The market for tech companies has shifted, as shown by a weak IPO market, a focus on profitability and pivots galore. Yet, despite the market’s ongoing re-correction, venture capital is a booming asset class. Last year, per CB Insights data, venture investment reached $621 billion, which is up 111% from 2020 levels. This year, while valuations are seeing some pullbacks, investors say expensive term sheets show that there’s still hope for founders.
Indeed, it’s a market of mixed messages. For startups graduating past the seed stage and thinking about landing that coveted Series A, what’s the best way to navigate these times? Stellation Capital founder Peter Boyce II joined us at TechCrunch Early Stage to answer this question, along with many more, in his Series A-focused chat.
Boyce, who left General Catalyst to raise his own $40 million fund, spoke from the perspective of a solo GP who helps portfolio companies design their next fundraise. We talked about a rare power-shift dynamic for founders to employ and why 20% fluctuations in your valuation don’t matter when you’re young.
A not-so-common practice
When a founder raises a Series A round, it’s often the first time that they’re establishing a board in a formal way. As a result, Boyce recommends founders perform reverse due diligence and interview not just the firm, but the person that will be seated on your board for potentially over a decade to come. It’s important to get right.
The investor said that founders should consider a number of factors when choosing a board member, such as work style, expertise in a specific domain, access to follow-on capital and broader resources. Interview portfolio companies, look for mutual connections, and, better yet, don’t be subtle about your investigation. Reverse due diligence, Boyce said, can show an investor that you’re “super serious” about your business.
“I’m actually really quite surprised that this isn’t a kind of more common practice,” he said. “The reason I love it for founders is that it totally changes the power dynamic once you’ve started doing your own homework on the investor … like all of a sudden you put them in a totally different interface and relationship with you.”
A well-stacked board of advisers could be the difference between landing the extension round that helps you weather a storm or losing focus so fast that you have to lay off half your staff. These folks don’t just own a chunk of your startup — they get an intimate picture of your business, can have voting rights and are accountability partners. Even still, things can go wrong.
In the case of Hinge Health, CEO Daniel Perez replaced his Bessemer board member with another partner after the original person invested in a competitor. The rare occurrence underscored one way to handle an investor on your board with whom you disagree. Boyce responded to this example by reminding folks that it’s important to vet investors to determine how they handle conflicts of interest — a particular worry in a time where deals can feel like they’re happening around the clock.
He thinks that founders should bring up competition and ask for boundaries in initial conversations. Founders can also name competitors in their Series A deal documents and request investors to not invest in them, if appropriate. Finally, if a board member does mess up, you can do what Hinge Health did and replace an investor — or just remove information rights.
“It’s often on investors to acknowledge and respect the initial relationships that you as an existing portfolio company had in the giant hierarchy,” he said. “I think you need to be catered to, out of respect.”
Valuations? Let’s talk about them
Let’s discuss how to think about valuations amid a shifting market. Per Carta, from November and December 2021 to January and February 2022, Series A rounds posted the largest average decline in round size in the United States. Outlier deal sizes are less frequent, and, as a result, the median Series A round also declined. The slight slowdown was somewhat balanced by the fact that Series A rounds on both a median and average basis in the same time period remain over the $10 million mark.
Boyce’s advice? Read an S-1 filing. Tables within the documents show the ownership breakdown between founders and investors at the time the company goes public. It’s a jolting reminder, he said, that you should think about percent ownership and percent dilution in that context because “owning 7% of a company that you manage to take public at a $12 billion valuation is stunning and life-changing.”
In a similar vein, the investor said that “20% swings in valuation price don’t ultimately matter in the long term.” He says strong businesses will rarely look back and think that they should have raised at an $85 million post-money valuation instead of a $75 million post-money valuation if the end product — good board directors, solid money — made sense.
He said that founders could raise a little bit more in early financings to give more control over runway, the timing for raising, and competitive dynamics for future pricings. Citing a term sheet he wrote recently, he said prices remain expensive and we’re still in a founder-friendly market. Here, he argues, not all firms are created equal.
For example, late-stage-focused firms that dabble in Series A deals may slow down their general investing cadence as public market prices struggle (and discipline becomes the obvious next step). Boyce recommended founders identify firms that have raised fresh funds because they’re less wary of near-term dynamics and have the capital to deploy. The vibe with these funds would contrast with a firm on the back half of their fund that is starting to do less investing and getting pickier.
Bottom line? Raising a Series A is an art, and a big part of the execution is explicitness, boundaries and maintaining perspectives on the long-term tradeoffs of this round.