In this video, we are going to break down startup funding rounds and what they mean
because honestly, it’s not the most intuitive of concepts.
The convention to name a round ‘Seed’ vs ‘Series A’, or ‘Series B’ vs Series C’ responds mostly to
the company stage, and a little bit to the size of the round. A lot of the confusion
comes from the fact that rounds can vary in size a lot: you can find Seed Rounds at $250K and at $2M,
and they are both true ‘Seed Rounds’ (or at least that’s how they are reported in Crunchbase).
So let’s get to it.
So the first thing you need to understand is the type of company that raises venture capital
because only a handful of companies have access to that type of capital.
The reason I know any of this is because we are a venture-backed company ourselves,
I spoke to a couple of founders of Series B-backed companies,
and most importantly because of what we do. We help companies navigate this mess. Shameless plug.
Venture capital normally comes when a company has the ability to scale
massively. I’m talking about tripling their revenue year-on-year for a few years and getting
to hundreds of millions of dollars in revenue.
Not all companies can achieve this. A marketing agency, a consulting company, a dev shop,
A blog or a Youtube channel, and most eCommerce platforms don’t
qualify as venture-backable companies, because they just can’t grow that fast.
In this day and age, venture capitalists aren’t looking for an eCommerce shop,
they are looking for companies like Shopify,
where over a million online shops live. They are looking for transformative companies,
that are using technology to disrupt how millions of people (or thousands of companies) do things.
We made a whole video about this difference between these two types of companies,
the venture-backable startup, vs the ‘small’ more traditional business.
They both have access to capital, but it’s different capital. This Series A/B/C
alphabet is most commonly used for this second type of fast-growing startup.
The only reason why we qualified to raise money is because we are a SaaS product,
our Youtube channel or our design consulting branch are not venture backable themselves.
OK, so let’s go through the stages of one of these fast-growth
startups. In this type of company, the first thing you need to understand is that around
should provide enough capital to reach the next round.
That’s a very common mistake founders make: they raise money without actually running the math
to confirm that they can reach the next fundable milestone.
Pre-Seed But let’s run a scenario.
A few guys got together, a couple of product people, and a dude with some
marketing skills and they figured they’d start a company. Maybe a B2B SaaS platform.
The first thing they need to do is raise some money to get started.
NO. WRONG.
The first thing they need to do is figure out if their product makes sense, and if there’s a market
for it. And you don’t necessarily need money for that. You don’t need a product for that.
There’s a phase of asking questions, talking to people.
There’s a phase of building a fake landing page and seeing how people react.
You can do all this without investor capital. Maybe savings, keeping your day job.
But if you were to raise money at this stage, we’d probably call this round a Pre-Seed round.
This is the earliest capital a company can raise. Pre-Seed rounds are normally used to build a first
product prototype, but not necessarily to launch it. This prototype might be enough to
get some customers, but the idea is that the prototype should unlock
the doors to go out and raise some more capital to launch and begin growing the platform.
Pre-Seed rounds are normally under $500K,
and are normally raised from Friends and Family investors because since there is no product,
all you are going with is a pitch deck, an idea, and the team’s reputation. That means
that going out to ‘strangers’ for this capital is unlikely to yield success.
are used to begin growing a product. The assumption is that the product is ready,
or almost ready and that the Seed Round should suffice to get the company to a Series A stage.
That’s very important about any round, and so often overlooked by founders. Founders often raise
money to launch a product, to get to a random number of customers, or for 18 months of runway.
A round needs to be enough to put the company in a position to raise the next one. Period.
It’s not profitability. It’s not 18 months. It’s the position for the next round.
Timing is important, though. The money does need to last for at last 12 months,
so that you are not immediately back fundraising right after closing the previous funding.
Fundraising is distracting and it stops the CEO from doing its job, which is growing the company.
The next fundable milestone after a Seed round is a Series A,
so let’s understand what’s required for that.
The benchmark for a Series A round varies
from industry to industry, and it varies depending on the fundraising landscape… but in our case,
Software as a Service, it’s usually about $1.5M in ARR. That’s about $125K in monthly subscriptions.
That of course comes with other variables:
a good understanding of what the company did to get there.
Signs of good product-market fit, where customers love the product, usage is high, churn is low.
Another variable is how fast the company is growing at that time. A company that took
3 years to get from $0 to $1.5M ARR is very different from a company that took 12 months
to achieve it. Momentum is very important. Fewer than half of Seed-funded companies make it here.
Series A rounds vary a lot. I’ve seen Series A rounds as small as $2M and as big as $10M
or even $15M. The average Series A in 2020 was $15.6M.
This is where things get confusing, of course! If a company $2M, is it a Seed or a Series A?
Remember, it’s not so much about the amount of money,
it’s much more about the company stage at the time of the raise.
Starting at this stage, funding rounds are very much tied to an anchor, or brand name
VC. If you are raising $10M you are not going to want to go to find dozens of Angel Investors.
Companies at this stage look for a venture capital firm that can lead the round.
The anchor or lead takes care of the diligence, negotiates the
deal, and provides credibility to the company so that other investors can follow suit.
There are a lot of angels and venture firms who will tell you that they don’t lead rounds,
they just follow, and it’s honestly a smart strategy.
Crowdfunding is another option once you’ve got a lead. Maybe the lead has committed $5M,
and you need to fill in the other $5M using other investors.
More on Series A, since we are dealing with bigger numbers, investors
want more oversight of their money. It’s very common for them to negotiate a board seat,
preferred stock, and other investor protection mechanisms.
After Series A, things get very serious. You are still a startup, but you are at a stage where
you should be making millions of dollars a year,
you have a clearly identified market and you are ready to take over.
Here’s Pete Sullivan from Jackpocket on what happened with their Series A. Just for context,
his company developed a system to sell lottery via an iOS app.
Before we go to Series B,
I want to talk about limbo. What happens if you don’t get to where you are going?
Say you have raised a Series A,
you have investors with $10M invested in your business, but the company isn’t growing fast.
That is a bad tight spot to be in. It’s a lot of money to be stuck with, your last valuation
was probably $20M, $30M or more, so finding an acquisition that makes sense may not be easy.
You see a fair share of cases like this: just search for Series A funded companies
that haven’t’ raised again in 3 or 4 years. They are probably in that limbo.
Another common limbo happens between Seed and Series A.
A company that’s raised $1-$2M, but has not reached the momentum needed for a Series A.
This happened to us, actually. I told that story in a couple of our videos-
I’ll link them in the description.
The name Post-Seed round actually comes from this:
a seed company that’s not yet Series A stage. For the most part, these aren’t’ great deals.
These are companies that don’t have a lot of leverage to negotiate the terms of that round.
But that’s not what this video is about. I can make another one
discussing some more examples of those limbo cases, and how to get out of them.
Let’s get back to the alphabet.
Series B
If things go ‘as planned’ you are on your way to a Series B, preparing to take over.
Taking over means a lot of expensive things. Branding, marketing,
a very experienced team (ex-pats of other startups, probably), and that takes money.
According to investorpedia, the average Series B is $33M. However,
the amount, goals and use of funds of a Series B can vary drastically.
We helped the guys from UpKeep write and design the deck that they used to raise their Series B.
They ended up raising $36B. Most of the time we spent on that deck was
on metrics. Proving to investors that they understood everything about their customers.
I also spoke to Eric Johnson from Membersy. They raised a $20M Series A as debt (not equity),
which is also an exception in itself, but for their Series B they raised $66M.
Tell me a little bit about it. Like, tell me a little bit about some, like the
expectations. What do investors expect will happen 18 months or 24 months after this round closed?
So. You know, for us, it's a unique situation because we've actually been
profitable for many years, even when I had that higher interest debt payment.
Right. And we, you know, like last year, like close to seven, $8 million in EBITDA. Right. So,
you know, we've always been a cashflow heavy business. So for us, it's not necessarily about
losing money right now. Right. It's more so about reinvesting any profits we have.
Right. And giving ourselves a little bit, you know, uh, more cushion to do.
Right. Um, this is a true kind of in, in all shades. And you know,
this is a growth investment, which is cool. Like it's not a,
Hey, you know, the investors are looking for dividend returns, right. And the next three years
are the investors are, are looking to just do nothing, but, you know, go buy companies, right.
It's, it's an organic growth story and we're going to be, you know, uh, you know, um,
opportunistic and. No M and a activity that makes sense, but this is a growth point all about. Now,
when you're going through around like that, you really have to lay out, you know,
at a very detailed model, right. It was very detailed.
Typically a five-year model has been a good one to kind of have a base best and worst case scenario
for the future. And then you have to sell the investors on that model and then understand
that model. So, um, that's where your banker really comes in and she out.
Um, and then once you have a model like that is, is, is testing typically,
you know, they'll just count them all right away, you know, on their end, usually 20%.
Financial Models and a detailed understanding of them became a common theme with everyone I spoke
to. It seems that what you need to accomplish with a Series B, looking to raise a Series C is,
An incredibly detailed understanding of your financials, projections.
Certainty- or something similar, that your company can scale a lot more.
These rounds happen on hard data,
not on ideas or expectations. Capital may come from VCs, hedge funds or private equity firms,
because you are essentially dealing with a large company and a proven business model.
Some of that funding may also connect to acquisitions. A company at this stage can
begin absorbing competitors or other strategic deals.
A lot of things can happen after a Series C.
These days you can see companies staying private with Series going all the way to E.
Alternatively, they can begin a push to an IPO,
which can provide investors with the much-desired ROI of their investments.
We made a video explaining the entire process of going public,
which I’ll also link in the description.
So in Summary: Pre Seed Rounds,
Pre-product. Mostly friends
and family investors. Usually under $500K.
Seed Rounds,
Need to be enough to get to Series A. Should be invested in growth.
Should give the company momentum to get on a track of growth.
Series A Rounds, Again, enough to reach Series B.
Focus on understanding the customer, and proving,
unquestionably, that the product works for them. Beginning to build a solid, proven team,
Series B and Series C Rounds, ‘ Are related to scale.
Focus on detailed financials and strategic partnerships or acquisitions.