaluating startups.

One such principle is the “Rule of 40.” You can see some great posts on it here, here, and here. The reason it’s popular is because it establishes a simple rule to trade off growth against losses. For example, if you’re growing by 100%, you can lose money at the rate of 60% of your revenues. If you’re growing by 50%, you can only lose up to 10% of your revenues. Growth + losses should equate to > 40% for a healthy business.

As with any good rule of thumb, the Rule of 40 is starting to get misused. It was designed for later stage companies. Brad Feld wrote in his original post that the bar was $50M ARR. Yet I’m seeing companies with $1M ARR ask me about the Rule of 40.

TL;DR — The Rule of 40 doesn’t work for early stage. But a different heuristic might.

Let’s take a hypothetical company with $1M in 2016 revenue. The table below shows various growth rates and the losses you can expect if you apply the Rule of 40.

You can immediately see the absurdity of applying this rule blindly by looking at the bottom row. In order to grow from $1M ARR to $5M ARR, the Rule of 40 allows for -360% EBITDA losses. This means losing $18M in 2017 to generate $4M in extra revenue. There’s no way any board is approving that plan.

What gives? The Rule of 40 works well when growth rates aren’t very high. For early stage companies which typically grow 3–5x YoY, this rule breaks down dramatically. Directionally, the rule is correct. You are afforded more losses for higher growth, but certainly not at the rate above.

A better heuristic for early stage companies is the revenue efficiency per dollar of spend. As we saw in the previous example, spending $18M to produce $4M in incremental revenue seems very low, it amounts to a 22% revenue efficiency per dollar spend.

To find out what the right percentage should be, we looked at companies from the Felicis portfolio performing in the top quartile. We discovered that they tend to produce >70 cents of incremental revenue for every dollar spent. Said another way, for every $1M in revenue growth, they tended to lose no more than $1.42M. The table below shows the 70% efficiency heuristic applied to the hypothetical company from above.

You can see that for 100% growth rate, the Rule of 40 and the 70% efficiency heuristics converge. But for higher growth rates, losses from the 70% heuristic are a lot more reasonable. Assuming this hypothetical company does the mythical T2D3 — triples twice and doubles three years in a row, here’s how the company might progress.

For the purists and the bootstrapped, even these levels of losses might seem crazy. But it’s not unusual to see >$102M spent in high growth enterprise companies to get to $72M in revenue / $100M run rate. AppDynamics, which was just acquired by Cisco for $3.7B, reportedly generated $158M in revenue in the first nine months of 2016 and had an accumulated deficit of $476M as of Oct 31, 2016. If we annualize that, it amounts to a 44% revenue efficiency. By contrast, Shopify had $100M+ in revenue for 2014 and only had an accumulated deficit of $33M when it went public in 2015, which is a staggering 303% efficiency. As markets oscillate, it’s hard to know whether to follow AppDynamics’ path or Shopify’s route. There are certainly many paths to success, but given the tighter markets in 2017, we advocate for founders to be more conservative and control their own destiny!

Welcoming Aamir Virani, one of our most successful founders, to Felicis

  • On February 2nd, 2017

  • by Aydin Senkut

Felicis celebrated its tenth anniversary last year. In this time, we’ve grown to a full-time team of 15, raised five funds (now 100% backed by institutions with world-changing positive impact), and celebrated three IPOs along with over 65 exits (at least one north of $1 billion each year for the past five years). Yet we are starting 2017 with an equally important and possibly more meaningful milestone.

I’m super excited to announce that Aamir Virani, cofounder and previous COO of Dropcam, has joined Felicis Ventures as a partner. As the first Felicis-backed founder to join our team full-time, Aamir will make new investments and help engineer success for our current founder community.

In 2012, Dropcam reimagined the connected home camera and quickly assumed the dominant position in the video services market. Aamir built the first client-facing apps and established the company’s sales and marketing foundation, later transitioning to SVP of Product. We backed Dropcam very early on, seeing its potential to usher in a new era of cloud-based, smart search-equipped video recording. In 2014, Alphabet (Google)’s Nest division acquired Dropcam for $555 million — one of our largest exits to-date.

In our quest for continuous learning and improvement, we’ve surveyed our founders annually for the past three years. We heard that partnering with someone who has been in their shoes —  as a founder and an operator — is invaluable for providing objective context on their company’s trajectory, and for lending unwavering support through both good times and bad. Aamir is a self-professed data nerd, an engineer’s engineer who approaches moonshot projects with a non-pretentious, positive attitude. As our identity and aspirations shift toward leading more early-stage deals, Aamir will help elevate our boutique support to be even more strategically and operationally valuable to founders.

In the meantime, our mission remains the same: to discover the world’s most iconic companies — regardless of geography or stage — back the founders’ vision with conviction, and become their most trusted, most thoughtful supporters. Though we’re very proud of our track record, we ultimately measure our success based on our founders’ realized dreams. Given that goal, I have no doubt Aamir will have a significant impact.


Deepening our Operational Excellence & Investing in Scaling Success: Super Excited to Welcome Ava Hahn as our General Counsel & Partner

  • On June 21st, 2016

  • by Aydin Senkut

In continuing our pursuit of exceptional talent for Felicis, I’m very pleased to announce the addition of our newest Partner and General Counsel: Ava Hahn.

Ava has served as a chief legal officer to both private and public technology companies for more than 15 years. Most recently, she was General Counsel and Secretary at Aruba Networks, Inc. (NASDAQ: ARUN). Ava has also held a number of business development, corporate strategy and general management roles. She started her career at the law firm of Wilson Sonsini Goodrich & Rosati, where she handled venture capital financings, initial public offerings, mergers and acquisitions and other corporate matters. She is a graduate of U.C. Berkeley and Columbia Law School.

Ava will be instrumental in adding another layer of professionalism in scaling our organization both internally and externally. This is crucial as we embark on leading larger investments. Even more strategically, we expect liquidity to come mainly from large scale M&A and IPOs in the near to medium future. Ava’s deep experience in management and scaling at both private and public companies will be key in these areas as well. Not only is Ava a fantastic culture match for us, she expands our already diverse team with a stellar background and a very large, complementary personal network. Unlike a traditional General Counsel, Ava will be actively involved in portfolio support, and will take board roles in our current and future investments.

Raising the Bar on Young Talent & Diversity – We’re Very Excited to Announce Niki Pezeshki as the Newest Member of our Investment Team

  • On May 6th, 2016

  • by Sundeep Peechu

We are a relatively young and diverse team with big ambitions. Despite our small size, we cover a wide range of age, ethnic backgrounds and personal/professional experiences that makes for a rich team dynamic. So whenever we embark on a search for a new team member, it’s quite an adventure to strike a balance between someone who inspires us, pushes us out of our comfort zone, and brings a unique perspective. We are seldom conventional in our searches and try something new every time. Sometimes it’s an unexpected recommendation from a friend or an inspiring conversation catalyzing into a partnership or an old fashioned cold outreach to someone we believe will make an enormous impact.

So when we decided to expand our investment team, we tried a new experiment with a select few people we thought could be a good match. We gave them a conceptual task that required some hustle to gather the right information and formulate a response. Out of that small group, Niki blew us away with his thoughtfulness, speed and creativity. He demonstrated convincingly that he was the best match. The process also allowed him a much better understanding of our firm and strategy. We are thrilled to welcome him to our team.

Niki was most recently part of the investment teams at Summit Partners and Vista Equity Partners. Coincidentally, he initially moved to the bay area to work at Climate Corp, one of our portfolio companies. He is obsessed about Warren Buffet & Charlie Munger and started the Value Investing Group at USC that has continued to thrive in the years since. And most importantly, he comes from a self-made background and an entrepreneurial mindset. We are super excited to welcome him to our investment team and look forward to a more colorful journey ahead.

From 0 to $200M – Celebrating our First Decade in Venture and Starting the Next with a New Fund

  • On April 21st, 2016

  • by Aydin Senkut

ZERO – Back in 2006, when I started Felicis, that number represented my deal-flow, the size of my network and the chance the venture establishment gave me of succeeding. It became instantly clear that to win, changing the rules was essential. So I applied whole- heartedly one of the core principles I learned from my experience at Google: obsession with questioning the status quo. I took a different path by pursuing companies poised for remarkable future growth (instead of the obvious hot sectors), being extremely flexible with ownership, not taking a board seat, and accepting uncomfortable valuations. The ability to write smaller checks more often allowed for learning much faster than at a typical venture capital firm. That initial approach swiftly netted a dozen exits by 2010, enough to help raise our first institutional fund.

To emphasize thinking differently and to consider a wide range of perspectives, I assembled a talented, self-made team hailing from very diverse, humble backgrounds, cultures and experiences – strikingly similar to our most iconic founders.

We diversified rapidly beyond largely seed-stage consumer-internet start-ups into a variety of new sectors and geographies that were not popular with most investors. Today, our investments are spread evenly across seed-, early-, and mid-stage companies that push the technological edge in an incredible range of areas from programming bacteria, to powering global payments; from platforms that power global logistics to next generation satellite systems. Our portfolio now encompasses companies with operations in 13 countries and 14 states. (We produced this brief video to capture the amazing spirit and diversity of our founders.)

We are very proud of the fact that, to date, our unique, unconventional approach has produced more than 60 notable exits and 3 IPOs out of 180 or so investments. We’ve had exits every year that we have been in operation except our first, even during the 2008-2009 downturn. Our biggest winners now include 11 companies valued at over $1B, including 5 already exited.

Collectively, our companies have created nearly 22,000 jobs, generated well in excess of $4.3 billion in annualized revenues as of last year, and raised over $4.5 billion of capital. For every $1 we have invested, $35 followed on average from other investors. Our current realized return across all our exits (including full and partial ones) is over 8x. (True to our tradition of transparency, these interesting stats and others are depicted in this new infographic here.)

On the back of this exciting momentum, we have just raised a new $200 million fund, our fifth, to mark our tenth anniversary. We will leverage that extra scale to make much bolder bets, and support our founders in more meaningful ways with one of the most diverse teams in venture.

As we embrace our next decade, we will always be mindful that the only success we strive for is the one that our founders envision for themselves. To make a stronger point of that effort, we were the first venture firm to commit to always vote our shares with our founders. Our mission is to help them realize their dreams and create their own destinies, anywhere in the world.

To work with entrepreneurs globally who will turn convention upside down, reinvent the things everyone takes for granted and give the world something it never knew it needed, but suddenly can’t live without, that is our dream.

Welcoming Beth Steinberg to Felicis Ventures as a Key Advisor for Talent and People Operations

  • On October 23rd, 2015

  • by Aydin Senkut

Pursuing the right talent along with building a unique, sustainable company culture should be top of mind for every CEO. So important in fact that in two surveys we conducted among our portfolio companies, it was highlighted as one of the most crucial areas where we can help. We listened and sought out one of the most experienced and respected executives in this field: Beth Steinberg. We’re very excited to announce that Beth has joined Felicis Ventures as Senior Advisor for Talent and People Operations.

Beth will assist us in offering our companies strategic advice in critical areas like attracting top talent and developing a scalable company culture in a high growth environment.

Beth is an incredibly talented individual who dedicated nearly her entire career to developing successful organizational and people operations strategies partnering with exceptional leaders. She served as the first VP of Human Resources at Facebook, then as VP Talent & Organization Development at Sunrun (IPO) and next as SVP, People Operations at Brightroll (acquired by Yahoo).

We have relied on Beth’s counsel not only to address our founders’ organizational challenges, but also to pursue awesome technology solutions to reinvent people analytics and operations. Beth’s unique insights reinforced our efforts to make some of our most strategic bets in this space, including Greenhouse and CultureAmp. Without a doubt, she will continue to have a tremendous positive impact on the people within the Felicis community, and beyond. We couldn’t be more excited to have her on board.

Welcoming Harley Finkelstein, Chief Platform Officer at Shopify, to our Founder Advisory Council

  • On March 11th, 2015

  • by Aydin Senkut

At Felicis, we have long believed that great companies can be built anywhere in the world, aided by the democratization of access to capital, customers and talent. We have been fortunate to back companies based in 11 different countries. We also recognize that Silicon Valley remains the central hub for entrepreneurship; founders come here, against all odds, leaving behind everything known to them, to start something new. Unsurprisingly, immigrant founders founded 52% of all new Silicon Valley companies between 1995 and 2005. True to our DNA, Felicis founders hail from over 29 countries.

Our founders have told us that support from someone who has been in their shoes is invaluable. That is why we are thrilled to announce that Harley Finkelstein, Chief Platform Officer at Shopify, has agreed to join our Founder Advisory Council.

Welcoming Harley to this role will allow our founders to learn from one of the most talented operators in our portfolio. We strongly believe that deepening our team’s operational experience is one of the best ways we can serve our founders as they build great companies.

A former attorney, Harley took a non-traditional path to become one of Shopify’s earliest employees, eventually helping to grow the company to power over 150,000 merchants. We have been privileged to support Harley as he and Tobi, Shopify’s CEO, led the company to become one of Canada’s epic tech success stories.

Harley is a special person. Warm and personable, he is a great hustler, community builder and operator. Shopify’s Build a Business competition is a strong testament to that effect. It has grown under his leadership from 1,378 new businesses launched in the first annual competition, to more than 21,000 in last year’s competition.

With five portfolio companies based in Canada, plus close to another half dozen in the US with Canadian founders, Felicis is deliberately long on Canada. We look forward to having Harley as our eyes and ears for the best Canadian companies yet to come.

Wesley Chan Joins Felicis Ventures

  • On January 13th, 2015

  • by Aydin Senkut

I’m extremely pleased to share that Wesley Chan, whom I’ve known for more than 13 years since our early Google years together, has joined Felicis Ventures as a Managing Director. Wesley is a phenomenal product expert: an early visionary on Google’s advertising system, he went on to found both Google Analytics and Google Voice, growing each business to tens of millions of users. He then switched to the investing side, playing a pivotal role in the growth of Google Ventures. Wesley made great investments in companies including Parse (acquired by Facebook), Optimizely, and iPerian (acquired by Bristol-Myers Squibb). He was recognized by MIT’s Technology Review as one of 35 Innovators Under 35 and has 14 US patents for his work on Google’s advertising system. He’s a really great guy all around, to boot.

Wesley will join as the fourth partner on our investment team.  To capitalize on this momentum, I am also pleased to announce that we’ve increased the size of our latest fund, Felicis Ventures IV, from $96M to $120M. This is an exciting way to begin the new year, which I have no doubt will surpass last year in terms of the amazing achievements of our portfolio companies. In 2014, we were fortunate enough to celebrate two new $1B+ companies (Credit Karma and Adyen) and seven $100M+ exits (Twitch at $970M, Brightroll at $640M, Dropcam at $555M, RelateIQ at $390M, LiveRamp at $310M, and Acompli at $200M).

To be clear, the addition of Wesley to our team and the increased fund size are two important moves reflecting our deep commitment to delivering an exceptional founder experience. As a team, we have always felt our most important customers are our founders. We are constantly optimizing how we can better serve them, particularly in meaningful ways aligned with the boutique nature of our firm.

Wesley shares my view that Felicis is, first and foremost, a product built for founders, and should be developed as such. With this in mind, we conducted our first founder NPS survey in late 2013. In summer 2014, we publicly committed to always vote our shares with our founders. Finally, last fall, we kicked off a deep survey of founders, including a few we did not have the chance to back, to truly understand how we could improve our level of service.

The two recurring themes stood out. First, founders needed greater operational expertise from our team. Our NPS survey revealed that 75% of founder respondents sought more support in building their companies at the earliest stages, including help with hiring, building customer pipelines, deeper relationships with partners, and coaching from investors who had been in the trenches as an entrepreneur. In our deep-dive interviews, 90% of founders rated an investor’s ability to help founders reach critical milestones as “very important” (4 or higher on a 5-point scale). 100% of these founders rated an investor’s ability to provide and be connected to a broad network as “very important.” On average, this deep, meaningful support was more important than thought leadership and domain expertise.

We also discovered an identity issue that reflects Felicis’ exciting maturation over the last several years. Founders had trouble placing us in the context of the broader venture capital landscape. They recognized that we had graduated from our super angel days, when we were fortunate enough to be among the first investors in Meraki, Twitch, Dropcam and others. Founders also noticed us making larger, bolder investments in later-stage companies around the world, such as Adyen and Rovio.

The latter observation is consistent with the type of firm we aspire to become: one that leads with conviction and offers actionable, deep support to founders in company building, regardless of geography or stage. Though we have been fortunate to achieve a stellar track record, we have realized that it also carries higher expectations of Felicis as an active partner to our portfolio companies. To that extent, both the addition of Wesley to our team and our increased fund size are squarely targeted at deepening our commitment to better serve our founders.

We are actively listening and are determined to support founders in the best way possible. Concurrently, Wesley has already hit the ground running with two pending investments, which we look forward to announcing in coming weeks.

Felicis Ventures Raises $96M Founder-Centric Fourth Fund to Invest in Reinvention of Core Markets and Development of Frontier Technologies

  • On August 5th, 2014

  • by Aydin Senkut

Felicis Ventures, the Palo Alto-based boutique venture capital firm, announced today that it has raised $96M for its fourth fund to back iconic companies with a focus on reinvention of core markets, such as security and mobile infrastructure, as well as development of frontier areas, including machine learning and personalized medicine. The fund, backed 100% by institutional investors, welcomes three university endowments as limited partners.

Since its inception in 2006, Felicis has refined its unique founder-centric approach while backing over 120 technology companies, 50 of which have been acquired or gone public. With each added fund, Felicis has tripled its aggregate enterprise exit value, which now exceeds $5.6B. The current portfolio spans a variety of sectors and includes startups headquartered in ten countries. Notable portfolio companies include Adyen, Bonobos, ClearSlide, Counsyl, Fitbit, Rovio and Shopify.

With its fourth fund, Felicis’s largest to-date, the team intends to lead more sizeable financing rounds and continue to play a pivotal role with its founders. “Felicis believed in our potential before everyone else,” remarked Manish Lachwani, co-founder & CTO of Appurify, a mobile testing company recently acquired by Google. “Many investors make introductions for their portfolio companies, but Sundeep made the most important one of all: he brought me and my co-founder together,” said Lachwani. “We frequently looked to him for advice and support all the way up until our acquisition.”

Felicis’s most important requirement for partnering with a founder is shared conviction. “Felicis sought us out after using our service. They were both prepared and enthusiastic at our first meeting. The team made it clear that they believed in our mission and would work with us to make preventable medicine achievable,” said Ramji Srinivasan, cofounder of health technology company Counsyl. “Their initial investment in our Series B and substantial follow-on support matched their conviction on day one.” Similarly, a strong belief in the enormous potential of global payments infrastructure led the Felicis team to pursue Netherlands-based

Adyen. Following two years of building a relationship with Adyen’s founders, Felicis became one of only two institutional investors in the rapidly growing company.

The new fund will also allow Felicis to meaningfully deepen its alignment with founders: today, the firm announced a commitment to always vote its investor shares alongside them. This initiative has been lauded by industry heavyweights, including Sam Altman, President of Y Combinator. “For the two years I was angel investing before joining YC, I often did this when I funded entrepreneurs. I applaud Felicis for taking this step and hope other funds will follow in their footsteps,” he said.

Jack Abraham, a founder Felicis has backed multiple times and whose first startup, Milo, was acquired by eBay, originally suggested the voting rights concept. Abraham, who is also an advisor to Felicis, noted that, “Renata, Sundeep and Aydin genuinely care for their founders.

The firm’s conservative fund size means that exits that wouldn’t move the needle to larger funds remain meaningful for Felicis, reinforcing their alignment with the companies they back. Whether it’s committing to vote their shares with the founders, or being flexible on the usual ownership, stage or location constraints, Felicis is trailblazing a truly special approach to venture capital.”

For more information on Felicis and a graphical representation of the fund’s impact globally, visit: