I’m going to get a lot of flack for writing this post. Lots of fellow investors are going to DM or email me to tell me that I’m wrong or not accurate. Guarantee it. Here we go anyway because in this case, it’s more important to be 50% right than not at all helpful.
Entrepreneur: So what do you think?
Investor: You’re too early. Come back when you have more traction.
Entrepreneur: Can you give me a sense of how much traction you’re looking for?
Investor: Mmm…there’s no hard and fast rule.
Super annoying! How are you supposed to know what target to shoot for? I’ve written about fundraising milestones for SaaS companies before on Jason Lemkin’s blog SaaStr. Christoph Janz of Point Nine has also written about SaaS funding as well. In this post, I’m going to generalize it a bit more for other industries.
Let’s first establish what the seed landscape looks like today in 2016 here in Silicon Valley. Note: the information below doesn’t apply to other geographies, and all of this will probably become obsolete in the next few years. Roughly speaking, there are 4 stages of early stage investing based on traction:
- Pre-seed: < $100k net revenue run rate
- Seed: $100k-$500k net revenue run rate
- Post-seed: $500k-$2M net revenue run rate
- Series A: $2M+ net revenue run rate
Note: Your ability to raise is NOT just about your traction. There are a LOT of other caveats and criteria, which I’ll go through at the bottom of this post. So hold your horses before you start tweeting at me!
New investors tend to do a lot of pre-seed deals when they first get started, but as they get access to more and more dealflow, they tend to move downstream and take on less risk. My employer, 500 Startups, is a good example of this. A few years ago, we were funding lots of companies that were super early. Heck, they funded my company LaunchBit when we were basically at the idea stage. These days, in most cases, 500 Startups is not even the first check in.
Pre-seed rounds today are done by family and friends as well as new investors who don’t yet have a lot of dealflow. A number of incubators and accelerators will also fund companies at this level. As a result, this type of round is extremely difficult to do because you either need to be well-connected OR you need to hunt down angels who don’t yet have a brand, which is tough to do when you don’t know who they are. For this reason, I’m inviting new investors to interview with me on my blog so that they can get more visibility and so that entrepreneurs can become familiar with new investors on the scene.
The seed level is typically comprised of more established angels who have dealflow as well as well-known accelerators or seed programs, such as YC, TechStars, and 500 Startups.
A lot of microfunds have cropped up in the last few years and have established their brands. They may have started out as pre-seed or seed investors but have moved downstream in many cases. Part of this is also driven by the fact that, as they’ve become successful, many of them have raised bigger funds, which means they want to deploy more money in startups at slightly later stages.
This is largely dominated by traditional, well-established Sand Hill Road VCs. The series A round in Silicon Valley is basically what the old series B round used to be because the traction requirements are often so high to achieve.
I use the term “net revenue run rate” above to attempt to put all revenue-generating startups on the same standard. SaaS companies have really high margins, but a marketplace might only have, say, 20% margins. You can’t really compare marketplace businesses to SaaS – this is an apples to oranges comparison. Even though it’s not perfectly accurate, I’ve found that a rough rule of thumb is to look at net revenue run rate because the bar is roughly the same across revenue generating sectors. For example, if a marketplace startup has a 20% take between its supply and demand sides, then it needs to do ~4-5x more sales than, say, a SaaS company to be equivalent from a traction perspective. Again, not perfect, but this rough rule of thumb should give you a sense of what order of magnitude you need to be hitting to raise each round.
Of course, there are a TON of caveats here. As I’ve mentioned before, each of the 4 categories of startups are looked at very differently.
If you are a business that is immediately-revenue-generating, all that I’ve said above applies. However, if you are in areas that are, a) highly regulated (such as fintech or healthtech), b) extremely technical (such as only 5 people in the world can build what you’re building), or c) a pure consumer product (e.g. Snapchat), then these traction benchmarks don’t apply. Investors will look at other things such as your user growth, your prototype, or how you’re navigating regulations. Those are much more subjective and hard to distill into numbers.
Moreover, even if you are an immediately-revenue-generating-company, just because you hit a certain traction number doesn’t necessarily mean you’ll be able to raise money from investors who back companies in the traction category you’re in. Lots of other things matter, too.
For example, if your growth is stalled, you probably won’t be able to raise from anyone! On the other hand, if you have an awesome team with a past track record or with pedigree, you may not need any traction at all to raise your next round! If your space is super competitive, you may need to prove out a LOT more traction than what someone else might need to achieve.
Tons and tons of caveats here, but even if this is 50% accurate, I hope it will still give entrepreneurs a sense of what rough numbers to shoot for. Moreover, I think these rough numbers are important to know because it helps you figure out strategically what your next milestone should be and, working backwards, you can figure out how much capital you’ll need in order to make that happen.