How many times have you read about a rocket ship company that’s taking over the world? You get green with envy after imagining what it would be like to sit on that rocket ship and experience the near flawless execution that enabled their success. Fundraising was probably a breeze and the best talent in the industry flocked to the company. What a Utopian picture, but deep down inside you know it virtually never works like that.
The evolutionary paths to startup greatness are something just shy of infinite and very rarely in a continuous positive-sloped line. You’d be amazed to know how many “overnight successes” were 10 years in the making and with lots of twists and turns along the way. Your new venture will almost certainly encounter its own twists and turns and I want you to know that’s totally normal. For this section I use both diagrams and metaphors to foretell and describe some of the paths you might experience on your own way to greatness.
This article explores just one of the topics covered in Chapter 1 of my bestselling book “Startup Success – Funding the Early Stages”.
You can listen to this chapter now and if you’re interested in the book, you can find it on Amazon here.
The best way to start is actually to review the most pristine, but least likely, path from the idea phase through a Series A. As you will see in the diagram below, I’m using the metaphor of shifting gears through the phases. The idea phase involves the activities described in the second chapter while the next three phases each commence with a fundraising activity. The new funds provide the needed fuel (time and resources) to accomplish whatever will be needed to reach the “sweet spot” for the next round of funding. With each such boost of fuel you are able to shift a gear.
Disclaimer: The examples used in this article are for a venture-funded company. Many startups don’t have the makings of a high-growth, venture-funded business but can still evolve into a great company. Additionally, there are other forms of financing than just equity investments from venture funds.
The best startups are adaptive, flexible, learning organisms. When they hit a dead end or some important assumption gets invalidated, they make an appropriate adjustment that’s often called a “pivot”. While some pivots are actually more of a minor tweak or fine tuning, others are fundamental enough to the overall business plan that the company finds itself taking a few steps back before being able to step forward again.
In the graphic below you’ll see that the pivot prevents making the planned gear shift and instead going around a metaphorical roundabout. This circular motion can continue multiple times before being ready to shift gears and move to the next phase. And if you’re concluding that too many times around the roundabout without fresh funding could kill the company, you are correct. Even with fresh funding each time you will feel the pain of additional dilution that otherwise wouldn’t have been felt. But we do whatever it takes to stay alive and gain our most valuable resource, time.
Sometimes (actually, often times in the early days), we exhaust the available funds from the previous phase and discover that we haven’t reached the “sweet spot” for the next phase. This means the next category or class of investors won’t yet be excited enough to invest. But since we need extra time in order to reach that point, we need to raise additional funding. We typically call that a “bridge round” and they can be required even after the company is generating millions or even tens of millions in revenue.
As the name suggests, a bridge round is intended to bridge a needed gap to the next round of funding. They can be very distracting and, because of that, the sooner you see the need coming, the better. That translates to getting better at forecasting revenue, expenses, product roadmap enhancements, new business partnerships and the like. Some of the planning tools in the next chapter should help in this regard.
Have you even skipped a gear when driving a car with a manual transmission? Doing so usually starts with achieving high enough RPMs while in one gear to be able to skip the next one. In other words, skipping from first to third gear like the graphic below suggests.
What does this have to do with a startup venture? Well, like the metaphor suggests, there are times when a startup achieves so much acceleration and traction during a particular phase that they get to leapfrog over the next traditional round of funding. They still need to raise a round of funding but, like the graphic below suggests, a super-hot idea phase startup might be able to skip a pre-seed round of funding and go straight to a seed round. It’s also possible that a hot pre-seed funded startup might be able to skip straight to a Series A.
These leapfrog opportunities are mostly only possible in the early phases of a company and not really something we talk about for companies that are generating millions of dollars. But just imagine the numerous benefits of being able to leapfrog. Multiple interested lead investors and more favorable terms, more attractive to prospective employees and less equity dilution just to name a few. I bet you thought I was going to say it offers a faster path to $100M in revenues. Yes, that too.
On the topic of growing to $100M, many first-time entrepreneurs see the hyper-sonic growth of some modern day unicorns ($1B valuation) and assume getting to a meager $100M mark in 5-6 years should definitely be achievable. I’m here to tell you that’s unbelievably difficult and almost certainly requires multiple “leapfrogs” in the early years. To demonstrate the point, below is a hypothetical path to $100M, including the associated annual growth rates:
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. If you could leapfrog the $2.5M year (go from $1.0M to $5.0M) and the $9.0M year (go from $5.0M to $15.3M), you could shorten the path to 8 years. 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 served as COO of a company that tripled revenue over a short two years but also had to grow from 150 employees to 450 in those same short two years. Talk about chaotic growth. Can you imagine successfully recruiting and on-boarding that many new employees while also acquiring and supporting the needed new customers to grow the top line?
At the outset of this section I suggested there are nearly infinite evolutionary paths for any given startup and hopefully now you see why. Multiple pivots and bridges are possible, including during the same phase. Hopefully either are later offset by a leapfrog but those are very unusual, so don’t count on one to save you.
To demonstrate how dramatically different the paths can be, below are two scenarios, one that we would all like to experience and another that is a little more typical.
- Idea phase
- Leapfrog to Seed phase
- Gear shift to Series A phase
- Gear shift to Series B phase
- Idea phase
- Gear shift to Pre-Seed phase
- Bridge to Seed phase
- Bridge to Series A phase
- Bridge to Series B phase
The differences are visually obvious and you can imagine the extra amount of time it took Shockwave AI to enter their Series B phase. But, for fun, let’s associate some assumptive metrics with each possible path through the evolution. We will use the following assumptions key:
- Idea phase lasts 3 mos and carries a fundraising unit of 0
- Pre-Seed phase lasts 6 mos and carries a fundraising unit of 1
- Seed phase lasts 12 mos and carries a fundraising unit of 3
- Series A phase lasts 24 mos and carries a fundraising unit of 12
- Each pivot lasts 50% of the time for that phase and carries a fundraising unit equal to 33% of the phase
- Each bridge lasts 33% of the time for the prior phase and carries a fundraising unit equal to 33% of the phase
If we apply the above assumptions to the two scenarios and round off the final numbers, here is the result:
Shockwave VR: 39 months and 15 fundraising units
Shockwave AI: 70 months and 23 fundraising units
I know this was just a hypothetical exercise but I hope it helps you see the dramatic time and funding impact that big pivots and bridge rounds can have. One company got to a Series B in a little more than 3 years while the other took almost 6 years and required 50% more funding to get there.
All of the previous examples reflected business ventures that moved from one phase to the next, even if not via the most efficient evolutionary path. What happens if there is no beneficial pivot and no available bridge financing? What happens if only flat or very slow growth is possible?
Many businesses hit a wall at some point for exactly these reasons. It can happen early in the venture (ie – seed stage) or even after generating millions or tens of millions in annual revenue. The key question if this happens is can the venture be self-sustaining? Even if it is losing money at the time of hitting the wall, it might have been resourced and spending money for continued growth, which could present an opportunity to reduce expenses to become self-sustaining. For more on dealing with tough times, read my related article here.
I recommend incorporating this concept into your various planning exercises. Assess where you are and the likelihood of reaching the next desired phase without requiring a pivot or a bridge round. If a pivot is justified, it should not be ignored because of the inconvenience or extra needed funding but rather it should be executed with precision to minimize the risk of having to go around the roundabout more than once.