Raising money the right way

Raising money the right way

There's a right and wrong way to do everything.

So you had an idea, scraped together your savings and through a combination of cunning, guile and frugal pragmatism have managed to get an MVP ready to go. 

The feedback has been amazing and you realise you’re onto something that could be, well, something.

And then it hits you, to take the next steps, to really be able to hit those next major milestones, you’re going to have to raise some money and that sends you into a panic. 

How are you going to raise investment, you don’t have a bunch of family and friends with cash, you don’t even really know how much you should raise and are worried you’re going to spend it on the wrong things.

But, whilst as founders ourselves, we can understand that anxiety, this blog serves as a guide to raising money the right way.

 

If there’s a right way, what’s the wrong way?

 

It’s worth taking a moment to think about the sort of things that folk get wrong when they go out to raise money and almost working your way back from there. From the work we do, here are some of the most common mistakes we’ve seen founders make:

 

  1. Not having a plan.
  2. Taking a spray and pray approach.
  3. Trying to raise venture capital when you shouldn’t.
  4. Not researching the stage, verticals, and thesis of their prospective investors.
  5. Raising too much.
  6. Raising too little.
  7. Not having the right materials.
  8. Underestimating the amount of time it takes.
  9. Overestimating the value of the business.
  10. Not looking at all potential sources of capital

 

Have a plan

 

If you’re reading this blog you’re already ahead of the game because it means that you want to ensure that you approach your fundraising in the right way. Planning for your fundraiser is about getting things done in advance, like prep before you cook a big meal. Make sure you have your materials ready, you know who you’re going to approach, who you’re prioritising and why. 

If you approach the fundraise in a haphazard way, investors will pick up that and it’ll jeopardise your chances at success so, always have a plan.

 

Personalise your approach

 

It is way too easy to assume that you can just take a spray and pray approach to raising investment. All these folk on LinkedIn with angel, or investor in their profile must be desperate to see your business right?

 

Wrong.

 

It is really easy to see who has thought a little about the person on the receiving end of the email or message, and it’ll probably make that person far more open to actually opening your message and having a look at your materials. And even if the investment isn’t for them, it will probably make it a lot more likely that they will give you feedback or even open up their network to you if they can see you’re the sort of person that takes a bit of time to tailor your approach and messaging. It shows you what to build a relationship and aren’t treating this as transactional.

 

It’s ok not to raise venture capital

 

We see businesses wasting their time trying to raise venture capital all the time. Why? Because they think the fundraise is the important thing, not a means to an end, or they’re more interested in the headline than the milestones or, and unfortunately, this is the reality for most, they just don’t understand how venture capital works and whether their business fits the model.

 

How venture capital works is a whole nother blog, but the thing to remember is that VCs are looking for a couple of substantial things – a HUGE market, a team that has proven execution abilities, some form of the moat that will protect their business and that all of this will lead to an exit outcome in the future which has the potential to return the WHOLE fund (not just the investment made).

 

The reality is that most businesses don’t fit this model and that’s ok, there is nothing wrong with building a great business that makes money and employs people. So take a long look at how big you believe your business can get and whether you, yourself are that interested in or even capable of trying to build a billion dollar venture and if you do decide to chase VC money, at least you’re doing it with your eyes wide open.

 

Send your fintech deck to a fintech investor

 

This is part and parcel of personalising your approach. Research the investors that you are interested in bringing on to your cap table, and ensure that you know that you fit their thesis. 

 

What does this mean?

 

Most investors will have a pretty specific idea of the verticals (industry sectors) they will invest in, the stage (early, seed or growth), and the cheque size/target ownership they’re looking for. So if you are a pre-seed, fintech business raising a £300,000 round, don’t approach a Series A, edtech investor who deploys £1 – 5m cheques and needs 10% ownership.

 

The great news is that whether on LinkedIn, Twitter, or their website, almost every investor publishes not only their thesis but also the best way to contact them. Some want emails, others have a form (see ours here), and others still will accept a DM as a first step. 

 

Raising the right amount

 

We’ll talk about the problems with raising too much money and raising too little money – from an investor’s perspective in a second but the first step is actually working out how much you need to raise at all. 

 

And this comes down to having a decent financial model where you can understand – and importantly explain to others – your numbers. As you might imagine, we see a lot of broken financial models with hard-coded numbers, circular references, and all sorts of Excel newbie errors – not to mention the poor understanding of financials in general.

 

This is where tools like Projected come in very handy, it’s quick and simple to get started with and because it’s built by CFOs and founders, it’s got exactly what you need.

 

Raising too much

 

It’s easy when you’re embarking on your fundraise, to just try and raise as much money as you can. This can send a poor signal to investors because it shows you haven’t thought about ownership structure, valuation (as compared to traction) and they would worry they risk spending their money funding endless experiments rather than a coherent plan.

 

Raising too little

 

The flip side is not raising enough money to get you through to the next milestone. Investors want to know that you have sufficient runway (cash availability) to see some significant traction. That means that as a founder, you are going to be in constant fundraising mode and not focussed on building. It may even suggest that you have misjudged your growth or revenue projections significantly which would be of concern – investors never expect you to hit forecasts fully, but they don’t want to see fantasy either.

 

Materials, Materials, Materials

 

It is not enough to just have a deck and assume that that is enough to get you through a fundraise. But your deck needs to explain the key problem and solution as well as show the market size and business model and, critically, should be well and, professionally, designed

 

You should expect investors to want to see not only the deck and financial model, but they’ll also want to dig into your data room.

 

This means they’ll want to see things like your accounts, cap table, significant contracts, technical road map, shareholders agreements, articles of incorporation and all sorts of other bits and pieces to complete their due diligence.

 

It’s really easy to let this derail a process if the various documents aren’t available (again showing a lack of planning and preparation)

 

Give yourself the time you need

 

Most founders underestimate the amount of time it takes to raise a round and again smacks of a lack of planning. You never want to be in a position where you have to take the first deal that’s on the table because you may have to wind things up if you don’t.

 

At later stages especially, expect a fundraise to take anywhere up to 6 months. Remember you will be talking to 100 – 200 investors and will likely face a lot of rejections (that will help hone your pitch), before getting to a yes. 

 

That takes time. 

 

And all the time you will also need to run your business without going crazy. So give yourself sufficient time and headspace to get through. It’ll never be perfect, but leaving it to the last minute is just going to put yourself under pressure that may derail the whole process.

 

Valuation is a negotiation

 

Confidently putting on your deck that your business turning over 200k is worth 10m (and yes we have seen this!) may have flown in 2021 but it won’t fly today. Overvaluing your business shows naivety and undervaluing your business means that either you’re desperate or you’ll be easy to take advantage of – neither of these are good looks when an investor is considering your business.

 

Valuation is always a negotiation, it is the price at which investors will purchase equity in your company and the price you will accept to sell that equity.

 

So don’t sweat the valuation till you have one, or preferably multiple, term sheets in your hand.

 

Not all capital is created equal

 

With all the headlines, it’s no surprise that founders often default to looking at investment as their best source of finance, but it’s actually the most expensive form of financing your business.

 

If you haven’t already, you should consider the other types of finance that are out there from revenue based financing, to startup loans, to R&D tax credits or grants to invoice factoring to our personal finance, sales!

 

Remember, your job as a founder is to keep the wheels turning, however you can.

 

So there we are, our guide to raising money the right way, hit us up with your best tips and tricks to running the capital raise gauntlet.





Missed "Making the Best Pitch Deck"?

CFO versus Accountant – An Insight into Strategic Finance

CFO versus Accountant - An Insight into Strategic Finance

Understanding the vital differences

You would be surprised the number of times we’re asked to provide basic bookkeeping services or whether we can run a company’s payroll and as startup CFOs we get that many founders wouldn’t have had the exposure to understand the difference between an accountant and a CFO, so in this post, we’re going to clear up some of the most common misconceptions of what a CFO is and why we’re not your run of the mill grey-suited number cruncher. 

The first major difference is that an accountant is traditionally external to the business whilst your CFO sits inside – often as a member of the senior team. Even portfolio, outsourced or fractional CFOs whilst not employed by the business will be intimate with all the inner workings. 

Secondly, accountants tend to be task focussed. They will have monthly, quarterly or annual tasks (such as filing your VAT returns or annual accounts) and their measure of success will be getting those done on time. CFOs, on the other hand tend to be more project and long term focussed. What they do tends not to follow a specific routine because it is highly dependent on the state of the business as well as the macro environment at any given point in time. 

Accountants tend to look inwards and backwards. That is to say they focus on internal reporting of what has already happened whilst CFOs tend to look outwards and forwards. What this means is that they are constantly gauging the market, the competition, the opportunities and whilst they need to know what has happened they are much more interested in influencing how the business performs moving forward. 

Accountants tend to be technical whilst CFOs tend to be commercial. What this means is that an accountant can tell you why they have applied a specific IFRS or GAAP standard (accounting speak for technical treatment), a CFO will be more interested in the implications it has on a business’ performance. They will be focussed on customers, margins, automation, revenue and cash flow whilst accountants will be more concerned with controls, processes and the minutiae of debits and credits.

It’s worth noting that a strategic CFO is only really valuable for your company once you have hit certain milestones. That might be having secured your first customer and taken your first revenue or it may be when you raise external investment for the first time or even as you start to scale or look at mergers and acquisitions activity. And for them to do what they do well, it’s imperative that you have the basics in place in your finance operations which is where a great accountant can really help out.

So when you’re thinking about how to make sure you’re compliant and not going to run afoul of the tax man, that’s when you should talk to a good accountant, but when you’re ready to grow and can see a bunch of opportunities ahead of you but want to ensure you’ve figured out how much cash you’ll need, where it’s going to come from and what sort of return makes sense, that’s when the right strategic startup CFO can really make a difference.

Ultimately finance sits on a spectrum from the highly technical through operational and out the other side into the strategic, where most CFOs prefer to sit. Both roles are necessary in a fast growth venture but if nothing else, it’s important to understand that they’re rarely going to be filled by the same person. 

What do you have in your business right now and what do you think you need to supercharge your growth? 

Looking for investment? We can help.

How VCs work

How VCs Work

Invaluable knowledge for Founders raising investment

The world of venture capital (VC) can be pretty opaque and as startup CFOs we’re often asked for advice about how best to navigate VC funds to try and ensure the best outcome for the startups we may be working with.

So with that in mind, we thought it would be helpful to write this guide to how VC firms themselves work, not only to make the ecosystem a little less opaque but also because we’re firm believers that if you have decent knowledge about how they work, it may help you as you navigate your next fundraising round.

What is Venture Capital?

In order to understand how VC firms work, it’s worth understanding what venture capital actually is. VC is a subcategory of Private Equity (PE) which is an alternative class of investment consisting of funds investing in unlisted companies (i.e. companies that have not been listed on a stock exchange).

Whilst PE tends to invest in more stable businesses, often with predictable profitability and cash flow, venture capital tends to invest in the earlier stages of a company’s life cycle when there is much less certainty in the business and its outcomes. This is why it is often referred to as risk capital.

So where do VCs get their money from?

As we said above, investments made into startups and scaleups are made via a fund structure. That is a pool of capital that has been entrusted to the VC or fund manager to deploy into these businesses.

Like a startup, therefore, a VC fund has its own investors, called Limited Partners or LPs. This can consist of one or more individuals or asset managers (such as pension funds or state entities like the British Business Bank) that commit to providing the capital that the VC fund will use to make its investments.

A limited partner, as the name suggests, has limits to its power, voting rights, and say over the day-to-day running of the firm.

OK, then who makes the decisions in a VC firm?

VC funds are set up by General Partners (GP) who, in contrast to LPs do have day to day responsibilities in the running of the firm and also have personal liability for the debts of the VC firm.

Alongside GPs you may have a number of other individuals in the firm, from analysts who do a lot of the low level transactional work, associates who may introduce deals and work with portfolio companies to principals who may serve on portfolio company boards, bring investments to the firm or negotiate deal terms. Beyond the principal role you have partners who take a more specific role in the running of the firm, the decisions around investment opportunities as well as being the outward face of the firm.

Why don’t VCs invest in certain industries, geographies, or company stages?

VCs tend to have an investment thesis that is like a framework that determines what sorts of businesses they will invest in. Some have very detailed theses around specific industry types whilst others may be more general.

An investment thesis may be thought of as

What
Why now
Why us

The “What” is the vertical, geography, or stage they will invest in, the “Why Now” is about why they think there is an opportunity for outsized returns in their choice of What (for example with the push for sustainability right now as well as changing dietary trends it might be the ideal time to invest in plant-based meat alternatives) and the “Why Us” is why the firm thinks that they have a real edge in this space – maybe they have deep connections within the wider industry or maybe they have very strong disciplinary backgrounds in science that can help with some bleeding-edge technology.

Ultimately, if all VCs invested in the same types of businesses and stages, there would be a lack of capital for others so ensure that you do your homework in advance and choose the fund whose thesis fits your business.

Why is there a time limit on when a VC can invest?

As we mentioned earlier, LPs provide the capital that VCs then invest, however, there are two important factors to consider here. Firstly, LPs don’t provide all the capital upfront but rather invest in a series of tranches when VCs trigger a capital call and secondly, LPs expect to get their money back (plus a profit) after a fixed period of time.

Most VCs will have a total fund lifetime of 10 years, often with 1 or 2-year extensions. They will invest a portion of the capital into new businesses over the first 3 or 4 years, reserve some of the capital for what is called follow on rounds (i.e. subsequent fundraising events after their initial investment) for the next 2 – 3 years, and then reserve the rest of the 10 year period to ‘harvest’ their investments, i.e. find a way to sell their shareholding of the company. This may be via a secondary sale (where they sell their shares to a new incoming investor), an exit of the business via sale to another company, or even a PE fund or a public listing via IPO.

Because of this cycle and time frame, there are two other things that follow. Firstly the VCs must be clear about their portfolio construction (which is a fancy way of saying how many businesses they will invest in, over what period, for how much cash, and in return for what level of equity and how much they will reserve for follow on funding) and secondly, that VCs will almost always be raising a new fund whilst they are still deploying from a previous one.

How do VCs make their money?

The bottom line is that whilst we may think that VC is all about funding new innovations or breakthroughs in science and technology, the reality is that this is often a happy byproduct of the real reason VCs exist – and that is to return capital to their LPs and pay the salaries of the partners and individuals involved in the running of the firm.

The way this works is via management fees and carried interest. Management fees are the annual fees that are used to ‘run’ the fund and carried interest being a share of the profits once the portfolio companies have exited. The most traditional structure is a 2 and 20, which means 2% management fees and 20% carried interest.

One thing to note is that the 2% is not just charged as a one-off on the fund, but is an annual figure. So, for a $100m, 10 year fund, the management fee will be 2% x $100m x 10 years = $20m. This means that there is only $80m left to invest in portfolio companies.

Let’s say the VC does relatively well and “3x’s” the fund, this means that after investing in and exiting their portfolio, they are left with $300m, they will then return the first $100m back to their LPs and then split the balance of $200m profit with 80% going to LPs and 20% being split between the partners. In this instance that would be $40m.

Side note on power law

VC funds and distributions tend to follow a power law, i.e. that the majority of value is returned across a small number of portfolio companies.

This is why VCs are always looking to back so-called Unicorns (companies whose exit value exceeds $1bn) because they need each potential investment to be able to ‘return the fund’.

Confused? Let’s walk through an example:

Let’s say that a $100m fund has the luxury of not needing to charge management fees and so deploys the full $100m with 50% as initial investments and 50% for follow on.

At seed, that likely means investing in around 25 companies at $2m per investment for a target ownership of 10% (i.e. a post-money valuation of $20m).

As some of those businesses start building value, they may need to follow on into subsequent fundraising rounds to maintain their ownership stake at 10% (as new investments will otherwise dilute or reduce their shareholding).

Now, we all know the stats around startup success, so let’s be generous and say only 70% of these businesses fail completely – that’s 18 where the investment has to be written off. Of the balance 7, it’s likely that 5 may have an exit where they either pay back the investment the VC has made or a bit more. Let’s say that those 5 exit for anywhere between $50m and $100m. On the assumption that the VC still holds 10% (i.e. followed on and didn’t get diluted), that means that they will make anywhere between $25m and $50m back from those businesses (highly unlikely but let’s play along).

On that basis, the fund would at most have returned 50% of the fund, it’ll be pretty hard to raise the next one if they haven’t at least returned the initial $100m that LPs invested.

So everything is riding on the last 2 investments and why they need to be unicorns. If one exits for $1bn, then at their 10% ownership, the VC receives $100m (and breathes a sigh of relief as has returned the fund) which means that the $50m from the 17 ok exits is now profit in which they can participate (but only 20% remember!), so it’s hugely important that the last investment also exits for a decent amount in order to really be something worth talking about.

Let’s say that it does well, but not quite unicorn status and exits for $500m, this means that the fund will receive $50m from that investment giving them a total of $200m: $50m from the ok returns, $100m from the unicorn and $50m from the last exit.

This would mean that they have 2x’d the fund and will receive $20m in carried interest.

Simple right?!

Dealflow

All VCs rely on dealflow, which is basically their ability to see as many relevant businesses that are fundraising and that match their thesis as possible. As a rule of thumb, VCs may only invest in around 1% of the deals they see – and they see a lot of deals.

This means that the average time they spend looking at a deck is low, and there has to be something in there that grabs their attention enough to want to move it through their process.

Even then there are no guarantees, we’ve had deals make it through 5 weeks of the process including multiple partner meetings only to be turned down for any number of reasons.

What happens if I get a term sheet?

A term sheet is a non-binding offer to invest in your venture. It will set out the terms of the investment including things like:

  • Amount to be invested
  • Pre and Post Money Valuations
  • Any preference rights the investor may receive
  • Any board or observer seat the VC may want
  • Any restricted matters such as founder shareholding, package, or new investment that may require investor consent.

This is a non-exhaustive list and it is worth paying attention to what a VC may ask for; many founders focus on the valuation when the control aspects may be more important.

But, once you have a term sheet in hand, it means you’re a large step closer to getting in the investment, there are really only two additional steps beyond that – due diligence and long-form legals.

Due Diligence and legals

Due diligence (DD) is the process whereby a VC firm does a fair amount of work to metaphorically kick the tyres of the business. They’ll look at the contracts in place with founders, whether there is a shareholder agreement, how much equity has been reserved for employees as part of an option pool, whether the financials that have been put in the pitch materials marry up to reality and other matters around incorporation, commercial and employment contracts and anything they may wish to see around the product or tech stack.

This DD can be quite time-consuming on both the VC and the founder side and a red flag for a VC would be where materials haven’t been provided in a timely manner.

If the DD has been successfully completed, the firm will then move on to the longer form legal documents that form the share purchase agreement. This is a continuation of the term sheet and formalises the investment.

Once these documents have been completed and signed by all parties, the fund will then deploy its investment.

So how does this all help me as a founder?

There are several takeaways from this that are worth paying attention to:

  • VCs invest in certain sectors, geographies, and stages. Do your homework and don’t go to a Series A, US, SaaS VC for investment in a UK-based, seed stage consumer product business.
  • Depending on where a particular fund is in its own lifecycle, it may not be the right time for them to invest in you (or for you to take investment from them). The last thing you want is to take investment from a fund towards the end of its deployment phase who will therefore be looking to exit their position sooner rather than later.
  • Give yourself plenty of time to execute a fundraising round. It can be relatively slow and you may have multiple conversations happening simultaneously. Some of the things you can do to prepare are ensuring your pitch deck is snappy and well designed, that you have a financial model in place that matches the narrative of your pitch and that you have a data room ready to go for the due diligence phase.
  • Remember that VC funds are driven primarily by financial returns and that these returns tend to follow the power law. You may be building the best online marketplace for shops on your high street, but that isn’t going to get their attention.
  • VCs are people. Build relationships early and make sure they aren’t transactional. If you are looking for funding in the future (and even if you’re not), they can be massive advocates for you and your business.

So there we have it, how VCs work and how to use that knowledge as a founder.

Looking for investment? We can help.

Other Finance Options for Start-Ups Beyond Angel and Venture

Other Finance Options for Start-Ups Beyond Angel and Venture

Maximising cash, extending runway

As startup CFOs it should come as no shock to anyone that we are constantly looking at ways of maximizing cash, extending runway, and optimising the capital structure of the businesses we advise.

Over the last several years, there has been a proliferation of new options available for startups – especially here in the UK – that are looking for ways to finance their business without going out to angel investors or Venture Capital firms.

So here are some options available to founders and their businesses that you might not have thought of before.

Startup Loans

These are government loans available from a number of sources and are ideal for founders that need a small amount of capital to get things underway, maybe to get a prototype built, or to buy your first stock or whatever might be that first step that gets you on your way.

These loans are aimed at UK residents over the age of 18 who pass necessary credit checks. They are currently structured as unsecured, personal loans repayable over 5 years at a cost of 6% per annum. You can find out more and check to see if you’re eligible via the startup loan website.

Convertible Future Earnings Agreement

There have been a few iterations on the income share agreement that has led to the Convertible Future Earnings Agreement (CFEA), but at its simplest, it’s an instrument where you pay back a fixed percentage of your income for a predefined period of time after you reach a certain level of income. The convertible element comes into play if the business then goes through a more traditional equity financing round and the balance is converted normally with a discount or cap to the round.

This type of finance is more suitable for founders that don’t want to sell a lot of equity in their business, who are looking to grow efficiently rather than the sort of fast growth associated with venture-backed businesses. You can find out more about the CFEA via one of its biggest champions, Horizan VC.

Grants

Grants can be issued from a number of different parties, from charities and foundations to government institutions. They are typically funds released to businesses in the pursuit of some form of research and development activity that leads to an innovative breakthrough or commercial activity. The application process can be quite difficult to navigate depending on the nature and size of the grant so be prepared to put in a fair amount of effort and wait a fair amount of time before you get a response.

Whilst some grants are given without the expectation of repayment, others may need to be repaid dependent on some predetermined conditions (such as securing match funding, hiring a certain number of people in an area, or commercialisation of the research and development activity). In the UK you may wish to check out Innovate UK to see what grants may be available right now or you may wish to speak to a specialist such as GrantTree who will write your applications for you – for a fee of course.

Working Capital Solutions

Next up are the more traditional forms of business financing, the most common of which are overdraft facilities and credit cards, access which will depend on your trading levels and your bank’s appetite to offer them. Bear in mind that with overdraft facilities in particular you may be asked to provide personal guarantees or even offer up security by way of your, or other directors’ properties as collateral against the debt.

Other types of working capital solutions that are tried and tested are things like inventory financing where you take out a loan or establish a revolving line of credit to finance your stock or invoice financing (sometimes called invoice discounting) whereby you ‘sell’ your debt to a company like MarketFinance who will advance you a percentage of the value of an individual invoice (or potentially your entire debtor book) and charge you interest on the balance until it’s repaid by your customer.

Revenue Based Financing

In today’s digital world and yesterday’s low-interest environment, it’s unsurprising that a number of companies came out to try and provide value to the plethora of eCommerce and SaaS businesses that have continued to flourish – especially during the pandemic where online sales jumped up substantially.

Companies like ClearCo, Out Fund, Uncapped, and PayPal, to name a few, hook into your payment providers such as Stripe, Braintree, or Chargebee to assess your trading volume. They’ll then advance you some cash based on their risk structure and recover it (plus a fee) by taking a cut of your ongoing revenue until the advance has been fully paid. The advantage of this is that if you see a dip in your volumes, your repayments decelerate unlike with a traditional loan which is a fixed monthly payment.

Pipe is driving the way for SaaS businesses to do the same by allowing you to transform recurring revenue into upfront capital.

R&D Credit Financing

Many technology companies in the UK take advantage of the Government’s attractive Research and Development (R&D) tax credit scheme. Via this scheme, you can either offset engrossed R&D expenditure against your corporation tax or, if you are loss-making, claim 14.5% of the engrossed expenditure back as cash.

What many people don’t realise is that there are some companies such as Fundsquire who will advance you a percentage of your anticipated tax credit as an interest-bearing loan with no repayments until the tax credit is approved and paid out by HMRC.

Crowdfunding

Whilst there are a number of equity crowdfunding platforms out there which we may explore in a future post, here we’re talking about the OGs such as Kickstarter and Indiegogo which are platforms that allow you to promote a product or service and solicit preorders. That way, you kill two birds with one stone – gauge the appetite for the product you’ve built and secure the cash (and sales) for your first release.

Loans

A huge number of intermediaries have been established in the UK such as iwoka, Funding Nav, and Swoop providing a marketplace for lenders on one side and businesses looking for financing on the other. Loans range from £1k microloans all the way up to 7 figures.

As with any loan, you need to make sure that you can afford the repayments and do your diligence before taking on any debt.

Summing up

There are a variety of solutions out there that might help you to finance your business without having to source angel or venture capital (and let’s face it, most businesses shouldn’t be looking for that type of funding in the first place) – you just need to work out what makes the most sense for you and your business.

Looking for investment? We can help.

Pre-seed to Series C, stages of startup growth

Pre-seed to Series C, stages of start-up growth

What do they mean, what typically happens?

In recent times there has been a lot of activity in the private markets juiced by cheap capital and the pandemic, this has pushed average financing rounds – at least at Series A and beyond – to new heights. 

So much so that it has become somewhat meaningless to talk about venture rounds in terms of average cheque size or valuation, so we’re going to take a shot at giving you some idea of where you should be at when you’re looking to raise that next round.

But first, because we’re nothing if not scrupulous (what else would you expect from a bunch of startup CFOs?!) so here’s some data on global deal sizes courtesy of this report by KPMG.

As you can see there has been a massive jump from 2020 to 2021 in median deal size with angel – or Pre-Seed – rounds at $0.7mn, Seed at $2mn, Series A at $10m, Series B at $23mn, Series C at $52m and Series D and beyond at $100m.

Given that median deal sizes were so much significantly lower in prior years, you can see why defining a fundraising stage by dollars invested is not a particularly valuable metric, so here’s our guide to funding rounds and what you should be looking out for.

Pre-Seed

Your Pre-Seed round comes before your Seed – simple right? OK, kidding aside, the Pre-Seed round is typically the first round you’ll raise from external investors who aren’t made up of your friends and family. You’ll be just getting your venture off the ground, maybe you’ll have done some surveys and have found someone to help you build get your first build-out of the door. Your venture will typically look something like this:

Team: Early founding team only

Tech: Pre product

Traction: Pretotyping or early validation

 

Seed

When ventures hit their Seed round, and whilst it is normally still funded by angels it is sometimes the first time they take on some institutional capital or maybe joined an accelerator. It’s the most exciting of rounds for founders because it’s the point at which they have seen some positive momentum in their business. Maybe you’ve built out your minimum viable product, or even taken it to beta, in some instances you may have already made first revenue.

At this point, your venture has moved to look like this:

Team: Founding team plus first hires – normally in product, tech, or marketing

Tech: Post prototype probably with an MVP in place

Traction: Early revenue, user growth, and signs of product/market fit

 

Series A

By the time you’ve gotten to raising your Series A, the expectation is that you’re showing some serious signs of growth potential, a growing team, more advanced signs of product/market fit, and efficient unit economics. By this stage, your venture has probably brought on some specialists in key commercial or technical roles and as a founder, you’re trying to shepherd your business from unconstrained, even chaotic, growth to more process-driven scaling. This is often the first round of venture capital you’ll take on.

By now your venture looks a little like this:

Team: Growing fast, typically doubling every 12 months or less

Tech: Product is refined, focus on new features and maintenance

Traction: Growing revenue (for venture minimum 2x year on year), entering new markets

Series B

The business is now substantially de-risked and the name of the game at this stage is to go big or go home. You may be entering new geographic markets and hiring in multiple countries, you’re likely looking at M&A (mergers and acquisitions) opportunities and need to keep a war chest not only to look at businesses to acquire but almost as important to pour fuel on your marketing to scale further, faster, At this point, you are pretty far from that scrappy startup raising your first round, you’ve got a substantial board of directors, senior C-Suite executives, and a large team. This may even be your first opportunity to take some cash off the table to de-risk yourself just as you have de-risked your venture.

Here’s what your venture looks like now:

Team: Continuing to grow apace, shift from technical to commercial hires

Tech: Building (or acquiring) complimentary products

Traction: Scaling rapidly, starting to approach the $100m revenue mark

Series C+

At Series C and beyond the likelihood is that your business is already cash-flow positive or could get there pretty easily if it tried so any capital raised at this point is about further growth, as quickly as possible, this might be acquiring smaller competitors, launching entirely new products, attacking massive new geographical markets or giving liquidity to early shareholders or employees. And just as the use of funds has changed, so might the nature of the investors. The business is now sufficiently de-risked to attract not just later-stage venture capital funds, but also earlier-stage private equity funds, hedge funds, and even banks. By this stage, you may have brought venture debt or more traditional loans into the mix. From here on in, typically any additional rounds you raise are predominantly a way of postponing hitting the public markets and all that that entails.

By now your venture looks like this:

Team: Early team has rotated out, founders may have moved permanently to the board

Tech: Fully-fledged product, upgraded to more efficient stack

Traction: Well established in the market, growth likely to have slowed down by this point

So there we have it, what ventures look like from Pre-Seed all the way to Series C and beyond. Where do you fit in on your fundraising journey? 

 

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10 bits of VC terminology you need to know

10 bits of VC terminology you need to know

Finance for Growth - Knowledge for Founders

If you’re a first time founder, or even if this isn’t your first rodeo, it can often seem that the startup and venture space is a minefield of insider phrases and acronyms that are like a mason’s secret handshake – only once you’ve been granted that secret knowledge and learned how they work can you get access to the club.

 

Well, as startup CFOs, we spend a lot of time here at EmergeONE simplifying the complex for the ventures we work with so we thought the least we could do would be to share some of that knowledge here too.

 

So here we go, 10 bits of VC terminology you need to know.

 

ARR

 

Annual Recurring Revenue – this is a metric that is used to infer the future revenue of a business based on its current monthly recurring revenue (MRR). It is calculated by taking the current MRR and multiplying it by 12. 

 

Easy right, so where’s the confusion? The confusion arises because many businesses shouldn’t be using this metric in the first place – it is very much valid for companies that have a recurring revenue model (i.e. SaaS or subscription) – but not if you are running an eCommerce business that relies on one off purchases.

 

Burn

 

A company’s Burn is the amount of cash that a company spends during the course of a month in order to keep running. What could be more simple!

 

But where we see founders tie themselves up in knots is by introducing complexity by qualifying Burn with terms like Gross Burn (Burn excluding cash in from revenue), Net Burn (Burn after taking into account cash from revenue) or Operating Burn (Burn excluding one off, so called, extraordinary items such as say a legal expense or fee paid to a broker for assistance with fundraising). Our advice? Keep it simple, Burn is the net change in your bank account excluding any investment or debt capital that is introduced into the business.

 

CAC

 

Customer Acquisition Cost is the average amount of money it costs to bring on one additional customer. Say you spend £1,000 on marketing and bring on 100 new customers, your CAC would be £10. So what’s the catch?

 

Basically the difficulty isn’t in understanding what it means, rather how to calculate it properly. A company that is serious about understanding how efficiently it is bringing on customers should be able to calculate their CAC per channel (e.g. Google ads vs Instagram vs Viral), only then will they be able to optimise for the best outcome.

 

Cap Table

 

The Cap Table (shorthand for capitalisation table) is a summary of a company’s ownership structure, if you want to gain a more in depth understanding, we suggest you read our previous explainer here. Whilst it may seem like an obvious one, we’ve heard founders call it a capex table (capex is shorthand for capital expenditure – i.e. investments in capital items like plant, equipment or property) and we’ve definitely seen them constructed poorly.

 

Dilution

 

Founders tend to learn this one pretty quickly but given its importance, it’s worth mentioning here. Dilution is the reduction in an investors’ proportional shareholding as a result of new investment having been taken into the company. For example, at startup, a founder would normally own 100% of the company – let’s say via ownership of 100 shares. Let’s say they then issue a further 25 shares to a new investor. In this instance, the founder has been diluted down by 20% as they now own 100 out of 125 shares which is equivalent to 80%.

 

Liquidity Event

 

A liquidity event is typically a milestone in a company’s lifecycle which results in capital being returned to investors. This could be via a sale of the company to a suitable acquirer, a listing on the public stock exchange (an Initial Public Offering or IPO) or even via a secondary round (see below). It is called a liquidity event because private company shares are typically not easy to sell as there isn’t an established market to be able to do this and it is the first time the founders, shareholders or employees receive cash in return for their investment.

 

LP

 

Just as a startup has investors, so do venture capital funds. These investors are known as Limited Partners or LPs because they have limited rights within the fund partnership structure. But it’s quite likely that in investing in a particular fund it is because they believe that fund can generate a suitable financial return for them, but also that they will likely invest in startups that fall within a them that the LPs wish to pursue.

 

LTV

 

Lifetime Value or LTV is the average value that a customer generates for the business over the lifetime that they interact with the business. For example, if you run an eCommerce business that sells candles for £10 that you purchase for £5 and ship for £1 and customers, on average, purchase 5 candles, you would say that the LTV of a customer is £20.

 

What many people get wrong is that value is not the same as revenue. In old accounting speak, we would equate value closely with the gross profit a customer drives to the business.

 

Preferred Shares

 

When you establish a company, you will normally issue Ordinary shares (in the US this would be called Common Stock) which have fairly standard rights on distribution, winding up and so on. However, as VCs are often deploying more cash and taking more risk, they will only invest in exchange for Preferred Shares. The terms of this class of shares will vary depending on what is agreed with the VC and, in every new round of financing you may end up with different classes of Preferred Shares as new investors come in. This can lead to a fair amount of complexity when the company finally gets to a liquidity event. 

 

Preferred Shares will typically give the investor the right to receive a multiple of their investment back before other shareholders receive anything.

 

Unit Economics

 

When VCs talk about unit economics, they are talking about the interplay between a business’ customer Lifetime Value and its acquisition costs and is often expressed as a ratio of x:1 where x describes LTV and 1 describes the CAC. So, for example, if our LTV is £20 and our CAC is £10, our LTV to CAC would be 2:1.

 

Typically VCs will look for a ratio that converges on 3:1, any less and it may mean that your company can’t scale efficiently (or may destroy value as customers become more costly to acquire) and, any more and it may be that the company could be deploying more cash to grow more quickly.

 

So there you go, 10 bits of VC terminology you need to know! If there are any terms, or phrases you’d like us to explain or expand on just drop us a comment and we’ll keep updating our list accordingly.

 

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Nothing Ventured – Episode 26 Jenny Ervine

Nothing Ventured - Episode 26 Jenny Ervine

In conversation with the Co-Founder of Raise Ventures

In this epsiode Aarish talks to Jenny Ervine, Co-Founder of Raise Ventures about her career and her passion, working with start-up companies.

 

 

 

Listen below or head over to Spotify or Apple.

Building business models is hard, we can help?

Nothing Ventured – Episode 24 Arfah Farooq

Nothing Ventured - Episode 24 Arfah Farooq

In conversation with the community expert and angel investor

Arfah joins us to discuss her journey to her current role as community lead at NHSX’s Artificial Intelligence lab, her angel investing and her work speaking and running workshops around community building. Most of us recognise the importance of community developing strong ones is a different matter. Arfah sheds some light on this alongside her journey from a media degree to working for the Government.

 

Listen below or head over to Spotify or Apple.

Building business models is hard, we can help?

Nothing Ventured – Episode 23 Chris Smith

Nothing Ventured - Episode 23 Chris Smith

In conversation with the Managing Partner of Playfair Capital

Chris joins us to talk about his rather unusual path into Venture Capital. From a career in law, a stint in the Isle of Man to his current role as Managing Partner at Playfair Capital.

Playfair invests early, typically with cheques between £100-£500,000 with a focus on the UK. Some of their portfolio includes the likes of Omnipresent and Sprout.Ai.

 

Listen below or head over to Spotify or Apple.

Building business models is hard, we can help?

Nothing Ventured – Episode 22 Kirsty Macdonald

Nothing Ventured - Episode 22 Kirsty Macdonald

In conversation with the Principle at JamJar Investments

Kirsty joins us to discuss her role at JamJar, what it’s like working with the team that originally founded Innocent drinks and her personal journey to venture.

 

Listen below or head over to Spotify or Apple.

Building business models is hard, we can help?