Sometimes it is good to go back to the basics.
There is no question that if you are a founder trying to build a business, you are facing some challenging times.
The common sense view of what is fundable? What can survive? What technologies and trends are better to invest in are all changing almost every week,
And investors seem to be focusing on keeping their existing portfolio companies alive rather than investing in new ones.
In light of some of my recent conversations with founders, I decided to do a simpler, back-to-basic post about the funding stages, how to strategize your funding rounds and sizes, and what milestones should be targeted for that particular stage.
It is hard to compare different industry deals, types of companies, experience, and track records of founders and then come up with some median valuation cap; that is why I prefer to use the ideal dilution average when looking at the deal terms. Then, using the ideal dilution and the amount of money one might need to reach the next stage, founders can decide how much money to raise at what valuation and how feasible those figures might be.
Another ideal critical data to remember for founders is that one would want to spend about 12-18 months between each stage, given normal market conditions.
That means if you are starting an innovative startup that would want to qualify for venture funding and a successful exit (not a unicorn, given those would, in most cases will, shoot for IPO as an exit and need more Series B,C,D,E... type funding and can take way longer to reach the finish line), you are looking from when you start to Series B (where you are likely to be an acquisition target), at the low end it will take you a minimum four years but most likely around eight years from beginning to exit.
Accordingly to Ian Hathaway's analysis of Pitch book data, the average time to exit (for acquisitions) from first financing is 6 years from first financing.
For IPO exits, both Ian Hathaway and Crunchbase analysis show that time exit could differ a lot from B2B to B2C, and industry, yet companies that started after 2010 the time from first financing to S1 filings to take longer. We can confidently say that with where we are with public markets today, the average time to Exit from first financing will get even longer.
At the end of this article, I will put some links for extensive data sources by stage regarding funding round size, dilution, and market cap. So lets go back to the subject of funding rounds:
What is the nomenclature of funding rounds? What is it in the US and what is it in Europe?
The good news is that your funding stage does not change by the size of funding you raise or what ecosystem you are in. Yes, in the US, the funding round sizes are almost double the sizes of Europe. However it is not the size of the round but the what you use the funding for defines the stage you are in:
Pre-Seed:
This is the stage your company is an idea and the co-founders (that might not even be full-time yet). Often this stage starts with your own funding, then family and friends, and towards the end, maybe an angel investor that knows your space so well that they get what you are trying to do very clearly, even before you reach the MVP stage.
At this stage, revenue is not there yet (hence the word pre-seed), and positive signals for the potential investors about the opportunity is their trust in you as the founding team, the quality of the research, how sound the plan is to get to the next stage "seed" and how big the opportunity is.
Expected Failure Rate:
The likely failure rate is very high at this stage. Unfortunately, there is a lack of true data of this stage (most startups at this stage only raise from friends & family and are not tracked by many of the industry sources). Here is a good summary of different data sources (https://nanoglobals.com/startup-failure-rate-myths-origin/) that explains why the general notion that 90% failure rate of startups classified as innovative is likely to be accurate.
Dilution and Funding Round:
The ideal dilution at this stage is 10-15%.
What does that mean for the round size or valuation?
If you are a B2B SaaS company and need $500k to get to the next stage, your pre-money valuation average raising that money should be at least $3 million. But if you are a life-science company that will need a minimum $2 mil, then you should be averaging around $13mil pre-money as you raise your funding.
Seed:
You have a minimum viable product (MVP), a prototype, basically something you can sell to someone, and you can complete a sale. It might not be the full product, and the opportunity is not just full yet but you have clients that want to pay you something because you are solving a problem for them. The exception here is regulated markets like Medical / Finance, where you might have the product/solution to run a clinical study or pilot, but you can not officially sell it for money. But that still means you can validate the need and use case by running a pilot or some clinical study.
Expected Failure Rate:
This is where things started to get a little more settled. One key differentiator criteria for estimating failure rate (of course, behind more predictive ones like the founders' track record, industry, business model, and such) is the amount of funding raised by the startup.
As this Crunchbase data summarizes well, once the amount of funding for the seed stage startup surpasses the $1 mil mark, the post-seed funding raising success rate increases from ~30% level to over ~55%, and given about 35% companies that get Series A to fail in the US, this indicates approximately 60% failure rate at this stage.
Unfortunately for Europe, despite the overall startup failure rate is not higher (Per McKinsey and Crunchbase 2020 reports), unlike the US ~55% Seed to Series A success (for over $1mil seed-funded startups), the figure in Europe is around 25% at best.
Dilution and Funding Round:
The ideal dilution at this stage is again 10-15%. However, my anecdotal observation of European startups, the situation is most different than the US companies at this stage. Since European companies spend more time in this seed stage than US counterparts and the Europen early-stage investor profile tends to value the risk higher than their US counterparts, my guess (unfortunately could not find any reliable Europe-specific data here) the average dilution of European seed stage companies are likely double of the US. This is one of the main reasons I would recommend European startups expand their sales and fund-raising efforts toward the US market. Otherwise, by the time a European startup company reaches Series-A, they might have too much dilution to deal with that challenge.
Series-A:
This is the stage where you have a product-market fit, at least an earlier version, with a limited vertical. There is no question that you are solving a problem, yet you are not entirely sure about go-to-market, growth, and all business model strategies. You have strong market validation and opportunities for growth, but you still need more work and testing before your strategies are solidified.
Suppose you are a company not based in the US but would like to make the US market your main sales growth engine and raise Series A in the US. In that case, you need more than just solvinge your product-market fit issue in your local base, but you also need to do the adaption for the US.
Expected Failure Rate:
Once a company reaches Series A funding level, the chances of their failure become less likely than their exit. Of course, this does not mean the exit will be successful for all investors - or even the earliest ones- but there will most likely be an exit event.
This graph from Mattemark Data visually represents how things get different from Seed to Series A for the startup matriculation rate - going up the fund raising stage to the next one-.
Dilution and Funding Round:
Series A is most likely to be the largest dilution event for the founders and the early investors. Finerva article shows that the expected dilution at that stage is anywhere from 20-25%. That is why founders must strategize their Series A fundraising well and time it to their best advantage. You would not want to do it too early, and position yourself in a way that multiple high-quality investors would compete for being the lead investors. That means you create enough value and validation, show momentum, and do not carry too much noise or baggage with regard to your CAP table, regulative ambiguity, internal founder conflicts, corporate governance, executive and financial leadership.
This is a major stage where European Founders find themselves at a disadvantage compared to their US counterparts. Given the fact that it is harder (and less likely) to raise Series A in Europe, many European Founders turn to the US Investor ecosystem. Unfortunately, they might turn their attention to the US Investors too late in their fundraising process, and the success potential of their efforts often is left to their existing European VC connections. As long as European companies do not have a stellar story, proven opportunity, and significant momentum, not being proactive and purposeful, at least a year in advance, could mean no success or, at best, worse deal terms.
Series-B, C, D, ....:
After Series A, all the following Series would mean growth, scalability and traction of business model and go-to-market strategies. The companies that will choose acquisition or IPO as their target exit will take a different path but the common goal would be about reaching to the next inflection point in terms of size, new business unit, channel or geography.
There is little different between European and US companies at this point, and often the borders become less meaningful as cross-border investors and teams start operating together. Plus, even though not all US companies will have a Europe or international plan, almost all European Startups will have an US plan for their growth. According to CB Insight Current Unicorns data, 22 of 25 top European Unicorns have a significant US presence.
Expected Failure Rate:
The expected failure rate starts reaching a negligible level after Series B and is almost non-existent after Series C.
Dilution and Funding Round:
Series B is the second most significant dilution stage for most founders and early investors (15-20%), and at each consecutive round, ratios start going down (at around 12-15% per Finerva article).
Conclusion:
I wrote the above to give a simple yet crucial big picture remainder for founders (European or US) of innovative startups as they build value (and change the world for the better) for their investors, team members, and themselves.
In the end, less than 1 in 12 entrepreneurs end their journey with a more meaningful financial result than working for someone else. And often, that does not even consider all the extra hardworking hours, sleepless nights, stress on loved ones in the form of debt, and mental challenges.
So in the grand scheme of things and especially in our current market conditions, even though the funding round terminology and facts are essential, the more important thing to remember for founders is to pay attention to what leads to failure for your startup. At least the ones they can control. And those are (according to CB Insight): Cash Flow, No-Market-Fit, Business Model, Pricing Issues, Team and Timing.
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