For a quick assessment exit, ‘What is the biggest risk right now, and how can I avoid it?’
You may have heard. Pre-seed, seed, series A, series B and so on and so forth. These labels are often not very helpful because they are not clearly defined – we’ve seen very few Series A rounds and huge pre-seed rounds. The defining characteristic of each round is not how much money changes hands, but how much risk there is in the company.
There are two things changing at once on your startup journey. By having a deeper understanding – and the connections between them – you can make a better sense of your fundraising journey and how to think about each part of your startup’s path as it develops and grows.
Generally, in broad lines, funding rounds tend to go the following way.
- The 4 Fs: Founders, Friends, Family, Fools: This is the first money that goes into the company, usually enough to start justifying some major technological or business activity. Here, the company is trying to build an MVP. In these rounds, you often meet angel investors of varying degrees.
- Forerunner: Confusingly, this is often the same as above, except by an institutional investor (ie, a family office or VC firm that focuses on early stages of companies). This is usually not a “valued round” – the company does not have a formal valuation, but the money raised is in a convertible or secured note. At this stage, companies typically do not generate revenue.
- Seed: This is usually institutional investors pouring large sums of money into a company that is starting to prove some volatility. The startup has some features and may have some test customers, beta product, assistant MVP, etc. It will not have a growth engine (in other words, it will not yet have a repeatable way to attract and retain customers). The company is actively working on product development and looking for product-market fit. Sometimes this round is valued (ie, investors negotiate the company’s valuation) or it can be worthless.
- Series A: This is the first “growth round” that a company raises. It usually has a product in the market that delivers value to customers and is on track to bring reliable and predictable cash flow to customer acquisition. The company may enter new markets, expand its product offering, or pursue a new customer segment. A Series A round is almost always a “value,” which gives the company a formal valuation.
- Series B and above: At Series B, a company often goes seriously into competition. It has customers, income and a stable product or two. Starting with Series B, you have Series C, D, E, etc. Rounds and the company will be big. The final rounds are typically when a company is preparing to go black (go profitable), go public through an IPO, or both.
For each round a company calculates the mechanics of growth and its business model, it becomes more valuable in part because it has a more mature product and more revenue. Along the way, the company will improve in another way, as well: the risk will decrease.
That last part is critical as you think about your fundraising journey. As your company becomes more valuable, your risk does not decrease. As it reduces the risk, the company becomes more valuable. You can use this to your advantage by designing fundraising rounds to clearly eliminate the “scary” elements in your company.
Let’s take a closer look at what you can do as a founder to avoid as much risk as possible at each stage of your company’s existence, and where the risk lies in the startup.
Where is the risk in your organization?
Danger comes in many shapes and forms. When your company is in the idea stage, you can connect with some co-founders who have good founder-marketing skills. You’ve identified a problem with the market. Your early potential customer interviews all agree that this is a problem worth solving and that someone – in theory – would be willing to pay money to solve this problem. The first question is, is it even possible to solve this problem?