Should we raise a small or large seed round? A Funding Scenario

small-is-big

I recently caught up with a buddy who is setting out on a new venture. We quickly got talking about his new project and the 2 seed funding scenarios they are considering.

She/He is based in the US, has founded and sold companies before, and is about to go again with their new venture. This discussion was  fascinating (for me at least) and it was exciting to learn about this new venture and their plans for fund raising. I often find as an entrepreneur that I’ve learnt so much from other peoples experiences and ideas that we both agreed it might be cool to share this real (but anonymised) scenario with others and see what they thought. Here it goes…

Brief Background:

The business is in the ‘Uber for X’ realm. It is a B2B proposition that  is geographically focused and would need to be replicated in each new local market if it is to scale (i.e. no network effects). The initial team is in place, has worked together before and is working on their MVP. They are smart guys and their proposition has huge potential to disrupt and their much longer term vision is to move towards a  B2B2C position once they have a strong B2B business established.The company will be ready to launch their MVP soon and are pre traction/revenue.

Funding Scenarios Presented:

  • Option A – Raise a big $1-2M Seed with the goal of securing a large Series A of $10M in 12 to 18 months.
  • Option B – Raise a small $250-350K Seed with the goal of securing a large Series A of $10M in less than 12 months.

My Quick Questions

  1. What option do you think is best? They preferred Option B. They felt they could close this Seed round relatively quickly and focus on proving the their model works in at least one market (even on a very small scale i,e, 5-10 customers)
  2. Would the Seed be priced or notes? The founder said both options would be SAFE (the new convertible note instrument from YC)
  3. Why do you need $10M for your Series A? What will it be used for? Engineering… AND scale the platform… AND operating costs… AND product… AND sales… AND marketing… AND customer service etc… (i.e. everything )
  4. If you could raise a $10M Series A tomorrow for 40% would you take it? If it was 30% yes.

Our discussion

My initial reaction was;

  1. It seemed to me the Seed discussion was a Red Herring as the company was targeting a Series A of $10M in all scenarios. I suggested that both Seed Funding scenarios were compatible. For example, they should aim to close their $250K Seed round asap and then raise additional Seed Capital using adjusted Caps in a ‘rolling seed round’ scenario as/if needed.
  2. Either way, since the $10M Series A is the real target they need to start a twin track process of engaging their target Series A VC’s now. The ‘dating process’ of getting intros. setting up meetings, getting advice & feedback, meeting other partners at the firm, preparing investor docs, getting to a potential term sheet, negotiation, passing due diligence, etc… will realistically take 6-12 months so this needed to start ASAP.
  3. I said that I thought their answer to question 3 really sucked. It’s obvious that money would go into all the areas they listed. I suggested they check out David Cancel’s ‘Golden Rule for pitching your startup or product‘ (which I’ve broken too many times to remember). In this great post David outlines why you should avoid the word AND when pitching. David is talking more around value propositions but I think it applies to all related answers as AND’s can ‘add confusion and show you don’t really understand your value proposition‘… or what you would do with $10M :)
  4. Instead I suggested their Series A should be all about one word. GROWTH. Therefore their seed capital needs to be used to demonstrate that they can achieve rapid growth and were ready to replicate their model in more locations. They must  ensure their seed milestones need are aligned around this goal so that they can be in a position to say something like;

‘We are raising a $10M Series A as we need to GROW quickly. We have early momentum and proven the model works. We now need $10M to replicate and scale the model into 10 new markets over the next 12 months. We estimate each new local market will require an initial $500K to enter. We  believe that the company will soon need to raise an additional $50+M Series B to then  bring this to 50 more cities and ensure nobody can catch us’.  

Obviously being so early stage, there is a tonne of unknowns to be discovered. I suggested that putting the $10M Series A (or whatever that number will be) at the center of their fundraising strategy when talking to all investors including Angels. As Christian Hernandez recently wrote 

 ‘Entrepreneurs need to fund raise to the level of their ambition and give themselves time to start down the path of achieving it’. 

I’m sure an experienced Seed Investor would be encouraged to hear that you are

targeting a $10M Series A in the next 6-12 months and are therefore looking for a smaller amount of seed capital today to first prove the model works in X local market’.

As long as the Seed Investor gets a valuation cap they are happy with then they might be more encouraged to invest.

We also had some great discussions around various topics such as Angels v Seed Funds, AngelList, Stealth mode, Approaching investors who have invested in similar / competing companies etc… but they are all topics for another day. I’ll make sure to maybe do a follow up post on this in a few months to see what route they took.

Major Disclaimer / Health Warning:

Of course every company is different (which is what makes startups challenging / exciting) and the correct answer is ‘It Depends’. Well that would be the correct answer if you were to ask a Top Tier paid adviser or consulting firm like a McKinsey, PA Consulting, Bain etc… This type of feedback exercise should really be treated more like a ‘brainstorming’ and ‘red team review’ session where ideas are proposed, attacked and defended in a safe environment. While too much advice and feedback can be quite negative and result in paralysis by ‘over-analysis’, I’ve often found it is very useful to discuss scenarios like these aloud with advisers when it comes to evolving and testing important strategic options. Remember, as Ciaran O’Leary at Earlybird VC says, ‘Don’t manage your startup by other people’s blog posts’ :)

I (and my buddy) would love to hear your thoughts, opinions, experiences and questions on raising a Seed Round and the scenario above. We’re both still hugely inexperienced and eager to learn how from others than may have been here before. Please drop a comment below or ping me on Twitter.

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3 thoughts on “Should we raise a small or large seed round? A Funding Scenario

  1. To that sage advice “Don’t manage your startup by other people’s blog posts”, I would add that “free advice is often overpriced”. But this post raises great issues so I’ll add my (not even) dime’s worth :)

    Your question seems to centre around raise a small seed round $250 – $350k now vs. a large seed round now, $1 – $2m. How much you raise is a function of how much your company is worth. It sounds like your pal’s company has nothing of value at this stage but an idea and an experienced team. They have no MVP, no traction and no revenue. Assuming they offer between 10% and 20% to the seed investors, and they go for $1m seed, that gives you a post money valuation of $5 – $10m. Either valuation is quite an unlikely scenario for a company that is pre-just-about-everything. However, an unpriced CLN issue in the more modest $250 – $350k range, gives your friend cash to take a shot at MVP and actual customers. So, as a bar-stool-style-comment, (not advice, no siree), I’d favour CLN route for the smaller seed round.
    To be blunt, your average startup (pre-everything) would just sound silly putting $10m Series A at the centre of their seed pitch. They just couldn’t credibly carry that off. But my guess is, this is not the average startup or you wouldn’t have suggested it.
    All in all, I think you gave your friend some great advice there. You’re probably both quite someway north of “hugely inexperienced” :) Experienced or not, there’s no real formula for this stuff. Valuation is only ever an opinion, price is a fact.

    I look forward to your follow-on post. Meanwhile, I wish your friend every success and thanks for such a thought provoking post.
    ~ Helen

  2. Thanks Helen and great points.

    I think the advice around the $10M was because their business model will require considerable cash to build out the ‘logisitcs’ they need to build their business. i.e. they are not just ‘SaaS’ as it has a strong service / people cost to get going. For example, like Uber, technology is part of it, but unlike Uber, they will also need to provide the equivalent of the drivers (service providers) too.

    So we thought signalling that to investors now might better help manage expectations that this business, while exciting, will require a good deal of capital to scale. It also helps them target Angels who can maybe help raise a Series A of that level.

    Thanks again for the comment. Agree there is no real formula at all and that is equal parts frustrating / exciting as I’m sure you know only too well!

  3. Hi Conor,

    Great post, it gave me a different perspective on raising our seed round. We are Irish founders developing a product for the US market.

    When we first approached Angels/VC’s in Ireland we got the same response as Helen gave above, you have no product no traction etc. You only have a valuation of €500,000 – €1m. We started talking to some friendly VC’s in the US who we knew through personnel contacts. They did not invest in our space but did invest in seed rounds. So I respected their opinions. We are pre-launch, pre revenue, pre traction but we do have a strong team in place, we targeting a booming market, strong partner/marketing contracts in place and our MVP will be ready in 6 weeks (which is self funded – $150,000). They did not bat an eyelid when we mentioned an valuation of $3 million.

    This leads me to the difference between Europe and the USA when it comes to funding and valuing startups. The average seed round in the US is $700k on a valuation of $2.8 million, the equivalent in Europe is €500,000 on a €1.5 million. Plus European VC’s take twice as long as their US counterparts to hand over the goods.

    This is only my opinion but I think the real difference between the US and Europe is their attitude, American’s look at the potential of a startup, i.e. team, market & product where European’s look at your traction, revenue etc. which i think is a bit counter intuitive considering it is a SEED round.

    I also see the difference in Helen’s attitude compared to the founder that Conor was talking about. The founder is looking at the big picture…’we want to dominate the market and it will take $10 million to do it’. It is my experience that VC’s in the USA what to see you reach for the stars, they want to see a guy come into their offices and show how they are going to build a global business.

    Again this only my opinion but I think European VC’s do not think as big, maybe they do think as big but their investment strategy does not reflect this.

    We are starting the process of raising our seed round so it will be interesting to see what really does happen when it comes down to the nitty gritty!

    Regards,
    Dave

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