# Series A Sweet Spot Combines Size & Slope

July 29, 2018Fundraising

I often get asked how much revenue is needed to successfully raise a Series A.  I can tell the entrepreneur wants me to confirm what they might have read in various articles or heard from other advisors.  A simple answer might be something like \$1.5M in annual recurring revenue (ARR).  But, like many things in the world of a startup, the right answer isn’t so simple.  Let’s explore further.

## Back to Basic Algebra

The slope of the line (revenue growth) matters a lot.  I commonly hear Series A VC’s say the revenue sweet spot they look for is in the \$1-2M range.  That’s a pretty big range and it’s not at all the right target for all types of startups but let’s use it for our example.  Why such a wide range?  I suggest that a big reason for the range has to do with the growth rate leading into the funding round as well as the track record and trends for other important company metrics.  But focusing on revenue first, the evidenced growth rate over the prior 6 months is probably most important.

To visualize this point, check out the three scenarios in the graph below.  The “Fast” company only reaches \$1.0M but does so in 12 months while the “Slow” company reaches a seemingly more impressive \$1.5M but it takes them 24 months to do so.

Which company do you think a Series A VC might be more interested in, using only the information provided in the graph?  I think the “Fast” company seems far more interesting than the others.  Just imagine where they will be in 18-24 months.

There is actually nothing wrong with the “Slow” company and their growth rate in absolute terms isn’t actually slow but rather just a lot slower than the “Fast” company.  In fact, if only the “Slow” company were shown on the graphic, we would all probably be impressed.  But VC’s see a lot of investment opportunities, which means they are going to come across all three types of companies shown on the graph and they will make the comparison before deciding where to deploy their capital.

Side Note #1:  I am obviously way over-simplifying the process a VC goes through to make an investment decision so that I can specifically isolate size (revenue) and growth (slope of line).

Side Note #2:  Although I use a “slow” label for the company that reaches \$1.5M in 2 year, I know tons of startups that would love to have that track record.  As I mentioned, it’s actually “slow” only as compared to the other two scenarios.

## Dialing-In a More Exciting Scenario

You probably have a financial projection model that produces a curve like one of the ones shown above.  That model has various assumptions that drive the results.  I know how easy it is to change one or two assumptions to convert your current “Slow” scenario into a “Fast” one.  But changing assumptions in a spreadsheet isn’t going to make it happen.

Getting to \$1M in 12 months versus \$2M in 24 months involves dramatic differences in month-over-month growth and associated stress on the organization.  The rate of new employee additions (sales, marketing, support) and the strain on both your technical architecture and operational systems will definitely be felt.  And don’t be surprised if the more aggressive 12 month plan consumes more cash than the slower 24 month plan, even though half the time is involved.  Many hyper-growth companies consume lots of cash.

What happens if you model and plan for a “fast” growth plan and start spending to that plan to make it happen (people, systems, service providers, etc)?  If you’re fortunate, the growth will come.  If not, you’ll consume the cash without the results and might end up in the Fundraising Chasm that I’ve written about.  That might not kill your company but it’s not very fun either and is why many startup advisors suggest raising more than you think you’ll need.

## One Hand on the Gear Shift

If you don’t have enough cash to dial-in and execute to your most aggressive growth plan, that doesn’t mean you should accept slower growth as inevitable.  Instead, put one hand on the gear shift while watching for the signs that your customer acquisition process is reliably repeatable (ie – “just add water”).  If that happens, shift to the next gear (hire people, spend money, etc) and closely watch to confirm the desired effect.  And if that works, consider shifting further to the next gear.  It all comes down to a key attribute – “reliably repeatable”.

## Acceleration versus Deceleration

The first graph in this article is too perfectly linear.  No company grows the exact same amount month over month for long periods of time.  A typical company’s revenue results don’t form a line but rather a curve.  The shape of that curve really matters.

Take note of the two startups represented in the graphs below.  They both start at around \$900K and both reach \$1.5M over a 6 month period of time.  But hopefully you notice a dramatic difference in the two companies.  Which are VC’s going to be more excited about?  Clearly, the startup that is gaining momentum (acceleration of growth) is more exciting.  Imagine what the next 6 months for each of these companies is probably going to look like.  If your graph suggests you are losing momentum, many VC’s will delay their decision to see what happens.

The graph on the left plots the companies’ actual revenue while the graph on the right plots the growth rate from period to period.  Notice how even more obvious the difference is with the second graph.

The company that is gaining momentum might have had one hand on the gear shifter whereas the company that is losing momentum might have overinvested from the start, discovered their customer acquisition strategy wasn’t quite working, did a layoff and started to “wobble” (see related article titled “Use Mock Layoffs for a Well-Oiled Machine”).  There are numerous scenarios that could cause either of the curves to happen.  What’s important is for you to be aware that the shape of the growth curve really matters to your fundraising success.

## Growth Versus Scalability

Experiencing rapid growth is different from having scalability.  Growth is an aspiration or end result while scalability is a capability that may or may not get exercised.  Growth can come in spurts and is most commonly thought of in terms of sales and marketing attributes.  Scalability, if present, is architected in and is commonly reflected in the “back office” or the technical architecture of the product solution.  In other words, not the sexy stuff but rather the “plumbing”.

It’s true that having genuine scalability can dramatically affect how your company is able to handle sustained periods of growth.  In fact, this is probably the right way to think about scalability – what is needed so that you can fully exploit sustained periods of growth with minimal risk and disruption to your company?  Going into a chaotic “all hands on deck” mode is one way of getting through periods of excessive growth but it comes at a cost of disrupting all sorts of things that are surely strategic and you can’t live in this mode for very long.

To dig deeper into this concept, read my article titled “The Difference Between Growth and Scalability

## More Scenarios

Even the above graph shows growth curves that are too smooth versus what’s likely to be experienced by a given startup.  Below are some scenarios I more commonly see for the very limited percentage of startups that reach \$100M.

## Multiple Seed Rounds Before Series A

Very few startups are able to reach their Series A without multiple rounds of funding during their seed stage.  Listen to my 5 minute podcast recording on this exact topic:

## Food for Thought – Growth Path to \$100M

\$100M is a nice big and round number.  I know it’s not \$1B but it’s still a respectable revenue figure to reach for almost any company.  What if I told you that you had 10 years to reach \$100M.  That’s PLENTY of time, right?  10 years seems like a really long time and we all know several examples of tech startups reaching that figure in considerably less than 10 years.  So why couldn’t that be you?  It could, it’s just much more amazingly difficult than most think.

Here’s a hypothetical path to \$100M, including the associated annual growth rates:

\$0.0M
\$1.0M
\$2.5M    (+150%)
\$5.0M    (+100%)
\$9.0M    (+80%)
\$15.3M  (+70%)
\$24.5M  (+60%)
\$36.7M  (+50%)
\$53.2M  (+45%)
\$74.5M  (+40%)
\$100.6M  (+35%)

The early years in this scenario where growth rates are 100% or more certainly can happen, especially since they are starting from a relatively small base.  But continuing to deliver 50-70% growth rates in the middle years and even sustaining 35-40% growth in the last couple of years is so amazingly difficult that it’s hard for me to describe.

I’ve been a part of three reasonably aggressive growth scenarios during my 28 year professional career.  Below I’ve listed the annual revenue results from the time I joined until our exit and can tell you the rocket ships were vibrating as if they were about to explode during most of the journeys.

\$5M        \$22M      \$20M
\$10M      \$32M      \$38M
\$17M      \$45M      \$60M
\$27M      \$57M
\$36M

## It’s Not Only About Revenue

This whole article has focused on revenue and revenue growth.  Those are critical, and even foundational, metrics to support a successful Series A but they aren’t the only thing investors evaluate.  You surely have other important operational and financial metrics that should also reflect improvement, to the point of either reaching a “best practice” level or at least approaching that level.  Series A companies should demonstrate an initially “well-oiled machine” that will continue to improve, especially with funding.

In addition to other important metrics that should be trending positively, having an exciting product roadmap, plans for new methods of acquiring customers, and big strategic partners recently secured or likely to close soon are an important addition to your Series A story.  But that’s a topic of a different article I wrote titled “Your Series A Readiness Scorecard“.  Mostly I wanted to remind again that it’s not all about revenue and revenue growth.

## Summary

I hope this article has helped you see the importance of the relationship between size (revenue amount), growth (slope of curve) and acceleration (shape of curve) when it comes to attracting institutional investors.  I also hope you discovered that these same concepts can be used to plot your potential path to \$1M or \$10M.

To achieve the best possible results over time while maintaining an adaptive organization, plan, measure, refine and repeat.  And keep a hand on the gear shifter in case the stars begin to align and you’re presented with an opportunity to get even more aggressive.

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