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Startups And The Series A1 Trap

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Hit the magical $1M ARR a year after your A but not so sure if you should be raising a B? And at the current burn your cash is going to last for 6 months more since you had actually raised for 18 months? And unsure whether you should call this round A1, A*, pre B, or something else?

I call it the A1 Trap — hence the homage to Admiral Ackbar from Star Wars. Before we discuss further let’s first clarify a framework.

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Image Credit: redpepper

Framework – What Do Round Terms Really Mean

The nomenclature has got very muddled — why is a company raising a $10M called seed but another raising a $5M is series A? The framework below is grounded on the thinking that what you call a round is not about the amount but what you use the cash for:

Pre Seed : Powerpoint
Seed : Prototype
Series A : Product-Market Fit
Series B : Business Model Traction

Typically between series A and B is when you start making money, and what investors look for especially is the first derivative (i.e. what is the growth rate).

The Trap – The Three Challenges And Their Solutions

Businesses with a strong consumer element can usually avoid raising an extension to this because the expectations are more about growing market share than revenues. But enterprise or really any business with SaaS is infamous for getting companies stuck at this stage. If your vertical has long sales cycles, such as health or cars where 9-18 months is typical, then even higher risk.

The Trap happens primarily because of a combination of the three challenges below. There are also easy ways in principle to mitigate or completely avoid it:

# Challenge Solutions
1 didn’t raise enough in the A instead of the typical 18 months, raise more in the A so you can go for 24 months under current projections.
2 revenues don’t grow quickly enough work on longer-term contracts earlier, grow existing contracts, close new contracts even if they are smaller.
3 burn is too high give employees the option to trade salary for equity, reduce salaries, leverage lower-cost labor, reduce salaries, downsize team.

Goes without saying the solution for reducing burn are listed somewhat in order of increasing pain and have high consequences on morale and in turn productivity. Which is why best to avoid the problem (#1) or mitigate it early (#2) than have your hand forced (#3). If you are stuck in terms of fundraising and have exhausted all the solutions above then consider selling part or all of the business. 

So You Got Trapped, What Now?

The 1-year mark after the A is really the watershed since a typical investment negotiation takes three months. If you don’t foresee being able to do within that time frame then it may take three months just to get the company ready for a partial or full sale. Which is why a good palliative for the A1 trap is to purposely pursue a dual-track of investment and M&A.

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Finally, you can call it your favorite term but in general if it’s an extension at the same terms then A* is the more common term, an upround is an A1, and a convertible towards the next round is a pre B. That said, a pig with lipstick is still a pig — savvy investors see very quickly through jargon and it’s best to be upfront to save yourself the time. If your existing investors are supportive it is often easier to just do an insider round. If you can get a new investor to lead even better. A common narrative is about a strategic coming in, which also accelerates a partnership (i.e. more revenues leading into the B). The key is to get out of the trap as quickly as possible even if it means taking a suboptimal path, because otherwise it really becomes a self-fulfilling prophecy and the most common route to a downround, recap or even company closure.

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Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.

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Amit Garg
I have been in Silicon Valley for 20 years -- at Samsung NEXT Ventures, running my own startup (as of May 2019 a series D that has raised $120M and valued at $450M), at Norwest Ventures, and doing product and analytics at Google. My academic training is BS in computer science and MS in biomedical informatics, both from Stanford, and MBA from Harvard. I speak natively 3 languages, live carbon-neutral, am a 70.3 Ironman finisher, and have built a hospital in rural India serving 100,000 people.

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