David Frankel, Managing Partner
The “Series A crunch” sometimes still feels real. It dooms many startups that could otherwise have easily survived if they had been more strategic about their seed-stage fundraising.
As capital floods into the venture markets, “seed” has long since gone from being a stage to being a gradient that encompasses everything from a $500K check to a professional $5M round. Entrepreneurs need to understand this new reality. Failing to appreciate the fluid nature of the new seed funding marketplace makes it possible to overcapitalize or sub-optimize your funding strategy in many new ways (in addition to all the old ways funding can create challenges).
There are sector and geography filters and exceptions at the edge that add nuance, but an early stage entrepreneur is likely to be lumped into one of these buckets. The danger is that entrepreneurs haven’t yet internalized these subtle distinctions and are casting about for capital unaware of some of the new dangers created by this evolving landscape.
Few startups plan to get to profitability on a single round of funding, so they need to think about a sequence of fundraises. A desirable series A in 2018 looks like at least a $30M pre-money valuation. To justify that level of investment, a startup will need to be on a $5M run rate, or else have genuinely compelling user growth numbers or a real case to be made about their tech stack. If your plan doesn’t hit those milestones, you’ll want to rethink your seed round as a multi-stage affair.
Optimizing only for valuation at seed is a trap. I’ve seen bright seniors in college trying to raise money for pre-product startups at a $10M pre-money valuation. Avoiding dilution feels like a major victory at the moment, but I expect many of these founders will feel defeated when they’ve failed to justify their valuations and are unable to find a follow-on investor in 12–18 months. These entrepreneurs are setting themselves up for defeat or minimally, a flat round or two.
Overfunding is a risk at any stage of a startup’s life, but it can be more manageable in the later stages. If a startup has figured out product/market fit, is generating revenue, and can grow organically, it is possible to grow into an ambitious valuation. Seed-stage startups don’t have this luxury.
A variation on the “lump sum” overfunding is a failure by a thousand raises. It’s now possible to:
At some point three to four years have passed, you’ve raised >$5M in “seed” capital and still don’t have the numbers to break into the A territory. Eventually, investors lose enthusiasm and the company winds down or is mercifully acquihired.
There’s a noticeable gap between the “Seed Plus” segment of the seed gradient and the minimum threshold for a series A. It’s all too easy for a seed-stage startup to get stuck in the $1–2M ARR range and not have enough in the way of intangible factors to close a deal.
It’s the most basic advice, but traction on any dimension — users, revenue, engagement, declining CAC, or reference customers — is the most valuable thing founders can bring to the table. A startup that looks like it is inflecting can paper over the fact that it’s stuck in a cooling category or led by people with thin resumes.
In today’s market, you can choose to optimize for price, speed, or quality investors. Unless you have achieved product/market fit and have built a repeatable sales model, you will most likely close faster if you raise at a lower valuation than a higher one. To be totally clear, founders will suffer more dilution this way, but they will “get it done” and will most likely minimize the chance that they’ll overvalue themselves before they’ve reached product/market fit. Flight instructors tell young pilots that “it’s better to have the runway in front of you than behind you” and the same basic advice applies in venture. I’m not suggesting that founders compromise on valuation — I am suggesting that you think through which dimensions you consider to be most important between price, speed and perceived quality of your investor.
Today, more than ever, founders need to do a better job explaining their progress in relation to funds raised and how the products fit into the macro environment. We’ve seen seed funds decide not to invest in promising companies because they believe they’ve already been seed funded when in reality, their funding was more in line with a pre-seed round. Get ahead of any potential misperceptions, or risk having doors closed prematurely. Metrics are the essential element of a pitch, but founders have the power to present them through a flattering lens. Getting to product market/fit on a million dollars invested is impressive. Continuing to fumble for product/market fit after five million invested…is less impressive.
We’ve seen companies with poor metrics raise at higher valuations, faster, and often from better investors than peer companies with better metrics because they could tell a compelling story about how their startup leveraged blockchain, deep learning, etc. Please don’t take this to mean that you should tell a story that isn’t true, or bend your product roadmap towards the tech du jour to raise funding. These herd behaviors have a half-life, and you shouldn’t mortgage your future for the sake of a single round of fundraising, but it’s also helpful to understand when and why you may actually have the wind at your back.
Capital is easy to come by, historically speaking, and this leads many startups to treat it as a perennial resource. Founders need to cultivate an ability to live within budgets, lest they fall into the “Death by a thousand raises” trap described above. We’ve previously highlighted 50+ companies that got huge, some who went public, without raising venture capital, never mind a seed round. Don’t forget about angels along with friends and family. They’ll invest because they love you or your idea, not the expected returns. It’s still actually possible to build something extraordinary with very little capital.