Samaipata is an early stage founders’ fund investing in digital platforms displaying increasing returns at scale, across Europe.
Over the recent months, we have seen early stage start-ups raising rounds that were significantly higher than the “average” seed round, e.g. Dija €20m, Cajoo €6m, Kili €6m, etc. NB: the historical median over the last 3 years is sitting at €1.6–€1.8m (Dealroom). It could be traced back to the high level of dry powder out there leading to an unbalance between the supply and demand of capital. Or it could also be a sign of the European tech ecosystem maturing, essentially catching up with other geographies, such as the US, leading to potentially higher exits. Finally, others would say that it’s linked to a more seasoned generation of founders on the market, characterised by a higher speed of execution and thus a higher level of trust from investors.
However, let’s go back to the basics: what actually drives the value of a seed company?
The theoretical number: ∑i=[1-n](DCFi)
The theoretical value of a business is the sum of all its future cashflows. At later stages, with more predictability on business operations and commercial development, it becomes easier to predict the value of future cashflow with some assumptions and hypothesis taken on growth and discount rate. But at earlier stages, these numbers are really difficult to predict because 1/there is a lack of historical data to predict what the “normal” cashflow will look like (especially when you are pre-monetisation) and 2/because it’s very early to state what the market growth will look like in several years. This is why valuing Seed stage startups is more an art than a science and entails a more pragmatic approach.
The pragmatic triptych: f (R, D, K)
What mathematically drives the valuation of an early stage round is 3-fold:
- R: The round size (i.e. the runway you are going to need until your Series A)
- D: The dilution rate (i.e. the amount of equity you are willing to sell)
- K: The multiple on business KPIs (e.g. 10x ARR)
The relation that links these 3 variables is:
Note: These 3 variables are interdependent. Yet generally speaking, talking about multiples this early in a startup life does not necessarily make sense (especially if you’re pre product!) and there are industry standards on what is considered an “acceptable” dilution, leaving you to play within a range of 15–25%.
Considerations on the round size
Before asking yourself “How much should I raise”, you should understand: “Why am I really raising money?“. A key answer would be “Because I want to deliver on a realistic plan which is a pragmatic translation of the vision I have for my company”.
Therefore, first step is to design a business plan which is 1/focused on delivering your vision and 2/realistic vs. what the founding team were able to prove during their previous iteration (i.e. length of sales cycle, tech development cycle, operations delivery , pricing level, etc). The output of this business plan will give you the amount of money you need for the next 12–18 months.
If you raise a lower amount, you won’t be able to execute on this plan and to reach your target.
Now when you have defined your floor (your need in capital), which amount could you go up to?
Personally, I think that the complexity of deploying capital is not a linear function of the actual amount you are able to raise but that it actually grows up exponentially. There are some incompressible variables linked to speed of execution such as hiring the best talents, developing and deploying technology, going through complex sale cycles etc. Therefore, if you raise 2x the amount planned, it will not necessarily mean that you will scale 2x faster. But what is certain is that at the end of the day, you are going to have to deploy 2x more capital which could lead to a loss of focus, spending on the wrong stuff, making wrong choices, etc.
Obviously, you should be flexible about the exact amount of money you will raise (either up or down), but this range should be somewhat both capped and floored.
- Floored by the money you actually need to stick to the plan
- Capped by the money you realistically can deploy over the next iteration 12–18 months
Considerations on the dilution rate
The dilution rate is measuring the equity you are willing to sell during your fundraising round. Remember, your equity is what should be the most precious for you so it shouldn’t be given away lightly. On the dilution rate, 2 factors have to be taken into consideration. 1/The amount you want to sell and 2/How this dilution is split between round participants.
Considering these factors, you want to keep a Series-A-proof cap table (i.e. the founders block above 70%) but you also want to incentivize your investor. Ideally, your lead investor should have an ownership stake large enough to be fully committed on the business, rather than having a fragmented investor base who is not incentivized to help you with regard to the equity they have and their fund exposure.
Considerations on the multiples on business KPIs
You can be ambitious but you need to be consistent with what you will be able to deliver until the next round.
Being punchy in terms of valuation at Seed stage can generates some pressure on follow-on rounds. You need to bear in mind that you will need to justify the valuation down the line with numbers (generally a clean equity story imposes a 2x valuation at next round).
Why is it a problem? Because down rounds are a reality and can become very punitive for founders (linked to anti-dilution mechanisms and ratchets asked by investors) and these are less advertised in the press. It’s very rare to read about a down round and about founders failing to deliver on growth down the line.
In the end it’s all about iterating and sequencing.
The startup ecosystem has taken a lot from the software development world cycles, i.e. sprints, short iteration timelines, the need to test things quickly and iterate over again. This is also true for fundraising dynamics. You better raise capital at a higher frequency hence mitigating total dilution, rather than raising too much money too soon from a T1 late stage VC.
Sequencing is key. It looks nice to have deep pocket VCs on your cap table but the question when and at what cost. And bear in mind that a small ticket from a deep pocket is risky as interests are not necessarily aligned and that at the end of the day, you will represent a really small share of his fund allocation
Despite the increase in Seed rounds witnessed over the past months, which could be linked to a maturing European ecosystem (i.e. larger exits, the emergence of a generation of 2nd- or 3rd-time founders, more interest of foreign funds, etc.), it seems that “the higher the better” equation doesn’t necessarily hold at seed stages.
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