A question I often get asked in conversations with early stage entrepreneurs is: What do VCs look for when evaluating Series A stage enterprise software startups — metrics or otherwise?
It’s an important question for entrepreneurs, and I can see why it can also be a frustrating one. There’s no science to what gets a VC excited about one startup vs. another. Some startups are able to raise a big round early on, while others have to slog it out even when the metrics look great. Why is this not more predictable?
One of the primary reasons fundraising is not predictable at the Series A stage is because the early stage investment decision is contingent more on the thesis and qualitative factors around the company/market than the metrics. Metrics can certainly make the investment case stronger, but at the earliest stages, they’re not the deciding factor. It is the investment thesis, and how a startup maps to that, around which the decision revolves.
With that in mind, below I outline the qualitative factors I look for in a Series A stage B2B startup, beyond that first step of feeling excited about backing the founders. Hopefully, these will serve as food for thought for founders looking to raise a Series A:
#1: Why now? To me, this is the most important question to answer in any investment thesis. Market timing is everything. Why should this idea succeed in a big way now? What macro trends are coming together to make it happen right now? For example:
- We’re fortunate to be involved with a SaaS startup called Gainsight that offers a comprehensive solution for customer success management. Prior to the advent of SaaS and the X-as-a-Service model, there was no need for a customer success solution. The market opportunity for Gainsight came to be because X-as-a-Service has become the preferred business model across the tech sector.
#2: Product category. Similar sized companies with similar margins can get a widely different valuation multiple. Often, the reason for the difference lies in the product category they play in. Some product categories offer more opportunity to build a stronger, faster growing and more valuable business over time. I think about the following questions here:
- Is the product you’re building mission critical to your users’ ability to meet their goals?
- Over time, will there be an opportunity to evolve the product into a platform connecting all other apps that are relevant to its users?
#3: Market size. Obviously, market size is important and a lot of people have blogged about it so I won’t repeat what’s already been said on this. I personally have a strong preference for a bottoms-up market sizing exercise. It doesn’t have to be super complex. But I would much rather hear the following: “we are targeting companies with 500–2000 employees; there are X such companies in the US and based on a price point of Y, we expect our addressable revenue opportunity to be X x Y” vs. “Gartner estimates that US companies spend $7.8b on [our product category] annually”.
#4: Distribution. Ultimately, startups are valued for growth. Accordingly, it really matters if you have an efficient go-to-market strategy. I think about the following questions here:
- Is the economic buyer already in the market looking for a solution like yours, or do you have to first convince them that they have a problem to begin with?
- Does the customer have a large enough budget for your solution, to justify the sales and marketing investment?
- Is there a way to establish a viral/word-of-mouth distribution strategy?
#5: Long term moat. Initial revenue traction is great, but investors are looking for companies that can build a sustainable advantage over their competitors over time. Companies that collect proprietary data on their platforms can build a data based moat over time. Enterprise marketplaces and vertical market communities/networks can build a network based moat. There are other ways to do this too. Salesforce’ AppExchange platform put it at the center of all cloud based enterprise software and built a network based moat around it. The network in this case was not a network of users; instead, it was a network of SaaS apps that can be deployed at a company with Salesforce being at the center of it. The key question I ask here is:
- Is there a winner-take-all dynamic that you can impose on the market once you have taken an early leadership position?
Those are the questions and considerations that go through my mind when evaluating a Series A stage investment opportunity. I don’t try to arrive at a perfect answer for each of them. There are obviously a lot of unknowns at this stage of a company’s life cycle, and it’s okay to not have all the answers. The framework above often ends up being a useful thought exercise for founders too in my discussions with them, and hopefully will be useful to the founders who come across this post.
If you’re building an enterprise startup and are thinking about some of the topics above, I’d love to hear from you. You can reach me at email@example.com.