It’s been five years now since large VC ‘signaling’ entered the seed stage entrepreneur’s lexicon. Yet even today, whether or not to take a (relatively) small check in a seed round syndicate from a multi-hundred million or even billion dollar fund is still a decision which takes quite a bit of consideration and sometimes consternation. It seems as though it’s been talked about ad nauseum in the blogosphere, but we see first-hand as entrepreneurs we’re investing in at NextView Ventures work through building their seed round syndicates, it really is a tough issue.
And although the new conventional wisdom became that it’s best to avoid a larger firm’s seed investment dollars as it depresses the ability to raise a Series A, entrepreneurs (often wisely) did so anyway. Moreover, research firms like CBInsights have recently debunked this rule of thumb with rigorous analysis. Looking at a smaller dataset of our NextView portfolio companies, we too see a higher “graduation-rate” of Seed to A when there is a larger VC which participates in the seed round.
In my own anecdotal observation, the reasons that startups which include larger VCs in a seed round syndicate are successful raising a Series A are twofold:
- There isn’t such a thing as being half-pregnant; you either are or you aren’t. It’s human nature for it to be more difficult for a VC firm (as disciplined as they may be) to completely cut off an investment after one round of funding. Or, to flip it around, a VC firm is more likely to invest more dollars if they’re already investors in the company than if they weren’t. There’s a reason that they wanted to become investors in the first place.
- There is a high correlation between the best (i.e. more likely to succeed) entrepreneurs having the opportunity to take a larger VC’s capital at the seed round. The best entrepreneurs can attract the widest options for their initial round of funding, including larger VCs. So there is an element of (positive) selection bias in the larger VC syndicate cohort companies.
Does that mean that entrepreneurs should ignore signaling risk and seek to include larger VCs in their initial rounds of capital if they can? Follow the larger VCs argument that it’s best to have accesses to capital with “deeper pockets” than exclusively seed-stage VCs? Not necessarily:
- Not all large VC seed round checks are the same. Many in the blogosphere including my partner Rob have drawn the distinction between large VCs making low-velocity high-conviction investments and large VCs writing machine-gun velocity option bets. So prevalent is this understanding that this large VC spray approach has waned (though not disappeared) in the past couple years.
- Not all startups are the same. “Seed stage” startups raising $1M-$2M rounds of pre-Series A capital come in very different flavors. Some are pre-product, while all the way on the other side of the spectrum, some have meaningful revenue and clear up-and-to-the-right metrics. The risk associated with raising a subsequent round of capital are different for different profile startups.
“Ability” to raise a subsequent Series A is only half the story. The other is valuation of the next round of Series A financing.
A larger VC in a seed round will naturally depress the price of the next round of capital because it inhibits (but not prohibits) the ability for an entrepreneur to run a truly competitive process. As soon as the “insider” VC realizes that the company has crossed the threshold for a Series A financing, s/he’ll understandably push for the round to happen sooner rather than later and lead it. External VCs realize this fact and want to avoid becoming a stalking horse for an inside deal. That’s not to say that an entrepreneur isn’t able to successfully able to bring in an outsider firm and allow them to get to their proverbial 20% ownership requirement while still holding the insider firm at bay… but it’s just that much more challenging … especially when trying to maximize valuation in the process. Again, we’ve seen all of these multiple scenarios play out within our own NextView portfolio.
So while there are clear benefits of diminished financing risk to including a larger VC in a seed round syndicate, it comes at a direct trade-off in later upside valuation.
What, then, are the takeaways for seed-stage entrepreneurs considering taking a larger VC in their round:
- Heavily bias towards a situation where the large VC partner has high conviction and only does a small number of this type of seed investment per year because it takes up a partner time slot.
- Determine given the context whether the goal is to optimize around success-rate of Series A financing -or- valuation price of Series A financing. Often, the more “raw” the startup when Seed funding occurs, the more risk there is in product-market fit, the better it is to take a larger firm’s capital. Better to be safe than sorry. Conversely, if the company already has established some early success metrics and is on a trajectory to look Series A-ready within 18 months, then eschewing a larger firm for now so that a competitive-run process then is likely a better route.
Of course, both of the recommendations aren’t to be taken blindly. Other factors include the value-add involvement of a larger VC taking a Board seat or active role, unique “value-add” portfolio services of the larger “platform” shops, valued prior working relationships, etc.
In another post, I’ll re-examine the benefits of including an exclusively-focused seed fund in a seed round even when there is already a larger VC firm involved.
Just about fifteen years ago, Josh Schanker and I, along with our co-founders Elliot Shmukler and Tammy O’Neil Bolduc started Sombasa Media together. Our company offered a series of consumer-facing properties, including our flagship property BargainDog, which was an early e-commerce daily deals email newsletter. Over the course of a couple short years, we grew that property to more than 5 million members and 250 retailer relationships, profitably selling the company to About.com. Back in those Web 1.0 days, we quickly learned the power of email in driving real consumer engagement and purchasing events.
In the intervening years while I pursued a career investing in startups rather than creating them, Josh continued as an entrepreneur starting a handful of companies including early social networking site Sconex, successfully sold to Alloy Media. Fast forward to today, and Josh and his current co-founder Nick Ciarelli (ex-Daily Beaster and more well-known as the mastermind behind Think Secret) have created another business which very much “rhymes” with what we had built together Sombasa, as it leverages the direct influence which email fosters in a buying process. On the surface, BookBub is an ebook discovery service for consumer readers, featuring acclaimed ebooks in categories matching readers’ interests. They have relationships with over 3,000 publisher and author partners, including all of the Big Five publishers and hundreds of small-to-midsize presses. And what Nick and Josh plus the team (including many with strong backgrounds from major publishing houses and traditional agencies coupled with rockstar web marketing and engineering talent) have built without a dime of outside capital has been astounding – the service is rapidly approaching 3 million members (tripling since the beginning of last year), with members purchasing 1 million ebooks through their service per month, driving millions of dollars of ebooks sales, and running profitable on top of it all.
Taking a step back and looking at the big picture, and BookBub is forging a new road in a book publishing market which is still transitioning in the wake of ebooks’ arrival. It’s no secret that the way that people find, read, and purchase books is increasingly digital. With the discovery of new titles taking place less in book stores, it becomes challenging for readers to sift through new options and for publishers & authors to get their works noticed. The result is that publishers are shifting strategies, transitioning to investing in direct-to-consumer marketing, which represents a shift in the $10B per year globally spent on sales and marketing for books. And BookBub is in the pole position to help readers and publishers through this industry disruption — today already, (outside of retailers) BookBub is the largest community of readers purchasing ebooks.
Today BookBub is announcing its $3.8M Series A financing. This funding will empower the company to hire more aggressively, expand internationally, and unveil some new products beyond its current core which will allow it to take an even bigger role in an industry in transition… more to come there before too long.
On top of it, this financing is a bit of a “getting the band back together” of sorts. Not only does our investment give Josh and me the opportunity to work together directly again (as I’ve joined the Board of Directors on behalf of NextView Ventures), but it also brings in Rich Levandov at Avalon Ventures who was our original Investor Board Member back at Sombasa. Plus, Eric Paley at Founder Collective (who has known Josh since high school and we at NextView have invested with numerous times together) and James Cham at Bloomberg beta (who has known Josh for two decades and myself for one) have joined the investor syndicate. Given the long working history of everyone involved, the trust and communication, which lay the foundation for success, are firmly in place. I’m excited about the entire band, with both new team members and old, playing a tune together which is becoming familiar to millions and millions of book readers. BookBub is already remarkably impressive, and it’s about to become something truly great.
Jay joins us from HubSpot, where he was a senior manager on the marketing team, specifically leading the blog and content strategy. In his Boston-based career, he’s also worked for Google and local startup Dailybreak, in addition to co-founding the community group Boston Content which has grown to hundreds of members.
This is a major step forward for NextView as we continue to focus on helping our existing portfolio, as well as proactively contribute to the larger Boston (and New York) entrepreneurial community.
Although the idea of venture firms developing a platform (i.e. resources, events, content, and other initiatives to help entrepreneurs) is not entirely new, to our knowledge this addition is the first such dedicated role here in Boston. Being a unique position, we were focused on finding someone equally as unique who was also entrepreneurial, energetic, and embedded in the early-stage tech ecosystem. In short, for those reasons and more, Jay is the perfect fit.
A few questions that might be worth answering right out of the gate:
Why bring on a Director of Platform?
As Rob explained in his recent post on this new role, the venture capital industry is experiencing unprecedented change, with new funds emerging and new and better strategies focusing on the needs of founders and their companies. At the core of this shift is the need for firms to add real value to portfolio companies beyond just capital and boardroom advice.
With that in mind, the three of us at NextView saw massive opportunity to better empower early-stage companies and the entrepreneurs who lead them both in our portfolio and throughout the greater Boston ecosystem.
My startup is part of the NextView portfolio. What does this mean for us?
We want to put your needs at the core of what we do even more. Over the next few weeks, you’ll be hearing from us and Jay – we’ve already got some initiatives in the works – as we hope to be more and more in-tune with your challenges to help you succeed and grow. As Rob said in that same post, the idea of a NextView platform is really dedicated to helping you win.
I don’t work for a NextView-backed startup. Why should I care?
For those who have followed the NextView story as we’ve built our firm over the past few years, we’re continually striving to advance the broader local startup community by fostering conversation and direct participation. With Jay’s arrival, we’re looking to take those efforts to a new level, so stay tuned for more news along those lines soon.
A couple years ago, my partner Lee penned a blog post about the milestone benchmarks for startups raising a Series A round of financing. The five conditions for a Series A financing which he enumerated are: a core team ready to scale, demonstrable market size, repeatable cost effective customer acquisition, metric momentum, and plausible monetization. But unfortunately these are neither necessary nor sufficient for raising that round, and are instead merely guideposts. There really isn’t a hard and fast prescription for start-ups to follow after they’ve raised their Seed round, so what’s a startup to do? Just plow ahead blindly and hope for the best?
In the past four years since we’ve been investing together at NextView, 70%+ of those companies in our portfolio which have made attempts at raising full-fledged multi-million dollar Series A after their Seed round have been able to successfully do so (with another additional cohort raising new capital subsequent to seed but not bona fide Series A). And in seeing that process unfold numerous times, I’ve picked up that there are really four main distinct playbooks which a Founder/CEO can run in the subsequent 12-18 months following a Seed round in preparation for the next round of financing.
The four winning strategies for startups to go from Seed to A are:
- Build Scale/Momentum. The strategy here is to foster product development and marketing which creates overall (semi-)organic user momentum. This focus translates into big top line figures, (admittedly) vanity metrics, and pretty graphs with less substance on business metrics or even deep engagement for now. We live in a demand-constrained world and if, with your Seed capital, you can show overwhelming top-level pull (whether consumer or businesses adoption), Series A investors can convince themselves that the rest will fall into place over time. This strategy is particularly helpful if the primary question of a Series A investor will be, “Is the (potential) market of this venture big enough?” Showing eye-opening demand, even if it’s just a proxy for the eventual business, helps alleviate those concerns.
- Generate Real Revenue. For B2B startups especially, revenue is the best signal of product-market fit. We’ve seen that exceeding a $1M revenue run-rate – however (liberally) defined – seems to be a magic threshold to attract serious Series A attention. Even if those customers are acquired unprofitably or the margins are thin/non-existent, this revenue figure begins to connect the dots about the potential for a real business developed over time.
- Craft a Small-Scale Machine. It rhymes with #2, but this distinct strategy is to go deeper: demonstrate ultra-high engagement and penetrations into a small number of users/buyers with a clear LTV/CAC ratio. No, revenue doesn’t reach $100K+/month like above, but the machine is built so that it’s extensible with a clear line-of-sight for the foreseeable future… “just pour on the gas because we’re now ready to go.”
- Create an Unstoppable Vision of Promise. All Series A rounds are raised on some level of promise in addition to reality, even in #3 where the promise is about scale. However, one (risky) strategy on the other end of the spectrum – but one that can definitely work – is to build as much excitement as possible about what’s still to come. Sensational press, luminary advisors, blue-chip customers about sign on, and a dream team of co-founders all are possible ingredients to bake this Series A cake. This approach is surely more art than science, and requires an entrepreneur with a special skill-set of being able to make Series A investors just believe.
All of these strategies point in similar directions, but are certainly not the same vector. There are inherent tension pulls between building scale and generating revenue, as well as between crafting reality and generating hype-full promise… all with limited resources, especially in a Seed round.
I don’t think that it’s incumbent on a new venture to start out knowing exactly which path above to pursue, as flexibility and optionality during an early experimentation phase along a company’s life-cycle can be incredibly valuable. But as the next fundraising effort shifts from something theoretical in the fuzzy future to an event on the horizon to plan for, devising one of the gameplans above will help crisp the story and the efforts of the entire company to rally around it. A fundraising compass is most helpful if you have a map of where you’re heading.
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.