How to Raise Venture Capital for Your Startup, From Pre-Seed to Series A
Every stage of funding for a startup requires a different set of metrics and milestones
Every year I teach classrooms full of students about business. These students end up leaving my classes understanding the basics of how to search for product/market fit — and thinking their next goal is to “get funded.”
That’s a mistake many new founders make because there are only two reasons to seek out funding:
- You have a killer idea that is only partially validated, that you think can get to $50 million+ of revenue in five years with 80%+ gross margins (if margins are lower, you need a lot more revenue), and you need money to get to product/market fit, or
- You already have product/market fit with real customers and real revenue and need money to grow and expand.
Not all startups need outside investment to grow
What most founders don’t realize is every stage of a startup requires a different set of metrics and milestones and founder skills. Knowing these will help a founder position her pitch to get investors’ attention. Founders need to keep their eye on the prize — not just the next funding round.
Luckily, I teach with two great VCs, Mar Hershenson of Pear Ventures and Jeff Epstein of Bessemer Venture Partners, who both put together presentations unraveling the mysteries of how and why startups raise money. Jeff’s presentation is from the point of view of “What Investors Want” while Mar’s takes it from the point of view of a founder trying to figure out the funding landscape. Here’s what we recommend, but keep in mind that there is no “one way” to raise money. Different investors will almost certainly have different models, and different regions may have different math. Still, there are some benchmarks to keep in mind.
The startup investment landscape
For startups the early stage funding landscape looks like this:
- Step one: The Pre-seed round — you raise $100,000-$750,000.
- Step two: The Seed round — you raise $1 million-$3 million (in some cases even $2 million–$5 million).
- Step three: The Series A — you raise $5 million–$10 million.
- Step four: Series B — you raise $10 million–$50 million.
- Step five: Series C, D, and beyond.
The definition of each startup financing stage has changed in the last decade. What was a Series A round in 2005 is now a pre-seed or seed round. And what used to be a seed round a decade ago is now a pre-seed round. There are lots of reasons for this shift, but it basically boils down to this: There’s a lot more money that wants to invest in startups, and all of it is racing to get in early.
This is a journey that can be planned and measured. In a pre-seed round, you are focused on building minimum viable products, testing your insights, and searching for product/market fit. In the seed round, you have an early product and by the end, you’ve found product/market fit and understand the scale of what you’re building and the levers that you can pull to accelerate growth. For a Series A round, you want to prove you have built a repeatable and scalable sales/revenue model and understand all parts of the business model. Series B is about proving your net revenue model (“Can you be profitable?”). Series C and onward funds growing your company to $100 million in gross profit.
But you’ll still need a great pitch
By the way, if your pitch is not going to knock investors’ socks off, if you cannot communicate a big vision and a unique insight about the 10x advantages that customers and users will care deeply about, then even if you build out the smartest, most thoughtful process of chasing fundraising, you will fail.
Team, product, traction, business model, and market
In each step of funding, there are five things that potential investors will want to know: They’ll want you to tell them about your team, your product, your traction, your business model, and the market.
Your team is just what it sounds like. You need to tell them why you’re the right person to lead this company. (A bad answer here is, “because it’s my idea.” A better answer is, “because I’m the customer.”)
Tell them about the group of people you’ve surrounded yourself with — your co-founders and your key executives. Each stage of funding and company growth requires additional expertise and new skills, and you’ll want to demonstrate that you have these with potential investors.
Your product is the product or service you’re building. One of the tough things for a startup is to figure out how much of the “product” has to be real and working at each stage of funding.
Traction is a fancy investor word for “show me you’re making progress.” It’s sometimes called product/market fit. In a startup’s early days — in the pre-seed and seed stages — this is not about how much revenue you’ve made, but more about how much customer passion your product is creating and how many more people are loving it each week and month. (For more context, read Ann Miura-Ko’s article on product/market fit here.)
Founders tend to fixate on the product. Now that product/market fit is part of the lexicon, most understand that the product also needs passionate customers. But a great product and eager customers are just part of what makes a great business. The rest is its business model. These elements of the business model—revenue, pricing strategy, distribution channels — are other, critical parts your startup needs to understand and have in place.
The market is a euphemism for “How big can your company grow?” Investors want to put their money to work in a startup that can be worth billions or tens of billions of dollars. What are your unique insights about technology, economics, change in market, etc. What evidence do you have that you can grow this big? How will you do it?
The big idea in all of this is that at each step of funding, the order and priority of team, product, traction, and market changes.
In the pre-seed stage, a startup is searching for product/market fit. There are no customers and no product, just a series of minimum viable products.
Funding: Startups typically raise anywhere from $100,000 to $750,000 in pre-seed. At the low end, this might come from friends, family, or angel investors. At the high end, pre-seed angel funds might invest. (Yes, there are venture funds that look for and invest in startups this early.)
Team: As you’re raising money from friends, family, or angels, investors in this round are betting mostly on you and your team. Have you or your team members achieved anything important in the past? Any wins to date in your startup? Do you have co-founders who complement your skills? (Warning signs are “We were in the dorm together” or “It’s my team from the class I took.”)
Traction: Tell investors about your search for product/market fit and what you’ve learned from potential customers to date. Show them the evolution of your minimum viable product and its current state. You need to begin to “instrument” your customer acquisition process with analytics.
Product/market fit: You’ve found the match between your potential customers’ pains, gains, and jobs to be done and the features of your minimum viable product — that is, your product fits the needs of your target customers.
Product: At this stage, you are building a series of low-fidelity minimum viable products(or MVPs). It might be a wire-frame, PowerPoint demo, or prototype. The goal of the product at this stage is not a sale, but to test hypotheses about customer product/market fit. Along with the MVP, you should share your three-year product vision to see if your product vision engages a passionate customer response.
Market: Tell us why this is going to be a huge market. Even better, start with a unique insight: What have people missed, what’s changed, what’s now possible? (Warning signs include, “No one has thought of this before/is currently doing this.”)
Business model: List all the parts of your business model. What are your assumptions about each part? What are some of the critical metrics that matter? Number of customers? Revenue per customer? Number of employees? Revenue? Gross Margin? Expenses? How do you plan to test them?
Goal/Time: By the end of the pre-seed stage, the company ought to have evidence that it has found product/market fit. You should be thinking about an end-to-end pipeline of how to get, keep, and grow customers. This pre-seed stage typically takes six–12 months.
Pre-Seed round paperwork: Smart investors will typically give you minimal paperwork — either a convertible note or a SAFE (Simple Agreement for Future Equity) or a KISS (Keep It Simple Securities).
The seed round
At this point (about a year into your startup), you should have evidence that they’ve found product/market fit. (One sign is that you are no longer changing your website/sales PowerPoint/product/app every time you need to acquire a customer.) Now it’s time to raise money to acquire paying customers.
Funding: Startups typically raise anywhere from $1 million–$3 million in a seed round. At the low end, this might come from angel investors and pre-seed funds. At the high end, funds specializing in seed rounds and Series A funds might invest.
Traction: For a seed round, investors want to focus on traction. You need to provide proof that customers love and can’t live without your product. This means you can show evidence that you’ve found product/market fit and have fanatic customers who are reference accounts.
You’ve built detailed analytics tracking into your product, and you should be seeing organic and viral growth, and can provide daily/weekly/monthly active users and 30-day/90-day/120-day retention. Retention and low attrition are good signs of customer validation. Note that each market (web/SAAS/physical products ) and channel (online/direct sales) has different metrics and different funnel steps.
Your annual recurring revenue (ARR) and revenue milestones will depend on what business you’re in. For example, not all revenue is recurring and even in a subscription model for a consumer goods company, your recurring revenue will not be valued the same as if you’re selling enterprise software, where operating costs are so vastly different. As an example, $1 of revenue for a direct to consumer company is worth ~$1 in valuation at scale (Zappos was sold for $1 billion when they had $1 billion in sales). On the other hand, in a SaaS business $1 in recurring annual revenue equals ~10x in valuation.
Product: At this stage you have a high-fidelity product, one that earlyvangelists (early passionate customers) can use and pay for. Enough of the product is demonstrable enough that you can gauge customers’ price sensitivity, depth of engagement, etc. The three-year product roadmap gets earlyvangelists engaged.
Team: You have a core team that can build the first product and get early sales. The culture needs to be focused around this cycle: hypothesis > experiment > data > insight > validate/invalidate/modify hypotheses.
Business model: In the seed stage, you often discover that your business has more moving parts than you originally thought. You may be in a multisided market with other customer segments/partners that are critical to your business. You should be testing all parts of your business model: revenue models/pricing, resources, activities, and partners.
Market: Tell us why the data validates that this is going to be a huge market. The founders usually do the first sale, then they must prove their first salespeople can repeat that sale.
Goal/Time: By the end of the seed stage, the company ought to have evidence that repeatable sales can be made by the founding team. This typically takes 12–18 months.
Seed round paperwork: While founders will still want minimal paperwork — either a convertible note or a SAFE or a KISS—professional investors at this round often want an equity round with a more formal set of documents for their investments. You’ll see a Term Sheet, Stock Purchase Agreement, Amended and Restated Certificate of Incorporation, Investors’ Rights Agreement, Right of First Refusal and Co-Sale Agreement, and a Voting Agreement.
The Series A round
At this stage—about two-and-a-half years into your startup—your startup has a repeatable and scalable sales model and a provable case that there can be a multibillion-dollar valuation.
Funding: Startups typically raise anywhere from $8 million–$20 million in a Series A round. This round typically comes from a venture fund or a corporate VC.
Market: You need to convince investors that this is at least a $1 billion+ company.
Product: At this stage, you have a fully featured first version of the product needed to scale sales. And you are working to the three-year product vision, iterating, and course-correcting based on customer feedback.
Traction: For a Series A round, investors want to focus on a repeatable and scalable sales model with efficient growth. That means you need metrics that prove you have it. Repeatable sales means if you hire an account exec, you know that they will close $1 million annual recurring revenue in a year. Or if you spend $100,000 in ad spend, you can get 100,000 new users. Startups raising a Series A round typically have $500,000–$4 million annual recurring revenue. Note that the focus should not just be on growth month-to-month but also on efficient growth.
For example, other metrics include achieving net retention of 80%–150%, getting a lifetime value/customer acquisition cost ratio greater than three, getting to two times customer acquisition cost payback period in fewer than 18 months. You should have a realistic plan to grow revenue 3x–5x in 12 to 18 months.
These numbers differ dramatically for e-commerce companies versus SAAS and so on. You should know what the right success metrics are for your industry. (The best VCs will actually tell you what metrics they’re looking for.)
Team: The core product team is working efficiently and the sales team for scale is in place (and 75% are meeting quota).
Business model: By the end of Series A, all parts of the business model have been tested and they add up to a scalable, repeatable, and profitable business.
Goal: By the end of this stage, the company ought to prove that it’s a business, not a hobby. You need to show more than $5 million in gross profit. Just to put your journey in perspective, if you want to achieve unicorn status or go public, you ultimately need to deliver $100 million annual gross profit in years 6–8.
Series A paperwork: You’ll be seeing a Term Sheet, Stock Purchase Agreement, Amended and Restated Certificate of Incorporation, Investors’ Rights Agreement, Right of First Refusal and Co-Sale Agreement, and a Voting Agreement.
What should revenue growth look like?
Some investors think of the ideal startup revenue growth with a shorthand of “triple, triple, double, double, double.” Here’s an example:
- Years one to three: $0–$2 million in revenue.
- Year four: Triple the revenue to $2 million–$6 million.
- Year five: Triple the revenue again to $6 million–$18 million.
- Year six: Double the revenue to $12 million–$36 million.
- Year seven: Double the revenue again to $24 million–$72 million.
- Year eight: Double the revenue again to $48 million–$144 million.
A note on valuations
Fair or not, not all startups are equal in the eyes of their potential investors. Some startups may be considered “hotter” than others and get much higher valuations. A hot startup may even be able to skip the pre-seed round and go directly to a seed round — meaning more money raised at a higher valuation. The criteria for a “hot” startup include: the background of the founders, being in a “hot market,” hype surrounding the company, the location of the company, and the fear of missing out (FOMO).
Every stage of a startup requires a different set of metrics and milestones and founder skills. Knowing what investors want at each stage provides founders with guideposts. Founders need to keep their eyes on the prize — not just the next funding round.