June 16, 2014

(Note: The majority of this post first ran on BetaBoston. This version goes a little deeper into some of my more nuanced thoughts)

There has been a lot of discussion recently about the bar required to raise a series A.

A few notable excerpts: Kyle Alspach’s commentary on seed and series A at BetaBoston; Brad Feld’s tweet a few weeks ago that “$100k MRR [monthly recurring revenue] used to be interesting. Now it’s table stakes”; Jo Tango’s blog post on the VC Bottleneck in Boston; and Mike Volpe’s comments on a post from my blog on raising seed rounds vs. Series A’s.  In fact, Mike allowed me to publish the following facts: When HubSpot raised their $5M series A in 2007, the company had $12K in MRR from 48 customers.  They had previously raised $500K in seed, plus about a $1M note shortly before the series A.

I can summarize the sentiment here in broad strokes.  The “traction bar” for series A rounds is higher than ever. On top of that, there are fewer series A investors now than there have been in the past (at least in Boston). And the investors that do exist have “no guts” (or so the dialogue goes).

Wow, that sounds really bad. Maybe we should all just close up shop.

I’m not quite as pessimistic. In fact, at this moment, we have a few early-stage companies in our portfolio at NextView Ventures that are raising really nice rounds in the face of this perception. One of our portfolio companies has no revenue, and good but not explosive user growth, and yet it’s still raising a very nice series A from a very good venture capital firm at a significantly higher valuation from our seed.  Another company raising series A doesn’t even have product in the market yet, while the third falls far short of the $100K MRR number despite raising from a top west coast firm. How do I reconcile this experience with the observations above, which seems to ring true for others as well?

My first and main thought is that an objective “bar” at which VC’s will want to invest in a company doesn’t exist — nor has it ever existed nor will it exist.  I get asked this all the time, and the formula just isn’t there.  I know that over the last several years, there has been standard guidance for SaaS companies to try to focus on getting to $100K MRR before raising an A.  There are other benchmarks in other segments too.  I think these benchmarks are helpful in allowing an entrepreneur level-set their progress with what others have been able to achieve in similar markets.  But I just don’t think it’s the right way to think about the bar for raising a series A round.

Instead, I think the most important factor that VC’s consider is the strength of the team and the excellence/uniqueness of the idea.  After that, they are looking for some demonstrable evidence that things are working. This is where traction comes in. If you are working in a very crowded space, you probably need more traction to show separation from others in the market.  But if the space is brand new or uncompetitive, then the traction bar will be lower.  Also, if the team or idea isn’t excellent, then the traction bar will be higher.  VC’s are very good at convincing themselves that a team or opportunity is interesting if there is enough traction.  But still, I find that the most unique and exciting companies are able to raise capital with relatively limited traction because the right investors require only a small amount of proof to be excited enough to jump in.

I think this was the case for HubSpot in ‘07, and I’d bet it would still be the case for them if the fundraising environment then was like it is today.  Sure, not everyone would be jumping up and down to invest, but those people would have been very wrong, and fundraising at the early stages is the search for true believers.

Couple other secondary thoughts:

  • There are more investors out there than you think. Some of the classic folks you think of as VC’s have shifted to other parts of the market, so there does seem to be fewer traditional players.  But there are more new or non-traditional players emerging all the time.  It’s the job of the entrepreneur and their seed investors to put in the hustle to keep their networks fresh and uncover potential capital sources that may not show up in a list published by the NVCA.  On top of that, investors from other geographies definitely do invest in early-stage companies that are not in their backyard.  Again, two of the companies I mentioned above are raising rounds from investors in other regions.  Also, just a few months ago, I connected an investor from True Ventures to the folks at Bolt, and they ended up leading a $2M seed round for Understory. Proximity does matter, but it’s become a little less important.
  • I think that emphasizing traction vs. emphasizing potential tends to flip-flop back and forth.  Actually, I think we are in the middle of this shift returning to the emphasis on potential, as companies like Oculus, Oscar, and others are showing that some of the most aggressive funds are very boldly going after series A and B rounds for technologies that seem industry transforming, even if actual traction is minimal (or the product hasn’t even launched yet).
  • What is challenging is that there is increasingly a market gap at the level of smaller series A’s.  As the venture industry has started to recover after the economic crisis, we have seen the best funds increase pretty significantly to $400M+ in size.  These large, mega-funds are able to write very large checks to get the ownership they want, or wait things out and invest a little later when there is more certainty.  Some of the funds that didn’t do as well are struggling to raise capital, or are shrinking or shifting strategies.  As a result, when it comes time to raise a series A and look for an early-stage investor that will write a $3M check to lead a $3-5M round, there are fewer players out there.  I see this as a temporary market gap.  What’s likely to happen is that some of the older funds will retrench and get back into the business of doing these deals and perform quite well.  Some seed funds will decide to migrate up and start making series A and B investments (this is already happening).  And seed rounds will continue to get a little bit bigger, and seed-extension rounds will be common and a perfectly fine ways for early stage companies to keep building before showing enough scale to raise a larger round.

Overall, I’m actually quite optimistic about the fundraising prospects for companies in the markets in which we participate.  There is a healthy volume of seed activity across the board, and although it seems daunting to raise series A successfully in light of some recent comments, it continues to happen at the same level of regularity as we have seen in prior years (at least based on our own portfolio).  Some of the players are changing, and the dynamics around these rounds are a bit different, but of course markets evolve. Overall, I think they are evolving in a way that is more favorable to founders at both the seed and series A stages of development.

  • Rasmus Goksor

    Great post. As a startup founders, to me the problem may be the qualitative difference between Seed and Series A metrics, not that the bar for the Series A is being raised. Read more here

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  • Rob Go
     - 10 minutes ago
    Cool design focused event @bladebos Nov 6. Limited seats available!
  • Lee Hower
     - 18 hours ago
    @vcparty agree. some LPs have to bend their model, though best LPs don't care much about concentration - they focus on accessing best funds
  • Lee Hower
     - 18 hours ago
    @vcparty that statement is true. FRC's LP base looks pretty similar to Sequoia's though
  • Lee Hower
     - 19 hours ago
    @vcparty thx - would slightly disagree trad'l LPs & smaller funds are misfit… best seed funds have trad'l LP base (albeit concentrated)