The Series A Wall And Why It's Good For The Venture Industry
Originally published on Forbes
Today, it’s harder than ever for a startup to move from seed stage into growth stage by raising their Series A. The growth metrics required to raise a Series A have changed, and growth funds have been hit by the recent downturn (although that seems to be improving).
Bridge Rounds
The result is that many successful seed stage startups that have hit growth milestones need to secure bridge rounds in order to reach the newer, higher metrics Series A investors want to see. This year, I have seen more seed bridge rounds than ever before. It’s a historic shift, and it’s important that founders and investors alike understand how to navigate this emerging dynamic.
It’s not all doom and gloom, and there might even be a silver lining that this intermediate funding round should become more normalized for the overall health of the industry and ecosystem.
A lot of big funds got burned over the last few years by investing in huge Series A rounds for startups that didn’t actually have what it took to survive an economic slowdown. That’s concerning because at that point in the startup journey, the companies should be transitioning from finding a product-market fit to developing robust sales pipelines and managing cash in a sustainable way. That’s a tough balance to strike!
Risk Growth
It’s possible that the metrics historically used to measure which startups are ready for a Series A round weren’t granular enough to reduce the risk growth investors face. In fact, I believe that’s precisely why we are seeing so many bridge rounds happening.
Early stage funding comes in the form of smaller checks at lower valuations relative to growth rounds. That creates a much different risk profile compared to Series A through C funding.
When it comes to growth financing rounds, the checks get much, much bigger, and the amount of equity per dollar that those checks buy is reduced relative to the earlier stages. Presumably, the risk to growth stage investors is mitigated compared to pre/seed stages—i.e., these startups have a proven, robust product and a clear path to significant revenue growth. This reduced risk allows investors to write larger checks for less equity.
As the risks to revenue growth increase from, say, macroeconomic trends, the ability to justify these bigger check sizes diminishes. Just a few years ago, a startup wanting to raise a Series A had to be earning about $1 million a year in revenue. Today, investors often want to see $3 million. That’s a big gap, especially if the founder was raising previous rounds with the goal of spending the amount needed to reach $1 million in revenue.
Shifting Dynamics
So, founders are now cutting deals with a mixture of their early stage investors and the growth stage investors they want in their eventual Series A to bridge that gap.
These shifting dynamics aren’t necessarily a bad thing; in fact, they might produce a much more battle-tested group of startups moving into growth rounds.
It’s also creating a healthy dynamic of blending the early stage investors who take a much more hands-on role in their portfolios with the bigger, growth stage funds that are specialized in taking startups to IPO.
The opportunity for early stage and growth stage funds to collaborate in bridge rounds is good for investors, good for founders and good for startups. It’s providing solid companies with a more linear transition period to achieve growth with an extended window to acclimate to two investor circles with each other. The collaboration between early and growth stage venture funds also benefits VCs, because early stage funds are getting more equity in the startups they believe in most, and growth stage funds are getting more equity for their money, with a reduced risk profile.
It wouldn’t surprise me to see the seed/Series A bridge becoming standard practice, even when the economic environment is in a full-on bull cycle. In fact, I’d like to see that because it’s contributing to a healthier, more vigorous and sustainable ecosystem overall.