You’ve raised your seed funding round and are on the path to Series A — Your startup shows promise! Investors have taken note. That’s fantastic, and we’re excited for you. But we also want to make it clear: Nowadays, to be a successful startup, you need to get right back to thinking about how you can spend that seed funding as wisely as possible. And you need to start thinking ASAP about how you’ll ensure your startup is deemed worthy of any additional funding.
Why the super-practical downer advice? While more startups than ever are getting seed money, fewer than ever are getting follow-on funding. So that Series A funding you’re hoping for? It’s not a given.
Also, as accelerator Y Combinator always advises its startups, it’s not your money. Getting more money is dependent on showing you can be a smart spender with good margins and a sustainable business model.
Let me explain.
What’s the “Series A Crunch”?
Analyzing Seed vs. Series A Funding
The venture capital community coined the term “Series A Crunch” to describe a trend they saw in Series A funding. Essentially, they noted that, while huge numbers of startups were easily raising large sums in their seed rounds, much fewer startups were moving on to have successful Series A rounds. In the big picture, that means:
- More startups are getting more seed funding.
- More startups are competing for Series A funding.
- PE and VC investors are becoming more selective, providing Series A funding to fewer startups.
- Increasingly, startups only receive Series A funding if PEs and VCs assess that they’re low-risk, high-reward business models with demonstrated traction in a growing market.
And therein lies the “crunch.” What does this mean for a successful startup looking to create sustainable competitive advantage?
Higher Expectations and Higher Stakes
The expectations for seed-stage performance are now higher. Only some startups will meet expectations. For example, VCs and PEs increasingly expect that seeded startups should be generating revenue before receiving Series A funding.
TechCrunch offers up a compelling analysis from Silicon Valley VC firm Wing. In 2010, only 15% of seed-stage companies that had raised Series A rounds were already making money. Compare that to 2019, when Wing’s data shows that “82 percent of companies that raised Series A rounds from top investors last year are already making money off their customers.”
What does this mean? VCs and PEs are unlikely to offer Series A funding to startups that aren’t showing sufficiently solid evidence of market traction. If a startup can’t show the potential for significant growth in both revenues and customer base, that follow-on funding is unlikely to flow.
The stakes are high, and the risk of failure is even higher. CB Insights found that “nearly 67% of startups stall at some point in the VC process and fail to exit or raise follow-on funding.”
What Are the Series A Business Risks for Startups?
VCs and PEs aren’t interested in funding risky investments. That’s why smart startups are focused on reducing their business risk, and on identifying sources of competitive advantage.
Risk impacts countless areas of any business. Below, we’ve covered the three most important business risks for startups looking to raise Series A funding.
Business Model Risk: Growth Matters
How’s that business model looking? Long gone are the days when a sparkly new idea was sufficient to generate funding beyond the seed round. Nowadays, to make it to Series A, startups must have business models that demonstrate traction in several key areas, including:
- Revenue growth: As mentioned above, even early-stage startups are expected to start making money. The next step is showing that the business model can create sustainable revenue growth.
- Customer growth: Are your customers out there? Even more importantly, will they buy your product? And can your customer base continue to grow?
- Market share growth: Can your business model compete and win in your chosen market?
Before VC and PE investors are willing to follow you to Series A, you must derisk your business model as thoroughly as possible in these areas. If investors don’t see a strong, data-backed business plan that shows clear potential for growth, they’ll mostly see… risk.
What you can do:
- Reality-check your business plan, examining your assumptions. Can you test your assumptions? Are they sound? For example, can you demonstrate that your market is large enough to provide the type of growth investors seek?
- Fully assess barriers to entry. How does your product stack up against the competition? Is your product truly differentiated against competitor products?
- Build out your business plan with as much data as possible. If the economics don’t make sense, investors are going to run the opposite direction.
Technology Risk: Speed Matters
Nowadays, technology development is part of a high percentage of startup business plans. That means VC and PE investors must consider the time, expertise, and resources required for design and development. After all, these variables all inform a startup’s technology risk profile.
When assessing startups’ technology-related business risks, VCs and PEs are likely to focus on:
- Development scope and type. Does your startup need to build technology from scratch, or can it leverage technologies that are already available? What alternatives already exist in the market, and is your product differentiated in meaningful ways? What is the risk that you’ll be unable to build the technology? Does your product rely on third-party services? What happens if those third-party services go down?
- Development speed. How quickly can development happen? How likely is it that development will take significantly longer than anticipated? Can you build and iterate quickly enough to deliver a reliable, functional product to customers?
- Development expertise. Do you have access to the expertise and skill sets you need to develop the desired technology?
- Development process. Do you have strong, proven, efficient processes in place?
- Compliance, security, and intellectual property risk. What legal or regulatory risks impact development? Do you own all of the code?
After all, nothing changes the basic, underlying assumption that — in order for your startup to succeed — you need to meet the demands of your customers, delivering a product that works.
What you can do:
- Make sure you’re prepared to answer all of the above questions. VC and PE investors will ask them. While development efforts always involve a degree of uncertainty, they want to see that you’ve put thought and planning into mitigating your business risk.
Competitive Advantage: Leverage Matters
The technology industry moves at lightning speed. New products enter the market every millisecond. Amidst this crowded, ever-evolving market landscape, how will you ensure that your product gains — and retains — competitive advantage? How can you differentiate your product against similar products?
Successful startups need to identify the sources of competitive advantage within their product. To achieve this, Redpoint Venture Capitalist Tomasz Tunguz recommends a strategy he calls startup judo.
Startup judo involves two main tenets:
- Never oppose strength with strength. It’s not enough to help you win.
- Maximize leverage. It’s crucial to identify your opponents’ strengths and weaknesses. Tunguz explains, “By attacking the weak points and matching them to customer needs, a startup creates maximum leverage.”
Ultimately, says Tunguz, successful startups are able to identify and leverage a competitive strength that fits their unique assets. Often, those competitive strengths address their competitors’ weak points.
What you can do:
- Perform a SWOT analysis of your product vs. your competitors’ products. If you’re unable to identify your strengths relative to your competitors’ weaknesses, you’re unlikely to demonstrate the kind of leverage investors are looking for.
- Be prepared to explain how your business plan capitalizes on your strengths and exploits competitors’ weaknesses. Get specific. Without true differentiation, your product will go nowhere.
What Matters to VCs and PEs at the Series A Stage?
Being a Revenue Engine
In the “no-duh” statement of the millennium, let’s repeat this bottom-line assumption: VC and PE investors are focused on making money. That’s why, by the time Series A funding is on the table, they’ll need you to prove your product is a moneymaker.
So you’ll need to SHOW THEM THE MONEY. Show them you can turn out a positive profit margin. Show them the size of the business opportunity. Show them that people will buy your product.
You can do this via business metrics. In your proposed market, by what metrics do businesses evaluate their success? Examples include:
- Profit margin metrics, including net profit margin, gross margin, and monthly profit/loss
- Revenue metrics, including sales revenue, monthly recurring revenue, annual recurring revenue, annual run rate revenues, and average revenue per customer
- Sales metrics, including sales growth, sales cycle, average purchase value / deal size, asset turnover ratio, return on sales, return on assets, qualified leads per month, open/closed opportunities, win rate, Net Promoter Score, sales cycle, and year-over-year growth
- Financial metrics, including cash flow, EBITDA (Earnings Before Interest, Taxes, Depreciation, & Amortization), burn rate, runway, accounts payable, accounts receivable, and working capital
- Asset and equity metrics, including quick ratio, current ratio, and debt-to-equity ratio
- Customer metrics, including total number of customers, retention rate, churn rate, average lifetime value (often referred to as “LTV”), and purchase analysis
- Human resource metrics, including employee turnover rate, early turnover rate, employee engagement, employee satisfaction, time to hire, cost per hire, and diversity
- Marketing metrics, including bounce rate, conversion rate, backlinks, customer acquisition cost, open rate, page traffic, and return on advertising spending
- Social media engagement metrics, including shares, comments, follower count, retweets, etc.
What you can do:
- Choose the right metrics. You don’t need to show investors ALL of these metrics. You do need to show them the metrics that tell a compelling story of future revenue growth for your product. Make sure to include crucial metrics such as EBITDA and margin. Inc. also recommends that startups track customer acquisition cost, retention rate, customer LTV, and return on advertising spending.
- Assign metric tracking and reporting responsibility to someone on your team. Metrics are only meaningful when tracked over time. Set up the systems needed to capture and regularly analyze your selected metrics.
- Embrace metrics as actionable data. If your metrics aren’t showing the levels of performance you seek, do something about it. VCs and PEs won’t be impressed if you’re not using your tracked data to fine-tune your operations.
Growing Your User Base
As discussed, VCs and PEs will want you to demonstrate that market demand exists for your product. Naturally, they’re primarily interested in products with big markets that represent even bigger potential. How large is your market? Is it stable? Growing? In that market, can you convert users into customers? Can your product scale to accommodate growing numbers of users?
In particular, a VC or PE investor will want to look at your “total addressable market.” That translates to the total potential revenue opportunity that exists for your product. It helps to demonstrate the scale of your market. Typically, it’s measured in terms of revenue.
Most businesses face competition, which means they can’t capture 100% of their total addressable market. Realistically, how many users can you capture in your addressable market? Are the timing and economics right for your product? Will you be able to overcome any significant barriers to entry?
What you can do:
- Calculate your total addressable market. It’s the clearest way to illustrate your market potential.
- Prepare to answer all of the above questions for potential investors. Use data, research, and facts to formulate your answers, not assumptions.
Ensuring That Cash Is King
VC and PE investors need to feel confident that you’ll spend their money wisely. So, when angling for Series A funding, it’s crucial to remember the old adage that “cash is king.” Blueprint Advisory CEO Brandon Metcalf offers this advice in his Crunchbase article on “The 7 Most Useful Lessons I’ve Learned About Scaling a Business.”
Clearly, growing and scaling your startup costs money. As Metcalf asks, when choosing where you spend your money, do you focus on ROI? Or do you spend money on things you don’t really need? Are you truly watching every penny (a practice Metcalf advises as a “must”)?
In the context of startups seeking funding, “cash is king” reflects the idea that it’s best and wisest to keep enough cash available to cover all your potential needs, problems, and opportunities. As a seeded startup seeking funding for continued growth, you need to be incredibly careful about how, when, and where you spend your money.
Investors look at your metrics and finances to see the true story of how you save, spend, and invest. So you want to make sure those numbers tell the story that you’re smart in how you spend your money.
What you can do:
- Seriously, pinch those pennies. Spend wisely. Do your best to assess the ROI of all expenses… before taking on the expense. Be wary of giving investors the perception that you overspend or fail to plan ahead.
- Create a realistic financial model. This advice, too, comes from Metcalf. He recommends a three-year model. He says, “The forecast will change, but it will help you plan, predict, and pivot.”
Why Should Partnering with an Outsource Development Company Be Part of Your Growth Strategy?
Series A Funding Has Dropped, But You Still Want It
With less Series A funding available, you can’t guarantee you’re next in line. So you need to make the most of the funds you’ve already raised. Get the most bang possible for your buck. By maximizing your seed funding’s ROI, you increase your chances of being seen as a worthy Series A investment.
Also, you’ve got to stay mindful of time. To stay competitive in your market, you can’t afford to wait a long time to get your product to market. Opportunities are often time-bound. Competitors could be one or several steps ahead. So you need to be efficient, figuring out how to scale your team and development efforts in a way that’s sustainable. Given the tech talent shortage, it’s unlikely that you can meet all of these demands by hiring internally. It takes money, time, and considerable effort to source top-quality talent.
So how can you speed up your development timelines and quickly source the resources and expertise you need? How can you show PE and VC investors that you’ve got what it takes to be a revenue engine, grow your user base, and treat cash as king?
Above, we’ve given several tips and strategies to help you prove yourself worthy of Series A funding. Lying just below the surface of several of them? Outsourcing. By saving you money, time, and recruiting headaches, outsourcing helps businesses expedite development, drive innovation, build important budget and staffing flexibility into their business models, and get to market faster.
Scaling Doesn’t Necessarily Mean Hiring More People
As Metcalf also points out in his lessons on scaling, “A lot of people measure startups by headcount. They shouldn’t. While hiring more people may feel like progress, it might just increase costs and create new challenges.”
That’s why he encourages startups to evaluate decisions about adding permanent headcount in terms of ROI, KPIs, and other metrics. Essentially, you need to ask yourself what you’re trying to accomplish. Then, do your best to determine whether a new in-house hire will really help you accomplish those goals.
One of the most successful startup growth strategies for scaling is indeed outsourcing. As the Harvard Business Review states, “Full-time employees are the most expensive and least flexible source of labor.”
Startups like Slack, GitHub, and Alibaba became global powerhouses by using outsourced talent to scale their businesses. By reducing costs that would’ve gone toward recruiting, training, full-time salaries, benefits, and development downtime, you’ve now got some serious budget flexibility. Even better, you can hire outsourced workers with exactly the expertise and skill sets you need, keeping them for only as long as you need them.
For startups seeking Series A investors, adding too much in-house headcount too early simply isn’t a winning business strategy. Metcalf continues, “Start off small, get it right, then add staff when the need is clearly justified. Don’t add people just because you can — that’s not the kind of growth you or your investors want.”
Business Plans Should Include Product Scaling for New Revenue Streams
Again, when it comes to finding Series A investors, proving your growth potential is crucial. New revenue streams are one way startups can do that. They have the potential to help startups scale more quickly and create sustainable competitive advantage.
If creating new revenue streams is part of your business strategy, it should be a key part of your business plan. Investors will want to know not only what you plan to do, but precisely how you’re going to do it. To make a plan for sustainable scaling, startups should consider:
- Timeline. Advance planning is crucial for scaling new revenue streams. Look one, two, and even three years out. What metrics and milestones do you want to achieve, and by when?
- Progress against timeline. Your timeline is only truly helpful if you use it to promote accountability, and to help you assess where you may need help.
- Resource plan. Are you capable of executing your plan within the desired timeline? In what areas do you lack expertise or manpower?
To fill resource plan gaps and expedite progress to meet timelines, many successful startups build collaborative partnerships. These long-term partnerships can be with other businesses (e.g., a FinTech partnering with a traditional banking institution), as well as with outsourcing firms. They can deliver important benefits, including:
- Improved reputation. By teaming with another established business, you increase the perception that your business is stable, reliable, and capable of meeting responsibilities.
- Increased business value. Partnerships can increase a company’s valuation. In the eyes of savvy PE and VC investors, you’re showing that you’re capable of building strong, strategic relationships that help you execute and innovate more effectively. They see a business model that builds in a safety net of external support.
- Mutual benefit. These partnerships are designed to be win-win relationships. For example, with an outsourcing partnership, you get the expertise and manpower you need whenever you need it, while saving time, focus, money, and headaches. Your outsourcing partner gets another satisfied client who’s helping to pay their bills, and whose success they’re genuinely invested in.
What’s the Value of Outsourcing at the Series A Stage?
First and foremost, outsourcing expands your options for how you can get things done. Outsourcing models flex to fit your needs, and you’re the one in control of what that model looks like.
As a startup seeking Series A funding, there are several ways you can go about realizing the benefits of outsourcing. There are three primary types of outsourcing relationships:
- Staff augmentation outsourcing, which allows you to “lease” workers from your outsourcing partner for as long as you need them. You still own all projects from start to finish.
- Managed team outsourcing, in which your outsourcing partner provides a team customized to the needs of your engagement. In this arrangement, the managed team includes an outsourced project manager, and you or one of your in-house team members serve as an overall Project Manager / Product Owner. Project responsibility is shared between you and your outsourcing partner.
- Project-based outsourcing, in which you essentially hand off your project (or a component of your project) to your outsourced team. You provide the requirements, and they deliver the product according to those requirements. In this model, the outsourcing companies own the projects from start to finish.
The right choice for your business depends on several considerations, including the type of value you’re seeking from the relationship. To assess which model is right for you, check out our complete guide to the three types of outsourcing. It outlines the pros, cons, and big-picture considerations of all three types. That said, all three types are capable of delivering three very important types of value for startups seeking Series A funding: increased focus on your business, faster time to market, and increased control over your burn rate.
Increased Focus on Your Core Business
You can’t do everything. To be a successful startup, it’s crucial to focus on the right activities at the right times.
To create a sustainable business model and give investors confidence that your startup can succeed, both you and your internal team need to stay laser-focused on your core product. So acknowledge your limitations. Even better, make a strategic plan for enlisting the outside help you need to be able to maintain that focus. Determine where you can delegate and where you can outsource.
Working with an outsourcing partner helps you preserve focus in many ways. Outsourcing companies can ably handle tasks that don’t deserve your time and attention. They can provide valuable expertise and manpower in areas where you lack capabilities. They can expedite your development timelines.
The best part? With the three different outsourcing models, execution can happen with whichever degree of oversight and involvement makes you most comfortable. You can maintain as much or as little control and responsibility as you like.
Faster Time to Market
VC and PE investors need to see that you can deliver your products on time, meeting customer demand. Demonstrating the ability to execute and iterate quickly is crucially important for inspiring their confidence.
Outsourcing is a no-brainer way to make this happen. It can help you:
- Launch the products customers actually want faster, helping you gain and maintain competitive advantage.
- Keep your internal team lean, laser-focused, and happy. Your extended engineering team helps you deliver your product to market in the most efficient, cost-effective way possible. Your internal resources aren’t spread too thin.
- Increase speed to innovation. With any type of outsourcing relationship, you’re able to quickly and reliably source the top talent and specialized expertise you need. With lack of skills acknowledged by Gartner as CIOs’ No. 1 barrier to success, this can be a huge advantage. Smart businesses are taking note: Deloitte’s Global Outsourcing Survey 2018 showed that 49% of organizations are moving services to outside providers as they innovate, an increase of 29% from 2016 figures.
- Be more Agile. In today’s world, the Agile development methods favored by outsourcing companies reliably translate to startup success. Agile is a lean approach that helps you get to market faster, and iterate more effectively. You deliver and improve your core product more quickly, gaining and maintaining that critical market momentum.
Increased Control Over Your Burn Rate
CB Insights found that 70% of technology startups fail. It’s a startling finding. While several factors impact whether a startup succeeds, burn rate is a big reason many startups fail.
Your burn rate is a measure of how quickly you spend your money in excess of your income. As defined by Investopedia, “The burn rate is typically used to describe the rate at which a new company is spending its venture capital to finance overhead before generating positive cash flow from operations; it is a measure of negative cash flow. Burn rate is usually quoted in terms of cash spent per month.”
Again, PE and VC investors want to see that you’ll treat cash as king, spending wisely and investing in the right areas. By outsourcing, you can greatly increase the amount of control you have over your burn rate in several important ways:
- Reduced development costs. Development efforts are more efficient and cost-effective. To start with, you’re not paying for developer downtime. And you’re likely to achieve better results at lower costs.
- Increased flexibility. Priorities evolve. Ideally, you can flex your spending to meet changing priorities. By outsourcing, you save massive amounts of cash you’d otherwise spend on recruiting, training, salaries, and benefits for in-house resources. Your budget stays flexible, allowing you to focus your spending where it’s most needed. And you can easily scale your outsourced team up and down as needed, keeping resources for only as long as you need them.
- Increased visibility over spending, and improved planning. The scopes of work you agree on with your outsourcing partner will clearly outline your investment and what you’ll receive in return. You’re better able to plan for expenses.
Make That Series A Funding Yours for the Taking
Yes, the Series A crunch is a real thing. By developing a business plan and growth strategy that shows investors you have what it takes to plan, grow, and sustain, you’ll put yourself in a much better position to win that funding, leaving all those other startups in the dust.
Anyway, once you get that Series A funding on lockdown? You’re well on your way to Series B — and to sustainable growth for the long term.
Ready to explore how outsourcing can help you inspire investor confidence and make the most of your money? Check out our complete guide to choosing the outsourcing model that’s right for you.
Anar Babaev is Distillery’s Managing Director. He has wide-ranging experience on the client side and the business side, having worked in account and project management, sales, and client relations at various international software and IT organizations. Anar is passionate about creating a better client experience through proactive issue identification and problem solving. In his free time, he loves spending time with his family, listening to music, and reading. He has a massive collection of baseball caps, rarely leaving the house without a hat.