Each round of scaleup fundraising brings with it unique challenges. That’s why we are breaking down each stage of the fundraising process, starting with Series A funding – so you can know what to expect.
While it’s not feasible to provide everything you will need to know in one article, we will be summarising the key information for each stage of the fundraising process in our new series – so that you can hit your Series A and Series E with equal confidence.
The jump to Series A from seed funding
The jump to Series A fundraising from seed is one of the trickiest leaps, catching out many unwary businesses ignorant of the different requirements and interests of the potential investors. You will likely only get one chance to pitch to each investor, so don’t fumble your opportunity by pitching the wrong things. As investor circles are quite small, prospective investors will talk to one another about your business. In this environment, a good or bad pitch can colour future talks with other investors.
Failing to prepare doesn’t only hurt your chances of receiving funding, it will also massively extend the process, with many rounds of funding lasting six months longer than the original business plan, as businesses realise they haven’t done their due diligence or haven’t been reaching out to the right investors.
The best signal that your business is ready for series A funding is once you have good product-market fit. Typically ARR is around £1mil, although each investor will have different requirements. Businesses at this stage are looking to expand their team and start approaching new customer segments.
The amount raised at Series A is usually somewhere between £3m to £20m, up from £150,000-£500,000 at seed. This is often the first round in which venture capital funds will get involved. While at seed you might have received all your funding from angel investors or even family and friends, Series A brings with it a different mix of investors who will be judging your business by different criteria.
Your company valuation will be a key factor in the success of your raise. Unfortunately, at Series A, there is no standardised method for valuing a business. This can make it difficult to set expectations – many companies fail to raise because they have set their sights on an unrealistic figure – and can lead to your business receiving different valuations from different investors.
Some investors will use market potential to value your business, others might measure users, revenue, traction or financial metrics. Accurate valuation at this stage is more about the milestones your business has achieved and predictions for its future performance than a standardised set of criteria.
If the product you are selling has a lot of disruption potential then it will often receive a higher valuation and attract more investor attention – and potentially attention from competitors looking to acquire it before it becomes a true threat. Intellectual property and growth potential can also drive competitive valuation, by suggesting future value to investors.
As a rule of thumb, investors will take 20-25% of the business in exchange for capital, meaning that most businesses will be valued at roughly five times the amount they are raising. This makes gaining a high valuation important for businesses looking to raise as much money as possible (at the lowest equity cost).
Funds operate differently from angel investors
This may change your company dynamics. For example, VCs will normally only subscribe to a preferred class of shares in the company in which they invest. These shares have certain rights attached, that are not shared by the ordinary shares held by the founders and executive team. VCs expect these additional rights because in most cases they are investing much larger sums than the founders and at a much higher valuation. At this stage, it is likely that investors will have 45% of the business, with 45% remaining with the founders and 10% with employees.
If you choose to raise VC capital, getting a reputable VC company on board is a top priority at this stage. Typically one VC firm will lead a funding round, and this acts as a signal to other investors to come on board. Major VC firms can also invite others to share the risk and reward and will provide positive PR when you join their portfolio.
However, this influence means that you will have to choose your VC investors carefully. With the investors you are onboarding taking a large share of company control, it is vital that they are aligned properly with your company’s goals, and that you are both clear on what you will expect from this relationship. It is important that you will be comfortable collaborating with them given their board seat and decision making power. This requires that you both understand what your expectations and responsibilities will be. A toxic relationship with a VC can not only damage your own morale and motivation, it often trickles down your whole company, creating an ‘us’ vs ‘them’ culture which will be very unhelpful in later rounds, or if your relationship with your investors becomes further strained.
What funds expect from your business
If this is your first experience with Funds, you also need to be aware that they will be performing due diligence on your business, just as you should on them. Each round of funding past seed will normally start with the potential investor valuing your business and performing their due diligence. As they will be doing their own research, it is imperative you have a good grip on your business and market as a whole, so you are not surprised by any of their questions.
You can expect scrutiny of your product/market fit; growth; LTV:CAC (lifetime value to customer acquisition cost ratio); CAC payback period; sales efficiency, or if you are a B2B company, Magic Number. There are a huge range of metrics out there, depending on your specific business model and industry, but metrics that demonstrate early growth, customer retention and efficiency are usually the most significant at series A.
Good pitches, then, ought to take these into account. If there are areas where your business has underperformed the pitch is a good place to explain them. It is here that you will also do the work to weave the businesses strengths into a cohesive narrative and position your business as an investment that can’t be missed. Knowing what investors are looking for can also allow you to try and address any business weaknesses before you get to the investors – so that you can show that your numbers are at least ticking in the right direction.
It’s a competitive marketplace at the moment, with investors showing a marked preference for larger companies as compared to startups – so you will need to be prepared to succeed.