Navigating The Gap Between Seed And Series A (2016 Version)
I try to help anyone coming through the network gear up for financings. Lately, the famous “gap” between seed and larger VCs for Series A has been exposed again. This “gap” has been written about ad nauseam, so I won’t do that here. Instead, let’s discuss how a founder can properly prepare for this gap, save time, and leverage the market:
How Much, How Long, And What? I’ll often look through a deck for a gap round and rarely see the amount the folks are raising, how long it will last them, and what the key milestones are? This is a sign of foolishness. The point of this gap existing is that the team isn’t ready for Series A, so to get to Series A in a credible fashion, an investor in this round would really need to see and understand an operational plan, the cost of that operational plan, the timeline associated with it, and identification of the key milestones to be reached. If you’re stuck in the gap and don’t know the answers to this, it’s a bad signal.
What About Price? I advise 90% of all extensions I see to raise “flat” to the last price or cap. This is hard because from the founder POV, they see all the progress they’ve made; from the investor POV, they’re looking for real growth. Usually in a gap round scenario, the new investors have to take on some serious market risk. An well known LP in microfunds once told me he cringes when his GPs do these extensions because he feels the data shows that most of these fail anyway. So, keep things flat and simple, because the party of the seed is over. A gap round, should one be so lucky to get one, might seem like a seed but it really feels like an institutional burden. It ain’t no party.
Where’s The Risk? Startups can face tech risk, market risk, or product-market risk. In a gap round, be honest and upfront about what risks are out there. In the angel and seed rounds, most of these are fueled by a hopeful vision of the future. By the time you get to this gap zone, you’ve already spent $1m — what risks have been eliminated, what risks still lurk, and how are they going to be mitigated? An ounce of intellectual honesty goes a long way here.
Insider Support? One easy way to show you’ve got some backing for the gap round is to see if your earlier investors want to invest more in you. Some do this as a policy, whereas some are not set up for follow-ons. It’s a good signal because if you’ve kept your earlier supporters up to date and they actually grow to believe in you move and see your progress, they can cobble together $500k of your $2m gap round and that gives a strong signal of momentum, even if small. It tells a future investor, “hey, his/her earliest supporters really like this.”
Speed Kills. Have a decent deal on the table? Close it. Shopping it is dangerous, if not done carefully. Yes, you will meet investors who may view the opportunity as predatory, or bargain shopping, but the last 5-6 years of valuations have been tremendous, so it’s still better than before 2008-09, relatively speaking. The reason I’m writing this is I do believe there are a class of great founders and companies which simply didn’t raise enough money to get prepared for Series A (and likely weren’t actively coached to get there, either), and there are founders out there who aren’t obsessed with the optics of a down or flat round or recap, and for them, I’m hoping this post helps them seal the deal faster and get back to work building the future.