Why You’re Mispricing your VR Seed Round
Disclosure: I invest in early-stage VR startups via my fund, Presence Capital, and thus, obviously, may be biased. In many cases, we invest in companies before a seed round is fully-formed. As a result, we are mostly aligned with founders trying to raise as much as possible while keeping dilution to a minimum. I try to remain neutral here and act as if I was a founder fundraising for my own startup, take this as a single data-point and come to your own conclusions about how you want to structure your round.
I’m all-in on VR and AR and believe these technologies are the basis for the future of computing. Acting on this, I co-founded Presence Capital to focus on finding and backing phenomenal entrepreneurs building VR and AR startups. That being said, I’ve noticed that many VR startups have trouble raising their seed rounds due to mispriced valuations (or caps) and an overemphasis on reducing dilution with their first round.
The reality is that most of the traditional advice on fund-raising that applies to Mobile, SaaS, or Enterprise startups doesn’t necessarily apply to VR because this market is so new and raw. You should raise with that in mind.
My goal here is to help founders optimize for success in terms of building a great business over the long-term, not just in raising the first round of funding. Similar to engineering, premature optimization can cause you focus on items that don’t materially affect your outcome and divert your attention away from those that do.
VR and AR are emerging technologies. Entrepreneurs routinely buy into the hype and fail to set their valuations to appropriately reflect the immaturity of this market and the time needed to reach meaningful revenue.
I meet with a lot of VR & AR startups. In the last year 400+ were tracked, 200+ meetings were taken, and ~25 investments were made.
When we evaluate a startup we look for team fit (grit & sense of urgency), product vision, and round terms that show intellectual awareness of the market and growth trends. Our goal as seed-stage investors is to back entrepreneurs early and help guide them to where they are able to raise their series A. In many cases, we’re the first check committed to a company and help raise the rest of the seed round through introductions and hustle. Additionally, against our own interests, we caution our founders to not over-reach on valuations in follow-on rounds.
Unfortunately, we frequently see founders that have a great background, a strong vision of what they want to build, but trip themselves up over the way they structure their round. More specifically, the valuation/cap they are trying to raise at.
We are often approached by VR and AR companies with minimal prototypes (if any) trying to raise at a $8m to $15m pre-money valuation or cap with a dilution target of 15% to 20%. As a contrast, a YC-graduated company that likely has the benefit of a launched product, initial traction, a large existing potential market, the YC network, and an investor feeding frenzy on demo-day usually raises at a $6m to $8m pre-money. For early VR companies that are pre-product launch, often a valuation in the $3m to $6m range or a higher level of dilution is more appropriate.
As a founder, there are quite a few ways a high seed-stage valuation can work against you and why you may want to consider lowering it:
- Turns off potentially great partners. Strategic and value-add investors are frequently valuation sensitive. Savvy investors are excited by VR but need to be intellectually honest about how quickly the market will develop.
- Sets your initial bar too high. You may be able to raise your Series A and even Series B as up-rounds on the hype around your team & VR in general but eventually you will be graded on revenue and traction metrics. Not just against other VR startups, either, but against other, more mature industries.
- Creates future round risk. VR is an early market, it’s possible you may need to raise another round before it develops and be priced too highly to raise a bridge.
- Takes the momentum out of your process. Raising when your valuation is misaligned with your reality feels like a drag on your fund-raising process. A lot of investors will string you along and not give you firm commitments. The opposite of this feels like a ball rolling downhill, you rapidly gain early commitments and are usually oversubscribed much more quickly than you expected. This puts you in a position of leverage to decide who to let into the round.
So given the above, what can you do to make your round go smoothly?
- Be honest with your situation. Your VR or AR startup is significantly more risky than a normal venture. You’re in a emerging market with a product that’s likely pre-launch, with little-to-no traction and few revenue opportunities in the short-term.
- Focus on the right metrics. It’s normal to be diluted 10% to 30% with your seed-round. Your team’s experience, product vision, and how far along the product is determines where you fall in that range. That being said, in future rounds, when you are in a position of leverage, you can command much higher valuations and reduce dilution at that point.
- Raise enough capital. You’re going to need time and may not want to be in the position of having to raise again incase the market cools.
- Manage burn expectations. Keep burn low and demonstrate a plan where you’re seed round gets you 16–24 months of runway. This is higher than normal seed-rounds (12–16months) because of the immaturity of the VR market.
- Look past the current round. Optimize not just for your seed round but for raising a series of rounds with the right partners. Choose an appropriate valuation that reflects the state of your company and how risky hitting your next milestone is. The valuation you raise this round at sets the bar for future financings.
When does this advice not apply?
- When you have significant revenue. This is unlikely for consumer VR at this point but may be possible for B2B and enterprise businesses. At that point standard revenue-based valuation logic applies (you need $1.5–$2m ARR to raise a series A)
- When you have significant traction in the form of retained users. Specifically, D1/D7/D30 retention that mirrors long-term engagement usage patterns you see on web and mobile: D1 50%+, D30 25%+. Side note: session length is not an appropriate proxy for consumer long-term engagement. VR also has higher-than-normal session lengths because users need to overcome a lot of friction to begin using a VR device.
I purposefully did not mention the experience as a founder at all as an exception. Sure, you may have a higher chance of success as a repeat founder but even experienced founders are at the whim of the growth rate of the VR market.
All of the above being said, each situation is unique and every founder needs to find their own path. We’re massive believers in the long-term potential of VR/AR and want to work with entrepreneurs that also take a long-term view of the industry. If that’s you, reach out to us: email@example.com
Thanks to Arjun Sethi, Nabeel Hyatt, Justin Waldron, and Daniel Hu for reading drafts of this.