Minimum Viable Raise

I was recently with a friend who has been a seed investor for the good part of the last decade. I asked him what he learned during the latter half of that time which wasn’t obvious the first few years. His answer struck a chord with me. “More companies that should have raised seeds raised pre-seeds.”

Nomenclature is weird, and I even get confused what the difference between pre-seed and seed is. My friend conveyed that some companies did not raise enough capital from the outset (perhaps they raised <$2M) to actually get market signal or de-risk their businesses sufficiently enough. Perhaps the 10x better solution for that market segment necessitated a longer product build or the company operated within an industry with longer cycle times. Without the right cash runway, founders would get distracted and have to go back to fundraising markets. In a more liquid and frothier financing market, seed or series A investors would fill the gap without needing external proof points and companies could get to the other side – deploying better products after appropriately investing $5M - $7M upfront. 

I have personally struggled with this question. I was (still am!) a huge believer in constraints. I generally think companies raise too much money. Selfishly, smaller financings are better for the pre-seed or seed fund model. There is higher ownership for a small amount of dollars and a large portion of the fund vehicle isn’t allocated to a single company upfront. I was always annoyed when multi-stage funds offered the classic $4M on $20M post or $5M on $25M post to a company I thought should’ve had a $10M - $12M valuation. It puts pressure on our business model. 

Yet, there’s a danger. That danger is to approach these initial startup financings through the lens of the local maxima for our business model and not the first principles view into how much the company needs to get an adequate product into market or have the time to introduce a better solution. There is increasing evidence to support that startups may raise a little more, not less, upfront. 

• As software markets mature, buyer expectations have gone up. They will experiment with point solutions, but purchase platforms. 

• Venture-backed software companies now operate (and can make a dent in!) traditional industries like manufacturing, life sciences, financial services, legal, and more. Customer education is expensive, sales cycles are long. 

• The primary input cost (labor and talent) for a startup does not seem to be getting any cheaper. 

• Founder know-how with investors / VCs is widespread, and the culture of startup fundraising has disseminated. One could make the argument that the quality entrepreneurs of tomorrow will know how to raise more at better terms. The reality of what founders are willing to take just looks different. 

• Compute is playing a bigger role in terms of use of proceeds. Although, I think this is a *very* slippery slope. 

• If you poll Series A investors about how much money they think startups need to get to PMF, the numbers look closer to $3M to $6M than $500K to $2M. 

• Many of the recent growth darlings raised more than you’d imagine out of the gate to get to market. Think Wiz, Anduril, Ramp, Rippling, Databricks. 

There’s possibly no radical change going forward with what I outline – maybe a company that would have raised a $2M pre-seed raises $4M out of the gate. I’m just trying to be open minded, and I maintain investment products should mold and bend a bit to meet changes with the underlying asset classes.

So, where does this go wrong? Where can one get tripped up? For founders, they need a strong opinion as to why whatever they produce with seed proceeds will matter for that end market. That juice needs to be worth the squeeze, and there’s an argument to be made that these types of initiatives represent true venture bets going forward. And for investors, they will need patience. A product-first worldview to investing requires *a lot* of patience and shared context with the entrepreneur(s) because conventional signals (like revenue, customers, usage metrics) may not rear their heads for a while.

Post a ZIRP-fueled funding bonanza, the irony of writing about how companies could and should raise more capital in 2023 is not lost on me. But to that point - perhaps the answer was “too much scale capital and not enough startup capital.”