How to think about early funding rounds

As a founder of a young company, you can waste a lot of time, and end up with a lot of bad investors if you don’t understand the stages that investors pay attention to in your company. There is a match between each stage and the type of investor that’s likely to be interested and add the most value.

Stage: Idea (Friends and Family)

At the beginning, you have yourself and an idea. You are trying to do early research to figure out if the area you are interested in has a clear need. Likely you are putting up web pages and driving traffic to them through Google or Facebook. You are trying to understand what type of solution people want.

Investors: At this stage, your chance of success is very small, so the people willing to bet on you are your friends and family.

Gotcha: Sometimes random uninformed wealthy people will show up with a check, but I would suggest you think twice about taking that. The correct expectation here is one of philanthropy, most likely you are going to lose your investors money. Also, don’t spend a bunch of time pitching angels and professional investors here, you are just too early.

The only exception is when the space you are in is ridiculously hot (Self-Driving cars in 2017) or if you are a serial entrepreneur. You will know because you will get plenty of inbound interest.

Valuation: A typical valuation at this stage would be $1-$2 million.

Stage: Early Validation (Pre-Seed)

The next milestone is when you have an early product or Minimum Viable Product out there and have started to see some validation. That can come in the way of vanity metrics like total downloads, slightly better ones like active users, or even more interesting ones like retention rates, superhuman scores, week over week growth, etc.

Investors: Pre-seed investors can range from angels to professional seed investors who are willing to invest early in people and ideas they like. You should be looking for people who have the time and expertise to give you a lot of help and advice.

Gotcha: Pre-seed is a bit more nebulous than the other stages, so you can waste a lot of time if you run out of money in this stage. My general advice is to spend some time trying to raise, but you are more likely to raise in the next stage, so if you can keep things lean until then, you will waste less time and give away less of your company.

Valuation: A typical valuation at this stage would be $3-$5 million.

Stage: Traction (Seed)

The next milestone is when your business has started to work, typically around $50k-$100k monthly recurring revenue, good cohort analysis for looking at things like retention and acquisition, an idea of the value of a customer, some early tests of the cost of acquisition, etc.

Investors: You should look almost exclusively at professional seed investors in this stage, specifically ones that specialize or have invested in your category before. They are the most likely to be able to help you get to Series A.

Gotcha: This is the stage where some founders start getting interest from venture firms. I would caution filling up this round with later stage investors, because they neither specialize in this stage, nor is the check large enough for them to spend much time with you. Find people for whom this is the typical check size and stage.

Valuation: A typical valuation at this stage would be $8-$10 million.

Stage: Product-Market Fit (Series A)

The base business is now working and you need to pour gas on the fire to scale up employees, spend more on acquisition, invest in growth and product, etc.

Investors: Venture firms.

Gotcha: If you don’t have solid metrics at this stage and a good story, you will waste a lot of time making the rounds. Work with your seed investors to make sure you have everything in good shape.

Valuation: A typical valuation in this stage would be $20 million.

Early investors are focused on some of the same things as later stage investors like how strong the market need is for your product, who you and the team are, and what size the market could become. Good early stage investors though have a lot of experience professionally and as investors in helping you get to Series A. This typically means they’ve taken their own companies to that point multiple times or served a key role in other startups (product and growth roles in particular) which have moved through that stage.

You can end up with a bunch of people in the early stages that don’t add a lot of value after they write their check. For sure, a certain number of free riders is fine since you need their cash. But what you are really looking for is the small set of people with the experience to be a meaningful thought partner as you navigate the early stages.