The Path to Series A
According to a Crunchbase study on 35,568 startups founded between 1990 and 2010, 81% of those no longer exist and only 19% achieved an IPO or acquisition. The numbers demonstrate a hard truth — that eight to nine out of ten startups do not survive, or each startup faces a 80 to 90% failure rate. However, that failure rate is not static and should decrease along a company’s life cycle because the likelihood of failure decreases when a company goes further down the venture capital funnel.
Generally speaking, the more stages of financing that a company goes through, the greater its potential and the lower its failure rate. Series A round is the first important milestone for a startup on the path toward success because it highlights the point when the company receives validation from institutional investors and is seriously considered. That being said, the path to Series A is never easy.
In fact, it has gotten harder, and most companies fail before reaching this stage.
Compared to previous rounds, such as friends and family or seed financing, the Series A is much harder because it involves big institutional players who have strict mandates and fiduciary duties to their Limited Partners. Series A financing requires not only a bulletproof presentation and a clear game-plan from startup companies, but also a detailed legal and an in-depth due diligence report from investors, thus taking a much longer time to complete.
On the other hand, when you raise money from friends, family or seed round investors, you are raising on the quality of the founders (team) and the strength of the vision (idea). The Series A, on the other hand, is not about storytelling; it is all about metrics and numbers. Those metrics and numbers need to demonstrate progress and traction in terms of customer acceptance, virality, revenue, engagement, and more, which a company needs to secure Series A funding.
According to another study by Crunchbase, which looked at 15,600 U.S.-based technology companies founded between 2003 to 2013, only about 40% of the firms that raised Pre-Series A funding actually made it to Series A.
The venture capital funding landscape has changed significantly since 2013 with the explosion of crowdfunding platforms, acceleration programs, and micro VC funds. As a result, companies have not had too much trouble raising early-stage money and seed rounds. In contrast, the substantial rise in seed-funded companies has led to increased competition for follow-on fundings; and, a growing number has struggled to execute a Series A raise. Therefore, we expect if we run the same analysis on the data from 2013 until today, less than 40% of seed-funded startups would actually obtain Series A funding.
The Series A Bar is Higher Than Before
A company raising a Series A round is held to a much higher standard than in previous markets. While back in 2010 only 11% of companies raising A rounds were already generating revenue, today 67% of startups have that distinction. Given the current average size of Series A, which multiplied 2.5x from $4.9MM in 2010 to $12.1MM in 2017, it is not surprising that Series A investors today ask more from startup companies. Investors wait to see real proof points, which represent growing momentum and an emphasis on de-risking business concepts before they will commit capital. Besides revenue, Series A investors also look at user numbers, level of engagement and other traction measures. They compare the metrics with those of competitors and analyze them on a MoM, QoQ, and YoY basis. For all of these, the metrics and growth need to be the result of legitimate product/market fit and execution, not distracting information.
In the period from 2002 to 2007, a company could raise a Series A before establishing any market traction or use the Series A to fuel product/market fit. In the current period, to whet the appetite of Series A investors, a startup company needs to have already gained enough traction, achieved some growth milestone, and showed its readiness to scale. The graph below demonstrates the theme discussed recently in the venture capital landscape: Seed is the new Series A and Series A is becoming the new Series B.
Reflection on Raising Series A
This summer, on-demand tax filing platform Taxfyle will join the Series A club, and we are working diligently to support them in this critical financing stage. Rokk3r Fuel ExO is very pleased that in less than a year, we have chosen to lead the Series A round for three companies in our portfolio. The experience has allowed us to draw several insights in developing a strategy for a company to raise strategically and successfully its Series A, as well as in recognizing if a company is ready for this critical funding stage. There are different strategies for raising a Series A which can be categorized into three groups based on what tools a company leverages to attract investors to a Series A round.
- Vision of The Future
With this strategy, the founders need to pitch the biggest vision that they believe in to excite the investors. The story should be concise and powerful, following this outline:
- Describing the world today with a specific problem, which affects a large number of people
- Presenting a solution and explaining how it disrupts the market and why it is the ideal time for the company’s product/service
- Closing with a real example to demonstrate how the solution makes the world much better and conveying what is to come: huge growth opportunity, great press, big-name advisors and blue-chip customers
This strategy seems to be the hardest because a lot of investors look for evidence of quantifiable data more so than a compelling narrative. However, if the company product/service is a disruptor and targets a very large total addressable market, the founders should go for it.
2. Forward Momentum
Founders need to focus this strategy on getting a lot of people to know and to use the company’s product/service. Perhaps they are not paying customers yet, however, the goal is to show that there is a strong demand for the product. Proven user traction is an indicator for big and increasing top line figures.
To prove product value to customers, founders can use Net Promoter Score survey, which shows how likely a customer is willing to spread the product, and the Sean Ellis product/market fit survey, which measures how many customers would be distraught without the product. Going beyond the surveys, to prove customer momentum, founders should graph any user-related data such as the number of active users, number of registered users, amount of engagement, etc. Those graphs should always show an upward direction and point to the right.
3. Real and Meaningful Revenue
Revenue is the gold standard of product/market fit, especially if it is generated from big and well-known corporate clients. This strategy has been working very well for Hyp3r to raise its Series A, which might be oversubscribed. We expect the same outcome for Taxfyle’s Series A round. While Hyp3r has an executed contract with Marriott, which has been extended from 5 years to 7 years, Taxfyle has partnered with a Big Four accounting firm on a five-year multimillion dollar contract. The partner company has recently requested to extend the platform to serve other branches outside of the U.S; the expanding scope of work is expected to increase the size of the contract substantially. The contract with a Big Four accounting firm has proved a strong market validation for Taxfyle and has opened the door to many new opportunities with other local and multinational professional service companies. Within a short period of time, Taxfyle successfully closed a partnership with a leading accounting firm in France with a massive global operation in 78 countries. Currently, Taxfyle is in discussion with several top professional tax & accounting firms; once closed, Taxfyle will have successfully partnered with two of the top ten in the world and four of the top twenty in the U.S. We believe that Taxfyle is a groundbreaking FinTech startup that seeks to disrupt the tax/accounting service industry.
Besides developing a fundraising strategy, we need to make sure that the company is ready for Series A financing. The readiness is measured by key factors including, but not limited to, proven unit-economics, revenue growth, proof of business model, product/market fit, customer acquisition strategy, or any systems to support efficient scaling. The Series A goalposts for these factors are always changing depending on the market environment and are different based on the industry. Specifically, B2B metrics for Series A are ARR of $1.5MM and YoY growth greater than 100%. Taxfyle has exceeded those requirements with $2.5MM ARR, growing 400% compared to last year.
We do not want our portfolio companies to raise capital prematurely and later suffer a downround. Before achieving product/market fit and getting ready for a Series A — the scaling stage, companies are advised is to keep their burn rates low. On the other hand, when a company has already achieved compelling enough milestones to convince investors that cash is the only constraint to scale the business, we encourage the company to start the Series A round. The round should begin at least six months before the company needs the money, given the time-consuming fundraising process. In addition, they should size the round in a way that provides the company with a sufficient cushion to achieve the next set of milestones.
Fundraising is one of the most challenging parts of a founder’s role. Our goal is to provide our portfolio companies with guidance and the right support at the earliest stages, so they can focus on having a major impact. We are looking forward to seeing, and helping, many more of our companies reach this critical stage and successfully secure Series A funding.
This post was authored by Rokk3r Fuel ExO Partner and Chief Investment Officer Maggie Vo, CFA. Maggie is responsible for managing investment activities, leading due diligence for potential new investments and performing valuation analysis for portfolio companies.