Attracting the First Round of Institutional Capital – Series A

The initial capitalization of most new technology companies comes in the form of founder’s capital, friends and family, individual angels or angel groups. As a result of advances made in development tools for building high caliber websites, it has become considerably less expensive for start-ups to build prototypes and eventually scalable companies. Seed and early stage capital if used appropriately is now enough to build an early quality product and the beginning of a loyal user base.

However, even with early stage funding taking companies farther along, for start-up technology companies to really succeed, additional rounds of capital are usually necessary. The first round of institutional capital is called a Series A round.  This Series A round typically ranges in size from a few million dollars to $15 million.  Venture capitalists are professional investors who invest for a living and their main goal is to make money for their limited partners.

CONTACTING A VENTURE CAPITAL FIRM

 From the entrepreneur’s perspective, building relationships with future investors is very important and critical to your company’s long-term success. Even though you think that you do not need capital at the moment, pitching your company to the right investors should be a goal. Get to know the right venture capitalists over time, who you believe will a good fit in the future for your start-up.

VENTURE CAPITAL EXPECTATIONS FOR A SERIES A ROUND

Attracting capital from a venture capital firm requires a rigorous due diligence process. Venture capitalists must follow strict investment guidelines and mandates and always have a fiduciary responsibility to their limited partners.  Venture capitalists need to see solid evidence that the target market wants and needs your product. They want to see a business model built on a large potential market that can be both profitable and repeatable.  They want to see that your company has the chance to scale and has a better chance of becoming the next billion dollar company than other companies competing for their funds. Venture capitalists spend a great deal of time analyzing customer acquisition costs. As companies scale, customer acquisition cost should certainly decline and be far less than customer lifetime value.

Venture capitalists today that are funding Series A rounds expect to see companies that are more further advanced than ever before and are beginning to show significant momentum in terms of user numbers and customer revenues.  The bar for customer traction is in the range of $500K to $1 million in monthly recurring revenues. Month over month revenue growth should be in the range of 20% - 30%. Customer acquisition costs and the time it takes to clear a transaction should both be trending downward. Remember, most venture capital funds have a finite life and as a result they must ensure that the management team of any of their portfolio investments can build a great company in the typical 7-10 year fund life.

Building a great company, usually involves a great team. It is sometimes an overused phrase, but venture capitalists “invest more often on the jockey and not on the horse.”  Venture capitalists are certainly excited to see investment opportunities that involve big markets and experienced and passionate teams. Founders that have had successful exits and have assembled the same team for a new start-up, usually have an easier time raising venture capital funding. No venture capital firm will ever turn down the opportunity to meet with a company that has a unique idea that could possibly change the world.

THE COST OF A SERIES A ROUND

When raising seed rounds of capital, it is very important not to give away excessive equity, which might threaten raising your first institutional round of capital.  Venture capitalists want to make sure that after a Series A round, the founders retain enough ownership to keep them motivated.  Every start-up situation is different, but founders typically should not give away more than 15% of their company during the seed rounds and probably not more that 25% during the Series A round. Remember many successful start-ups have additional funding rounds beyond the Series A round and thus additional dilution for the founders. Dilution is not necessarily bad, since the company is getting bigger with each round. However, since dilution does cause founders to lose control of their company, they should only take investor capital when they really need it and take it only from investors that they respect and agree with strategically.

Most venture capital backed companies also have a stock option plan set up for founders and other key employees. They receive a portion of their compensation in company stock and these stock options act as a significant incentive to encourage employees to continue to diligently work to build a valuable company.

_{Note:  Article published in February 2015, TechNews, a publication of New Jersey Technology Council, Vol. 2, Issue 2.}