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7 Atypical Rounds of Startup Funding: What Founders Should Know

   Jul 7, 2014
  

As the VC seed market has institutionalized, especially over the past five years, there has emerged a prototypical seed round profile: $1M-$1.5M raised, the first non-friends-and-family capital, comprised of one to three institutional seed investors or larger VC funds, on a priced equity structure (though sometimes convertible note), with a valuation mechanism in place priced in the single digit millions.

While there has been much discussion about the variances on syndicate composition and structure, and of course pricing variance, but essentially the “deal” is becoming fairly standard for all parties. The standard seed round will buy the company 12 to 18 months of runway as it looks to prove out early-stage milestones to raise a Series A before running out of cash.

However, also occurring are a set of “seed” rounds which don’t look like the above, despite involving most of the same players.  They’re common enough to become sub-categories in and of themselves, but they are just atypical enough that they’re not as commonly discussed.

The following is a list of somewhat unusual (or at least less common) seed-like rounds. Note that some institutional VC investors who invest at the seed stage may also make these investments:

The Good

Genesis Round

These rounds are designed to happen prior to an “institutional” seed. The goal is to literally start the company and begin working on a product before running a fully optimized seed fundraising process. Genesis rounds are usually less than $500K total funding for a pre-product, largely founder-only team on a convertible note. This usually amounts to less than 12 months of runway.

Typically, this kind of round features only individual angel investors, but sometimes dedicated seed funds (like NextView) will participate. My partner Rob Go blogged more extensively about this type of round, which we’re seeing increasingly often.

“Lean-In” Seed Extension Round

This situation occurs when a company has already raised a classic series seed and has successfully accomplished enough meaningful milestones that existing investors are truly excited to put in more capital — they’re “leaning in.” The round sizes are typically $1-2M and give the company the opportunity to accomplish additional milestones before they go out to raise a Series A.

Most often, these rounds are comprised of existing insider investors contributing their pro-rata, often at a moderate step-up in valuation. But sometimes, lean-in seed extensions are led by or have participation from a new outside syndicate investor which pushes the valuation even higher.

“Building” Seed Round (aka Seed II)

Some startups going through accelerators (or are involved in other catalyzing “demo day” events) and often receive new, largely outside investor interest — even if the startup has already closed a seed round. Some entrepreneurs, realizing benefits of the extremely accessible capital, will raise an additional “building” seed round of at largely more company-favorable terms than that raised just previously.  The amount can be as small as an additional few hundred thousand dollars to a $1M-$2M round larger than the original seed.

“Super” Seed Round

Entrepreneurs who have the magic fundraising touch can go out to raise a large $1.5-2M seed round and find that they have overwhelming interest from a number of syndicate players. With this strong demand and the belief that having more capital is beneficial, the company ends up raising closer to $2-3.5M in a “super” seed round from a syndicate of a handful (three to five or even more) VC investors.

Often along the way, the valuation creeps up from the original discussions given that the clearing price of supply-demand balance is higher than anticipated and the entrepreneur is “making room” for additional participants.

“Preemie” Series A

The opposite of the Super Seed, this situation occurs when a startup is further along the company life-cycle path with demonstrable traction (customers, revenue, etc.). Perhaps a genesis round was raised originally, or maybe the company was completely bootstrapped. Regardless, in this case,  the founder/CEO has the capability to raise a multi-million dollar Series A but instead decides to raise a seed round (typically with at least one dedicated seed VC) which is smaller than the available investor demand.

Usually this happens based on the founder/CEO’s stance on dilution: taking the less dilutive seed round now, combined with a presumably less dilutive Series A further down the road (given the additional milestones accomplished in the interim), will still be less net dilution than jumping to one, multi-million dollar Series A immediately. Because the state of the business resembles that of a Series A ready profile, the valuations here are commensurately higher than a typical seed.

The Bad

“Pass-the-Hat” Seed Extension Round

Cap with money

The “pass-the-hat” seed extension round usually arises when a startup isn’t as far along as it needs to be to successfully raise a full-fledged, multi-million-dollar Series A. In other words, the outlook for the company is likely questionable.  Sometimes, one or more of the parties involved try to disguise this round as the “lean-in” seed round mentioned earlier, but the distinguishing characteristic of the “pass-the-hat” round is a tougher pill to swallow: reluctant existing investors attempting to minimize the amount of additional capital put at risk, while still jockeying to position themselves as “supportive” of the company. The valuation can be a very most step-up from the original seed round, but it’s more typically flat.

Bridge to Sale/Financing

As a startup is nearing a cash-out date, the team will explore a number of “strategic options,” including selling the company.  Other times, a Series A is on track and may be soon, but unfortunately, the company will fall just shy of enough cash to make payroll before the larger capital infusion.

In cases like these, the existing investor syndicate will put together a small convertible note bridge financing that enables the startup to make all of its short-term obligations prior to the strategic event, whether a larger round of funding or a sale to another company. (Note: Because a positive event is on the horizon in some examples, this doesn’t warrant placement under “The Bad” 100% of the time … but more often than not, something isn’t going quite right at the company.)

The Ugly

Bridge to Nowhere

With a cash-out date on the horizong, and without a solid, imminent strategic event in sight, an existing investor set will sometimes put together a short-term financing as an alternative to shutting down the company. Often this round is thinly veiled as a bridge to a potential event, but in reality, it’s a bridge to nowhere: The target event has only a small likelihood of actually occurring. This type of fundraise can be the first of many similar and smaller financings which “drip-feed” the company to avoid the likely end result of a company shutting down.

For more on raising early-stage rounds of funding, subscribe to The View From Seed.

StartUpRoar
David Beisel is a co-founder and partner at NextView Ventures. He has been focused on early-stage internet and mobile startups his entire career, both as an entrepreneur and investor. He previously served as a Vice President at Venrock, Principal at Masthead Ventures, and founder at Sombasa Media, sold to About.com, where David served as VP, Marketing. David holds an MBA from Stanford Graduate School of Business. He is the founder of Boston's popular Web Innovators Group, attracting over 1,000 entrepreneurs quarterly.
  • http://about.me/brandonmarker Brandon Marker

    The title is “Atypical” but I think we’re seeing these rounds become more common and the right way to hit a real Series A raise.

    • http://sorryformarketing.com Jay Acunzo

      Brandon, apologies for the late reply. In talking with the partners here at NextView, here’s some more info — Collectively as a group, they happen quite a bit, but individually, we’re still not seeing one or two become more “recognized” or more common than the standard seed-A-B-C approach. I realize that’s a qualitative answer, but we haven’t seen any stats with more granular details. Part of the challenge is that many of these round types aren’t exactly “good news,” so most companies + investors would probably characterize or count them differently rather than what they truly are.

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