In the event of a rapid rise in valuation, think: ‘What is the greatest risk at the moment and how do I remove it?’
You’ve probably already heard it from pre-seed, seed, series A, series B and so on and so forth. These labels are often not very useful because they are not clearly defined – we have seen very small Series A rounds and huge pre-seed rounds. The defining characteristic of each round is not so much how much money changes hands, but how much risk there is in the business.
During your startup’s journey, two dynamics are at play simultaneously. Understanding them thoroughly – and the connection between them – can give you much more insight into your fundraising journey and how you should think about each part of your startup journey as you evolve and develop.
In general, the funding rounds are broadly as follows:
- The 4 R’s: Founders, Friends, Family, Fools: This is the first money that comes into the company, usually just enough to prove some of the core technology or business dynamics. Here the company is trying to build an MVP. You will often find angel investors of varying levels of sophistication in these rounds.
- Pre-sowing: Confusingly, this is often the same as the above, except this is done by an institutional investor (i.e. a family office or a VC firm that focuses on the earliest stages of businesses). This is not usually a “priced round” – the company has no formal valuation, but the money raised is on a convertible or SAFE note. At this stage, companies usually do not generate revenue yet.
- Seed: These are usually institutional investors who invest larger sums in a company that is beginning to prove some of its dynamism. The startup will have some aspect of its business up and running and may have some test customers, a beta product, a concierge 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). retain). The company is working on active product development and looking for product-market fit. Sometimes this round is priced (i.e. investors negotiate a valuation of the company), or it can be unpriced.
- Series A: This is the first “growth round” a company picks up. It usually has a product in the market that delivers value to customers and is well on its way to finding a reliable, predictable way to put money into customer acquisition. The company may be on the verge of entering new markets, expanding its product offerings, or entering a new customer segment. A Series A round is almost always “priced,” giving the company a formal valuation.
- Series B and beyond: In Series B, a company is usually serious about getting to the races. It has customers, revenue and a few stable products. From Serie B you have Serie C, D, E, etc. The rounds and the company get bigger. The final rounds are usually preparing a company to go into the black (be profitable), go public through an IPO, or both.
For each of the rounds, a company becomes more and more valuable, in part because it gets an increasingly mature product and revenue as it figures out its growth mechanisms and business model. Gradually, the company also evolves in another way: the risk decreases.
That last piece is crucial in how you feel about your fundraising journey. Your risk does not decrease as your business becomes more valuable. The company becomes more valuable as the risk decreases. You can use this to your advantage by designing your fundraising rounds so that you explicitly don’t risk the “scariest” things about your business.
Let’s take a closer look at where risk arises in a startup and what you as a founder can do to remove as much risk as possible at every stage of your company’s existence.
Where is the risk in your company?
Risk comes in many shapes and sizes. When your company is in the ideation phase, you can get together with some co-founders who are a great fit for the founder market. You have determined that there is a problem in the market. Your early interviews with potential customers all agree that this is a problem worth solving and that someone is – in theory – willing to pay money to solve this problem. The first question is: is it even possible to solve this problem?