David Cohen is the founder and co-CEO of Techstars, the worldwide network that helps entrepreneurs succeed. To date, David has backed hundreds of startups including the likes of Uber, SendGrid, Twilio, ClassPass, PillPack and more. In total, these investments have gone on to create more than $80B in value. Prior to Techstars, David was a co-founder of Pinpoint Technologies which was acquired by ZOLL Medical Corporation in 1999. Later, David was the founder and CEO of earFeeder, a music service that was sold to SonicSwap. If that was not enough, David is also the co-author (with Brad Feld) of Do More Faster: Techstars Lessons to Accelerate Your Startup.
David spoke with Harry Stebbings on The Twenty Minute VC to discuss why seed investing is a different asset class to venture, what makes the best and the worst board members, and why every company has to have a pessimist in the room.
“I love what you’re building and I want to invest, BUT I just need to see some more meaningful traction.” -Every VC Ever
Every entrepreneur has heard this at one point or another. I heard it all the time as a former founder myself, and I’m embarrassed to admit that I’ve used it a few times as an investor…but no more, and I’m writing this post in part to hold myself to it.
Traction has become this ubiquitous term that too many VCs use to meekly pass on companies, especially early-stage or pre-seed startups. I recently read a post about “The Current State of ‘Seed’ Investing” by Nick Chirls of Notation Capital, in which he argues that modern day “seed” funds invest more like Series A/B investors of previous generations. I agree wholeheartedly with this and like Notation, Wonder Ventures likes to be the first institutional capital in, which often means we invest in startups before there’s any meaningful traction. We do this because we think it will provide outsized risk-adjusted returns when compared to many other stages in the market.
So then what exactly do we look for when we meet true early-stage founders before they’ve achieved meaningful traction? I look for things that I’ve started categorizing as “Micro-Traction.” There are a ton of resources available for founders looking to raise capital from the traditional seed firms once they have this so-called traction, so this is a post about three key elements of micro-traction that founders can demonstrate to create funding momentum before meaningful revenue or customer growth.
(Note: This is for companies with products already in market … a future post will talk about investing in pre-product companies.)
- Show Small, but Measurable Trajectory of Growth
- Identify Customers/User Groups
- Prove Micro-Customer Acquisition
Show Small, but Measurable Trajectory of Growth
“Let’s stay in touch. I’d love to invest when you grow to $100K MRR.”
I’m guessing you’ve heard this one before. And when you did, you probably thought, “No duh! When I hit $100K MRR lots of people will want to invest.”
So how do you show traction to early-stage investors before you hit $100K MRR? Show measurable growth and a positive trajectory in an important business area (most likely revenue)….it’s OK if it’s on a small base.
For example, as explained in Mark Suster’s seminal post about investors looking to “Invest in Lines, Not Dots”, you could show an early stage investor the following trajectory:
- Meeting 1 (Jan 1): Pitch the Idea & Vision for the company
- Meeting 2 (Feb 15): Have your first 20 customers paying $50/month
- Meeting 3 (March 30): Have 100 customers paying $50/month and show a marketing channel that has led to acquiring half of those customers in the last 2 weeks.
At this point we’re talking about only $5K MRR (a lot less than $100K), but the trajectory of the three months of accelerating growth and execution shows me where your business is going and gets me excited about it. This may not be a big number by traditional “seed” investor-traction standards, but investors love to extrapolate from results. Plus, you’ve just demonstrated your ability to execute across three months of interactions with the investor.
Identify Your First Users/Customer Groups
“Your product looks great! Let’s talk again when I can see 12 months of customer data and a cohort analysis of churn”
Thing is, you haven’t even been in business for 12 months! You only launched a beta of your product three months ago, so “seed” investors are basically saying they won’t even consider your business for investment for another nine months. How do you show where your revenue is coming from and who your customers are without large numbers and months of data?
As an early-stage investor, I am less concerned with the scale of these numbers, but rather that you can prove that you’ve identified a prototypical customer and you know where to find more of them. One way for me to understand the organic fit of these customers is to become one myself. In an ideal early-stage scenario, an investor can use your product while getting to know you.
If your product is for a specific customer who is not the investor, then push the investor to think of a friend, contact or, even better, a portfolio company that can use the product instead. Either way, be generous in giving free and easy access to your service and showing how valuable it is. And if they’re sharing it with others, this doubles as great business development for your company by getting intros to the investor’s contacts. There’s really no reason to be stingy.
Prove Micro-Customer Acquisition
“It seems like your customers really love your product. Can I see the last $100k of marketing spend broken down by channel?”
$100K? You haven’t even raised $100K of funding yet, much less spent $100K in marketing. Many “seed” or Series A investors will ask to review your marketing spend over a couple of months, looking for statistically significant proof that you have already begun spending the $$ to acquire customers at scale.
So, how do you prove your command of customer acquisition to early-stage investors? The key is to prove at least one (ideally two) channels at a small scale. Find ones you can test for a modest amount of money (say $500) to obtain specific metrics on acquisitions costs, conversions, and most importantly, the scalability of the channel.
For example, Google Search Ads are often one of the best ways to show micro-customer acquisition, as Google provides you with the tools to spend small dollars, clearly track performance and get a decent feel for the scale of potential leads they can provide.
One note, I often hear founders tell me their acquisition strategy will be driven by free channels, such as, BizDev, Partnerships, Advisors, SEO, Content Marketing or PR. Heads up, these are examples of the types of answers that usually don’t stand up to the test. Because they are free, every startup is going after them and you can’t buy scale.
If you’re going to mention the above strategies, you would not only have to show me a detailed plan for execution, but also make me believe you have a unique competitive advantage to be able acquire customers via these very unpredictable means.
If your company can clearly enumerate the 3 key elements of micro-traction, but lack, say $100k in MRR or 12 months of customer data, then traditional Series A and modern “seed” funds may continue to pass on your company. Because let’s face it, they are risk-adverse and not truly early-stage investors.
But showing micro-traction will definitely be useful in pitching your business to Wonder Ventures and other similar early-stage firms. You can hold me to that.
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This was originally published on Medium.
We recently held an AMA on the topic of fundraising, what investors look for in a business and team, moving to the next round and more (Ask Techstars: Going from Seed to Series A) with Ari Newman, Partner at Techstars; Bryan Birsic, CEO of Wunder Capital (Boulder ‘14); and Bora Celik, Founder of Jukely (NYC ‘13), a 2-tap concert concierge.
This post is the first in a series with Q&A excerpts from this AMA. Check it out!
What is considered “Seed” to “Series A” these days?
Ari: It varies widely. It’s a very difficult question to answer. It has more to do with where the company is at that stage than the dollar amount as a seed round can vary from 500K to 4 million these days.
The Seed round in today’s market is really about giving the company the capital it needs to take some early traction and early feedback from the market and prove that it can be operationalized and that they have true product-market-fit and enough learning to then be ready for scale of capital.
Of course, $4M is considered Series A territory but the scope and scale of a company raising a seed round of this size would signal a huge opportunity that’s been validated.
For the entrepreneur, an important thing to understand is, regardless of how much money you can attract from the market, when you go out and raise a Seed round, you have to make that money work to get to the next set of proof points.
What I see, consistently, very few companies raise a Series A after a Seed. There’s always another Seed. Or there’s a bridge on top of the second Seed. Or some other financing in between.
Entrepreneurs, by nature, are optimistic people. We all want to believe that we are going to hit our schedules, we are going to hit our milestones, but although it’s easier to start companies today, (infrastructure costs less, there’s capital around the system, you can hire a global workforce, etc.) the amount of data and proof around product market fit and unit economics and the company’s place in the world, (in terms of becoming an ongoing concern), that hurdle continues to get higher.
What I see very consistently is second Seed rounds. Financing is not a dot, it is a line and it is part of your job as a founder and a business leader to keep the capital coming in. If it was a world with just Seed, then Series A and then Series B, it would make everyone’s life easier.
The reality is, you can’t always control the things that you can’t control.
Bryan: My co-founders and I got into the entrepreneurial scene and started our first two companies in NYC – we were used to those kind of norms and how people talked about these type of things (Seed, Series A, etc.). We moved to Boulder and were looking to raise what serial entrepreneurs in New York would find as a very reasonable first round with basically the angel round at $500K or $1M.
We had some weird cross-cultural miscommunication with investors here who thought, “who do these guys think they are raising $1M?” The size of that round was not seen as an appropriate amount based on where we were.
If I go to the Valley, and say we have a $3.6M Series A, they think I’m a noob and I don’t know what I’m talking about. That’s a big Seed round. In NYC I can describe it as a small Series A, in the Colorado area it’s a very solid Series A. Understanding that when you are talking to those markets and how people are going to bucket you is really helpful to just not come off oddly.
We even had different decks for different people in terms of what we were raising. Sometimes they won’t take a meeting with you in the Valley unless you’re raising at least $2M. If you take that same deck to a local investor in Colorado, they are going to think you are really capital intensive or don’t know what you are doing. So, it’s really worth knowing the markets you’re pitching.
Ari: That’s very good advice, and I think in general that’s a good point for folks to remember, which is know your audience.
If you’re talking to a $50M Seed fund, you have to ask them what their normal bite size is. If what you are raising is in a strike zone where their normal bite size will buy them a reasonable amount of the company, that’s the first proof point that you could potentially work together.
So knowing your audience and also being realistic about valuation based on the market you’re in are two important things as well.
Bryan: On that point, I think entrepreneurs are often scared to ask investors questions because of the power dynamic. Ask where they are in their fund, how much they have left, what are their follow on dynamics? That’s an important question people don’t ask a lot.
Those are things that will put you on more even footing, make you look more sophisticated and give you information you need.
Ari: Back to a dating analogy, it’s no different than, do you want kids? Do you not want kids? Are you an athlete or do you sit on the couch? If you got two incompatible dynamics between the investor and the company, ultimately the deal is not going to happen anyway.
Bora: For me in the beginning, and I think a lot of entrepreneurs do this, they actually feel this illusion of the power dynamics, where, “I need money, they have the money, so they have the upperhand.” Everyone I know, including myself, started this way coming out of Techstars.
One of the things I learned along the way, which changed a lot for us, is that it’s actually not really like that.
What is on the other side of the table is money (and a lot of people have money), but on this side of the table is something that is very unique, and that is the entrepreneur and the company, and there’s only one of me.
Ari understands both sides of the equation. I think that is one of the very important things that an entrepreneur that is fundraising needs to believe in. That power dynamic isn’t like that, it’s an illusion.
Ari: I think it is a tough headspace for an entrepreneur to be in. When you walk into the room feeling like you have the upperhand when, quite frankly, a lot of the venture community and the venture apparatus is set up to scare the shit out of you.
For those who have actually pitched on Sand Hill Road, you go into this huge building, the receptionist walks you into a huge oak gilded conference room, the partner walks in 20 minutes late, they tell you absolutely nothing about themselves or their fund, they ask you a million questions, and then they say thanks, super interesting, I’ll chat with you soon. You walk out of there wondering what the hell just happened.
That was the power dynamic I was talking about. What Bora is talking about is flipping that idea on its head and being the person that says hey, I got something special and unique and if you want to work with me for the next decade, let’s figure out if we are going to be able to connect and have a relationship.
There are a lot of investors out there, and just because someone else gave that investor a checkbook does not make them either a genius or a person for you to be spending the next decade working with.
This was originally published in Factory Berlin’s Magazine.
So you have an idea and now you need some financial support to get the ball rolling. At this point, seed capital can be helpful. Although the seed round is usually smaller and can come from many funding options (friends, family, incubators, angels, VCs), it’s important to be strategic, because it builds the foundation for later rounds of funding.
Since there’s no formula for how to do this and navigating this process can be overwhelming for budding entrepreneurs, we spoke to two seasoned VCs about some key things a fledgling entrepreneur needs to know when raising seed financing from a venture capital firm.
Consider Timing and the Amount
A common question among new founders is: When is a good time to raise a seed round? When a startup thinks they’re “onto something”, the time could be ripe to examine options for seed financing, said Florian Heinemann, founding partner of Project A Ventures, an early-stage investor and VC focusing on e-commerce, marketplaces and SaaS.
“When they see the first signs of their idea potentially develop relevance, then it makes sense to think about whether this development could be accelerated by some additional funding to sharpen the business model, and pre-finance the development of an initial configuration,” he added.
As for the amount, seed capital can range from €100,000 to €1 million. “I always find it difficult to tell anyone there’s an absolute amount that is correct”, explained Gabriel Matuschka, partner at Fly Ventures, a VC firm making seed and pre-Series A investments in the areas of machine learning, marketplaces and SaaS across Europe. “It’s a case-by-case and company-by-company thing. It really depends on the type of company and what you can do.”
Typically though, the goal should be to raise enough to hit the next defined milestone with a bit of a buffer.
“The seed round should be a step towards raising a Series A, so founders have to ask themselves what elements of their business they want to have proven by raising the Series A,” said Heinemann.
“Often, this involves demonstrating first commercial traction, some understanding of profitability on a per customer level, and first scaling of the organization. Ideally the money should give them a runway of 15-18 months.”
Be Clear and Concise About Your Story
“At the seed stage, it’s not so much about metrics as it is about clarity and purpose. Investors want to know, ‘Who are these people and what are they doing?’” said Matsuschka, who has worked on both sides of the table – as an entrepreneur and investor.
Being able to describe your idea and talk about your team in a compelling manner is more important than showing metrics at this stage.
Founders should know how to talk about their team, their product, the market, their story, their customers, the pace of product development, etc. in a very easy-to-understand and concise way.
Educate Yourself on the Process
For entrepreneurs, the sheer amount of information at our fingertips can be both a blessing and a curse. When looking for resources on raising seed capital, Matuschka suggested looking at Seedsummit to get a grasp of core terms in venture, as well as getting an idea of the kinds of term sheets people use for UK or German deals.
“If someone asks for 30 percent of the company, that’s probably wrong, if someone asks for more, that’s very wrong. If someone asks for 2.5 percent and gives you a million, the likelihood of them being a crook or not knowing what they’re doing is very high. There are certain ranges that are okay in terms of valuation, but the cool thing is that most of these things are already in the public domain today,” he added.
Heinemann advised that entrepreneurs should educate themselves on the concept of vesting, cliff and liquidation preferences. When in doubt, consult experts.
Don’t Forget About Speed
It’s not uncommon that startups go through a number of rounds of funding in their lifetime, so try to be as efficient as you can when going through this phase.
“Speed is a critical element at the seed stage. A typical company in this stage is so small that this round occupies or distracts oftentimes many or all of the founders,” explained Matuschka. “Trying to get done with it sooner than later is an important element.”
Find the Right Entrepreneur-Investor Fit
Regardless of how many investors participate in the seed round, it’s crucial to think about the reputation of your investors and whether they’re a good fit for your vision.
“There are great investors that are probably just not great investors for you,” said Matushka. “Getting a sense of who the right person is for you because they understand your space and they’ve done something there is key.” Additionally, Heinemann said that it’s important to be aware of the likelihood of participating investors to do or support follow-up rounds.