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APR 18, 2017 - 48 MIN

From Seed To Series B


Cloudant founder and now investor Mike Miller shares his experience from both sides of the table. He discusses three classes of investors, what they look for from SaaS and infrastructure companies, and reveals his approach for translating investor expectations into revenue targets.

  • Introduction
  • From Seed to Series B
    • Universal Startup Trajectory
    • Industry Trends
    • Three Classes of Investors
    • What You Can Control
    • Investors Care About Marketing
    • Series A: SaaS
    • Series A: Infrastructure
    • Series B
    • A Typical Early Stage VC Fund
    • What is Meaningful Return?
    • Figuring Out Revenue Requirements
    • When Your Round Isn't Happening
    • How Bridge Rounds Really Work
    • Venture Debt
  • Q&A
    • When Profitable Companies Should Raise Capital
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Thank you everyone. So I'm a founder turned investor. I'm actually a recovering particle physicist turned founder, turned investor, and I wanted to tell you about my experience going from seed to series B as a founder, and then talk about what it's like from the other side of the table.

I think that the main takeaway of this is that there's a bunch of literature out there. You can find blog posts about all the magic numbers you have to hit and then the seed, series A and series B money is just going to roll in like it's clock work. In reality, that's not the case. Every single investment route is different, great companies get funded, poor companies get funded, awesome companies don't get funded.

It's a pretty stochastic process. So I'll try to be transparent about what I have experienced on both sides of the table and am happy to answer questions. So my background real quick. I did experiments on particle physics at the Large Hadron Collider, got big into distributed systems and then along the way, started a company called Cloudant, which was very early in Y Combinator, it was the summer of '08.

It was the last batch in Boston. It was about 15 companies at that time. So pretty different than now, and we were a fresh start, no idea what we were going to do. We were actually a search company when we started, but we had two cofounders that I really trusted. And we really enjoyed working together and we were pretty technical. And we pitched actually something totally different.

Paul Graham at YC said "as long as you're going to go be a pain in the butt in the side of Amazon, which was brand new in cloud services, then I'll fund you. Otherwise, no". And so we did that, we didn't even have to quit our day jobs. We pretty much did everything he said we shouldn't do and vice versa. But we were in a market that was so good, cloud services in 2008, 2009, 2010 that we got swept downstream and ended up being successful despite ourselves in the early days.

So we ended up getting bought by IBM in January of 2014. It was a great exit for the founders, for the customers, for the team, and now it's a very large organization that reports up, I think one level below the CEO at this point and has thousands and thousands of people that work for it. But I like small teams, that's my passion. My favorite times were starting research groups, and when our company was small enough to basically fit in the closet that we rented in Boston and we thought it was a palace.

So I jumped across the table and wanted to become a venture investor, but after kind of test driving a few VCs that were kind enough to offer me a chance to be part of their team, I realized that I really wanted to start something myself. So through Y Combinator, I ended up getting matched up with Joe Montana, the quarterback turned investor who actually has a really prolific career investing after winning a couple of Super Bowls for the 49ers, and another YC alumnus, Michael Ma.

And we went out and raised a 30 million dollar seed fund that we started raising in 2015 I guess at the end and closed in 2016. And we invest generally just to be very transparent, about 250,000 dollars into seed rounds or kind of first checks and actually, there are a few Heavybit companies we've invested in. So that's my story, that's Liquid 2 Ventures. And I just think it's ironic because the last time I gave a talk at Heavybit was I think almost three years ago to the day, which was right after I had my first set of twins.

And then through a weird twist of fate, had a second set of twins, natural, which is one in 3,000 and one in 5,000 odds. My wife and I are both scientists, we felt it'll never happen again. Well, it does and so I am six weeks into our second set. So if I'm a little tired and bleary-eyed, that's why.

From Seed to Series B

Paul Graham from Y Combinator has this great slide, which is kind of the universal trajectory of a startup. You start your company, you're super excited, you get some early press that you kind of graduate from either just your early stages or maybe an incubator, like YC, or Accelerator, and then you go into the real world, the initial shock wears off and you're just out there alone, struggling not to die.

And that's a really tough process. And if you get through that process, I'm not going to go into detail on this this time, but if you can manage to get through that process mostly because you really like the people you work with, you really like the problem that you're working on, then you can start to really build value.

And I think, to founders, that value is really working on something that you care about, you believe in the mission, you're able to build a team of people and really rally them around on an idea. But I think, to be honest, the whole thing is measured on a couple different axes, and the most obvious one is definitely just money. The revenue that the company makes, the exit value of the company, how much you're able to raise. I'd like to think that, you know I started Cloudant not just for the cash.

I was actually pretty happy in life already, but it's maybe one of the best proxies that we have for how the companies are growing. So I'm going to talk about that. I should just stop and say that this can be a long trough in the middle.

I think every company, no matter how successful, goes through that trough.

So don't feel bad if you're going through it, surround yourself with an environment where you're able to be honest and talk to other founders about how not awesome things are going, because that's something founders do not do enough, I think, is just really talk about how hard that can be. But as investors, one of our limited partners, who are the people who give us money as a venture fund, basically say that our job as investors is to keep your startup alive long enough for it to realize its potential. To get through that valley of despair.

Universal Startup Trajectory

So I did a little data analysis from Pitchbook. I forgot to reference this data, this comes from Pitchbook, which has almost all the data on every single financed venture round of companies that you care about, venture capital funds, as well as exits. And I can tell you off the record how I think they get that data, but it's quite a data set. And so this is just a plot of what I call the top 5 to 10 companies over a decade of Y Combinator.

So 5 to 10 companies per batch, 2 batches a year over 10 years. So there are a lot of companies in there, and I just plotted as a function of months since they started on the x axis, what their post-money valuation was at every funding round or exit. And you can see that on log log scale, so this is an exponential, it's flat on a log log scale and there's order of magnitude scatter, but things kind of cluster around.

So the whole industry, whether you look at consumer products, B2B, SaaS, infrastructure, marketplaces, all kind of clusters on this semi common trajectory.

And that trajectory is how much capital you can raise to keep your business growing and building value? Now I'll be totally honest, I think the best companies are the ones that never need venture capital funding. If you can build a business that you're a hundred percent in control of and actually grow it through revenue, that is what you should do. Don't get sidetracked in trying to compete about who has the best investors, who raised the most money.

It's all about delivering value to your customers. That's all that really matters. But what we're going to talk about today is how you raise capital and how you actually keep your company alive long enough to achieve value.

Industry Trends

So this is Mattermark data, I think, from Danielle Morrill. And basically, the top line here is from, let's see, 2005 to 2015, the number of seed and angel deals. And then below that is series A, below that is series B and below that is series C. So you can see that around 2013, the number of seed stage deals totally peaked. While the number of downstream funding around stayed essentially flat.

All right, so when all these companies that were getting funded at the seed stage went in to raise capital, it was not the prettiest of pictures. And so this is that analysis then folded together, which is the start up, I guess if you have a seed stage company, what's your probability of raising a series A within two years downstream? Right, you can see it's basically that big peak as the numerator divided by the flatline as the dominator. So it starts, it peaks as high as 45 percent around 2009 and then plummets right down to below 10 percent.

And it's actually very hard to answer the question of what fraction of startups make it to series A, what fraction of startups make it to series B. And the answers you get really depend on what the starting population was, and in particular who really did the first funding, where the company is and how it's been growing. So I asked a lot of investors that I really trust what they think, and what I would call one of the top five seed funds in Silicon Valley historically, their data is really strong.

So over many years, they found that 65 to 70 percent of companies reach series A, and about 40 to 45 percent get to series B.

So if you compare that with this plot here that shows a peak around 45 and then plummeting to 5 percent, if you can raise solid seed funding, then you're on, you have a fighting chance is what I would say. And that's what the rest of this talk is about.

Well, the whole point of this talk is just to try to tell you what you can do to increase your chances, okay? And what you can do to be in control of the situation. All right, so here's my take. I'm a founder turned investor, so I think I have the ability to basically shut down the conversation at venture cocktail parties. I don't get invited to many, but this is my very personal take, okay?

Three Classes of Investors

This is not an industry standard, but I think this is why deals really get done. There are kind of three broad classes of investors, those that use a phrase like coverage, and I do this too. Deals go around the valley, they go around the community, investors talk and there is a real fear of missing out, not just because you're afraid of the potential opportunity but because your own investors hold your feet to the fire if there's a breakout hit and you're not a part of it. So that's the biggest part of the triangle.

Then there are investors that are very happy to invest on market and team. And then at the very top are some highly quantitative investors that will look at B2B SaaS metrics across 11 dimensions, like when your product has been live for two or three months. And they're able to really discern whether or not it's their thesis. And I would say in general, you really want to deal with the people in the top two, that is the top half of this triangle.

And it's not just funds and firms and brands that matter, it's the individual people you work with at these venture funds.

So if you're a founder and you sit back and we have about 90 investments now in our portfolio and they all ask so what do I have to do to get funded, and so I'm going to talk about a few different things, what you can and cannot control. I'm going to talk about what the stats are on series A that you can kind of ballpark, but those are just goals. There's no guarantee that if you hit certain numbers you get a round.

But I did survey about a dozen I think really high quality, top 20 funds, partners that I really respect that'll give you some answers, and then what's going on at the series B and then what to do if your rounds are not coming together, okay? So here are the things that you cannot control. So if you can put these out of scope and stay in your lane, do it because these will just cause you worry. You can't control your competitors, you can't control geopolitics and macro trends. If you're a manufacturer right now manufacturing in China, that's something you can't really control.

So I think you just do what you can to adapt, but keep running your business. Venture capital is full of dogmatic answers. I keep trying to get to the bottom of the rabbit hole of why people do things certain ways. And in some cases, I can. In other cases it seems to be just imprinted in the industry. And what you also cannot control is the outcome of any specific deal.

These are super stochastic and I've seen so many investment rounds that I feel like if you set exactly the same initial conditions and ran the experiment again, you'd find a different outcome. So I think people in board rooms have incredible group-think situations. So just appreciate that, it's kind of like applying to a top-tier university, it's really stochastic. You could have the exact same SAT score and qualifications and not get in sometimes and get in other times.

What You Can Control

So put that out of your memory, and think about the things that you can control, which are your product and your team and most importantly, your revenue stream. That's the whole take away here. If you build something that people like and the market really finds it valuable, you can make money doing it. Your net promoter score is a huge thing.

Focus on your customers, and then when it gets to the fund raise, second, maybe third order, the messaging around your round, this is something that has seen hyper stratification in early-stage venture since I went through.

So there's friends and family, then there's pre-seed, seed round, seed prime, seed plus, bridge, series A. But these are just semantics. All you need to do is raise a certain amount of money at a certain point in time.

And if you remember the initial plot, there's kind of a log log cluster. There's this general exponential trend that startups take depending on domain, but your messaging can help or hurt you. If you say you raise a seed in a seed plus and then you're not at the series A numbers and you have to raise a bridge, investors won't enter a bridge if you're not already part of the company. Little things like that. So lean on any investors or friends that you have just to understand how to message.

Timing matters, and then optimizing the raise. These are things you can do. Who you pitch first, whether or not you establish or understand the market value of your company. I'm going to talk about that a lot more later on. I thought it was the hardest thing in the world of black magic to establish a pre-seed or a seed or a series A valuation. It's not.

It's not like if you come out of Y Combinator and you're going to command an eight to 12 million dollar market cap, or cap on a convertible debt note, if you come out of AngelPad, you'll probably get six. If you're in Seattle, you'll probably get four. There's a market to this. And if you can jump in and talk to people, you get a lot of it. As an aside, I'll just note the biggest mistake I made with my own company that I talked about last time, three years ago, that I see a lot, is not investing in marketing.

Investors Care About Marketing

Marketing is really, really important even at the earliest stage before you launch a product. And I just didn't understand it. I thought it was a point of strength that people paid you and you didn't pay any marketers. It's kind of the exact opposite.

Marketing is like going to the library before you actually start doing lab research. A little time in the library can save you months or years in the lab experimenting.

And it really just goes if you market well, you can understand whether or not you've really identified the core business problem that you're solving. In our case at Cloudant, we were totally enamored with distributed systems technology. We figured once we told customers that we've built an Erlang across multiple providers, that they would just fall at our feet.

And it's like the Betamax/VHS story, community matters. The reason people join things are network effects. How easy is it to set up, one click, three seconds later you have MongoDB running. And even if it was spilling your actual data onto the floor, it was really easy to get started as a developer. And it's becomes a solid product. But understanding what the problem is that you're solving is marketing more than anything else in my experience, or product, and it's a really tight overlap between those.

But you know series B downstream, it's going to help you understand whether your sale is repeatable because if you build a product and you have a solid marketing team, my very personal opinion is that you can be light on sales. And it's about lead generation, who you're selling to, what the value proposition is and showing that the product really brings that value. So it's just kind of a tangential aside.

Series A: SaaS

So what are some broad metrics to focus on for the series A? So I have to show this slide, theres a lot of information on here. So I talked to just under a dozen really solid seed-stage investors that will also participate in a series A, but not generally lead it.

But the name of the game for seed-stage investors, is to invest in the seed, try to win the relationship with the company. And then those seed investors will try to lever up at downstream rounds to get to 20 percent ownership.

And that's just something that I'd like you to just consider. I didn't know this at the time, people in investment venture funds, limit partners, their most basic belief is that concentrated ownership equates to solid outcomes. So if you're not highly concentrated, you're not going to drive a large return for your fund and vice versa. So they want to see 20 to 25 percent of a company at exit for a seed-stage investor. So that's very important to know because it defines a lot of the behavior of seed-stage investors.

So if you have a good seed fund that has enough capital to do a series A round, if things are going well, they will try to jump that A for you. And I didn't quite appreciate that at the time, but it's a really important thing to know. Hopefully, if things aren't going well, they'll also help you with bridge rounds and prop you up and give you a chance to prosper. But their goal, traditionally venture capital, is to make small bets, win the relationship and when things go well, you kind of back the truck up and you dump half the fund into a company, and you try to get 5x or 10X on that.

So I'm talking about money. This all sounds pretty crude from somebody that was a physicist turned founder, but it takes money to build a company. And that's something that I've come to appreciate. It's not a terrible thing. So broad numbers here for a B2B SaaS company, the bar for series A is pretty high. I think it expects to raise about two and a half to three and a half million dollars total in your funding before a series A.

Hopefully in one round if you do it well, maybe two rounds, and that will allow you to hit these marks where you're making 100 to 250,000 thousand dollars a month in recurring revenue. That equates to about one to two million in ARR. And then growth, the growth numbers, very strongly depending on who you talk to, 10 percent month over month I see people asking for as much as 20, 25 percent month over month. But these are broad brush strokes.

The one thing I found that the people I surveyed were pretty split on, some VCs wanted to see three months of trailing growth data. So you could hit that number in a three-month YC program if you have a solid company, and we have some companies in our portfolio that have done that. But other investors really want to see 12 months to make sure that the product is sticky in the market, that the value continues to be delivered.

Even 12 months is too early to learn, whether or not you're going to lose customers, but this is broadly what you're shooting for. And so again I should say there's broad disagreement on what these numbers are. So the point of this is

If you think that you're going to get to $150K in MRR and magically a series A is going to fall at your feet, that's not the case.

So just prepare yourself for that, know that in your planning and think about giving yourself a buffer. And as you look at the runway, think about what to do next.

Series A: Infrastructure

If you're an infrastructure company, it's not radically different. There are kind of two big differences. One is that it just takes more money. It takes longer to build an infrastructure company if you're building something that's hard. So if you're defining the next level of cloud services or platform or the way to deliver video or something like that, it takes longer than building an enterprise SaaS company.

And so however you call the rounds, think of raising about what we're seeing in the industry right now, it's four and a half, five million dollars in pre-series A funding. Our series A Cloudant was two million dollars spread over two tranches. So that's a big slug of money to get started. And then again, one to three million in ARR. But the key here is I think some of the valuable things are three to five marquee customers.

These are people that are leaders in their fields, whether it's IT, DevOps or something else, and they're willing to really step up and say that there's a lot of value in this, that's why we're using it early on. And you also need to have a contract that's big enough to demonstrate that you're solving an important problem. And this is something that I see a lot of companies kind of suffering from right now.

So how big is big? I think it's got to be at least 60K a year is kind of what I've seen. So it's about five K a month if you're building something in infrastructure, and that's a starting point, then you want to start to see it growing over time. So it's harder to do infrastructure than it is B2B SaaS. All right, for the series B, this is small and hard to read and that's kind of the point because the estimates diverge wildly here.

Series B

The most valuable answers I got when I talked to people that invest in series B were that

You should do 5x your series A numbers in 2 years.

And that's kind of I think a traditional VC role or guess, which is if I give you five to seven million dollars, then you can find 5x the company in two years and then either be profitable or go to the next round of funding. Some other answers I got, calling out specific companies, GitLab is a nice example from our portfolio. This company is growing really aggressively even though they're not perfect.

They recently had a pre-transparent outage. They're pretty transparent about their development process, the product's roadmap, all kinds of things running in the cloud. But even then, there's such a demand for the service that the business is growing rapidly. And so a company like that is not going to have an issue in raising a series B. They do not, they raiseda solid one. But broad numbers, MRRs back up to 500 to a million basically. In AR, that's six to nine, maybe six to ten and you're starting to quantify numbers like your churn, your acquisition cost for a customer, your lifetime value.

Team size is growing and you're starting to spin up marketing and sales divisions, and you're growing at the rate of two to three X year-over-year. And that's what I'm going to talk about for the rest, where does that number come from and why is that important? But just so you know, around five percent month over month revenue growth to 10 percent month over month is getting you two X to three X annually.

So this is kind of the back half of my talk. In my opinion,

To really achieve a series B, your trick is to prove that you're going to be a meaningful exit for your investors at that stage.

So if you can grow the company on revenue alone and you're happy with that, do it. Don't stop and raise capital. There's no reason to raise capital unless you feel like you're being squeezed out of the market by the opportunity being given to somebody else. So this is a great post I recommend. I'm just going to walk you through what it means to be a meaningful exit to a VC, kind of how VC funds work, what a meaningful exit is and then what that means to you in terms of your revenue ramp as a function of time. Because that's the thing you can control. The product you build, how you sell it and how much people pay for it.

A Typical Early Stage VC Fund

So real quick, typical venture capital funds take two percent annually management fee and then 20 percent of any dollar they return to their investors after they've been made whole. So you give me a dollar, I give you a dollar back and I take 20 percent of everything beyond that dollar. There's about 20 core investments per fund. This is pretty interesting. This seems to be true across two orders of magnitude in fund size.

There's kind of this idea that you can only engage with so many companies. The goal is 3x to 4x gross returns. So if you raise 10 million dollars, you want to get back 30 to 40 million dollars gross. And gross in that is just your management fees, which management fees on a 30 million dollar fund two percent a year is five million dollars over the lifetime of the fund. So it matters.

But the big takeaway here is that most investors expect the following

Of their 20 investments, 7 will be write-offs, 7 will give your money back and 6 will perform. Of those that perform, 1 will be a home run and will return 1X of the fund.

So everybody says every check you write has to have the ability to return the whole fund. And that's what really drives a lot of what you see and the amount of money people put into a round, what percentage of ownership they want, et cetera. So I think the most realistic model people use, and this is again from the same link, and there's a whole bunch of references here, it's five meaningful exits and one home run of your six wins.

So just bear with me. That means the returns you have to get in terms of cash on cash multiples in the numerator from those five meaningful exits, you got six wins, one is a home run, so you factor that out, so you want to make three X under the fund, that's the first number, subtract off the one home run. So you've gotta make basically two X, and you know that 1/3 of your investments are going to be money back, okay?

All right, that was seven over 20 basically. And the seven zeroes you have don't contribute anything, okay? So that's basically where the money comes from on the top, subtracting off the home run and then the number of meaningful exits you have.

And if you work that math, it means that a meaningful return is one that will give the investor back 1/3 of their fund size.

That's the investor's goal at the early stage, okay? And I don't know why, but no investors ever told me this. They'd say things like 10X or that we want to have big outcomes, we want to invest in the tail and black swan hunting. It's 1/3 of the fund size, and that's basically what investors are going to reach for in most cases. Some will really swing for volatility and go only for homeruns.

But once you know this number, you can basically run the math on what you have to do revenue wise to hit that mark. So if you'll bear with me, that's what I'll do in the next couple of slides.

What is Meaningful Return?

So what is meaningful? Well, it depends on the fund size. So this is kind of busy, but just assume for a second that your early-stage investors are basically just seed stage. 50 million dollar fund size. If you 1/3 of that, that's about 17 million dollars that they have to get back, okay, which is a lot of money. For a home run, it has to be the full size of the fund. That's the 50. And then each investor has kind of a goal of what fraction of the company they own, and these are fairly dogmatic I think.

And I think that those models are being challenged by funds like us that just like to invest in great people with a nose for big market and try to help them get to these various stages. But most funds are going to want 20 to 25 percent of the company at the exit if they're an early-stage investor. That's the bottom line. So that means that your exit basically has to be 17 divided by .2, which is about 83 million dollars for the smallest fund.

Or if you're going to be a home run, that puts you in the 250 million dollar range at exit. And the stakes get higher as the fund size gets bigger, okay? Another interesting thing, I didn't quite get the data turned, but in Pitchbook, you can also look up the total fund size and the total number of partners that make investments and take board seats. And that is not linear, that's logarithmic roughly. If you squint at it.

So you would think that this would just be a linear scaling, that if I have more partners, then 100 million dollars fund with two partners is the same as a 50-million dollar fund with one partner. That's scaling breaks, and these expectations are actually pretty reasonable. The bigger the fund, the bigger your expectation, and that's what I would stick in your head.

So your goal is, if you're going to be a meaningful exit in B2B or SaaS and looking at the type of people that invest in early-stage funds, you're going to have to do somewhere between 300 million dollar exit, maybe more like 500, but at least 100 is the general rule here. So how do you make your company worth that much money? I had no idea when I was a founder, and nobody took us aside and told us, not our investors, we had great investors, they didn't tell us.

Customers didn't know. The advisors we had, they didn't tell us. The answer is pretty, pretty clean. And I'll talk about that on the next page, but I'll just say, even if investors want to challenge the assumptions that go into this math, because obviously it has implications, obviously there are funds that will write small checks and hit wins with companies that are consumer breakouts, Uber or Airbnb or something like that.

But still the people that put money into venture capital, the endowments, the pension funds, the fund of funds and family offices, this is their math. This is the dogma and it works its way two degrees down to you, the founder, as expectations, okay? So even as you see people change it, the driver in this case is basically endowment money, universities, to first order. And this logic is just burned into the brain. And they have a lot of data that shows that this delivers returns. So this is LP math is how I like to call it.

Figuring Out Revenue Requirements

Okay, so how much is your company worth? And how does that translate into revenue requirements? Basically, this all just works backward from public markets. So you can go in to find a company like yourself, that even if you're doing something that's new, you're kind of defining a new space, investors are going to put you in a bucket. I didn't understand this. So I can never crisply compare Cloudant to another company. Yeah, we're a database company but not really a database.

We weren't meant for business ledgers. We were meant for application state in the web and we're spread across 35 data centers and we replicated your phone. We did all these things that Oracle didn't do, we did all these things that Amazon didn't do. We were in a class of our own. Not the case, okay? Not the case. And who's the final arbiter of that decision? It's the public market. New York Stock Exchange, Dow Jones, wherever companies are being traded, that's where the value of your company is being decided.

And you're lumped into classes. In the end, even Salesforce, Tableau, some of the companies that were trading in 10X, their forward earnings 10 times their next 12 months projected, they kind of all collapsed about 18 months ago to the mean. So if you're an enterprise SaaS company, you're going to trade at 3.7 to 3.8, and that's forward revenue, modulo the amount of debt that you have.

So that is your asymptote and you cannot escape it. Salesforce escaped it for a while, Tableau escaped it for a while, but eventually they collapsed to the market mean. And we're actually in a stage right now where things are trading significantly higher, which makes me think a little bit about public markets. But you'll get there.

What your company will be sold for is some multiple based on your future potential times what the public market will value it at.

And I'm not going to go through this in detail, just say that for an enterprise SaaS company, if you have high margins, 75 percent, you can be sold for five times your forward AR. So it's not monstrous. So in the end, unless you sell really early, in the end your value is based on how much money you make and what market you're in no matter how innovative your product is. There are outliers here, but I think the data shows that they collapse in the mean.

So know your asymptote. I didn't, I didn't know that I was four X, forward revenue. In retrospect, our exit was great because we exited for way more than that, but honestly, I don't think we really appreciated what was going on at the time. So once you know that you can work backwards to what your revenue requirements are, and so if you're an enterprise SaaS company, and this is your SaaS target, if your early-stage investors are from a 50 million dollar fund, remember you gotta sell for 83 million dollars, for them to get 20 percent of that and return 1/3 of their fund.

So that basically means that in five to seven years, which is the timescale on which all venture funds expect returns, you got to hit basically 20 million dollars. It's the target I'd say at least, which is actually pretty steep on the five to seven-year goal. And if you want to hit a home run, completely different. But market places, e-commerce and consumer hardware, all kinds of things have public market asymptotes.

They have well-established exit values. So when you're talking to an investor, they're sticking you in that bucket and they're working backwards from public market comps. That's what they're doing. And if they're super sophisticated, I haven't met anybody that does this yet, they do cash flow analysis and all kinds of things that late-stage investors and private equity quants do, but that's your goal.

You gotta hit at least 20 million AR in five to seven years. It's a pretty steep goal, so how do you get there. And this is kind of the final rule in this.

What investors look for is that you're going to triple your revenue in each of your first 2 years, and then double it in the subsequent 3 years.

So it's T2, D3. I wish I had known that. In retrospect, I actually don't know what we did at Cloudant. But to triple your ARR, that means you got to do about 10 percent month over month and to double annually at about six percent. And so the idea is you grow quickly in the beginning and then you hit some challenges, your growth slows down, but you have to show that you can stay in two X growth year-over-year.

And I think that what I wanted to do is to go back and look at AWS reporting and estimates from the earlier error when they didn't break it out. AWS is what, 13 billion last year. Is that right? I forget, and they were doubling almost every year. So I forget the exact number, but I think that's a really, a really strong kind of comp that a lot of companies in the Heavybit ecosystem can compare themselves to.

So triple, triple, double, double, double. If you do that, investors will look at your company and see a meaningful return. It's hard for them to not see a meaningful return. So when you think about the things that you can control and can control,

Series A is a little more milestone-driven. Series B, the investors have to sit back and look at if this is a meaningful return for their fund. It becomes much more about magic equations and much less about belief in team and people and market.

That's the trend that you're on.

When Your Round Isn't Happening

So what to do if you're progressing down this path? What do you do if you're growing, you're executing, you feel like you're doing everything right that you want to do but the fundraising market, you're not just getting the capital that you need to grow the company, not just to maybe accelerate growth but just to keep the lights on.

So what are the things we can do? I'll talk about a few different things. But I think the first is be honest with yourself and be honest with investors because investors talk. I didn't appreciate the extent to which this happens, but I have pushed companies that we invest in early to other investors that I really respect, trying to get them to fill out a round, and then I've seen within a day or two that email go around the investor circuit and come back to my inbox with somebody else's from address and kind of tailored.

So it's my propaganda that goes out and boomerangs back to me, and I didn't appreciate the extent to which that happens. So word gets out. And if you try to bluff investors, they know. Look, if you're a home run, you don't worry about this. And if you're on a path to a meaningful exit, you will probably raise money fairly easily. But remember, your job is to keep your company along alive long enough for it to realize its potential.

Believe in it long enough, struggle long enough and you will find a way to be successful in a market. So don't push it if it's not working.

Try to be honest with your spec, talk to your advisors, talk to your existing investors about when to pull back and try another path. I would say, if you're getting near the six-month mark of cash out, put a bridge plan in place. Have that in place before you go out to raise another round if you're under a year.

And what does that mean? I'll talk about that. Do everything you can to extend your runway. We had a really, really strong consumer company. I didn't get the okay to say their name but maybe I'll tell you off the record. They were in the on-demand space. They hit every single one of their goals they said when they came out of Y Combinator and executed for two years. Incredible execution. Month over month growth, unit economics, exactly where they wanted it, everywhere they thought they had to be.

And because some of their competitors had folded, which you think would be a good thing, the venture market just pulled back. And Home Joy kind of ruined that market for quite a long time. The people believed that okay, after home joy, we all know that, that domain is not going to be successful, where there are companies out there executing in that exact space, projected on slightly different problems.

And so that company, we had to tell them " hey, this is not happening for you, you've been at this three months, you've hit all your numbers for a series A. Totally get it, you've done everything you said you were going to do and more. If this was nine months ago, this would be a slamdunk series A from a top 10 firm. Now, nobody's going to touch it". And so all you can do, put a bridge plan in place, lower your burn, grow the revenue, extend your runway as fast as you can and talk about venture debt.

How Bridge Rounds Really Work

So that's what I'm going to do now, talk about how bridge rounds really work. Bridge rounds carry special semantics. If you say it's a bridge round or a seed extension, it's not really a growth round. If things are growing well, your existing investors are thinking "hey, I signed a 20 percent uncapped note just so you can have an extra two million dollars from me because I believe in you so much." Oh, isn't that nice? No, they're afraid they're not going to get a piece of the next round. And so the name of the game if you need a bridge is to be honest about what it means.

So almost everybody has to do bridge rounds. I think at Cloudant we did four, maybe three or four until we finally found out what it was that we were bringing to the market that really had value. Bridge rounds are almost always insider rounds.

Most VC's just have a rule that they will never enter into a new company at a bridge round.

Some VCs will basically relax that if one of the existing investors in the bridge round is a top five. But usually, people just don't want to touch bridge rounds. So don't spend a lot of time talking to outside investors about that. Before you talk to anybody, make a list of your biggest investors, get in front of them in person and try to get a handshake for 50 percent of their previous commitment, okay?

That's your goal. They'll probably want to give you less, but at least 50 percent from your anchor investors because the first question one of your other investors is going to ask, "oh, if X is the lead in, in your seed round, how much are they putting into the bridge?" And if you don't have that answer, the bridge dies on the spot right there on the floor. So have that in place, and don't expect much, if any, bump in the terms. And even potentially, a little bit down around on a convertible note.

So once again, if things are going really well, this doesn't happen, people are pushing term sheets on you, uncapped notes just trying to get a piece of the action at the next round. But everybody does bridge rounds so don't feel bad when your time comes.

Venture Debt

Okay, the next step is venture debt. I'm not going to talk about this in detail. See me afterwards if you want some more detail. But we put a venture debt plan in place at Cloudant. This is the work of our CFO. He looked at all the different attributes, interest rates, warrants, right of first refusal, et cetera, things you care about, some other things that we weren't so interested in and then basically the color scheme, green, yellow, red is how good or bad the terms were. And then we looked at two different bank-driven venture options in two different venture debt funds, which I'll talk about in a little detail.

It's complicated. Has anybody in here raised venture debt? I should ask. Venture debt is complicated. I didn't even know it was possible. My brother in law is a commercial lender. I thought you had to have hardware or machines that make cars or something like that, or computers for somebody to actually write you a loan. What's the collateral?

The collateral is basically how much money you've raised in equity and how fast your company is growing.

So there are a lot of things here, but they basically break down into two different categories. Honestly, we would've been somewhat paralyzed if we didn't have a really solid CFO. This was basically to bridge us to the B. I think we've got timesheets in place and didn't use them in the end, but depending on the timing of our B, we were going to need some cash. So it's complicated. Banks, Silicon Valley Bank, First Republic, they'll generally give you loans that are Wall Street Journal Prime plus one or two percent.

And then there are funds specifically, WTI, I think, was the first, where they go out just like a venture capital fund, they raise money from limited partners and then they lend on that capital, but they also take more on coverage. So it's a mixed model, like bank-type returns, as well as equity in your company when it sells. And the terms are all over the place. The ones you really care about are interest, warrant coverage, right to participate in downstream rounds.

So just a couple of quotes from folks in both of these different realms, this is from somebody that we worked with a decent amount in the top five venture debt fund, I'll call a few things out. Basically, post seed, they like to do about 25 to 40 percent of your previous equity raise. So if you've raised a million dollars, you're going to think about getting 250K. And that depends on where you are.

Typically at the A, they'll do 35 to 45 percent of your previous raise. They'll want to see things. This is after your series A. They'll want to see things like how replicable is your business, do you understand basic stats, contract value, customer acquisition cost, churn, what's the revenue growth.

After the B, you can get a debt line that'll be 50 to 60 percent of your equity raise and even more in some cases where they're starting to really dig into the SaaS metrics.

Their goal is to give you 6 to 10 months to just bridge the stage that you're at and basically perform the way your company or your business will perform so that when you try next time for that fund raise, the market appreciates it.

But even then, they're expecting doubling year over year writing your revenue lines. So that's from a venture debt fund. And last but not least, from one of the top banks, their answer is all over the place in what their terms are. But basically, you can get between two to five million dollars of debt from a bank depending on what the revenue is, what the contracts look like.

I should note that the terms of these two styles of loans are very different. Some of these you can draw all the way down. Some of them they can just say "hey, I need my money back." Which is a tough thing if you're a startup. So venture debt is complicated, but it's really important and especially if you're going out in a marketplace or something like that where you need strong operating capital.

So with that, I'm going to try to wrap up. Not too far over time. You need money to build your business. If you don't, that's great. That's the business you should build. But the majority of startups here in the Valley need money to grow. So focus on what you can control, try as hard as you can to put the things you can't control out of your mind. Look inward, build your team, build your products, make your customers happy, keep the costs down, really down, under 100K per month down and grow revenue.

If you do that, you will probably be rewarded. If your round isn't happening, know your options. Talk to your existing investors for a bridge. Talk to the debt funds, go back to your existing investors, talk about what it takes to really grow and extend your runway so that you can execute and really lean on your community for advice. So if you went through Y Combinator, talk to them.

Talk to the network. If you're in Heavybit, that's awesome, they have a lot of experience with these things. Don't keep it all pent up. Don't think that you exist in some unique bubble that you're the only one having trouble raising a B or an A or even a seed round. And I'll just close by saying that I learned that fund raising for startup is actually easier than fundraising for venture fund, especially the first time. But some certain rules apply in both cases, which is like fundraising is inherently a network thing.

It sucks until it doesn't. And once you get somebody that believes in you, then they'll generally tell two people that they believe in you. And if that goes well, then it really starts to go. So fundraising sucks until it doesn't. So stay at it if you have to do it. And with that, I'll close and take questions, thanks.


When Profitable Companies Should Raise Capital

So when should a profitable company or one that's executing raise? In our case in what I've seen with some of our best portfolio companies so far and maybe friends that I have that are founders that are wildly more successful than me, once you're starting to make real money, you should always have somebody in finance that's presenting. Our leadership meeting started with our path to profitability, where are we on our path to profitability. So it's something that we danced around the whole time.

So if you're actually putting too much money in the bank, you're probably not investing enough in your company and its future growth. And so the answer there I think really depends on the market conditions around you. So in our case at Cloudant, we're a database- as-a-service company, we kind of helped brand NoSQL. We were all kind of young technical renegades who thought that we could kind of take over the database market. It wasn't super easy. And so we thought we were competing with Oracle. In the end, we were really competing with do-it-yourself, people that were, you know what, I don't need to buy anything.

They're going to hire a human, they're going to stand up to MySQL or whatever, Postgres, whatever it takes. That was our competition. And then out of nowhere, Amazon Web Services. We just didn't appreciate how quickly it was growing, and that they basically owned the surface area of the majority of enterprise companies right now that don't do everything themselves.

So it's a clear example of where the market is forcing your hand. And I'll just close by saying at Cloudant, we sold in 2014, that was great timing for us because we were having our hand really forced. We started to get great term sheets, we started paying attention to them. Eventually, somebody gives you a deal that you can't say no to, it's just too good. But if we hadn't done that, what would we have had to do?

We probably would have had to raise 50 to 100 million dollars. We raised 15 million dollars total in the lifetime of the company. But for us to be relevant in the database as a service market, which then took off, we would've had to really accelerate our growth. So I think that the growth is just like if the opportunity is there and you feel like somebody else is going to move in, in that space, then you better take it. Thanks everyone.