When is your tech company ready for a series A raise? If you have an epic story to tell and you’re deep into your act one milestones, the time could be right. You may be ready for your second act—the turning point of your narrative in which you secure the type and sources of funding to help ensure that your innovation will force a change in the status quo. Like any great legendary tale, you want your solution to be the reason things will be forever better.
To extend the analogy just a bit further, the second act of your entrepreneurial storyline is the point where you as protagonist must demonstrate that you have the requisite strengths to overcome any forces of antagonism that confront you—technology challenges, financial pressures, hiring needs, competition, etc. It’s your time to show potential investors who you are and what you’re capable of.
To achieve your fundraising goals, at any stage, you must understand what investors are looking for and deliver on it. For a series A raise in particular, your company should have achieved some key milestones to pave the way—those include momentum, management strength, market size, revenue growth and customer base expansion.
By the time you embark on a series A raise, you should have established a foundation of external funding from friends and family, angels, strategic investors or some combination thereof. And you should have used those initial funds, along with your own money, to build out your beta or the first version of your platform. In most cases, entrepreneurs will obtain such seed round funding via convertible notes as opposed to equity. Priced round investors like to see this type of early investor commitment because it proves that there are others besides the founder that believe the idea has merit.
Having a top-notch management team is absolutely crucial. Series A investors are drawn to companies with highly competent leadership. And while it might seem obvious, the “team” by definition should be more than just one person. Often at the seed level the company is a one-person show, which is perfectly acceptable. But after that point it’s important to show that other professionals, especially those with industry track records and previous wins, believe in the company as much as you do and are willing to put their own careers and reputations on the line to join the fold.
Venture investors have to believe that there is a large enough market for your business to achieve explosive growth and ultimately an even greater exit at multiples that far surpass the VC’s original investment. If your market is too niche-based, you may want to consider whether it’s truly a VC play. Perhaps your company would be better suited to growing organically and remaining a closely held lifestyle business. If your market is too small, then another option could be to pursue a strategic investor that will fund your build-out and incorporate your product or service into their business.
If you do go the VC route, you’ll be faced with investors focused almost exclusively on large exit/win opportunities. The reality is that VCs are in a very high-risk business—many companies in their portfolios will not make it. So, they need to buy into burgeoning markets that will yield huge wins to offset their downside risk.
Your company should already be generating revenue before you seek a series A raise. And the revenue trendline should, of course, be progressing upward—because there is usually a direct correlation between revenue and the beginnings of your pathway to traction. As the company begins to gain revenue momentum, you have started to prove that your solution solves an immediate need in the marketplace and that the opportunity is sufficiently large and scalable.
Customer Base Expansion
For a successful series A raise, investors need to see not just revenue but also an increasing base of customers willing to pay for your product or service. Revenue alone is not enough because it can come from sources other than your core paying customers, or core revenue streams. Similarly, you could have substantial revenue but only from a single customer—this alone won’t do. What VCs want to see is a multitude of customers that have begun to utilize your solution and a strong pipeline of customers progressing through the purchasing process. Perhaps the most important objective of series A funding is to turn your business into a repeatable, sustainable marketing machine.
EMBARKING ON YOUR SERIES A RAISE
Setting the Valuation
When you begin your series A round, it’s a time of several firsts for your company. It’s typically when you land your first institutional investor, your first priced round, and the point when your initial company valuation, and thus the per-share price, is set. At the same time, VC funding impacts your seed investors by triggering their conversion from convertible debtholders to equity shareholders.
There are many valuation methods that can be used, but ultimately it will come down to negotiation between the founder and the VC. The per-share price you establish at this stage is vitally important because it will impact your company valuation over the long term. You want the valuation to be low enough to attract additional and future investors and set the company up for a future exit, while being high enough to keep the management team happy and motivated. There is a balance to be found there. Sometimes founders will agree to a lower valuation to get a better lead investor involved, or in order to get other terms in the term sheet that may be more important to them. You can also offset the dilution by how much capital is raised at each round. It is all a balancing act. Regardless, founders should keep their eye on the goal, which is to get funded and grow their business.
Finding a Lead Investor
Your lead investor is one of the most important players that can help launch your company onto a successful trajectory. The lead will work with you to create a term sheet to fill in the rest of the round and may also take on the responsibility for securing those additional investors. In most cases, the lead investor will also take a seat on your board of directors to impact future company decisions. Because of this pivotal and influential role, it’s important that founders align with the right person to be the lead investor—someone like-minded who also has broad industry expertise and a network of contacts with investors and potential partners. First and foremost, you want a lead investor who will be personally invested in your success and can help accelerate your company growth.
Creating Your Board of Directors
Before a series A raise, many startups begin with a more informal advisory board. But institutional investors will expect a formal board of directors to be put in place with established governance procedures and guidelines. A five-person board will usually be sufficient. This should include two common stockholders, of which one should be the CEO; two preferred stockholders, of which one should be the lead investor; and one independent director, ideally an industry expert who can open doors to an active network of contacts.
Establishing Your Legal Entity Structure
Finally, when you go for your series A raise, investors will want your company to be established as a C corporation. The C corporation is widely considered the best legal entity structure for business owners that anticipate significant growth and seek personal protection from business liabilities and debts. Many startups begin as LLCs because they provide better liability protection than a general partnership and are less costly to maintain than a C corporation. But a C corporation is the preferred structure when it comes to attracting outside investors and shareholders.
THE END OF THE BEGINNING
Successfully securing series A funding is certainly a major turning point in the evolution of your startup, but it’s not the end of the story. It’s more like the end of the beginning. Before you even think about fundraising, you should be able to show that you have developed a groundbreaking idea with a huge untapped market and a management team that not only can make it happen, but already is doing so, as evidenced by revenue growth, customer base expansion and market traction. In fact, the only thing that should be standing in your way is funding. And if that’s all you need to be successful, you should have no trouble attracting investors.
About the Author
Alison Malloy is director of investments on the Connecticut Innovations Venture Team. You can contact her at Alison.Malloy@ctinnovations.com.