Tomasz Tunguz has done a great analysis of the likelihood of follow on financing based on the size of your seed round. You need to check it out, and just read his blog in general, it’s awesome.
What Tomasz has found from analyzing thousands of deals (from Crunchbase) is that there’s only a 12% chance of raising a Series A if your seed round is $300k or less. If you raise between $300k and $600k, you double your odds of raising an A round, and if you raise between $600k and $900k you raise your odds to 33%. After that, there’s a diminishing return on raising more capital.
So what does this tell us?
In the Fall of 2011 I wrote, The $250,000 Funding Trap. I didn’t do any scientific research, but I had seen a lot of startups fail because they ran out of money too quickly. My experience was that $250,000 was enough to give founders the impression that they had a lot of money (and a lot of time), so they spent too liberally, and subsequently never got the traction they needed to keep going. If you give an entrepreneur $50k (say in an accelerator) they pinch every penny and get very creative. When you give them $250k they suddenly have a nice office, fancy chairs and catered lunches. I saw (and still do) a lot of startups that were Startup D.O.A.
As Tomasz points out, “The data indicates that larger seed rounds substantially increase the odds of raising a Series A. More runway implies better odds of success.”
This just makes sense. Startups almost always take longer and cost more money than expected. And raising a Series A round means having legitimate traction, which you won’t get in a few months after raising too little money. When you raise too little, you’re forced to get back out on the roadshow too quickly, which is a further distraction from building your business. It’s a death spiral.
Unfortunately, a lot of founders start by trying to raise too little. It’s particularly true in Canada (and I suspect other places outside of Silicon Valley and New York). The thinking is that it’s easier to raise a smaller amount (which is far from universally true!), and you can prove what you need to pretty quickly. Of course, you then hit some kind of snag, things don’t work out quite the way you wanted, and a few months in you realize you have to start fundraising again. But you haven’t proven enough and you’re stuck. I also think too many founders don’t have the guts to ask for more. Most of the time when I meet entrepreneurs about fundraising I tell them to raise more. Even if they don’t get what they’re asking for, it forces them to think bigger and act braver. Investors can tell when you’re hedging your bets, and they’re going to hedge theirs too (by not investing).
One thing that’s not clear about the research that Tomasz did is whether or not it includes the money that (some) startups receive after leaving an accelerator. That can amount to $100-$200k depending on the accelerator and the deal they have with investors. I don’t even look at that money as a seed financing–it might be the start of it, but it definitely shouldn’t be the sum total you raise at that stage. If you can’t get more than the guaranteed amount you get from leaving an accelerator, there’s a problem.
Tomasz has done everyone a valuable service by doing the research. If you raise too little (specifically < $300k) you've got a very small chance of raising a Series A. Financing doesn’t equal guaranteed success by any stretch of the imagination, but most startups need at least a couple rounds before they even have a chance of winning. If you can’t get to the starting line (e.g. raising enough seed capital, and then a Series A), why even bother? You need to ask for more capital. And I’ll re-emphasize this point for Canadian entrepreneurs. You need the vision, plan and team to believe that you’re worth more than a small seed round, which is likely dooming you before you’ve even started.
Photo courtesy of marinacast.
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