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.
My partner Rob wrote bit more on his blog about our motivations for adding our first new team member at NextView Ventures — a Director of Platform and Community. All three of us are excited to expand our efforts and are currently in the process of seeking an exceptional individual to fill a unique role in building our firm together. To expand on Rob’s outline, I’ve pasted a full job description for the position below. We’re looking forward to hearing from people with great ideas about leveraging this opportunity.
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NextView Ventures (www.nextviewventures.com) is a dedicated seed-stage venture capital firm focused on investments in internet and mobile startups.
We are looking for a passionate, outgoing, and talented individual embedded within the local Boston entrepreneurial community to facilitate information sharing between NextView portfolio companies, spearhead community-building & outreach efforts, and help promote our firm. This new position at NextView will build upon the existing community and research infrastructure which we’ve already created, and help us take this work to a new level with the creation and growth of new initiatives to strengthen the platform we’re building with our firm.
Plan and produce small- and large-scale events with entrepreneurs and high-level technology executives.
Establish firm contact and communication system for managing and coordinating business development interactions.
Formulate and conduct NextView’s media relations strategy, both with traditional media journalists and online influencers (creating, executing, and measuring). Execute effective social media strategy and broader targeted outreach (including writing and managing multiple social media presences).
Coordinate research projects to drive towards specific work output.
Strategize new project initiatives based on top-level firm goals, set priorities, and manage towards operational completion.
A “digital native” with an established personal web presence and a strong interest in new technology. Possessing hands-on proficiency with many online tools for managing social media interactions, event production, and project management.
Active contributor to the Boston entrepreneurial community with extensive network across technology startups.
Strong communication and interpersonal skills with a proven ability to foster communication and cooperation among diverse individuals online and offline.
Self-motivated with dedicated work ethic and entrepreneurial attitude. This individual will work in a largely unstructured yet goal-directed environment. It will be up to him/her to take top-level goals, translate them into a tangible workstream, and then execute effectively.
Effective writing skills with established body of work.
Previous experience with (tech) public relations and media outreach.
Exceptionally high attention to detail.
Experience involving business operations and/or project management a plus.
This two-year role is a unique opportunity to work full-time within a venture capital firm, setting and executing on a outward-facing strategy to interface with both its portfolio and the broader entrepreneurial community. Compensation will be competitive based on experience.
Please contact David Beisel (email@example.com) expressing interest in the role. Include pointers to your LinkedIn profile and other professional web presences.
I’ve commonly heard entrepreneurs recite some version of “I don’t want to waste too much time fundraising because it will distract me from building my business, so I’ll only talk to a few potential funders.” The idea is that a couple of highly-qualified VC conversations will follow the 80/20 rule of a “good enough” financing in a relatively short amount period without taking the time of an extended process to truly optimize the funding outcome. Better to spend energy maximizing long-term valuation by building underlying business value rather than short-term optimizing a bidding process… so the intuitive thinking goes. In a small number cases that approach can work, but in an overwhelming majority I’ve observed it doesn’t necessarily play out as planned.
The reality of the vast majority of eventually successful VC fundraises is that they are still a messy process. It’s rarely a straight line from point A to point B. Venture capital firms are comprised of people, which natural means that their idiosyncrasies seep into the process. Partners who would be interested in a potential investment are distracted by other new investments, portfolio companies, and personal matters. On top of it, there are coordination costs in communicating and politicking internally, especially in the larger firms, which can delay things further. And that’s assuming a particular partner & firm is sincerely interested… it can take a number of meetings for them and especially the entrepreneur to truly suss that conclusion out.
The primary point of leverage which entrepreneurs can exert to counteract above is scarcity in the round. Actual scarcity is better than perceived scarcity (though the latter sometimes suffices). Running a broad process initially (by approaching much more than just a handful of potential investors) empowers an entrepreneur to credibly be able to directly communicate a steadily-progressing process. The first venture firm at any one juncture progressing to the next step (first meeting, second meeting, diligence, partner meeting, term sheet, etc.) becomes the “pace-car” for that lap. As each step is completed, effectively communicating that fact to the other firms serves as a forcing function to other firms that they need to continue at the current pace or drop out of the race.
Running this type of coordinated effort broadly front-loads quite a bit of work, but systematically yields both the best – plus shortest & ultimately least effort – outcome. By contrast, without utilizing the credible threat of scarcity in the round based on timing, a dialog with a small number of funders can drag out for weeks and even months… as each wants to maintain the option value of seeing how the company progressing during the timeframe absent any instigation to act. Hence, the VC fundraising timing paradox: spending much more time up front fundraising will yield a shorter and less time-consuming process in the end.
One salient showcase of this theory in action is the successful accelerator model. While a good portion of the benefit from these programs is meaningful mentorship honing their businesses and developing customers, a disproportionate amount of effort is devoted to positioning and synchronizing the fundraising. The capstone event of a specific visible “investor demo day” serves as a pace-car for fundraising conversations, both before and after the event itself. With it, the startups’ fundraising has the best chance of being optimized, thus hopefully starting a virtuous loop around other aspects of the business.
But joining an accelerator is only one path towards running an effective fundraising process. The more common path is to navigate this process with the help of current investors, advisors and sherpas – it’s certainly less clearly defined, but so is the entire entrepreneurial road. The key is to a timely fundraising process is to set out broadly initially, rather than have stalled steps force you to do it later.
My partners and I at NextView talk a lot about how fundraising is about finding the true believers rather than convincing the skeptics. The energy that it takes persuading someone who starts with a bias not to invest is much better suited searching for additional prospects who want to believe in what you’re building. We’ve observed it repeatedly in our portfolio as Founder/CEOs seek additional rounds of financing: the engaged skeptics just never quite get there, but the entrepreneurs who cast the nets wide enough find someone who believes.
Because of this learning, we counsel our seed companies when raising a Series A to run a full & synchronized process with a broad array of firm sizes, types, and shades to determine what profile will become believers… and the same recommendation is true for seed stage startups raising their first round of capital, institutional or not. It’s not until you have had a broad array of conversations are you able to tease out the profile of (and subsequently specific) firm(s) which will be attracted to your company.
There is a challenge with the “believer approach” mindset, however. At some point, if a company is unable to raise an additional round of capital after speaking with numerous potential funders, the market will have spoken. In these situations, there are strong diminishing returns to approaching a new source of capital once there is a reasonable conclusion that the round is in jeopardy. And with the focus on searching for a believer, there is risk in an entrepreneur (and existing investor-set) convincing themselves that going just a bit broader, initiating just one more conversation, speaking with just one more firm will a new (and better) result.
I’ve seen both outcomes in a prolonged “believer” search. Just when an entrepreneur had felt as though all options were exhausted, a bluebird firm appears to swoop in and lead a new (up) round of financing. But I’ve also seen entrepreneurs continue to slog it out with yet another umpteenth VC meeting when in reality those efforts were better served determining an alternative course of action.
How is a CEO to know if it’s time to pull the plug on fundraising or keep searching for that would-be believer out there?
Keep searching to find believer when:
- There have been numerous final full-partnership meetings at different firms that there’s the likelihood that another reaching the same point in the process will result in a different answer.
- The company has made substantial milestone progress since the start of the fundraising process.
- The company truly is disruptive and hard for investors to wrap head their around because it’s so different. (This one is the hardest to be accurately self-aware.)
It’s time to pull the plug when:
- The type of firms approached varied exhaustively by size, scope, profile, prestige, and other dimensions.
- The company has spoken with literally multiple dozens of VC firms.
- You’ve heard feedback that your startup is being perceived as “yet-another-XYZ” company (even if that perception is genuinely unfair).
- The fundraising process with almost all firms rarely proceeds past first or second meeting stage.
- The competitive landscape of the space you’re in is crowded or there’s a well-funded primary competitor (…VCs are having a tough time discerning your advantage over the (multitudes) of others).
- There is an unnecessary amount of time on VCs part spent in diligence on minutiae (financial models, sales pipeline forecasts) rather than discussion on big-picture direction.
- The prospect firms are qualified in that they “get” what you’re building and seem to understand the space or category, but still don’t believe.
- There is enough cash in the bank to make additional progress or accomplish specific milestones which will make the investment opportunity more attractive at a future date.
At the end of the day, lack of fundraising traction is due to either reasons which can be ultimately addressed (approach/strategy, positioning, traction/progress, etc.) or reasons which can’t be addressed (founding team DNA, market size perception, etc.). Timing can change the former, but only a believer can see the latter differently.