From Pre-Seed to Series C: Startup Funding Rounds Explained
This is part two of my nine-part series, exploring every imaginable aspect of startup funding. From funding rounds to valuation methodologies, get ready for a complete crash-course in funding.
THE FUNDRAISING JOURNEY
So far we’ve covered the why of funding. Now we can start to cover the how, and look at the process startups go through on their fundraising journey.
The last decade has seen a few persistent trends reshape the way startups raise investment. To fully understand why modern-day investment looks the way it does, we need to get to grips with these changes:
1) INVESTMENT HAS INCREASED MASSIVELY
There are peaks and troughs in fundraising, typically driven by exuberant over-investment followed by reactive belt-tightening. But despite these fluctuations, the overall growth trend for fundraising is hugely positive: year-on-year, startups are raising more capital at higher valuations.
2) IF THERE’S A BUBBLE, IT HASN’T BURST
The escalation of company valuations and ever-increasing round sizes has led many to speculate about an investment bubble. So far though, the data shows that current slowdowns have been short-lived.
3) THE EARLIER THE ROUND, THE RISKIER IT IS
Perceived risk levels impact the types of investors attracted to a deal, and the amounts raised: expect early-stage investment to attract risk-loving angels and VCs, and later-stage fundraising to appeal to risk-averse financial institutions.
4) MOST INVESTMENT TAKES PLACE IN THE ENTERPRISE
80% of venture capital investments happen in the enterprise, with the lion’s share of those investments going to enterprise software — second only to the burgeoning biotech industry.
5) “SEEDS ARE THE NEW SERIES A”
This continued increase in investment has created a kind of fundraising inflation, with startups expected to work harder for each round of investment than ever before. We’ve even seen the introduction of a new term into the fundraising lexicon: pre-seed investment.
Seed rounds are typically regarded as the first type of fundraising round available to founders. But in an increasingly competitive marketplace, huge growth in the number of startups has allowed “traditional” seed investors to become far more discerning in how they choose their investments — raising the threshold required to attract “traditional” seed funding.
A typical pre-seed round sees a founding team (often pre-product) receive a small investment to hit one or more of the milestones they’ll need to ready themselves for “true” seed investment: from hiring a critical team member to developing a prototype product.
Led by many of the same investors that lead seed rounds, pre-seed financing is often used to bridge the gap to the next round.
Average Funding Amount: <$1 million
Typical Company Valuation: $1–3 million
Common Investors: Friends and family, early-stage angels, startup accelerators
Capital from a seed round often fuels a startup’s move beyond its founding team, funds product development, and in some cases, even facilitates early revenue generation.
Wrapped-up within seed investment are expectations that strong signs of Product/Market Fit and some some degree of traction (in the form of a growing wait list, or month-on-month revenue growth) will begin to emerge, paving the way for later fundraising.
Traditionally, seed rounds were the reserve of angel investors, but the proliferation of cash-rich VC funds and a huge range of startups to invest in has attracted more venture capital firms into seed round investment.
This has created a huge variance in seed sizes: the median angel-funded seed size is around $150,000, but the median VC-led seed size is closer to $1.5 million. The involvement of VCs leads to seed rounds ten times larger than those led by angels — with the largest seed round in 2015 a staggering $10 million.
Average Funding Amount: $1.7 million
Typical Company Valuation: $3–6 million
Common Investors: Angels, early-stage VCs, startup accelerators
Revenue growth is the name of the game in Series A. By this point, a startup is expected to have clear and growing evidence of Product/Market Fit, translating into significant revenue growth from new customers and increasing ARPA (Average Revenue per Account).
It’s also here that SaaS marketing and sales become more important. Until this point, growth has often been driven by a single (and not always scalable) channel. To keep growing at a rapid rate, it’s necessary to develop new sales and marketing processes, identify new channels, and get to grips with your ideal customer.
Angels (often referred to as “super” angels) will sometimes invest in Series A rounds, but it’s usually the venture capital organisations that dictate this round. The increasing involvement of VCs also means that Series A rounds are rapidly increasing in size (in 2015, ride comparison SaaS Karhoo raised a Series A worth $250 million).
Average Funding Amount: $10.5 million
Typical Company Valuation: $10–15 million
Common Investors: VCs, “super” angels
The previous rounds have been fuelled by relatively tentative signs of progress, from a promising idea, through leading indicators of Product/Market Fit, to early traction and the first signs of revenue growth.
In Series B, investors are looking for the next stage of growth: the ability to take everything you’ve learned, and make it work at scale.
In practical terms, Series B investment might allow a startup to make expansive hires (across business development, strategic accounts, marketing and customer success), expand into different market segments or experiment with different revenue streams, and in dramatic instances, even buy-out businesses that offer a competitive advantage.
Average Funding Amount: $24.9 million
Typical Company Valuation: $30–60 million
Common Investors: VCs, late-stage VCs
Series C rounds are raised to fuel large-scale expansion, like moving into a new market (commonly international expansion), or to fuel acquisitions of other businesses.
After Series C, there’s theoretically no limit to the number of investment rounds a startup can raise: some companies will go on to raise investment through Series D, E and beyond. Given the relatively low number of startups that make it to this point, there’s also a huge amount of variance in the amounts raised, with investment determined on a case-by-case basis.
At this late stage, the business is also de-risked enough for financial institutions to involve themselves in investment. These players often bring huge chequebooks to bear on financing rounds, generating truly staggering round sizes. In February of 2016, “cinematic reality” startup Magic Leap raised an unbelievable $793.5 million Series C — possibly the biggest round in venture history.
Average Funding Amount: $50 million
Typical Company Valuation: $100–120 million
Common Investors: Late-stage VCs, private equity firms, hedge funds, banks