Seed fundraising is rarely easy, but it certainly used to be a lot less complicated than it is today. In a simpler world, a seed investor (or maybe two) would lead a round, which meant that they would write the terms of the deal in a term sheet and then pass that document to their friends to flesh out the funds and eventually close the round. That universe of investors was small and (unfortunately) often cliquish, but everyone sort of knew each other and founders always knew at least who to start with in these early fundraises.
That world is long since gone, particularly at the seed stage. Now there are thousands of people who write checks into the earliest startup venture rounds, making it increasingly challenging for founders to find the right investors. “Pre-seed,” “seed,” “post-seed,” “seed extension,” “pre-Series A” and more terms get batted about, none of which are all that specific about what kinds of startups these investors actually invest in.
Worse, obvious metrics in the past that helped stack-rank investors — like size of potential check — have come to matter far less. In their place are more nuanced metrics like the ability to accelerate a deal to its closing. Today, your greatest lead investor may be the one who ends up writing the smallest check.
Given how much the landscape has changed, I wanted to do two things for founders thinking through a seed fundraise. First, I want to talk about how to strategize around a seed fundraise today, given the radical changes in the market over the past few years. Second, I want to talk about a couple of the archetypes of startup stages you see in the market today and discuss how to handle each of them.
This article focuses on “conventional” seed fundraising and doesn’t get into a bunch of alternative models of VC that I intend to explore in the coming weeks. If you thought traditional seed investing is complicated, wait until you see what the alternatives look like. The upshot, though, is that founders with the right strategy have more choices than ever, and, ultimately, that means there are more efficient ways to use capital to get the desired outcome for your startup.
Thinking through a seed fundraise strategy
Let’s get some preliminaries out of the way. This discussion assumes that you are a startup, looking to fundraise a seed round of some kind (i.e. you’re not looking to bootstrap your company) and that you are looking to close some sort of conventional venture capital round (i.e. not debt, but equity).
The problem with most seed fundraising advice is that it isn’t tailored to the specific stage of the startup under discussion. As I see it, there are now roughly six stages for startups before they reach scale. Those stages are:
0. Team – deck: This might be dubbed the “hello world” stage of a startup’s journey. There is at least one person looking to build some form of company, but the full team, product, market and target aren’t fleshed out at all.
1. Team + deck: In this stage, there is leadership for the startup and the founder(s) have identified a working hypothesis for a product or at least a market they want to tackle. Because there is no product, there is obviously no product-market fit (PMF).
2. On course to product-market fit: There is a real product, there are users, maybe even a bit of revenue, but everything is sort of ambiguous and the team is still actively experimenting and testing ideas around the product.
3. Product-market fit, pre-scaling: The startup has identified and developed a product that has clear signs of product-market fit, which might come in the form of high NPS scores, strong word-of-mouth marketing, excited feedback from users or some other data that says users of the product love it.
4. On course to scalable growth: There is a product people love, but now the company needs to prove it knows how to spend money to buy growth. This means setting up marketing channels, handling growth marketing within the product itself (on-boarding, sharing tools, etc.) and, if relevant, building out a sales team. Many of these functions haven’t been fully tested by the startup yet.
5. Proven, if early growth: Growth channels have real and positive data that’s comparable with other startups.
That’s my ontology at least of the seed stages of a startup. Startups never fundraise at all six stages, of course, but many will certainly fundraise at more than one stage.
Here’s the problem that a lot of founders at this point find out the hard way: Seed investors often only invest in one or maybe a small handful of these six stages. In some cases, seed investors will say that they do “pre-seed,” and I have heard from a number of seed investors in the past year that they are “pre product-market fit.” The reality is that these checkpoints are fluid, as are the stages at which investors are willing to invest. Founders often only learn the details, though, after spending weeks, if not months, fundraising.
The iron law of seed investing then is to accurately identify at what stage your company is, and then to only focus on seed investors that are willing to do a deal at that stage of your company’s development.
Fundraising at stages 0-1 (team -/+ deck)
Let’s be honest right at the outset here: Not everyone gets to fundraise at this stage. This is a very privileged stage, and, unfortunately, access to capital here in many, many cases is pre-determined before you even walk into a conference room.
There are a couple of ways that fundraising works at this stage, and all of them have to do with the biographical gravitas of the founder(s) walking in through the front door (after all, there isn’t much else to evaluate at this stage, is there?).
The easiest fundraise here is going to be for a multi-time founder who appears to be ready to take a big swing for the fences and has prior proof that they can build a scalable startup. These are obvious cases, and if you are in this boat, you probably already have cash in the bank and don’t need to read this section at all.
Next, I’d say there are a variety of fundraising networks that work well for founders with the right pedigree. There are university networks around schools like Stanford, Harvard, MIT and others that will lock in this round of capital reasonably early for the right alumni. There are also “mafias” around companies like Google, Facebook, Square, Dropbox and others where former execs from those tech companies who have become VCs will quickly fund their favorite (and hopefully best-performing) former colleagues to get them out of their jobs and into the startup realm. If you have the right noun on your resumé, then this is obviously a good option to pursue.
Finally, there are a handful of venture firms that specialize in these two stages, particularly for founders that come from less tech-enabled industries (think healthcare, insurance, logistics, etc.), or for founders with in-depth market experience where they might be able to sell really well or build earlier partnerships than other founders. These firms are betting that the knowledge in a founder’s head will outcompete the smart-but-naive product founders in the Valley.
Maybe there are a few other categories of founders here that I am missing. The reality though is that these networks either exist for you, or they do not, and not much else is going to change at this very early stage.
If you happen to be outside of these exclusive networks, don’t despair — obviously most founders don’t begin with a nice cushy seed round to build their company before they even have an idea. There are all kinds of options, from accelerators, to corporate incubators, to friends and family rounds, to crowdfunding, to simply paying the bills yourself to try to get past this early stage.
But the reality is that if you don’t have the biography to get a fundraise done, then you really need to move on to the next stages of company building without early funding. That might mean bootstrapping or funding company operations with services, or finding some other way to keep the lights on in the early years. No matter what, you need to keep building, because it is always going to be easier to fundraise with a working product and actual data rather than just a PowerPoint slide deck.
Fundraising at stage 2 (→PMF)
You’re on the road to product-market fit, but maybe don’t have it yet. In the past, this was a Death Valley of funding — it was nearly impossible to find investors who didn’t say “come back to me when you find product-market fit.” The good news is that there has been an explosion of funds that specifically target this stage and actively work with founders to help them reach product-market fit.
There are a couple of signs to look for when trying to determine if a venture investor will be compatible at this stage. First, you want them to literally say “pre product-market fit” (or something very similar) when they discuss the kinds of investments they are looking for.
The reason this is critical is that your startup is still at a very ambiguous stage, and so it’s critical for your investors to understand that everything can change about the company in the coming months. The product can change, the market can change, heck, even whether it is consumer or enterprise can change. Investors who understand this stage will get that you will experiment, try things that may not work out, and nonetheless continue to be supportive.
Second, investors at this stage will talk about how they can help you find product-market fit, and even better, talk about startups they have helped reach the next stage. This is not only important because you want your startup to progress, but it is also a sign that the VC understands that the next markup in their portfolio will come when you find a great product with the data to prove it. This help may come in the form of “advice,” an advisory network of folks who are experts in product, engineering, design or market verticals, or even just a promise to cheerlead as you explore options (don’t underestimate the value of pure moral support at this early stage).
Funds that invest exclusively at this stage are going to have very small checkbooks. Often, these funds will be as small as $5 million or $10 million and will only invest in a dozen or so companies. The model for investing at this stage only really works at this scale — it’s impossible for one or two partners to each simultaneously help more than a handful of companies.
The key thing to align on is the open-ended nature of the coming months of work. Finding product-market fit is something you can operationalize, but that doesn’t mean you can guarantee results on a certain timeline. You frankly want optimistic investors who are open-minded about what the future will bring but who are always intent on pushing you to find the product that’s going to be a huge success.
Ultimately, the motivation of these investors — like all VCs — is to get a good deal. That means that you will raise less money with more dilution at this stage than you would if you could prove product-market fit in the first place. The VCs at this stage want to buy in before the valuation of your company jumps, which is also the gamble for you as a founder — do you want this capital right now or can you wait until product-market fit to get a better deal?
Fundraising at stage 3 (PMF)
This is the classic “seed fundraise.” There are ample volumes of discussion across the internet (and on Extra Crunch) about this stage, so I don’t want to rehash a lot of advice that is easily accessible elsewhere. I do want to focus, though, on two strategic elements here that are key to this stage in 2020.
First, this fundraise is among the most complicated in 2020 because of the sheer number of check writers interested in this stage and the wildly different scales at which they invest. These sorts of seed fundraises are often small enough in terms of dollars where almost any investor from small angels to mega funds can meaningfully invest.
We often use the phrase “find a lead investor” to mean finding someone who is going to take most of the round and then close it out with relevant angels or operators. Today though, I think the phrase should be more “find a champion investor” for this particular stage of seed fundraising.
Here’s what I mean. Yes, there are still lead check writers who will take most if not all of this seed round. But I am also increasingly seeing seed rounds at this stage where an angel or a small seed fund investor may put in a small check, but has a very engaged and high-depth network of other investors who will almost always close a round behind him or her. Sometimes these are so-called mafias, sometimes these are friends and sometimes it’s just having a good track record that everyone else wants to follow. Regardless, a check from that champion is basically the same as having a lead investor, even if they aren’t providing the bulk of the capital.
Unfortunately, there aren’t great lists of folks like this, so your best bet is to build relationships with other seed-stage founders and get their references and feedback on specific people or funds in this category. Most founders are helpful (after all, someone had to help them!) and they know who to talk to first.
So one dynamic is the massively expanding universe of seed investors. The other strategic consideration today is to think about whether you want a fairly narrow cap table with a handful of bigger owners or whether you want a true party round. For example, Haus recently fundraised a $4.5 million seed and as our Anna Escher wrote, “Helena equates their fundraising process to more of a crowdfunding approach than a traditional VC round, with over 10 funds and 100 individual investors contributing.”
It used to be that party rounds were looked down upon by many other investors. But there is one upside to this model these days, which is that there is less pressure in the next round for existing investors to build up their stake on the cap table. Given the amount of demand for startup equity these days, reducing that demand in the first place could make future fundraises just a bit easier, while also reducing some level of signaling risk for your company.
Outside of those two strategic points, all the standard advice about seed fundraising applies just as much today as it did a decade ago.
Stages 4-5 (unproven versus proven growth)
Finally, we get to the stage in the seed world that can encompass all kinds of startups, and can sometimes last years. This is the post product-market fit, pre-Series A stage when everything becomes about the growth engine at the heart of your startup.
Here’s the deal: Just because you have product-market fit doesn’t mean that your product is going to suddenly capture its market. People are busy, procurement is hard and everyone is tired. Better solutions don’t always win, and sometimes you have to almost jam a product down a user’s throat for them to realize that they need a different option than the one they are already using.
There are huge questions that must be answered at this stage in order to move forward. For example, how are you going to get user growth? What’s retention like? How are you going to find and lock in effective marketing channels? Are those channels economical within the context of your startup’s business model? What are the sales strategies that push a sale to closing? How long does it take to get a customer conversion? Can we hire the right people to make all of this happen? And the questions go on and on and on.
And so you have a massive spectrum of ambiguity in a startup’s ability to grow once it has an interesting product. There isn’t a clear divide between unproven and proven growth (stages four and five here), although investors will definitely have a sense if you are in one bucket or the other based on your data and how much conviction that offers them.
What’s changed in 2020 compared to a few years ago is that many venture firms now feel comfortable using a set of well-worn playbooks around growth to move a startup forward. There comes a certain inflection point around the ambiguity of a startup’s growth where investors go from “can the founders do it at all?” to “okay, I know what we need to do next.” The tolerance for investors for ambiguity in growth has gotten much better and so this inflection point has gotten earlier and earlier for startups.
At this stage, there are a couple of factors to consider as you search for investors. The most important is coming to agreement on what the next few months of a company are going to look like and what numbers need to be hit in order to lock in a Series A. Given that the valuations of Series As have become so pricey, hitting the right numbers is great for lowering dilution down the line.
The best seed investors at this stage are going to directly help startups achieve the right trajectory, perhaps with customer introductions or providing help around scaling out different functions of a company (recruiting, sales, marketing, growth hacking, etc.).
By this stage, you should know your product and market, and at least be able to sketch how you will grow. You are looking for investors who match that sketch as much as possible. If you are a consumer app, you want people who know how to grow consumer apps, and likewise with big enterprise sales, SaaS, SMB customers, etc. Even if these investors don’t help you with direct operational support, just the fact that they understand the mechanics of growth for your type of startup will create compatibility across a range of decisions that are going to come up in the coming months.
Finally, if you are on this course, then you do want a Series A and preferably one with the highest markup and highest capital invested. The best investors at this stage have cultivated not only a well-performing portfolio, but have built out a highly-engaged network of Series A investors who are going to jump all over you when your seed investor calls. In other words, your investor is going to do most of the work of creating FOMO for your startup and drive that valuation as high as it will go.
Match your startup to your investor
To double down on this iron law of seed investing then: You want to make sure you are aligning the exact stage of seed your startup is at with the investors who care about that stage.
There are more gradations in the species of “seed investor” than ever, with more and more sub-species of investor being classified every year. These investors all have different tastes, and it is critical either to ask these investors directly for what they invest in, or to get feedback from other investors and founders to understand the kinds of startups in which they want to invest.
Sadly, many seed investors will take meetings with founders even if the underlying startup doesn’t meet their investment criteria. Even if you are too early, the thought is that it is never too early to start building a relationship with a founder. The problem, of course, is that founders end up spending serious time working with investors who don’t really intend to write them a check.
You can avoid this state of affairs by just being realistic about the stage your company is at and who might be interested in it. Your list of investors is going to be much shorter, but it will also be a much more compatible one, and ultimately, you want to spend your precious fundraise time focused on the investors who are most likely to write you a check. Take into account some of the unique strategic dynamics that are hitting in 2020 and then get back to building a great company.