Size Matters in Seed Investments

big and small

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.

As an angel investor, looking at this data, it reemphasizes my interest in only participating in deals that raise enough capital. The risks are simply too great if you invest in a startup that’s only raising $200-$300k. There’s a very strong likelihood that the startup won’t make enough progress and they’ll come back too quickly for more money. So as a simple criteria — startups need to raise at least $500k for me to be really interested.

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.

February 10, 2014 Posted in Startup Fundraising by

  • David Jorgensen

    Very valuable post. Thank you.

  • http://www.instigatorblog.com/ Benjamin Yoskovitz

    Thanks David, glad you found it helpful.

  • http://context.io Bruno Morency

    the 250k$ trap is one we fell into (although our seed was 350k$ to be precise), we didn’t have enough to get to growth metrics that would get us a Series A.

    That being said, do people really get nice offices and catered lunches with such a small raise? That sounds very foolish for what is definitely a modest amount of money

  • http://www.instigatorblog.com/ Benjamin Yoskovitz

    Hey Bruno — ya, the “catered lunches and nice offices” is a bit of an exaggeration on my part to point out that I think $250k SOUNDS like a lot of money which leads to misspending and thinking you have more time than you do. But it runs out REALLY, REALLY fast.

  • Jeff Thompson

    Too many founders worry about valuation, and they underestimate the true cost of an 18-month runway. I also see a huge difference between amount of seed round north & south of the border. Maybe Canadian startups are being too conservative, or investors are more risk adverse. All said, many run out of asphalt on the runway and burst into flames. Great post Ben.

  • ThomasRankin

    agree on many of your points Ben. in Canada, we often confuse a seed round ($1m+) with an angel round and the two merge to create a ‘death round’. is it really uncommon to see companies raising $100-$200k angel rounds in the US in advance of the $1m+ seed?

  • Pingback: The Post-Funding Trough

  • http://www.instigatorblog.com/ Benjamin Yoskovitz

    I’d say Canadian entrepreneurs are too conservative AND Canadian investors are more risk adverse. But if both groups look at the data, you’d think they would say “OK, let’s go from $200 to $500k and give everyone a better chance of winning.”

    Thanks for the comment, Jeff.

  • http://www.instigatorblog.com/ Benjamin Yoskovitz

    I’m not sure if the research separates angel and seed rounds. You do see angel rounds out of accelerators–and I pointed out in the post that I’m not sure if the research includes those per se–but I think these can be pretty risky too. If you can get $200-$300k out of an accelerator, that’s pretty much seed money at that point, running the risks of burning out before you even start.

    Still, it would be interesting to dig further into the data on angel rounds vs. seed rounds and what’s happening there.

  • http://blog.bmannconsulting.com/ Boris Mann

    I am seeing Seed1 <$500K and Seed2 $500k+ – $1.XM. Angels participate in Seed1 and Seed2, and Seed VCs typically only participate in Seed2s.

    So I agree with Tomasz analysis but I also believe that labeling of raises may be an issue here.

    I always counsel for 12months minimum runway. The only exception is if there are Seed2 leads who have said to go close some customers in a 6 – 9 mo period and they will then fund a Seed2 round.

  • http://www.instigatorblog.com/ Benjamin Yoskovitz

    How many of the companies that you’ve seen got to Seed2 from Seed1? There may be a labeling issue / debate for sure (what’s a seed round, angel round, Series A, etc. – it’s all getting mashed together), but irrespective of that, if you raise too little out of the gate I think you set yourself up poorly.

    And even 12 months is tight. You raise for 12 months, which means the last ~4 months of that time you’re out looking to raise again (say Seed2 now), which means you have 8 months from the minute you raise to build enough traction to justify Seed2.

  • http://blog.bmannconsulting.com/ Boris Mann

    To be clear, I am not at all disagreeing that ~$700K is probably a healthier amount for a Seed1. I am dealing with the realities in Canada, where that is a lot of $25K & $50K checks to round up.

    In my extremely small sample size, 2 got to Seed2 so far.

    I would also say that pre a formal Seed1, convertible notes & a rolling raise are common.

    So back to semantics – not sure how we are labelling these rounds.

Ben Yoskovitz
I'm VP Product at GoInstant (acq. by Salesforce).

I'm also a Founding Partner at Year One Labs, an early stage accelerator in Montreal. Previously I founded Standout Jobs (and sold it).

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