A Guide To Post Seed Financing Options

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This Industry Is Completely Ridiculous. Let’s Hope It Stays That Way.

Editor’s note: Paul Martino is a co-founder and GP of Bullpen Capital, an early-stage VC firm. He is formerly the founder and CEO of Aggregate Knowledge. Follow him on Twitter.

Seed capital availability exploded at the same time the traditional Series A ecosystem began consolidating to fewer and fewer funds. By some counts there are now over 135 active seed capital funds and now fewer than 90 truly active traditional Series A firms. This has caused what everyone now refers to as “The Series A Crunch.”

A majority of these early-stage companies won’t survive, and a large percentage of those deserve to fail as unsuccessful experiments. Some seeded companies that will fail, however, are founded and operated by some of the smartest people in the world – the laws of math are just brutally unforgiving under these conditions. My partners and I know this feeling well, as the three of us have been involved in starting 14 companies, and getting to that first stage of institutional funding is no trivial task.

In 2014, as the biggest venture capital firms continue to grow, the size of the checks they need to write in order to be effective also grows. As a result, the progress and traction they expect to see from startups seeking investment becomes more and more demanding. Given this ever-higher bar for “de-risking” a deal, what should the founder of a seeded startup do? A small handful at the top will quickly get venture capital, yes. And a non-trivial number at the bottom will just die naturally. Some of them will find a soft landing through an acqui-hire, or more rarely, a merger with a larger startup.

Yet, within all those thousands of seeded companies, we believe a large number of them exist with good fundamentals, traction, early revenues, and product-market fit. Despite these positive signals, however, these companies may not be at the stage where large venture capital firms are comfortable investing. In these cases, we ask: “What financing options does a founder in this position have?”

For founders today in 2014, here’s our take on what options are available:

Micro VC Firms. Large VC firms manage so much money that they need to invest in opportunities that will translate into big returns. In early-stage companies, however, those strong attributes may not yet exist or be apparent. Smaller VC institutions, usually with $100M or less under management, can often lead deals with smaller checks, say $2 million to $3 million or so.

Equity Crowdfunding. Today with platforms like AngelList, Indiegogo, Crowdtilt, Kickstarter, and more, entrepreneurs can leverage the Internet to connect all different types of capital to their private-equity opportunities. It’s unlikely to find a “lead” investor on these platforms but they are certainly of great value when filling out or completing a round.

Bridge Funding. This is typically financing from existing investors and/or friends and family who may have also been part of the initial or angel round of funding. Many of the “fail fast” institutional seed funds (which invest broadly at very early stages and only continue investing in companies with traction) don’t offer this because it’s not part of their model. They required a third party to come in prior to continued investment.

Strategic Investors. Some companies with valuable technologies or innovative APIs, for instance, may have developed relationships with larger corporations in their space, some of which may want to get closer to the company, license or test the technology or solution, or partner in some way. At times, these relationships can be strong enough where investment is possible, and with more corporate VCs sprouting up and doling out money, this could happen more and more. In many cases this money can even be completely non-dilutive as it can be structured as an NRE (non-recurring engineering) expense. I have successfully used this method in two prior startups.

Pivot Quickly Toward Revenue. It’s in fashion to build up product and audiences while leaving off revenues for later. The argument here is that, once a product is reaching scale, it’s easier to lock-in use and extract revenue at scale. But, what about products that are very far from anything that looks like scale? Here, founders can pivot the company to focus on revenues, and if they’re in a position to ring the cash register, buy themselves some time. The downside to this strategy is that the market is currently overvaluing growth vs. profitability. So while the company might be break-even, it no longer is attractive to venture as its growth rate has slowed significantly.

The Small “A” Round. This is what I do at Bullpen Capital and it is what others like Venture51 do as well. Our firms focus on investing “into” the Series A Crunch. Our formula is straightforward. We focus on early-stage companies that have already been seeded, products with early product-market fit, and companies that show strong evidence of being able to hit the next big milestone within a year or so.

Our first deal was Assistly (now Desk.com), which was seeded by True Ventures. Its founder, Alex Bard, found himself in the post product-market fit position with the option to raise a $6 million to 8 million round from a big fund. He lamented to Phil Black at True, “I only need $2 million, why doesn’t any fund offer me that?” Phil introduced Assistly to Bullpen and it became the first deal we completed in our fund. This strategy worked well for all parties when Salesforce acquired the company only nine months later.

Our frequent co-investors at Venture51 first recognized this opportunity, which they call “Post-Seed” or “Pre-Series A Traction Rounds,” when we both invested in Life360 (the first-ever venture-funded Android application) back in 2011. Its founder, Chris Hulls, had several term sheets in hand to raise a big A round, but the proposed size of that round didn’t make a ton of sense for the stage of the company.

Instead, Venture51 worked with Chris and other investors (including Bullpen Capital) to raise a smaller traction round. That round focused on optimizing the company’s unit economics over an 18-month timeframe, enabling it to hit key milestones that would allow them to tell a more complete story as they raised subsequent rounds of financing. The company successfully exceeded its key milestones and, as a result, raised $16 million in Series B funding. Life360 is now the largest family mobile application in the world with over 30 million families relying on it.

In the right situation, investors focused on the post-seed round can offer founders some key advantages. Founders can retain more equity in their companies, and they don’t have to shake hands on a big financing round too soon before it’s apparent whether their company could be huge or not (which averts both the danger of taking a valuation that’s too high to live up to, and buyer’s remorse of taking a valuation that proves to be too low).

These types of investment rounds work best when the interests of the founders are aligned with the interests of their existing investors. This is critical because aligning our interests with the founders and existing investors helps us all prepare for the next milestone when the companies in our portfolio get ready for a bigger venture round.

For the past few years, Venture51 and Bullpen were two of only a small handful of funds doing this kind of round. We are seeing new players enter this space. These sorts of funds are just one of a number of viable financing options currently available to today’s founders, so choose wisely and good luck.