A few months ago, I was talking with a friend of mine who is a successful serial entrepreneur. He has done incredibly well financially on his past two startups, and he’s now building his third company. When we were talking, he expressed frustration in raising his series A round. This was surprising to me. I asked him about his metrics, which are good, but they were not at series A level. I asked him who he was pitching, and he rattled off a list of usual suspects on Sand Hill. All of those investors told him that he was too early. It turned out he was going after the “wrong” group of investors. People he would have pitched 3 years ago had all moved downstream now that they had raised much larger funds, and he really needed to be pitching “post-seed” funds.
It struck me that a lot has changed about the fundraising landscape even in just the last three years. So, I thought it might make sense to take a step back and talk about all the stages of early stage fundraising here in the Silicon Valley.
In early stage investing, at least in Silicon Valley, there are basically 4 stages: pre-seed, seed, post-seed (or pre-A), and series A. In the “old days,” there were only seed and series A, and before that, only series A! All of these changes have created a lot of confusion.
Here are my thoughts on these stages:
This is really the old “seed.” Very typically at this stage, little to no traction is needed, and investors are looking for lower valuations than seed investors for taking on extra risk by going in so early. Another consideration here is that, in the minds of pre-seed investors (who are very often small funds and will be allocating most of their capital in the first round or two), valuation matters a lot more to them than a larger fund who might invest in you at this stage as an option for later. If a startup comes to me looking for a $3m effective pre-money valuation vs another company who comes to me looking for a $7m effective pre-money valuation, basically what is being suggested here is that the latter company has to have a 2x+ greater exit in order to be just as good of an opportunity as the former. The outcomes of both companies are, of course, unknowable, but that is essentially what goes through the minds of investors who are looking at lots of companies with different valuations.
Also, to be clear, pre-seed doesn’t mean that one just thought up an idea yesterday and has done nothing. There’s a lot of work to do to prepare to raise money at this pre-seed stage. It could be building an early version of the product, or getting your first set of customers, or even doing pre-sales or lead generation well before having a product. In fintech or health, it could be in dealing with regulations or getting particular approvals even if you’re not able to launch.
Investors at this stage are very much conviction-investors, meaning they either bought into you and your thesis or they did not. It’s very difficult to convince an investor at this stage to change his/her mind. This is a bit of a crap shoot because even if a pre-seed investor has bought into you as an awesome operator, if he/she has not bought into your thesis, it will be difficult to land an investment.
These rounds are typically < $1m in total.
Today’s well-known seed investors may have previously invested at an earlier stage with smaller checks, but because many of these funds have now raised $100m+ funds, they are now writing much larger checks. Typically this is $500k-$1m as a first check. This means that they have to really believe in you and your business-thesis in order to pour that much capital into a business. As a result, this stage has created a fairly high traction bar. It can be upwards of $10k-$20k per month or more!
Seed rounds today are quite large – typically $1m-$5m! I believe that some of these seed rounds are way too large, and there’s a looming market correction on the horizon for everyone. I’m of the belief that early ideas can never effectively deploy $4-$5m in a very cost effective way.
This is a stage that was created because the bar for the series A has gone sky high. This really is what the series A used to be. A few years ago, people touted that in order to raise a series A, you needed to hit $1m runrate. Now, you typically need a lot more traction to raise a series A round. This magical $1m runrate number is now the rough benchmark for the post-seed stage, but it’s not series A investors who are investing at this stage. New microfunds have cropped up to invest here. They are looking for $500k-$1m runrate level of traction. This was my friend’s problem; he wasn’t quite at series A benchmarks and needed to pitch post-seed investors.
These post-seed rounds are also quite big these days, sometimes upwards of $5m+.
This is really the old series B round, but Sand Hill VCs who are known for being Series A investors are serving this stage. This is typically a $6-10m round. Companies typically have $2m-$3m revenue runrate at this point.
If you do the math, VCs are buying roughly 20% of a startup, so valuations can be upwards in the $50m+ range for today’s series A rounds! On the low end, I haven’t seen a valuation of < $20m, and that would be for a really small series A round.
Some additional thoughts:
1. There are lots of caveats around traction.
If you’re a notable founder, have pedigree, are in a hot space, or you run your fundraising process really well, it’s possible to skip a stage. I’ve seen some really high flying series A deals happen lately with friends’ startups, where they are not quite in series A traction territory, but they have so many investors clamoring for their deal that they can raise a nice big series A round. They’ve run their fundraising process well, and they generally have great resumes and are in interesting spaces. Same with the seed round – if you are notable or have pedigree, you can often raise a large seed round with little to no traction on your startup.
2. Sometimes the line between post-seed and series A is quite blurry, but the valuations are very different.
I have a few founders I’ve backed who are just on the border of post-seed/series A metrics and are able to get term sheets from both series A and post-seed investors. There’s a huge difference in valuation. The post-seed deals tend to be $10m-$20m effective pre-money valuation, and the series A deals are at least $20m+ pre-money if not much much higher. So, if you’re on the border, running a solid fundraising process is especially important in affecting your valuation.
3. Large Sand Hill VCs are doing seed again – selectively.
Sand Hill VCs who tend to invest at the later stages have now found series B to be too competitive to win. They are now starting to do series A deals and seed deals to get into companies earlier. In many cases, the deals they are doing at seed are large deals with little to no traction.
You may wonder, “Doesn’t this contradict what you just wrote?” What’s really happening is that the world of early stage investing is becoming bifurcated. If you have pedigree and are perceived to be an exceptional high signal deal, you can raise a lot of money without much of anything. These are the deals you read about in the news that make people think fundraising is so easy. “Ex-Google product executive raises $4m seed round.” This goes back to point #1.
If you don’t have that pedigree, then you basically need traction to prove out your execution abilities at the seed, post-seed, and series A levels.
4. Lastly, with the definition of “seed” expanding, more fundraising is done on convertible notes or convertible securities.
I’m now seeing more rounds get done with convertible notes and securities for much longer. This is actually good for founders because it means you have a much larger investor pool to tap. In the “old days,” if you couldn’t raise a Series A from the, say, 20-50 Sand Hill VCs out there, you were dead in the water. Now, you have a lot more flexibility to raise from angels and microfunds without a formal equity round coming together. I think this is a really good thing for the ecosystem because at this stage, it’s still not clear who is a winner based on metrics. There’s still a lot of pattern matching around who gets funded at these early stages. By the time you get to the series B level, it’s pretty clear who is on a tear and who is not, and that is much more merit-based investing. Short of that, the more angel investors we can bring into the ecosystem of startup investing, the more companies will get a shot to prove themselves.
You may wonder, “Well, are there actually companies that are being overlooked by VCs in earlier rounds who later are able to hit series B metrics and raise a VC-backed series B round?” Having looked at a lot of data around this, the answer is definitely YES! While it’s true that the vast majority of companies who end up raising a series B round from VCs previously had notable institutional VC backers even as far back as their seed rounds, VCs still end up missing a number of companies at the earlier stages. These actually go on to do well without them and end up coming out of left field and raising money from late stage VCs.
Header photo by Ross Findon, Unsplash