We’re in a barbell financing market. At the seed stage, caps greater than $10M aren’t uncommon. Series As routinely fetch $30M post-money. In the growth stage, it’s a seemingly weekly event for a $1B+ valuation financing. In all of these cases, investors are pre-paying. Investors bet the company will grow into a valuation in 18 to 24 months, perhaps 36 months on the growth side.
I joined the venture business in 2008 (at the bottom of the market) when the typical seed raised at $2 to $4M. Investors priced the A at $10M to $20M post, the B at $25 to $40M post and so on. Over the past 36 months, seeds are priced at $10M+, As are $20 to $30M post and Bs top out at $150M. There has been a significant change in investor mentality : at each stage, an investor was willing to assume greater risk and prepay for milestones not yet achieved.
Typically, startups raise 18 to 24 months’ of runway and aim to achieve certain milestones to raise a subsequent round of financing. In a market where investors at every stage are willing to prepay, raising a high cap seed or high-post money A works, because the valuation of the B will be commensurately higher and so on. But if any one segment of the market becomes unwilling to pre-pay, there’s trouble.
Today, Series Bs are the toughest rounds to raise because Series Bs tend to be the riskiest investments. Most of the time, companies raise their Bs with a modicum of market validation – a few customers, some early but small revenue, and the Series B investor must extrapolate the market opportunity and the company’s ability to capture it from a few data points. In all likelihood, the size of market opportunity hasn’t materially increased and by definition, the return at a higher price is less than the A.
The Series B market today is the kink in the financing chain. Perhaps the Facebook IPO correction and the late stage investor losses on Zynga, GroupOn and others have changed the risk/reward perception for Series B investors. Or Europe. The reason doesn’t matter. If a company has to raise a Series B at a valuation equal to the A (or lower), there is a sense of lost momentum in the press, within the team, within hiring circles and potentially even for the founders. Maximizing valuation in the short-term can seem like a good strategy, but the goal is to maximize the success of the startup.
The lesson I’ve learnt is finance companies to milestones, milestones that the company can achieve and that will value the company at a material increase to previous rounds.