The dynamics of a series A round have changed in recent years. As seed rounds have become much more common, it’s been said that the “seed is the new series A”. This is sort of true – it used to be that Series A’s would often happen pre-product, and certainly before product-market fit. With capital efficiency, companies in certain sectors have been able to do more with less and show some market traction even after a pretty modest seed round.
The end result though is that the dynamics around series A rounds has started to seem pretty murky for entrepreneurs. But for investors who see a lot of these deals, it’s not as unpredictable as it seems. Below are some broad guidelines on the major topics around series A’s that I hear entrepreneurs thinking about.
VC Ownership: Institutional VC’s that lead series A rounds still target ownership in the 20%+ range. Historically, VC’s wanted a bit more, 25% or so, but 20% is a threshold that has been around for a long time. This hasn’t really changed. As a result, questions around valuation are less about “what is the value of this company” and more “how much capital is a VC willing to part with to buy 20%?” This is why larger funds are on average are able to be a bit more aggressive on price than smaller funds because they can stretch to invest a bit more to get the ownership they are looking for in a competitive situation.
This leads to some interesting sub-dynamics, especially when a larger VC is in your seed round. In theory, if that VC is really excited about the opportunity, they should be willing to pay a higher price for the series A than anyone else because they are already partial owners of the company. It’s a lot easier to get an investor from 7% ownership to 20% vs. getting a new investor from 0% to 20%. In practice however, this doesn’t happen as often as you think, because large VCs that bore the seed risk will often feel like they ought to get higher than 20% ownership because they put in the hard work early in the company’s life.
I find that it’s also pretty typical for an existing VC investor to be willing to syndicate the deal with another outside investor. This enables the large VC to have another deep pocket around the table post Series A to be able to add capital into the company with less friction in both a good and bad scenario. In that case however, the founders might end up taking a lot of dilution. The existing investor will need to buy up to get to 20%+, and the new investor will want to buy 20%. This potentially makes it all worthwhile if the round is pretty large, and this is how some series A rounds end up being $10 – $20M of new capital, rather than the more standard range of mid single-digits.
Speed and Timing: Insitutional seed rounds typically provide companies with enough cash to take a company around 14-18 months. This assumes some increase in burn over time, but the capital could also be stretched to go longer. As an entrepreneur, one could always make the argument that it’s best to keep operating longer and show more progress before raising to get the best valuation possible. In practice however, many companies that have the most successful series A fundraises raise their rounds much sooner, often <12 months from the seed. This happens for three reasons.
First, time is of the essence. Waiting 6 months longer to raise may improve valuation in the short term. But having the capital in the bank to make the most of an attractive opportunity sooner usually is the better move overall and will enhance valuation in the long term. Second, when things are working, founders will usually lean into the opportunity with the capital they have, which will reduce runway but make their growth curve steeper. Third, it’s more advantageous to raise capital when you don’t need it, and having a nice buffer gives you more boldness to negotiate a better deal.
This certainly is not to say that companies that take longer than 12 months or raise their A are not successful. In fact, there are a quite a few examples of companies that needed to raise extensions of their seed to get to a place where a successful series A could happen. But for companies that have something that is working, I find that being more aggressive and raising sooner tends to be better at the series A stage.
Who To Choose?: Series A investors are almost always going to want a board seat, and it’s very hard to get rid of a board member that you don’t like. Therefore, who invests is much more important than valuation. 10/10 times, I will recommend that a founder go for the series A investor that they have good rapport with, trust, have aligned vision with, and they believe will most impact the long term performance of the company. Investors that will pay a higher price but have misaligned styles and goals just aren’t worth it.
Valuation: Taking my own advice, I propose thinking about valuation in terms of round sizes. There are broadly three buckets of series A’s, and therefore, three valuation buckets.
- Solid Series A: New VC investor invests $3 – $4M and owns 20-25%. This suggests a post-money valuation range of $12M – $20M. Remember, usually the round is bigger than just the capital that the new investor puts in because of pro-rata rights or other smaller angels that may want to participate. That’s why I’m focused on post-money here and solving for the ownership ranges of the new VC.
- Great Series A: New VC investor invests $5 – $6M and owns 20-25%. This suggests a post-money range of $20M – $30M. These are terrific series A outcomes.
- Outlier Series A’s: Outliers exist with extreme traction and/or extreme competition for the deal. In these cases, a new VC investor invests $7M+ for 15% – 20% ownership. In these cases, the new investor may break their rule to own less than 20%, and is writing a large check for series A standards. This does not happen that often. Sometimes, you see rounds like look like huge series A’s and it’s discouraging to entrepreneurs. The reality though is in those rounds very rarely happen and/or something else is going on. Something else might mean that the total dilution is a lot higher than one would think because an existing investor is also buying up. It might mean that the “seed” was actually quite a bit bigger than the typical institutional seed, so the company has already taken in a fair bit of capital.
Founder Liquidity: It used to be that founder liquidity would almost never happen until very late into the life of a company. Today, it’s become a tool that is used earlier to better align incentives between founders and investors. Usually, it’s not a huge amount of liquidity – often a few hundred thousand dollars to a million max. It’s enough so that the founders will feel emboldened to step on the gas and go for a big swing rather than play it conservatively to preserve value, but not enough that they won’t work maniacally hard to win. I personally think this is a reasonable thing, especially when founders have gone a long time with limited pay and/or are struggling with the dilution of a big round. It’s not uncommon these days to see some founder liquidity in the series B and C rounds of companies. It’s still very unusual to see them at the series A stage as usually, an investor wants every dollar to go into the business they are investing in. But it’s not entirely out of the question, and can (in very rare instances) be orchestrated in large series A rounds when there is a huge amount of competition and investors are scrambling for ways to get as close as possible to their 20% threshold. But overall, I’d recommend not even considering this until later in the fundraising path of your company.
We have always been believers in trying to be helpful to the entrepreneurial community through the content we publish on our blogs. But we find that these only go so deep, and at times, certain practical topics warrant more attention.
This is why we are going to start publishing a series of “Growth Guides” over the next 6-12 months. The point of these are to:
- Take on topics that we often here as questions that are held specifically for early-stage companies in their first 12-24 months of life
- Offer more practical insight than what one could gather through blogs or Quora and bring in both our perspectives and those of other experts in the field.
- Present information that is actually useful to founders and their teams. So in addition to some theory or broad commentary, these will include actual hacks and other tips and playbooks that are immediately actionable for a founder or an early team member.
We launched our first one of these around content marketing for startups. It’s a form of marketing that we often hear a lot of questions about and can be effective for early stage companies. But it’s also a form of marketing that is very noisy, so we tried to cut through the noise and present something that is practical but has sufficient depth. It also helps that Jay, our Director of Platform and Community led content marketing efforts at HubSpot prior to joining.
Looking forward, we are going to be publishing more of these, and I’d like ideas for common topics that early stage founders and team members care about. It can be anything from mission critical stuff, or even more mundane stuff that takes up time and makes you think “why hasn’t anyone just figured out the answer and told all of us founders?” Here are a couple ideas that we’ve been throwing around, but I’d love to hear from you what we should include!
Current possible topics are:
- Hiring your first five engineers
- Product management before product-market-fit
- Seed stage board decks and board management
- Interviewing and reference checking
- Tools, providers, and services. All the stuff you will need after raising your seed round, but don’t really want to research
- How to incorporate user feedback into product decisions
- Performance marketing tests that you should do before PMF
Others or more broad suggestions? All thought are welcome. And again, check out our first Growth Guide on how Content Marketing can be used for startups.
There is a ton of chatter today in the news about the expiring lock-up of Twitter shares and what it means for the company and its prospects long term.
There have been a ton of headlines over the past few weeks comparing Twitter to Facebook. The narrative goes something like this: “Twitter usage is not growing fast enough, therefore, it will never be as mainstream as Facebook, and thus, is a much less attractive company long term.”
I don’t have a meaningful horse in this race, as I don’t own any Twitter stock. But I’ve had a long held belief that most people make a flawed comparison between Twitter and Facebook. Facebook is a social network, and Twitter is a media company. Two totally different types of businesses.
But beyond that, I have a pretty strong belief that in the long-term, Twitter will be a thriving service much longer than Facebook.
Why is this? Facebook wins so long as it is the dominant communication medium between one’s social network. But what we’ve seen is that there is massive fragmentation happening around this use case, and it’s only accelerating. Want to send messages to your friends? There are dozens of messaging apps for that. Want to interact around products? There are networks like Pinterest for that. Want to interact around photos and media? There are others for that. Facebook totally realizes the threat of this network fragmentation, and so far, has masterfully used M&A as a means to stave off massive losses of mind and time-share of their users. But it’s amazing to think that in the short history of the company, they’ve already had to address the threat/rise of massive services and been forced to pay ungodly amounts of money to keep them (and their audience) within their ecosystem. I think that this is just evidence that the pressure on Facebook to maintain its network dominance will only get greater and greater, and at some point, there will cede their position. It will happen faster than people think.
I find Twitter to be pretty different. Twitter wins as long as it remains the easiest, fastest way that anyone publishes to the public. If the content producers leave, the service will die. But as long as the content producers find value, the service will have immense value. And that value is not entirely captured by the number of times one’s Twitter feed is refreshed. It exists every time you hear a news story mention content that was generated on Twitter, when you see photos from faraway places capturing major moments through Twitter, or when you consume other content or information that is surfaced to you because of what is trending on Twitter.
The importance and impact of the Twitter ecosystem goes way beyond page views. As a result, I just see it as a more durable property long term than Facebook. It’s a lot harder to think about competing content publishing services that have been a real threat to Twitter in the past few years. There have certainly been fewer threats than Facebook has faced. If you were to compete against Twitter on this dimension, I don’t know where you would even start.
All this said, Twitter’s ability to monetize does (currently) depend on the size of their direct audience on their own stream. And the growth challenges certainly dampen some of their prospects. Perhaps it is true that Twitter’s valuation is pretty rich compared to its current revenue generation potential. And perhaps Twitter is never destined to be at the scale of Facebook, and thus is overvalued now. But I do think that in the longer arc of time, Twitter will survive, and has a better chance of thriving.
Seed stage investing has developed significantly over the past 7 years that I’ve been in VC. What started as a rogue, almost anti-VC strategy has become very common. It’d pretty standard for entrepreneurs to contemplate raising an “institutional seed round” prior to approaching VC’s for series A rounds. Many have said that the institutional seed is the new series A.
This is rational because seed investing makes sense for companies that can have capital efficient beginnings. The challenge for those in the market of seed investing is that the barriers to entry in seed are relatively low. The main reason is that it just doesn’t take that much capital to get started. A lot of folks can pull together a few million bucks from high net worth individuals and start operating as a “seed fund”. One could go about writing dozens and dozens of $20K checks, catch a winner, and then build on that to gradually raise more money. Accelerators and crowd-funding are encroaching on this territory as well. On top of that, you are also seeing funds that used to be classic series A and B funds struggle to raise capital, and so go down-market to write more seed checks.
This is why the market has become so confusing, and why there seems to be a wealth of seed investors. But some winners have emerged, and I’d argue that their position is pretty well cemented. How do they do it? Three things.
1. Leadership. The seed stage is filled with folks who follow. It’s extremely common for me to talk to an entrepreneur that has tons of demand for their round, but is actually looking for someone to lead, set terms, and be the anchor investor in a $1-$2M seed round. If you think about the number of investors that have capacity to invest $500K+ and lead a round, the number of seed funds dwindles to single-digits (in the east coast). It’s a very different skill set, and requires a LOT more conviction (and more capital). Entrepreneurs are also going to be a lot more discerning about who is going to be a major investor in their round and potentially take a board seat or board observer seat. The market doesn’t need another seed fund that rides along with other investors or hangs around the hoop until a hot investor validates an opportunity then tries to get in.
2. Early. The complaint I’ve been hearing more and more is that many “seed” funds are only investing in companies that already have traction. I totally don’t get it. I find that the market leading seed funds, and the up-and-comers I respect get into deals very early. In our portfolio, over 1/3 of our investments happen pre-product. When I think about some of the other market leaders in seed, I see a similar commitment to being true seed-stage investors and get in early.
3. Gravity. After the investment happens, the best VC’s continue to distinguish themselves by the way they work with their portfolio and impact their outcomes. This is particularly hard for seed funds because a) most seed funds invest in quite a lot of companies and b) the funds are smaller and it’s impractical to hire an army of folks like bigger funds like A16Z.
Despite these challenges, the funds that show leadership in this space find ways to exhibit gravity around their firm and portfolio in a way that founders really appreciate. There are a few ways to do this. Firms like First Round and others have created small “Platform” teams to add leverage beyond the human capital of the GPs. We’ve started to do the same by being the first VC in Boston to hire a top-notch full time person dedicated to platform and community. Related to this, some firms also find ways to create stronger connective tissue between portfolio companies, so that there is collective strength in being part of the same network (SV Angel is the classic example of a firm that does this with a very large portfolio). Finally, a lot of gravity can simply be achieved through focus, which is something that most seed VC’s lack. It’s extraordinarily hard to be a focused, active investor in a company if you are making 8+ investments a year per investor or more. It’s much more practical to concentrate your capital and time in a smaller number of companies where you have high conviction and the skills and ability to make a meaningful difference.
The seed VC market will continue to mature and change. But I do think that as things progress, we’ll see more and more separation between the really strong players and everyone else. And I’m pretty convinced that the winners will distinguish themselves through these dimensions above, even as new players come and go and new innovations continue to change the early-stage financing market.
Early stage founders have to do a lot of storytelling. It’s important for fundraising, obviously, but also for recruiting, speaking to the press, motivating the team, etc.
There has been a meme going around about a talk that Kurt Vonnegut gave regarding the “shapes” of stories. The idea that there are only so many different story-arcs out there, and that they can be illustrated in a particular way. There is a cool infographic here and there is a video of him talking about it here.
This got me thinking about the story-arcs of VC pitches, and the stories that get me (and I think a lot of different investors) particularly excited. There are a few of them, but these three below really tend to stand out to me.
Story 1: Winter is Coming
Synopsis: Some structural change or shift is happening that is going to turn an industry upside down. The hero company is either is making that change happen (best case), or is going to solve some major problem or capitalize on some major opportunity that presents itself because this change is happening.
Example: Uber. The first time a cab medallion owner saw Uber working, if he was a Game of Thrones fan, he said “oh shit… winter is coming”
Story 2: Jiro Dreams of Sushi
Synopsis: This is a story of craftsmanship. There are tons of things broken about how a problem is being solved today. The hero company is going to solve it 10X better than anyone has ever solved it before. You trust this hero because she is just that good.
Example: Oculus is a good example of this. When you see their Kickstarter video, what do all the industry experts say? “I have seen lots of different VR goggles before… but nothing like this”. Another one of my favorite startup pitches I’ve written about before was for 2U (FKA 2Tor). The first line of the pitch was “bar none, online education sucks. We are going to make it great”.
Story 3: The Undiscovered Country
Synopsis: I have seen the future, it’s just not here yet
Example: Ethereum or something like it is a possible example. In this story, the hero company contemplates a future that is a step function or two different from the current trajectory of technological innovation. It sounds whacky, crazy, hard to understand, and could be a complete miss. But what is being proposed really does change everything, and that change will span multiple industries, making it a different narrative from story 1. BTW, to learn more about Ethereum, check out their explainer video here. (Thanks Aaron White for this example!)
In a future post, I’ll talk in a bit more detail about how entrepreneurs can craft their story effectively for different audiences, and go a bit deeper into the shapes of these narratives. Until then, I’d love to hear other story-lines that I may have forgotten that are particularly effective and motivating.