In my first post in a two part series, I detailed the dynamics in the venture market leading to a current atomization of seed rounds. Not only has Seed become the new Series A, but the capital path for startups to approach that milestone has become less straightforward. In this second post, I’ll examine what this means for entrepreneurs planning their capital strategy as well as how we think about this atomization at our firm, NextView Ventures.
This shifting of the Series A bar could be seen as a harbinger of trouble for startups. However, the ability for many of these very same companies to be able to raise additional incremental amounts of capital to prove out real successive milestones in reality unshackles them from the linear up-or-out framework of the past. Plug-in monetization platforms for both consumer and B2B business means that, if made a priority, revenue metrics earlier in the life of company can yield tangible real proofpoints for existing and prospective new investors. And the lean-startup approach with founding teams that are measured about their initial burn rate means that incremental rounds of capital won’t derail the progress which is being made.
The result is that Founders should potentially think about “seed” not as one round, but as a stage that can encompass a couple of financings. Specifically, what we’ve seen emerge beyond the classic seed round are both “pre-seeds” earliest in a life of a company and “second seeds” after an initial seed round has already been raised.
Pre-seeds have appeared as a distinct subcategory in this atomization, and earlier this year we as a team at NextView wrote a couple blog posts to define, explain how we think about them, and show some examples of how we participate in this so-called pre-seed stage. In fact, since those posts just a few months ago, we’ve made two new pre-seed investments. For founders, raising a pre-seed round can attract more sophisticated investors earlier in the life of the company, minimize the net dilution vis-à-vis raising a large seed round immediately, and set the stage for a successive larger round of financing if things begin to work quickly.
On the other end of the spectrum are seed extensions, post-seed, second seed, or recently dubbed runway seeds.
Now is a moment in time where we see a unique opportunity for second-seed rounds being particularly attractive, especially for B2B SaaS companies, both for us at NextView and for entrepreneurs alike.
The reasons for this situation are threefold, one related to scale, one multiples, and one expediency. On scale, my partner Lee has blogged in the past about how revenue = product market fit:
“[Revenue] is the best signal of product-market fit for B2B startups… If a business customer is willing to pay something for your early product, even nominal or beta pricing, that’s a pretty healthy indicator the product has value in terms of features and functionality.”
Generating $100K in revenue monthly recurring revenue surely signals confidence in in strong product-market fit… yet somehow the current early stage Series A market isn’t rewarding it fully… this gap is an opportunity.
The second aspect of the current landscape making second-seed startup financings attractive, for B2B software companies in particular, is the prevailing public market multiples which have translated into the private markets. Others have blogged about how the past two years we’ve witnessed a dramatic compression… up to 57% drop in forward revenue multiples. The best entrepreneurs have observed the same phenomenon, of course, and they realize that the best time to raise large amounts of capital isn’t when it’s expensive but rather than when it’s cheap, and vis-versa. Simple economic math prescribes entrepreneurs should raise big rounds when capital is plentiful and inexpensive, and instead raise milestone-driven capital when the capital comes with greater costs.
Thirdly, there is benefit to the potential speed of fundraising for a second seed. In many cases, the raising a smaller amount sooner is preferential to a long drawn out process for a classic Series A. This expediency might not be true in all of the time, but on the whole a second seed will be less consuming, and it’s a distinct strategy advantage for companies that might take a longer time with an involved process to raise a large A.
So it’s time to lose the baggage with the term “seed extension,” as it connotes that something isn’t working. In 2016, a B2B SaaS second seed isn’t an extension of last resort of failed Series A fundraising efforts, but rather a deliberate approach which optimizes the current reality.
Whether it’s in conjunction with an early pre-seed or later second-seed round of financing, the atomization of seed round capital means previous stigma surrounding around another seed round financing is significantly diminished or even gone. The real questions for startups remains the same: how much capital should the company raise now to prove out additional value-inflection milestones (regardless of label)?
For my colleagues and me at NextView, our broader and enduring mission at is to invest across the seed stage, and includes being opportunistic in all sub-segments regardless of the nomenclature of the day. Given our right-sized fund where both the pre-seeds “matter” to us, but we have the ample capacity to catalyze and lead larger multi-million dollar second seeds in revenue-generated B2B startups, the entire seed stage area where we have been investing from the inception of our firm. We are excited by companies where the founders have become only more bullish about their market opportunity and product, but see value in investing more aggressively in product and sales efforts now before raising a full-blown series A.
The atomization of the seed stage landscape has in many cases made the path towards a Series A for startups a muddy one. However, it has also created a situation where the excesses of overcapitalization of companies seen in the later stages isn’t nearly as prevalent. Atomization means that incremental capital with incremental milestones further aligns entrepreneurs and investors to concentrate on the important items which need to be accomplished, all without significant time and capital at risk. The landscape is surely shifting, but those changes create opportunities for everyone paying attention to the changes.