Once you get VC funding, there is no way out!

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Aug 10, 2023

Getting your first money as a startup is an extremely difficult task. It can be easy for founders to focus solely on securing their first round of funding, but it’s important to keep the bigger picture in mind. Of course, we would like to understand what hypotheses the founders want to test with the round at hand. We as founders understand that you need to juggle many different balls at the same time, but as investors, you need to take a different perspective.

In practice, we identified this to be a dangerous trap that a lot of startups tap into and never get out of again. Especially now, as times of freely flowing money are over.

Think like a VC

If you are going with VC money, founders need to be prepared to meet VC expectations, and they should start thinking about it from the beginning. Often VCs expect certain traction at specific stages of the company. In contrast to angels, they are way more data-driven, even at the early stage.

Very often, you will hear they require to reach €1 million ARR (annual recurring revenue) for a SaaS startup. Of course, this does not reflect the whole truth, but why does it need to be €1 million?

First, it is a pretty good indicator of the two most important factors:

1. They most likely achieved product/market fit

2. They identified (scalable) sales channels successfully

In addition - as €1 million in ARR is most likely achieved in the first 2-4 years after launch - the startup has probably some good data on retention. So it becomes pretty obvious that VCs use this proxy as a first decision gate, before diving deeper into the topic.

In other industries the indicators can be more diverse e.g. $5 million Revenue for a marketplace startup with >3X year-over-year growth, or >$15 million revenue and gross margins of 50% for a Direct-to-consumer startup.

Why €1 million ARR alone doesn’t matter

Next to having a clear target (induced by the VC’s expectations), it’s crucial to understand how you will get to this target. Especially today, achieving absolute numbers becomes less important in comparison to achieving them efficiently. So instead of “just” getting to €1 million ARR, you will need to get there with limited resources.

Taking against the reference on a software startup, the most commonly applied standard is the Bessemer Efficiency Score (by BVP).

Read more at https://www.bvp.com/atlas/state-of-the-cloud-2019. It’s a simple calculation to weigh achieved revenue against the spent capital.

In short, the higher the score the better. As a general indication everything above 1.5x is considered best in class, while capital efficiency around the 1x mark is still considered above average.

In addition to this macro indicator, there are of course multiple more detailed efficiency indicators like CAC (customer acquisition cost) payback and LTV (life-time-value) / CAC, which can deliver a comprehensive picture of your capital efficiency.

Avoid bridging and plan for VC readiness

It becomes clear now that early-stage founders should always start with a reality check to see if they can achieve the VC targets with their first fundraising round. Obviously, there can be multiple planned rounds to achieve VC readiness, but founders definitely need to think of a comprehensive plan to achieve VC readiness with their fundraising roadmap. If we assess a startup and see no meaningful plan forward to reach VC readiness, we often pass right away.

Planning or relying on a series of bridge rounds is often a sign of unstructured leadership, which will most likely fail due to two reasons:

1. It will take away the founder’s focus from their most important tasks (building and selling a product)

2. Often angels will not do bridge rounds (and really only should do it if there is a clear perspective for the following fundraising round)

Therefore, we often challenge why founders do not consider raising more if possible and rather take into account bigger dilution - cash is still and will be their oxygen. Hence - next to proving the key hypotheses - the angel round should show a clear way to realistically achieve VC readiness, rather than treating fundraising as a side project.

The angel perspective

Why is this important for angels? Most angels love the entrepreneurial approach of supporting good founders and their businesses, but there is also an investment side to it. As angel investors, it’s important that there are follow-on investors (e.g. VCs) that take over the lead to help the company grow in a structured and well-funded way.

Too often startups end up in “nowhere land”: They are generating some revenues, but far away from the magical mark of €1 million ARR. In addition, they still need to burn considerable amounts of money to continue their growth, while still being too unsustainable for a potential early (and small) exit.

For angels, regular and growing financing rounds enable higher liquidity by offering opportunities for secondaries and by showing a value increase of their shares. Ultimately, also for angels there needs to be a considerable multiple on invested capital (MOIC), to account for the large risk of early-stage startups.

Read more in our last story: https://www.jvh-ventures.com/stories/why-3x-is-not-enough-return

Conclusion

In conclusion, discussing the next round of fundraising with VCs can provide startups with a better understanding of their trajectory and targets for future growth. Adopting the VC mindset, reality-checking targets, and raising more money at the beginning can all help to ensure a startup’s long-term success. As angel investors, we value follow-on investors who can help to grow a company in a structured and well-funded way.

Are you a founder and don’t know how to think about your valuation?

Hit us up, we are happy to give feedback: www.jvh-ventures.com/pitch