From One Round to Next
Last week, we spoke to two portfolio companies, and one of the topics we discussed during both meetings was what goals and timeline to work backwards from for the next round. It’s an exceptionally important part of a startup’s journey, so I thought I’d share how to approach this.
But first, some important context: we invest at pre-seed/seed, which means that the next round for portfolio companies depends on achieving product-market fit. My focus with this essay is going from seed to Series A. As you graduate to Series B/C, the goals shift to revenue scale, improving margins, and expanding to multiple markets. However, the broad framework still holds.
There are two parts to it: hitting business goals while managing burn, and fundraise timelines.
Business Goals
I’ll start by sharing examples from our portfolio of how companies in different sectors defined their product-market fit. We practically invested pre-product in all of them:
- Consumer brand – X monthly revenue with cumulative burn under Y
- B2B AI SaaS – X ARR, and Y revenue retention
- Consumer social app – X user retention, Y user base, CAC under Z
- AI services company – X live projects, Y repeats, and Z gross margin
- Modern retail chain – X stores, Y revenue, Z inventory turns
X, Y and Z are placeholders for specific numbers.
The tricky thing about PMF is that it will be defined differently by different investors. However, it’s important that, whatever your vision for the startup, you pick the most important 2-3 things, which if you can validate, mean that what you’re building is valuable. Put another way, these are also the existential risks to the business, which you must de-risk.
You will have to pick your own metrics that define the business goals, and target values to track progress. I’ll share a heuristic to help you with this; it’s usually a combination of 2-3 things:
- revenue – either absolute, or indirectly through the most important revenue driver (# of users, # of orders, etc.)
- then, stickiness – through revenue retention, repeats, or user retention
- cost side – usually your most important costs (for ex: COGS, CAC), or profit margin (gross margin, contribution margin)
I acknowledge that with the initial 2-3 fundraises, it can be confusing because there’s ambiguity around what goals you can hit with how much capital you have, and how much capital you can raise based on what goals you’ve hit. Here, your investors can be helpful as they keep talking to other investors in the market.
We work with our portfolio companies to help them figure out what are the most important things to prove, what kind of traction (quantitative) and validation (qualitative) next round investors would want, what size of raise can make sense, and how companies are likely to be valued. Your next round size depends, to some extent, on your previous round size.
For example, if your first round was <$1mn, your next round is likely to be ~$2-4mn. But if your first round was $2-3mn, then it would make sense to target $6-8mn in the next round. And of course, your progress needs to justify your ask.
Managing Burn
Business goals usually come down to some version of achieving a certain scale within certain spends. We’ve seen companies manage their burn in two distinct phases.
During the first phase, your goal is to iterate as quickly as possible to progress on the value proposition (product), customer acquisition (go-to market), and operations. Here, you should keep expenses to the bare minimum. Practically, your runway could be as much as 4-5 years as you validate your business at a micro-level.
Once you see enough pull from the market, then you start scaling – you invest more in team and operations, and increase spends to acquire more customers. The litmus test here is that revenue should grow – if it doesn’t, you probably started to scale prematurely. Given the spends at this stage, runway comes down to 12-15 months, and ideally within 6 months, you should hit your goals with clear momentum.
There’s an implicit understanding here that in order to hit these goals, your product, distribution, and operations must continuously improve, which is the qualitative progress. It’s important for you to understand and articulate these aspects well because these will answer what’s working, and how you were able to hit those goals.
Fundraise Timelines
There are two steps in this: first is getting a termsheet, and then from termsheet to getting cash in the bank. On this, I’ve seen founders make two common mistakes:
- They start the fundraise process when they have 6 months of runway. It’s important to understand that even once you sign a termsheet, it could still take 3-4 months to get the money in the bank, and getting a termsheet/finding investors takes time. Ideally, you should start your fundraise when you still have ~9 months of runway.
- They spend too long fundraising. I’ve seen founders spend 6 months in the market and still be unable to get any commitments. Instead, prepare well and run a tight process over 6-8 weeks. If by then you don’t have a termsheet (or at least IC-level conversations), it’s much better to go back to building, and go back out once you have stronger traction/validation.
The key to timing the fundraise is to balance showing strong momentum on traction, which makes the business exciting, while having enough runway to reduce burn, in case the fundraise doesn’t materialise.