GenuineVC David Beisel's Perspective on Digital Change

March 18, 2014

Fairly often entrepreneurs will pitch investing in their seed-stage company, and it starts sounding great… interesting market… great team… notable early traction… until we arrive at the financials + fundraising slide and the projections state that this round of Seed financing is planned to be their last. Sometimes it’s even presented as an additional feature of the pitch itself: “We’ll never need to raise money again!”

Seed financing direct to long-term profitability is often both a realistic and laudable goal, especially given capital efficiency of internet-enabled startups. However, it doesn’t match the ethos of our investment strategy at NextView Ventures. We’re looking for investments which have the possibility of what we call “golazo,” which is a soccer expression for an exceptional, improbable goal. We use it to describe the bold and ambitious nature of the founders we hope to work with. In other words, we’re looking for investments which have the potential to be truly enduring and industry transforming. Of course not all of our investments will achieve this lofty aspiration, but it’s always part of our mindset from the outset.

Any additional capital fundraising, whether it’s for debt or equity, startup or mature public company, is to facilitate growth ahead of cash flows generated by the business. (Or perhaps also to dividend out cash to shareholders in mature public companies with a low weighted average cost of capital, but that’s irrelevant here). So theoretically-speaking, if there is truly a huge venture-scale opportunity ahead of a startup, there should be an appropriate cost of capital for future financings to expand which make sense for the company. But that “if” there is very important… perhaps in many cases the desire for the Seed round to be the final round of financing is a tacit signal that it doesn’t have the potential to be “venture scale” after all, even if the opportunity is a real one (and a corresponding viable investment for the right player). The vast majority of successful business started aren’t venture-scale. In the past, one could argue that early founders + employees + angels have different risk/reward profiles in comparison to later-round financiers funders and are rationally willing to sacrifice upside in return for greater certainty of outcome; however, the emergence of liquidity options for these early players has diminished that negation.

That is not to say that gunning towards cash-flow breakeven (CFBE) isn’t a stated short-term goal of some of our portfolio companies, even those just having raised a Seed financing round. CFBE empowers entrepreneurs to raise money on their own terms, when it isn’t necessary but out of being advantageous, pursuing greed instead of fear of cash-out. For truly venture-scale growth start-ups, achieving CFBE early in a company’s life-cycle can be a means towards optimizing the growth trajectory and ownership for early constituents.

But bolding predicting that a single round of financing will be its last reflects a markedly different mindset about what type of company an entrepreneur is looking to build (which doesn’t match our own stated strategy). Our approach, though, obviously isn’t the only feasible one, as there are many strategic paths to seed investing. It’s perfectly reasonable for a seed investor to seek businesses which don’t require much additional capital and will be able to be funded on near-term cash-flows. In this case, the range of outcome exit sizes will tend to skew lower but perhaps (and hopefully) the success rate of any individual company within a portfolio will be higher. In contrast, when we make a new initial Seed investment at NextView, we’re anticipating that the company is going to raise a Series A in 12-24 months. Not all of them will be successful in doing so (though we have a 70%+ “graduation” rate from Seed to Series A, which we’re proud of), but we believe if an entrepreneur is shooting for a golazo-sized win that the Series Seed will not be his her last planned round.

To generalize beyond the specific NextView Ventures case, for entrepreneurs raising Seed rounds, it’s helpful to do the proverbial homework about a particular prospective investor’s follow-on strategy and investment approach. One shouldn’t assume that “never raising capital again” is a feature and not a bug, and that claiming so doesn’t (mis?-)signal about the prospects for the business.

  • http://rickmaher.info/ Rick

    Thanks for this post David – I’m in the middle of seed fundraising now and wondered about this exact topic.

    Not knowing how my prospective angels view this topic, I offer a best case scenario and leave the door open for either option (raising an A round or not raising an A round) by saying, “if we hit our growth milestones we’ll be able to decide if / when to raise money next”

    How would that message resonate with you?

  • Jordan Thaeler

    I think it’s important to understand how venture works. Angels and rich individuals aren’t beholden to LPs. Mark Cuban can invest in as many businesses he wants and if they take 20 years to mature, or don’t mature at all, big whoop. As soon as you take venture money you will need to liquidate <7 years usually. The best case is IPO, where the founders might own a few collective percent. The worst case is not very pleasant.

    VCs all sit on the same side of the table and they don't care that you remain in control: they are focused on the ROI. That's not a problem, they just need to be honest about it. As soon as the founders own less than 50%, the VCs (collectively) make the decisions. Usually this is achieved in 2 rounds of capital. If you're the AirBnB/Facebook outlier, you can get better terms. But by math, this is not the case in 99.9% of instances. So if things aren't looking good, and you've gone through 2 rounds, it ain't up to you to make those decisions.

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