Category: Investing

Yesterday I was in a discussion on Twitter with Semil Shah and Marc Andreessen about the value of a pitch deck. Marc thinks that the pitch deck has to be well polished and Semil and I think that a bad pitch deck with an awesome presentation by a passionate founder is ok for a seed round.

Tweet Storm

That was the critical differentiator: the round. If you look at the conversation, Marc and I are in agreement on the need for a quality deck, we just disagree on the stage. This got me to thinking of the main difference between raising a Seed round and a Series A round.

As several Fresco Capital portfolio companies are currently raising a Series A or have just completed one, the difference between Seed and Series A is fresh on my mind (hence why I felt bold enough to challenge an icon like Marc yesterday..)

If you remember from my previous post, typically when you are raising a Seed round you don’t have your product-market fit figured out, nor do you have the exact facets of your business model ironed out. You typically figure this out during your Seed round and execute on your business model in a Series A.

Raising a Series A round is very different than raising a Seed round. Seed is about finding a business model, Series A is about executing that business model at scale. Marc is correct and you need polished deck for the Series A, however, you also need to demonstrate two other important things in order to get funding: you need a repeatable business that scales.

Repeatable Business

In order to demonstrate a repeatable business, you will have to show that you have customers, users, etc, coming back for more. You want to keep the customers you win engaged rather than churn them out. Measuring engagement is not going to be the same for each business, but you need to figure out what it means for your business. Typically it has to with the Customer Lifetime Value (CLV) and how many customers your business can support.

If you are building a consumer app similar to Instagram for example, you have to demonstrate the engagement of the users you have posted XX photos per week. How many comments they leave, etc. If you are building an e-commerse mobile app, it may be defined by the transactions performed each month, a game can measure how often they play and level up, or in a B2B service, how often certain tasks are performed. Even in the Seed stage, you should be able to determine this number, even if you have to do small tests and experiments to do so.

Scalable Business

Having a repeatable business is not good enough, you also need a scalable business. I’m not talking about the techie versions of scalability where your app and site perform the same under load as they do under normal conditions, but rather the business model. Typically this has to do with customer acquisition costs (CAC). Specifically, you need to work through this formula: CLV – CAC = $some really big number

Where CLV is your Customer Lifetime Value or the amount of profit each customer brings to your business over the course of their entire experience with you. This is difficult to calculate at an early stage (as you hope to have customers for 10+ years and you may only be in business for a year), but with enough cohort analysis and other data analysis, you should get a good feel for this number by now.

CAC is the Cost of Customer Acquisition. This is how much it costs you to get a person through the funnel and convert to actually buy something. This number may be easy to calculate if you get 100% of your customers from marketing campaigns, take the total cost of the marketing campaign divided by the number of people who converted into customers. (For example if you spent $100 on AdWords and 4 customers converted, your CAC would be $25.)

Let’s look at how important this formula is:

CLV ($45) – CAC ($45.01) = -$.01

Here you are losing one cent on each customer and will eventually go out of business. Not good, not even the best deck can save you here.

CLV ($1) – CAC ($0.99) = $0.01

Here you are earning one cent on each customer and will eventually build a profitable business. The difference of just two cents can make or break your business!

Now in reality, I’d like to see something like this:

CLV ($6) – CAC ($1) = $5

Meaning, for every $1 you put into your customer acquisition/marketing campaign, $5 comes out. Very scalable. If you are raising a Series A of $5m and in your deck you show this formula and say that $2m of the $5m is earmarked for customer acquisition, the investor knows that $10 should come out- assuming that your formula is correct. (Actually as an investor, I would expect you to focus like a laser beam on the funnel optimization and get that CAC down while simultaneously increasing the CLV.)

As you move your business out of the seed stage and onto a Series A, make sure you make Marc happy and have an awesome deck. In addition, if you want his (or my) money, demonstrate that you have a repeatable business that scales.

If you have ever seen me speak at an Accelerator or startup event, I usually refer back to my experiences fundraising for my past startups. I’ve had experience raising venture capital in four distinct eras: the “dot com era” circa 1999, the post dot com crash circa 2002, the post Google IPO-pre-Lehman collapse era (2006-2008), and the more current (post-Lehman) environment. While many of the rules of fundraising are the same, the stages, amounts, and terms have drastically changed over the years. Living and investing in Silicon Valley, I have observed the new pattern of fundraising, which I have broken down to four stages.

The four stages are:

• Acceerator Round/Initial Capital
• Seed
• Series A
• Series n

While there are all kinds of startups out there from pure software to BioTech to hardware, I’ll use the example of a typical software startup in the example below. The rounds and rules hold true in broad strokes for most startups, but the dollars, metrics, and sources may very.

Accelerator Round/Initial Capital/Friends and Family ~$100,000 USD

This is the round where you move from idea to prototype, possibly to a first version you let people play with. Lots of experimentation, MVPs, and customer discovery. You use this round to get a sense of a “product-market fit” but not necessarily a business model. Typically you have two or three founders working on sweat equity and some money borrowed from friends and family. This is the stage to go through an accelerator or have a single angel investor. The average size of this round is about $100,000 USD, excluding the value of the sweat equity. Once you have demonstrated the ability to execute and launch a functional prototype and can extrapolate the results, you are ready for a seed round.

*Note that if you are a hardware startup, your Kickstarter campaign, would typically come into play here.

Seed Round ~$1-1.5m USD

This is the round where you obtain “product-market fit” and find your business model. You develop and release your product and start to measure the results. Your customers may not pay you a lot at this point, but you have built an audience or customer base. This is the round where you bring on your first non-founder hire and move out of the garage, typically to a co-work space. The range of this round is between $1m to $1.5 USD structured as a convertible note. The typical scenario is that you have 3-4 investors, one lead at half the round at $750k and the other 3 investors in at $200k – $300k each. It is important to have a lead that is capable of investing in your next round, possibly leading that round as well. As general advice, beware of an AngelList Syndicate as your lead during this round, a lot of the time that syndicate is only good for the amount of the syndicate in your seed round and not capable to lead the Series A. Syndicates are good to round out the round, but not to lead-unless the Syndicate head has the ability to lead your Series A.

Series A ~$3-7m USD

This is the round where you execute on your business plan and scale. You have paying customers, you know where to find them, and you just need to accelerate the process of onboarding them. Typically with a Series A, you don’t need the money as you can grow organically, however, you raise a Series A in order to grow faster. Typically you use a portion of the funds raised for customer acquisition as well as some new hires in both sales and marketing roles. The range of this round is typically between $3m-$8m USD with some if not all of your seed investors participating. Sometime about now you think about moving out of that co-work space and into your own office.

Series N… $25m-$1b USD

After a Series A, typically the later rounds (Series B, C, n…) are for massive growth. I like to use the analogy for a Series B as “rocket fuel.” For example, you found your product market fit in your seed round, you developed and executed on your business plan in your A, and you have a repeatable business that scales. You’re making money and have a great team. You know where your customers are and how to get them to give you money. If you grow out of revenues, you are going to get to the target (say 30% market share or $150m in revenues), but it will take you a long time organically, say 3-5 years. This is the airplane taking off and going fast, but hovering above the tree line. With a Series B, it is like pouring afterburner rocket fuel on to your airplane and the goal is to get to the target in 1-2 years, not 3-5. Later rounds continue this trend and are also used for acquisitions to speed up the process as well as provide some capital to enter foreign markets.

While this is not the exact path that your startup will take, it is the “textbook” course a startup will take. Use this information as a guide and as with everything in this business, your milage may vary.

Over the past few years I’ve had the opportunity to work with hundreds of early stage companies looking for funding. They all seem to approach fundraising the same way: make a big list of investors, ping their network for warm intros, and take every meeting with any VC that replies. Unfortunately this is not an efficient way of doing things.

Instead, I advise startups to filter the list of potential investors by three critical criteria and only meet with an investor that matches all three. If an investor meets only one or two of the criteria, you are wasting your (but potentially not the investor’s) time. So what are these three criteria?

Size of Check

Perhaps the most important criteria, and also the most overlooked by a founder, is the typical size of check written by the investor. For example, let’s say your startup is looking to raise a seed round of a $1.5m convertable note. The typical scenario is that you have 3-4 investors, one lead at half the round at $750k and the other 3 investors in at $200k – $300k each. If this is the amount of money you are looking for, don’t seek out Angels who are only going to put in $25k-50k at a time or don’t seek out VCs that typically invest $25m or $75m in a round. The size of the check that they typically write won’t match up with what you are looking for.

Domain

Another common mistake is to hit up an investor who matches your check size, but doesn’t invest in your domain space. For example, let’s say you are a hard core B2B business and you approach an investor who only invests in consumer mobile apps, looking for the next Instagram. Big waste of time. What if you just finished your Kickstarter campaign on the next awesome IoT breakthrough and you approach an investor who has never made a hardware investment before. If they were even willing to invest, why would you want their money, they have no expertise in hardware? Instead filter only investors who actively invest in the space that you are in. They will add the most value since they understand your domain. In addition, they will have the most patience since by definition they are a believer in your space.

Location

Location is often is overlooked as a third matching criteria. I don’t mean your physical location, which is important to some investors-particually in Silicon Valley or a government backed fund, but rather the location of your target market and customers. If you are a startup targeting the Indian market, find an investor that is comfortable with that market and has an expertise there. You don’t necessarily have to find an Indian investor, but one where you are located that understands the Indian market and is not frightened by it and can connect you with the local ecosystem.

After you have applied your three criteria filters to your list of investors, now it is time to reach out and get those warm intros. Only then will the meeting be productive. Often times I get pushback from founders saying that they are meeting with Investor XYZ that meets two of the three criteria. I tell them that the investor is wasting your time. What they are doing is taking the meeting to learn about your domain or target market without having to invest. For example if Investor XYZ never invested in Africa and your target market is Africa, they may take the meeting to see what is going on in Africa and report back to their partners. For them a one hour meeting in their office hearing your pitch is a worthwhile use of their time to get educated for free.

Same if an investor typically writes larger checks, say $25-50m average, but also has a new “seed” fund. Avoid those investors at the early stage. You get very little synergy from the brand name and will never meet the famous partners. In addition, if it really is a seed fund and there is no avenue for follow on pro-rata, you are back to square one when you are pitching the “main” fund. Also, in some instances the “seed” fund at a larger fund is typically the “B” team-young partners recently hired who are thrown into the seed fund without any real influence at the senior partner level.

One of the worst parts of investing in early stage companies is saying no. A lot. We say no more than 100 times for every 1 yes.

Since our investment philosophy is people first, some assume that people are our only filter. They believe yes means we like the team and no means we don’t like the team. But that’s not the case. We also need to have conviction about the business and market plus of course need to be comfortable with the deal structure. As a result, there are many times when we say no even though we like the team a lot. That’s not fun for the team, or for us.

So why do we bother to give a clear no? Why not simply hang around on the sidelines with a maybe? Especially since it’s probably better for us, just in case the deal becomes hot and we can jump in at the last second.

Because that’s not fair to the team. We hear too many stories of investors playing games with entrepreneurs, resulting in wasted time. In addition to being fair with time allocation, we also try to be clear with feedback and give specifics of why we are saying no. If we have done serious work on the opportunity, by definition it means that we have been impressed by the team, and so we try to make this feedback useful for them. Once again, too many investors give a one line no, without any context for the decision.

Although there are no short term benefits for saying no clearly, we strongly believe that there are long term benefits for us by taking this approach. Great teams appreciate clear feedback, good or bad. When teams are doing due diligence on us, they inevitably speak to others who have received a no from us and how we act in these situations is a reflection of our overall approach. Great teams are smart enough to appreciate the connection.

So, even though it’s no fun for anyone, we will continue to say no a lot. Even to teams we like. Knowing that it’s the right thing to do for them and for us.