Seed 'extensions' are becoming the new normal in fundraising
venturebeat.com
venturebeat.com
Anyone have any advice on raising enough on the seed round to match your needs without having to create an absurd valuation that will crunch you in A?
Grow extremely quickly by doing everything else right? There's really no shortcut or trick, that's just what it takes.
To raise <$1 million and be ready for a Series A is just brutally difficult. For example, my brother just raised his A and he said investors were looking for a $1.5 million run rate and 3-4x YOY growth. So in ~18 months with ~5 people you'd have to build product, make that many sales and still have compounding growth.
That's set up to find the companies that are doing extremely well. It will happen, but that's not something you can really brute force (it didn't happen to my company, even though we're on a very promising trajectory).
Now, say you raise a $2m seed extension. That gives you an additional ~18 months to hit those same metrics, while hiring a couple more people. That's just so much more doable. Especially considering most first-time founders (myself included) spend the first six months making mistakes around building the right team. (One way to help make it to a series A on your seed is to have all the people you want/need ready to be plugged in.)
I think either the Series A expectations will come down slightly or "seed prime" rounds will become the norm, as they already are becoming. Not many are ready to go to the NBA after playing in High School. Simple as that.
Rather than raise more seed, we decided to buckle down and try to fund through paying customer growth. Slower of a curve than a 2 or 3 million dollar injection, but no strings attached either. And I figure you need to develop your billing and customer chops eventually anyway, so why not start building those skills now?
There is a risk, though. (I'm sure you know it already, but I mention it just to balance out my enthusiasm for others.) If a company's revenue is $0, investors can imagine anything they want. But if revenue is $1.39, investors may be subject to an anchoring bias [1]. I don't think that's a huge risk for companies that have a well-understood business model; if you are selling annual software subscriptions, it's pretty easy for investors to imagine scaling that up. But I think Twitter and Facebook were smart to avoid revenue for a long time because it let them sell the dream.
> In many of these cases, the founder simply didn’t raise enough to hit the milestones they promised. Product development often takes twice what was anticipated, and many early stage companies simply didn’t have the capital to achieve what they hoped in advance of an A round.
This is contradictory. On one hand, the author claims "a lot can be done today with a small team and $50,000 a month" but on the other he's admitting that many of these companies aren't able to do what the founders "promised" they'd be able to do.
> Valuations tend to be flat or flat-ish.
> In the end, however, the entrepreneur benefits because they usually see a step up in valuation from the first to second seed.
Which one is it?
> These differ from your classic seed. They tend to have new participants, unlike the more classic extension, which is merely the insiders injecting additional capital into the company.
This is the perfect demonstration of what happens when there's too much money chasing too few opportunities. New investors are willing to put more money into a company that underestimated its funding needs, missed its targets and can't raise a Series A, and do so at the same or slightly higher valuation as previous investors. Insanity.
The "seed extension" phenomenon also demonstrates why early-stage startup employees should be skeptical about equity. These "seed extensions," which look like dumb money bridge rounds, can be really destructive. Just do the math on what happens when a company raises $1 million at a $10 million valuation, and then raises a $2 million "extension" at a "flat-ish" valuation.
I'd certainly prefer people taking multiple seed rounds to them taking a ton of money up front. Too much money is startup poison.
Is there any reason that a large seed round could not be drip fed to the company? As an investor I would rather the company get on with building and stop worry about fund raising, but I would not just want to give then a huge amount of money that they blow on a hiring craze trying to hit some ludicrous growth number. Something like "here is $3 million, but we aren’t going to give it to you at more than $100K a month - now get on with building and stop worrying about fund raising. If you hit all your targets early come back and we will talk more."
Honestly, I've never heard of investors saying, "Hey, slow down on the spending." I'm sure it must happen, but the stories I hear are all the other way, encouraging investors to spend faster and get bigger to establish market dominance. Founders are in some ways naturally more conservative, in that they have exactly one company to gamble with, while investors are just hoping for a couple big hits in their portfolios.
Couldn't the valuation issue be solved with SAFE? Also if the funding was locked in and handed to some third party to administer then the founders could stop worrying about investor approval changing?
Maybe I think too much like an founder, but the last thing I would want to do as an investor is give some 22 year olds a couple of million dollars and let them go crazy. Having personally been through a similar situation it is all to easy as a founder to convince yourself that getting more money in the future is going to be easy.
If it were my money, I'd certainly be concerned with young founders overspending. But I'd solve that just by energetic board meetings and occasional calls with the CEO. And with VCs, it's not their money anyhow. Their constrained resource isn't cash, it's time.
I agree VCs are trying to create unicorns rather than maximise the chance of the founders succeeding. If you are an early stage investor with limited funds to throw around then you might be better off not chasing unicorns and instead concentrate on minimising losses.
I see this statement over and over. You know what? I call bullshit.
Maybe in the valley. I'm not even sure I buy that.
Most of the places that I have seen that went apeshit with investor money did so because the investors demanded it. Most of the businesses that have been frugal to that point don't magically start buying hookers and blow just because they got a couple million in cash. They know all to well how quickly money goes out the door.
You know what raising enough money does? It makes you independent of the need to raise more money. Which moves the power balance from the VC's/investors to the founders/managers. This is why all the VC's/investors whine about "too much money is poison" and are so stingy with Series A's.
Bootstrappers are incredibly focused on the core feedback loop: they do something valuable for a customer, and customers give them money. But the more cash in the bank a startup has, the easier it is for them to get away from fundamentals and totally wreck themselves. For example, look at Homejoy:
https://medium.com/backchannel/why-homejoy-failed-bb0ab39d90...
As far as I can tell, they never had a functioning business. Money was too easy for them, so they never focused on delivering a reliable service with positive gross margins. Instead they got it half working, scaled up, and mistook action for progress.
And yes, investors definitely push for that kind of stupid spending. Why? Because they don't want mildly successful businesses; they want giant winners. They're perfectly happy destroying 8/10 of their portfolio companies if they can get 1/10 doing amazingly well in a winner-take-all market.
Raising "enough" money is a nice dream, but I don't think it will happen much. Not because investors are rubbing their hands together over power balance (although I'm sure they enjoy thinking like that). But because it's in nobody's interest to take that kind of money early on. Before product-market fit, and investor only wants to find out whether you'll get there; any money invested beyond that is wasteful. And entrepreneurs don't want to take more than that either, because it's too dilutive. Once they've proved fit, they can get money on much cheaper terms. And they're sure they'll prove it.
There is a vast difference between a company never having a functioning business, and a bootstrapped company getting a cash infusion.
To me the initial seed round is some people saying, "We have a theory about what it will take to demonstrate a real business." Maybe they're right, in which case they can proceed to a series A. Maybe they're completely wrong and they close up.
But say they're partly right. Say that their initial theory was wrong, but they've got plenty of evidence for a theory that's as good or better. I'd say the right thing for all parties is another modest infusion of cash.
Is there some alternate approach you're advocating for?