Perils of Series B Fund Raising

Many a times, it is easier to sell a “Concept” than “Real Business” to Investors. When Investors like the founding team and the market opportunity, they end up making bets. Often these are gut based decisions as opposed to data or deep due diligence driven.

Valuation methodologies differ by the stage of investment and the availability of quantitative and qualitative data. Since a majority of these companies raise their first round at pre-revenue stage, valuations are very subjective. Based on the "ASK" and VC Firm’s ownership requirements, Start Ups' valuation (Pre Money/Post Money) gets determined. For example, on a $2M raise, if a VC firm demands 1/3^rd ownership, the valuation gets set at post money of $6M.

Almost all Start-ups encounter the following bumps during their journey

Markets growing slower than anticipated
• Too many me-too companies creating confusion in customers' minds
• Operational and Execution challenges

It always takes longer and costs more than what’s stated in a company’s financial projections to achieve business momentum for the next round of financing.

Companies that execute well and achieve escape velocity close “UP” (Series B) rounds very quickly. Often there is a race among Investors to preempt financing of these companies.

“Getting to Plan B” and Slow Growing Start-ups, find follow-on fund raising process slow and painful. Though new Investors like the Company and the market space it operates in, Post Money valuation of the previous round acts as a deal killer. This time around, Investors start evaluating real business. An idea of Flat Round doesn’t gel well with Entrepreneurs. From their view point they have made considerable progress on the product/customer/brand fronts, compared to where they were at during Series A financing.

Also existing Investors will expect the highest price for new Investors (UP round) to be able to mark up the value of the investment on their books and look good to their LPs. New investors will always bargain for the lowest price they think will enable them to get a financing done, given the appetite (or the lack thereof) of the existing investors in putting more money into the company.

Caught between the Rock and the Hard Place, Start-ups could end up getting demotivated and distracted, losing value quickly. My advice would be Focus on making the Pie Bigger as opposed to owning a Big Piece of the Pie. Close the round no matter what, get the money into the bank and start executing.