Feel the Boot 23. Why are even successful startups and entrepreneurs having trouble raising their Series-A rounds?
When I talk to startup founders or angel investors, one topic has started to dominate the conversations: the lack of A round financing.
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Many founders and seed stage investors have a story for how a startup will grow. Initially friends and family will fund early prototypes. About six months later, once there is some traction and market interest, angel investors will fund the work required to demonstrate product market fit. Six months to a year after that the company will close a $5 million series-A round that will fund explosive growth.
But in reality, it is taking much longer to reach that A round investment, often a number of years. So the CEO needs to find other ways of funding the business until it happens, or skip further funding entirely.
I am working with several companies right now that: have working products, that customers like, are growing, and generating revenue. Yet, after multiple years of effort, they still can’t close that A-Round.
The problem with A rounds is structural. Funds are getting bigger which leads to larger investments. Investments of any size require a similar amount of work from the VC firm. With a larger amount of cash to deploy and a roughly constant amount of labor available, the rounds need to be larger. Rather than investing $5m, I am hearing that many investors won’t invest less than $15m.
Of course, with that larger investment comes higher expectations. Reaching those higher hurdles takes longer and consumes more cash. The entrepreneur typically needs to to back to angel and seed round investors multiple times before they clear them.
At Anonymizer, we raised a total of $2.5 million over about 7 years, all from angel investors. The slow growth in the consumer space never got us to a place where we could bring in VC with their larger investments, even in the more permissive late 1990’s environment. As it turned out, that saved us when the market crashed in 2000 because we were small and lean, unlike some well funded competitors who had high burn rates but no prospect for additional money.
Other than in the medical space, which seems to have its own set of industry specific hurdles, I am seeing three paths to A-round funding.
The first is to be growing exponentially. While 30% year over year growth is respectable, the VC are looking for 30% month over month, doubling every quarter. In addition to that, they are looking for strong fundamentals and unit economics. Finally, they want to see a clear path to continued growth at that pace. With all that in place, the investment decision is fairly easy.
Another path is to have the right history or some unfair advantage. If you have multiple massive prior exits investors are much more likely to take a chance on this next venture. Similarly, if you have a rockstar team of people with track records of amazing execution, they will have more confidence that they can do so again. Finally, investors tend to move as a herd. If you have extremely impressive investors in your seed round, they will know the general partners at the VC firms and be able to leverage their reputations to secure the investment.
The final path is to create enough track record to remove the risk. If the company has been executing for several years showing reasonable growth and reliable results, it will be in a position where a $15 million investment is warranted and relatively safe.
Anonymizer never did raise an A round. Once we did our big pivot towards the national security community we started generating revenue faster than we could effectively spend it. While the VC might have been interested in us, we no longer needed them.
Like Anonymizer, you might choose take many small investments until the company is self sustaining. Alternatively, you might be able to bootstrap the business with little or no funding at all.
Sometimes the problem with growth is timing. The market forces and conditions are not yet right for your business. If that is the case, and you are confident they will be aligned soon, then just surviving till then can be the right strategy.
Finally, it might be a sign that your business model is just not going to work. You either need to pivot to something that will generate the growth you need, or you should wind things down and look for a new opportunity entirely.
Fortunately, two companies I have helped recently scored A-Round funding. One through the medical device exception, and the other through the long track record of reliable growth approach.
The key is to build your business in a way that it can succeed even if the A round funding take much longer than expected or never happens at all. Model your finances without that investment to make sure the company has a viable plan B for survival and success. In this new reality, angel and seed investors need to see that kind of robust business model.