Seed is not the new Series A

The incredible success of the cloud business applications space in recent years has driven up valuations and fundraising across all stages of venture investment. That has in turn increased VC fund sizes, led to massive cloud IPOs and brought a new cadre of investors to further fuel the fire.

The median Series A raised by cloud companies these days is about $8 million and can often go well above $10 million, according to PitchBook data from the first quarter of 2021. Series Cs now routinely include secondary capital for founders, and many Series Ds are above $100 million with valuations in the billions.

There is a widening gap in the funding continuum between angel/seed funding at inception and the new-age $10 million Series A at $2 million in ARR.

Such an influx of capital and interest has upended many structures and long-held norms about how startups are funded. Venture funds continue to grow and must write larger checks, but ever-higher valuations force many firms to hunt for opportunities earlier. The VC alphabet soup has been spilled, making A rounds look like Bs used to, and the Bs seem like the Cs of old.

Which begs an interesting question: Is the seed round the new Series A?

We don’t think so.

Seed rounds have certainly grown — averaging about $3 million nowadays from around $1 million to $2 million previously — but otherwise, seed investments are the same as before and remain very different from Series As.

Diversification is the primary risk mitigation technique for seed investors. Most seed firms make a lot of smaller bets relative to their fund size — for instance, a modern seed fund might be $250 million and make 50 to 80 investments, spreading the risk wide. That sort of scale also allows for shared services such as recruiting, or a network of former entrepreneurs, executives and domain experts the firm can leverage across a large investment portfolio. That can be very valuable to a startup.

Conversely, a large portfolio means partners at seed firms are often spread thin and can’t afford to devote enough attention to any one startup. In fact, it is a common refrain among founders that they don’t get enough high-quality, one-to-one time with their investors.

That’s ironic, as this phase of a startup’s life is precisely when founders need the most advice. For first-time founders, advice from an experienced investor can make a huge difference when it comes to important aspects like technology choices, product-market fit, testing, tuning go-to-market messaging, experimenting with business model and pricing variations, as well as hiring crucial early leaders and the executive team. This is precisely what Series A investors are traditionally known for: More focus and hands-on support.

However, Series As have now grown, and so have their investment thresholds. Most Series A investors today look for around $2 million in annual recurring revenues (ARR) before they lean in, but getting to that figure is a very long and thorny path. In our view, there is a widening gap — a hole almost — in the funding continuum between angel/seed funding at inception and the new-age $10 million Series A at $2 million in ARR.

The Classic Series A

To provide founders a stepping stone from angel to the new Series A and fill that gap, we have framed a new investor: the “Classic Series A.” Here are the defining criteria:

Stage

The Classic Series A firm invests in early revenue companies with $200,000 to $500,000 in ARR, when they still haven’t determined their product-market fit. A company does not require $2 million in ARR to qualify. Investing this early is not for every firm, and it takes specialized experience to see the opportunity, as well as patience to navigate inevitable setbacks.

Reticence around ARR and premature focus on current SaaS metrics like LTV/CAC are indicators that an investor is outside their comfort zone. In fact, a true Classic Series A firm will even invest pre-revenue at the alpha- or beta-product stage, allowing founders to skip the seed round and go straight from angel checks to the Classic Series A.

Capital

The Classic Series A round is about $4 million to $8 million in size, which is enough capital in the cloud application space to reach the goal posts required for a subsequent $10 million to $15 million round led by a larger firm. In our experience, a $2 million to $3 million seed round just does not provide enough capital, and that is particularly true if you are going after a big, competitive category, because the bigger the market, the faster you need to move. To solidify a leadership position in the market, you need the right amount of capital, even at an early stage.

Focus

The Classic Series A is led by a specialist firm that focuses exclusively on companies in this stage. At this phase of development, you need a committed partner who has both the time and the experience to guide you. The Classic Series A firm partner must have years of operating experience in the cloud business market.

The firm should focus on a small portfolio of no more than 10 companies per investing partner, and make no more than two investments per partner, per year. This is important because it ensures your partner has time for you and is equally motivated to succeed.

Syndicate

The Classic Series A firm strives to create a strong investor syndicate. Such a syndicate could include seed investors, as leading seed firms add value through scale — for instance, they often have recruiting partners who help find crucial executive hires or offer CEOs shared learning across their large portfolio.

Similarly, a strong syndicate could include hand-picked angel investors with deep expertise and customer/partner networks in the startup’s space. The Classic Series A firm understands the importance of a strong syndicate over the near-term maximization of their own stake.

The correction in public cloud stocks we are currently seeing conforms to a historic pattern, but the mid- to long-term outlook for the space remains extremely positive and many more exciting new SaaS startups will be created. If you are the founder of such a startup and are trying to make sense of these shifts toward larger rounds with higher bars, then maybe a Classic Series A is just what you need to get from angel/seed to a $10 million funding round.