Mind the Gap: Getting from a Seed Round to a Series A Round
By: Kyle Welborn (Partner, Cultivation Capital)
Pitchbook recently released some great data on the average venture round sizes and the corresponding company valuations from last year. In 2014, the median seed round was $1M with a pre-money valuation of $5.3M, the median Series A round was $4.1M with a pre-money valuation of $12.9M, and the median Series B round was $10M at a pre-money valuation of $35.6M.
At Cultivation Capital, we pay particular attention to what is going on in the Midwest. Fortunately, the Midwest, like much of the rest of the country, has seen an explosion of seed funding available for startups. These seed rounds are often funded by friends and family, local angels, and accelerator programs. However, as the media has covered in depth, Series A money is harder to find. Getting your company to where it deserves a $4M+ Series A round means that the enterprise value should be around last year’s average of a $12.9M pre-money. To take a company from around $5M in enterprise value, the seed round average, to the Series A average, requires significant value creation.
Let’s take a SaaS (software-as-a-service) company as an example. A recent study done by the Software Equities Group placed the average enterprise value of a SaaS company at 7.3 time their annual revenue. To hit the median valuation of a Series A round last year, a SaaS company needs to be on a run rate of $1.767M in annualized revenue. This equates to monthly recurring revenue of $147k. We see lots of SaaS investment opportunities from throughout the Midwest at Cultivation Capital, but very few have that type of revenue traction.
Here are a few pieces of advice on how to grow your company’s value from the seed stage to the Series A stage:
Don’t overprice your seed round. All entrepreneurs want to maximize their valuation at each round, and the seed round is no different. But seed rounds are often filled by friends and family, and they are less likely to negotiate hard on valuations than institutional investors. We’ve seen a number of startups with overpriced seed rounds that struggle at getting interest from an institutional Series A investor. As a founder, you need to understand how future investors are going to value your business, and should work to price your company as appropriately as possible. Down rounds are never fun, but they are particularly painful when you have to heavily dilute your own family who took the greatest risk and invested early in your company.
Communicate with your seed investors so they know what traction will be required for you to successfully get to your next round. Using the SaaS example again, let’s say you were doing $50k in monthly recurring revenue (MRR) when you closed your seed round. To get to last year’s average Series A valuation, you will need to grow at 15% month-over-month for almost eight months. (Eight months at 15% growth gets you to $152k in MRR or just over a $13M pre-money valuation). Do you have eight months of runway? Can you sustain 15% month-over-month growth? Your existing investors are the group most likely to provide bridge financing if you get caught between two rounds. Making sure they know what is going on can help ensure you can get your company to the next value inflection point and round of financing.
Give yourself plenty of time to raise your Series A round. Almost all entrepreneurs are surprised by how long it takes to fundraise. Remember, fundraising is a sales process like selling your company’s product. Map out your prospects, get referrals, and follow-up. Providing data each month to prospective investors as your company grows is the most impressive way to get someone from the interested stage to the negotiating stage. When someone sees that you not only have a good growth plan, but are executing on it each month, it makes your company far more desirable to investors.