What's In a Letter? Or, The Fallacy Of Round Nomenclature.

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Of the companies we looked at in 2017, 48% were raising a Seed, 52% a Series A or later. Based on this information, you have some sense of the types of companies with which we spend our time. But round nomenclature has become increasingly arbitrary and less relevant to how we segment opportunities. The meanings of Seed, Series A, Series B, and other round terms have changed in the last three years and will continue to morph as new technology is introduced and startup costs change.

Much the same way averages in statistics mask the most interesting information about datasets, the round nomenclature process used by most founders today ends up obfuscating important operational milestones. More fundamentally, it shouldn’t be important to entrepreneurs what a company calls a round - instead a round should be about bringing the right partners and right amount of capital into a company to achieve milestones and de-risk the opportunity set.

The letter of a round in its simplest form is a measure of the number of times a company has raised equity financing. However, in the last few years we’ve seen even that logic break and round nomenclature morph into more of a distraction for early stage teams. The rise of terms like Pre-Seed and Series A-1 reflect an evolution in early stage capital strategy but not substantive changes in asset classes. It is true that the naming of a round can be helpful filter for entrepreneurs to sort through potential investors. Yet, merely knowing that a firm is a “Series A Investor” is no longer enough granularity to understand potential investor-company fit.

Instead of round letters, founders should think in terms of milestones on the path to inflection points. A more accurate representation of stage is whether a business has built a minimum viable product (MVP), begun the process of testing and customer segmentation, determined product-market fit, or started to scale. Inflection points can come at different round letters depending on the industry and business model of the company, so creating a broad standard for round letters can’t work. For example, healthcare and insurance businesses usually take more time and more capital to reach many of these milestones, which should be reflected in their capital strategy.

Round letters can sometimes be a useful shorthand for broad categorization of companies, but it is just that: a shorthand, and not something on which we encourage entrepreneurs to focus as it’s not something on which we constrain our investment decisions.

Examples of the chaos

To explain why entrepreneurs’ time is better spent outside of naming their round, we submit a few examples of how the name of a round can be distracting:

  • Seed is the new Series A. It’s widely acknowledged that seed investments today look like Series A investments did a few years ago—more than two-thirds of seed deals in 2017 were between $1m and $5m, according to PitchBook. A “Pre-Seed” round, by contrast, is sized roughly where Seed used to be, in the high six figures. Further, technology advancements allow entrepreneurs to start businesses with less capital, meaning that investors that write sub $1M checks are moving into earlier stages of businesses to stay competitive.
  • The rise of Pre-Seed. The behaviors of Pre-Seed investors are not new, even though the term has been popularized in the last three years. They are investors that get involved very early – usually pre-revenue or even pre-product. In the past, this level of risk was taken by angels, friends and family rounds, or other early advisors. Now, as round sizes have gotten larger, Series A investors have less comfort with uncertainty. They want to see product-market fit earlier, hence a need to raise Pre-Seed capital or multiple Seed rounds. The creation of this expansion in vocabulary is a reflection of the fact that seed rounds have gotten larger, but this isn’t a new asset class.
  • What does Series G even mean? The last time Uber raised a primary equity round, they called it a Series G. While there may be some mental models to understand what a Series A company should look like, there aren’t ones for rounds later in the alphabet. We don’t agonize over the names of later rounds, and so suggest entrepreneurs don’t do that in the early rounds, either.

An alternative rubric for finding the right investor

If the letter of a round isn’t a complete segmentation for entrepreneurs to use when considering potential investors, what factors should they consider? Fundraising is a time-intensive effort. so understanding quickly if there is potential investor-company fit can save weeks or months of time. There are three major areas where entrepreneurs should look for alignment:

  • Average check size. The typical check size of an investor is usually a better single measure of fit than round letter. The two are certainly correlated, but typical check size relative to round size gives founders a clear indication of process and the types of risk they usually take.
  • Focus of the fund. This is one of the most overlooked and easily searchable metrics for founders to pre-screen investors. Investors have fund mandates and focusing time on investors that are interested in a specific topic will streamline fundraising. When there’s fit with a fund thesis area or interest, entrepreneurs usually know early in the process.
  • Alignment with what the entrepreneur wants from the investor. When an entrepreneur brings on a new investor, she’s hiring a team member she can’t fire. As such, investors and entrepreneurs should be very closely aligned on the goals and structure of the relationship before any deal is signed. An entrepreneur should look at what skills, resources, and expertise an investor can bring to the table—e.g. experience scaling companies rapidly or a strong network within a certain industry. She should also consider how much she wants the prospective investor to be involved in the actual building of her business. Some investors prefer to see an entrepreneur execute more or less independently on her vision while providing occasional guidance and oversight; others take an active role in strategic planning and decision-making. As a guideline, make sure you are bringing in investors and board members with the specific skills you expect to need for the next 2-3 years of the company’s development.

In summary

Too often we see entrepreneurs focused on the name of their round vs. conveying how achieved milestones reflect an inflection point in their businesses. It’s important to be specific about what information the letters in rounds actually convey as well as what nuances they erase. That’s especially true as the lexicon expands and meanings shift. In determining the capital strategy of a company, entrepreneurs should plan for what it costs (with cushion) to achieve specific milestones. Similarly, when trying to find an investor who will fit those capital needs, entrepreneurs should consider more specific criteria than arbitrary letter categories.

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