Series A Fundraising Guide
marathon.vc
marathon.vc
What is the reason for this?
Lead Series A investors usually get pro-rata rights. Generally, the wisdom in startup investment is to double down on your winners and you typically can only do so if you have pro-rata rights. In other words, if the startup does super well, that VC will likely invest 10x more in real dollar terms to upkeep their pro-rata.
Take 2 pretend funds: CoolVC has a 20% target ownership and CheapVC has a 10% target ownership. They do their pro rata every round.
Rocketship Corp. will have the following rounds (super simplified):
Series A @ $25M post-money
Series B @ $100M post-money (15% dilution)
Series C @ $600M post-money (10% dilution)
Series D @ $3B post-money (5% dilution)
Series E @ $5B post-money (5% dilution)
Exit @ $9B
CoolVC would have exited with $1.8B + spent $100M (profit $1.7B) CheapVC would have exited with $900M + spent $50M (profit $850M)
In other words, for an additional $2.5M in the Series A, CoolVC bought an option that would ultimately make $850M more in real dollars than CheapVC.
In the VC world where 1 needle in the haystack makes or breaks your fund, it's an inexpensive option. At Series A, there should still be at least 50X potential upside.
Why do most VC funds target 15-20% ownership? Probably that's probably the most they should get to balance founder ownership through further dilutive rounds. If you look at my above example, remember that founders will probably own less than 36% of the company (they also will get diluted by employee incentive plans).
Anyways, VCs at series A want to buy enough equity percentage (e.g. 15% to 25% ownership) to make their exit numbers work. Investing a smaller amount to only get 5% of a company is not a "meaningful percentage" or "meaningful stake". (In contrast, YC does buy a smaller 7% equity but their $150k isn't considered "Series A".)
To me, talking about investment scenarios in terms of "valuation" always seemed to make things more difficult to understand. The following math is equivalent but I think the explicit percentages layout is easier to grasp in a few seconds:
Mark Z is considering 2 offers of investments for his young Facebook startup in 2005:
Don Graham offers $6 million at a $60 million post money valuation.
Accel Partners offers $12.7 million at a $80 million post money valuation
Don Graham offers $6 million for 10% of the company
Accel Partners offers $12.7 million for 15.7% of the companyExample:
"We're going to invest in a basket of startups whose aggregate value will be $X billion in 5 years and we will own Y% of those companies at that time."
If they can't hit that Y number, they are not doing what they said they'd do.
There's a finite amount of time in an investor's day, and somewhere around 20% ownership of a company is, for whatever reason, considered the magic number where it's worth it to spend that much time with them (through assistance, board meetings, etc).
Much more realistic and prudent are the common advice and reports of reality that fund raising is difficult and challenging, a full time job, with effort so large it is a risk to the startup, contacting hundreds of VCs, straining to get warm introductions, taking dozens, maybe 100+, of in person meetings, for just one check, much less several, and months of time.
The firm is asking way too much in time, effort, and expenses from the founder, e.g., flying to meetings with VCs. A founder would need a significant source of funds just to apply as described.
There is the pitch deck with more advice that is challenging but obscure. Bluntly, there are NO good guidelines, many guidelines that vary wildly and no good guidelines, for what should be in a pitch deck. As a result, if the VCs need something other than just a good version, well organized, with the information clear, the spelling correct, of a business document, then they are looking for something founders have no way to supply.
Many VCs seem to want and expect to be swept off their feet by some block buster summer popcorn movie, but any such production is way too expensive in time, money, and effort for a Series A and close to irrelevant for serious business and financial work.
The firm is basically asking that the founder have a going business, at least traction and, to be realistic, likely earnings. Given the earnings, there is considerable question if the founder needs or should accept an equity check.
E.g., in the past, a Web site startup needed big bucks for Sun servers, etc. No more: $2000 in parts will build a very powerful server and the cloud can supply a lot of pay as you go server computing right away.
Given the traction of the startup, the firm thinks WAY to much of the importance of their check. The OP has the simplistic notion that the VC check will be the crucial enabler for future rapid growth; that view is in strong conflict with how successful businesses commonly grow.
Net, the firm, for the whole process, is asking WAY too much and giving and doing WAY too little.
Heavily that view of a Series A is from a dream version of the VC industry from 10+ years ago. That part of VC is gone with the wind. There is still lots of opportunity to make money in information technology startups, but ideas as simple and profitable as, e.g., Hotmail, are long gone.
IMHO, computer science and VC funded startups are out of sufficiently good new ideas, out of gas, at the end of the road. For computer science, programming language syntax, parsing, compiling, linking, fundamental algorithms, database, TCP/IP, etc. are rock solidly done work, but computer science doesn't know what to do next. Similarly for VC -- projects as simple as Hotmail are done. There is more to do and very much worth doing, but computer science and the VCs need to find some new directions.
Again, once again, over again, yet again, one more time, we find that VCs who desperately need very rare and very exceptional projects are proceeding with simplistic attitudes no more serious than a family shopping for a standard SUV.
There is a lot of very serious work in our economy in research, engineering, law, medicine, national security, and parts of finance, but Sand Hill Road and the OP are not nearly serious enough.
In the end, instead of the OP, a founder of a rapidly growing startup should consider the common advice that they should just wait until a VC notices the startup and contacts the founder. In the meanwhile, the founder should just keep working on the business.
There is so much great work being done if you just look around a little bit. The advances in computation photography this decade are incredible. AR will be ubiquitous soon enough. VR has a chance to change how we communicate. There's autonomous sailing drones scouring the seas and mapping them out, streaming data back. There's tiny low cost satellites being launched frequently to image the planet. There's rapid progress on electric transportation in full swing.
There's a lot of these areas that are funded in part by VC. The very nature of VC ensures that the quality of firms also follows the power law so it's not surprise that a majority of funds lack imagination. But if you look at the really great firms, they're still investing in big ideas. Sure they may not be the lowest hanging fruit in the field as you mention, but they aren't precluded from being big, or impactful ideas driven by technology.
For AR and VR, I see some markets but am reluctant to expect wide usage.
The last really big idea was, what, Facebook? I know: There have been a lot of $1+ billion exits since the start of Facebook, but I haven't kept up on the small fry!!!
I started my career near DC in applied math and computing and there saw a lot of fantastic national security projects from research. E.g., I was in the group that did the Navy's version of GPS, before the USAF did GPS. There was some really nice math, physics, and research, powerful stuff, in that group. E.g., how to design a satellite that will orbit the earth not very high up and have essentially no "drag" at all? Cute. Important.
In an important sense, GPS, etc., are information technology (IT), but from all I can see the role of applied math, physics, and research so heavily used by US national security is missing from Sand Hill Road funded IT projects. E.g., if I were looking for some promising background at Stanford, I'd go to D. Luenberger, B. Efron, or P. Diaconis and not the computer science department. At Berkeley I would have gone to one of my favorite authors, L. Breiman, but of course eventually the computer science people did that to some significant extent.
For Breiman's boosting and bagging, I suspect some important connections with resampling and some math in a paper I published. I suspect that there is a nice, more powerful, valuable way to explain such ideas, maybe with connections with sufficient statistics. E.g., order statistics are always sufficient. But such things are not relevant to my startup and, thus, on the back burner.
Bluntly the US DoD, NSF, NIH, etc. eagerly support and exploit research with a batting average much higher than VCs, while as best as I can see Sand Hill Road, for IT projects, hearing research, soils their clothes and runs to the rest room. It appears that Sand Hill Road believes that the "technology" in IT is mostly just software with no connections with anything new, correct, and significant from research. Yes, they are pursuing AI and ML, but my view is that those are not very promising directions.
The VCs need stuff that, among other things, is NEW, and we know where the "new, significant, and correct" stuff comes from -- research. So far Sand Hill Road for IT (but not for bio-medical technology) has with great determination refused to have anything to do with research, even if already done, rock solid, in production quality code. So the VCs just want to see traction, significant and growing quickly "up and to the right". But the research is a crucial part of estimating the future of the company, past current traction.
IMHO, Sand Hill Road needs to get serious about "new, correct, significant", powerful and valuable in IT.
- 'Fast' progress, i.e. weeks (I mentioned a couple months as your target): If a deal is hot, things can happen even faster. If you don't have progress within such timeframe, chances are the round is not moving forward at all.
- 'Full time job', 100+ meetings, months of time: If you take a closer lok, we are not necessarily in disagreement with this.
- Requests from the founder: This guide does not describe what we 'ask' from the founders of our portfolio companies, but addresses a much broader audience. Indicatively, we make intros to ~30 relevant VCs in each case and book initial meetings/calls, then the founders take over.
- I agree that advice varies on the internet with regards to what makes a good pitch deck. It is also subjective at some extent. I provided a very high level guidance (and definitely did not request a blockbuster movie production)... At the same time, the deck is what will help you make it through the first stages of the funnel; its importance should be straightforward.
- Re traction requests: VC requirements and the definition of a Series A round may vary per geography, industry or firm (or even per case); what I'm trying to stress here is that such reqs differ compared to a Seed round (i.e. "we want to build this" vs. "here is something that works and we want to go faster")
I hope the above clarify things further. Thanks for your comment!
> If you raised a Seed round, sooner or later you’ll be fund raising – again.
This statement is very eager just to assume that each successful information technology (IT) startup will, naturally, of course, be doing round after round of equity funding.
I've been to enough yacht clubs to see a lot of people who have done really well in business but never accepted an equity check.
Yes, there is the view that a startup is necessarily some solid fueled rocket on a 10 G acceleration into orbit or bust, but that situation is rare in business. The last one was, what, Facebook? I'm reluctant to count AirBnB or Uber due to the risk of their being regulated out of business.
> sooner or later you’ll be fund raising – again.
Hopefully not and maybe not: For some really good projects, e.g., Plenty of Fish, maybe won't need the funds. For a business that grew to pre-tax earnings of $20 million a year, maybe the growth is then too slow to attract VCs. Or maybe the business is about to fail.
Or, "sooner or later you will" see a dentist but not necessarily a VC.
> A core part of a CEO’s job is to secure the resources for your team to execute the company’s mission.
But for a startup with the traction that it appears is coveted by VCs for a Series A, those "resources" might be available from the seed round or organically, that is, from current revenue.
> You should expect that you will be spending a significant part of your time on fund raising-related issues going forward.
Hopefully, maybe not: Maybe there are plenty of funds from the seed round or current revenue.
> At the same time, being successful in fund raising is a big part of building a successful company – there is no shortcut or workaround, and this is not time wasted.
There is a "workaround": have a startup that doesn't need equity funding.
> Fund raising is about being religious in doing the small things right; as long as you establish a discipline about it, things become straightforward.
On the one hand, it is commonly accepted that running a new business is running at full speed all the time, putting low priority work on the back burner or the trash and doing the most important things ASAP.
In that situation, there's not a lot of opportunity to be:
"religious in doing the small things right".
That perfectionistic work approach may have been crucial for some of the tricky core code of the startup. But for candidate investors to ask the founder of a promising IT startup far enough along to get a Series A to be so perfectionistic is, as I wrote, "asking too much".
For
> i) Deck – This should include some context about the problem (why it’s big), your approach (why it’s unique), your team (why you’re the ones), early validation (how it’s winning), next steps (where you’ll be in a year or two) and grand vision (your version of the world). It should be easy to read and appealing enough to get you a meeting.
If the only goal is a meeting, okay, do whatever gets the meeting and leave everything else important for later.
But some VCs don't like superficial decks just as a teaser to get a meeting and want enough to know to write a check or at least to get quite serious. Maybe when they say that they really are looking for educational materials to contribute to their "deep domain knowledge", but maybe they are serious and don't want a deck that is just superficial and raised questions instead of answering them.
I can believe that for a Series A a large fraction of VCs will need just the name of the startup so that they can try the product or service. Or, "don't TELL me; SHOW me", and with that common advice a pitch deck is not very promising.
But I was struck by the
"your approach (why it’s unique)"
sounds superficial. E.g., "unique" doesn't mean much. My view is that the "approach" is likely -- now needs to be -- the crucial core of the business, its ability to please the customers/users, to be difficult to duplicate or equal, and to provide a Buffett moat barrier to entry. So the "approach" needs a lot of attention; it might need a 50 page paper of original applied math and an NDA. So, okay, can't have the 50 pages or get an NDA in the first foil deck, but
"your approach (why it’s unique)"
still sounds superficial or, worse, that the VCs are not used to really serious work on "approach".
Or, I have this terrific idea for a startup: An airline that flies NY to Sidney at Mach 15 for $100 per passenger. The market is huge. The idea is "unique". Only problem: How to make money at only $100 a person and, really, how the heck to fly from NY to Sidney at Mach 15 at all. Or, it's easy to come up with fantastic ideas if we don't take fully seriously the "approach".
> A budget for the next couple years
How about, we have some cash in the bank, enough for a rainy day, week, month, or quarter (IIRC early on Gates wanted enough such cash for a year of zero revenue), and otherwise we spend money depending on current revenue and slowly enough not to dip into that cash. So, we don't really have a budget and instead have a dynamic, feedback control for the uncertain future. Or, since our rapidly growing startup is facing unexpected problems weekly or so, we don't know the revenue or unexpected expenses and, thus, can't fix a budget. Or, such a budget would be like asking a football quarterback to call all 4 plays on first and 10. Instead he calls the second down play after seeing the results of the first down play.
Or, my Ph.D. dissertation was in stochastic optimal control, best decision making over time under uncertainty. There it was more solid than granite clad in cast iron and Kryptonite that fixed plans in the face of an uncertain future commonly are very poor controls.
Sure, the founder knows his on-going monthly expenses and his revenue in recent months and the growth in revenue but, still, he may not have such a budget, may never have bothered to develop one. Really, that budget sounds like a lot to ask of a very busy founder and not much help for the VC. Or, what founder wants to report to a BoD with VCs who would take such a budget seriously?
> List – A list of all investors you want to go after, to be used in a fashion similar to a CRM (i.e., track progress across the pipeline, etc.); these are either leads you’ve been in touch with, or new ones you and your partners will be reaching out to.
From all I've seen, commonly VCs take great pride in being really difficult to get to respond at all. E.g., a "cold contact" can be treated as contemptible "over the transom" with some scatological implications. Or a founder who sends a deck to INFO@VCxyz.COM, if the deck is noticed at all, puts the founder on the dunce list. That is, the e-mail address INFO@VCxyz.COM is a honey pot for fools.
Sure, for the list, go to the National Venture Capital Association (NVCA) and get a copy of their membership list. Presto. Bingo. Done. But to what end?
> make sure that everything is top-notch
So, we're back into this perfectionism stuff. Commonly "top-notch" is not so much good work as a sign of the anxiety disease OCD. My wife was really good at doing "top-notch": Valedictorian, Summa cum Laude, Woodrow Wilson fellow, NSF fellow (two years support in one award), PBK, top research university from world famous professors Ph.D. It was fatal: She never recovered, and missing her body was found floating in a lake. I have a good pure/applied math Ph.D. from a world class research university and, thus, know what "top-notch" work really is; I doubt that many VCs do know.
> Do the pitch to 3-4 friendly VCs that are not top of your list to make sure your narrative is clear and well-received, or fix any weak points that may occur (if the reception is not enthusiastic, you need to take a step back and iterate until it becomes such).
Where does a startup founder find "3-4 friendly VCs" when sending 100 copies of the pitch deck may result in 0-2 responses?
For the "fix any weak points that may occur if the reception is not enthusiastic", that's asking that VCs be "enthusiastic", and that was the source of my parody that the desire is a pitch deck like a summer blockbuster popcorn movie. I'm not sure even Spielberg and Lucas could develop a deck that would get VCs "enthusiastic".
That's enough.
From such considerations I repeated the common advice that a startup that might want a Series A might just f'get about VCs, concentrate on growing the business, and let VCs discover the company and show their interest by contacting the founder. E.g., some months ago at AVC.COM Fred Wilson told the story of a startup his firm USV pursued for some months and finally talked the founder into accepting a USV equity check.