As seed rounds have atomized, it’s not uncommon for founders to raise 3 or even 4 rounds prior to a series A. These include angel rounds, pre-seeds, institutional seeds, second seeds, pre-A, etc.
The reality is that if a founder raised every one of these rounds, and lead investors always got their “target” ownership, the level of dilution would be ridiculous. No good investor would want the founder/CEO of a company to have insufficient ownership by the series A, and every founder I know is sensitive to taking too much dilution.
So, if a founder is going to avoid this level of dilution, the question is “which round to skip?”. Or, if you can’t skip a round, when should you try to work extra hard to minimize dilution and when should you be prepared to take more dilution for the right partner/situation? I think the answer to this depends on a bunch of factors, but here’s an effort to simplify into three broad buckets.
1. Founders with limited experience
If you are a founder with limited experience, you probably don’t have the ability to skip the pre-seed for practical reasons. Also, the benefit of raising a pre-seed from great partners probably outweighs the cost. Hopefully, by bringing on strong partners early, you will get great advice and support to minimize your overall dilution down the road.
The challenge here is that inexperienced founders sometimes get the worst of both worlds. They find weak pre-seed investors or angels who are almost predatory in their early stage pricing and add no value. You want to be very careful in selecting your first investors, and make sure that whoever you work with has a great track record of helping companies at your stage.
A quick rule of thumb for me is that the more complicated the deal terms sound for a pre-seed, the more you should be wary. Pre-seed investing should be super simple, so any signs of pro-rata rights, tranched financings, charging the company for value-added services, etc. should be avoided.
As an inexperienced founder, you are very likely to take at least two rounds of financing before a series A, so the round to try to skip is any sort of second seed. This means being really conservative with your cash burn early on until you have clearly found product/market fit. As a first time founder, having a few million dollars in the bank after a successful seed raise may seem like a huge amount of capital, and it’s easy to lose discipline around your burn rate.
But the best founders I know almost always operate as though they have much less money in the bank, and won’t scale burn until they are super confident in their product/market fit.
2. Experienced founders: B2B
For an experienced founder building in B2B, the round to skip is the pre-seed. The reason is that b2b fundraising is largely driven by data and metrics, and pre-seed dollars usually don’t get you to many meaningful data points. Some very early dollars may be required to assemble the early team, in which case I’d lean towards bringing on some angels who are willing to invest in a company at a very favorable price.
I’d keep the dilution really low at that stage, and focus on very cheap customer development tactics or even a hybrid services model to test out your initial hypothesis without requiring meaningful outside funding.
Further down the road, I find that second seeds are often necessary to help B2B companies achieve a really strong series A, even for companies with solid PMF. Most series A’s in B2B require a minimum level of top line revenue and a minimum amount of historical data to prove retention and some sort of repeatable growth engine.
This usually takes a non-trivial amount of capital and time, and the more your metrics can separate you from your peer set, the more likely it will be that you can attract stronger series A investors at a superior price.
3. Experienced founders: Consumer
For a Consumer business, fundraising is largely about finding true believers who really resonate with the product, team, and mission of the company. Early stage fundraising is about raising money on promise, but it’s even more the case for consumer companies. This means that the right pre-seed or seed investor may get excited enough to jump in and lead a round at a fair price pre-product.
Similarly, the right series A investor is probably going to be the one that falls in love with what you are doing well before you hit the typical metrics one would expect for a series A stage company. Unlike in B2B, you don’t necessarily want to use a second-seed round to get to metrics that every investor will appreciate. You are better off running a broad process for the series A to find the investor that is willing to extrapolate from a smaller data set and get involved earlier.
In any of these cases, there isn’t a standard path that all companies take. There are always exceptions, on both the positive and negative side, and many companies really shouldn’t be raising venture capital at all. But if you are building a venture backed business, it’s more likely today than ever before that you’ll need to raise a couple rounds of financing before your series A round.
Hopefully, it will just be 2 rounds of financing at the most, and you won’t end up selling 80% of your company just to get there.