Avoid the Labels — Understanding the Changing Funding Landscape

A piece of advice that we often give startups is to be more specific when describing the round they’re raising. We’ll meet a founder who says “we’re raising a seed round” or “we’re planning to raise our Series A at the end of the year.” After asking what they mean by the “seed” or “A” round (and understanding the company’s current traction), we discover that many of these plans are based on outdated definitions and assumptions and not reflective of the changing funding landscape.

This change in the funding environment has been occurring for the past 10 years or so but has really accelerated in the past few years. We are all aware that the costs of starting a software-based company have decreased and as a result, companies can initially get further on a smaller amount of capital to reach milestones such as product and customers. From an investor’s perspective, this capital-efficiency has created two investment approaches — invest smaller amounts to get to these key milestones — or invest comparable amounts in companies that are further along.

This dynamic has created an opportunity for smaller dollar amounts to have a greater impact on startups in the earliest stages, hence the rise and increasing role of accelerators, angel investors, and newer, smaller institutional funds that focus on investing at this earlier stage, leading to new terms such as “Micro VC”, “Institutional Seed”, “Pre-seed” or “Post-seed”.

These new labels have added more confusion to the market as the new funds are trying to differentiate their investment stage from the Series A, Series B stages that many traditional institutional funds have maintained as their focus even if, in reality, they were actually investing later (in terms of a company’s progress) than they had before. This has led to the articles on how “Seed is the new Series A” or that “Pre-seed is the new seed”, etc. (We have listed several below.)

Because of this complex funding environment where the definitions and expectations of Seed, Series A rounds vary (even greatly) by investor, companies find themselves targeting the wrong investors at the wrong times with the wrong asks. We would highly recommend that anyone that is planning to raise investment needs to understand these dynamics and do the following:

  1. Be specific in describing your round and avoid the labels — don’t simply say I’m raising a “seed round” or “Series A” — this will lead investors to assume different things based on their perspective. Talk about the amount you’re raising and what tangible milestones you’ll accomplish with that funding — paint the picture of what your company looks like as a result of this funding round. The investor you’re talking with today is trying to determine whether that company (12–18 months from now) will have made enough progress to raise the next round (at an increased value), be cash-positive or even exit.
  2. Be careful with fundraising advice that doesn’t reflect today’s market conditions. The company profile that raised a “seed” or “Series A” five years ago (or even a year ago) may fall short in today’s environment. In fact, as the definition of these rounds has been changing, you are probably not comparing apples to apples even if you control for timing.
  3. Know where the bar is today for a company like yours to raise a particular type of round. Just as the times needed to win an Olympic gold in track or swimming continue to get faster, the traction bar for startups at given stages continues to move upward and it’s important to understand where that bar is. For example, a year ago, a guideline we were hearing was that a SaaS company needed to reach $10K MRR to raise a $1M seed round. While this metric is not absolute and can vary based on team, growth trajectory, target market, customer acquisition costs, pricing, geography, etc., it’s still important to understand the “bar” as a starting point for planning your fundraising. (Late add: We just found this great SaaStr interview from last week with Elizabeth Yin of 500 Startups that provides some updated traction guidelines for SaaS companies.)

If you want to read more about this changing funding landscape, we have included several posts below that do a great job of explaining this market dynamic

We noted the location of the writer and the time period when the post was written because that context is important to keep in mind when forming your takeaways. Some of the stage definitions and round sizes outlined may not match what you’ve experienced locally. However, we will assert that these directional trends and resulting implications are relevant for all software-based companies looking to raise money, especially if you are looking to raise from investors in markets such as Boston, New York or San Francisco.

Written by AlphaLab Executive Director, Jim Jen.