As we close out the third quarter and look ahead to Q3 venture capital results (early work here, here and here), I am curious about present-day targets for startups at different stages. What does a startup need to have done — and what does it need to forecast — to raise a Series A today? Or a Series B?
Traditional rules of thumb for such transactions have been obsolete for some time. But the rules that supplanted the conventional wisdom became all the more ironclad during the 2020-2021 startup cycle peak; those new rules are now old rules — we’re in a new market and a worse economy.
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What are the new new metrics, then? Let’s chat through old guidance, the benchmarks that consumed attention last year and what we may be seeing today.
Consider this a part of our regular work to understand where we sit today when it comes to the private-capital consumer market (startups, for our purposes) and private-market capital disbursers (venture capitalists and their ilk).
This year, we’re told, profit is in and growth is out. Yet, there’s some indication that growth expectations may actually be higher than ever. Let’s attempt to square the circle.
Old, new, new new
Dua Lipa probably didn’t mean to comment on the state of venture capital investing thresholds for startup performance in her hit song “New Rules,” but the lyrics fit our task today:
I got new rules, I count ’em
I got new rules, I count ’em
I gotta tell them to myself
Call it the venture capital mantra over the last few years.
In the past, there were loose guidelines that mattered for startup growth. To pick an example, it was often said that to raise a Series A round, startups would want to have roughly $1 million in ARR. That meant that startups had to reach a revenue run rate of seven figures before they closed their first institutional round of capital.
That chestnut came from a time when the delineations between rounds were more concrete, and seed rounds weren’t a multipart transaction that could see startups raise eight figures of capital across multiple tranches. The times were different.
So what changed during the last startup boom? A lot.
In the 2020-2021 period, conventional wisdom indicated that growth was valued above all else. So, startups that were growing quickly even from modest revenue bases — the smaller a startup’s trailing revenue, the easier it is to grow at triple-digit speeds! — were piled high with capital, often in quickly succeeding rounds that left many somewhat small companies with huge valuations and bank accounts.
In short, the era of cheap money reached a fever pitch with the entire pandemic-era trade of piling money into tech stocks and private tech companies reaching its zenith. Next came rising rates, falling stocks, and the complete shuttering of the IPO market. Suddenly, what made sense in 2021 was not translating to 2022: expensive burn rates in the name of growth were said to have lost some of their shine, while investors became more willing to accept slower growth if the profit picture was less egregious. (Naturally, we have some doubt in our bones that venture investors are really letting up on their growth demands, but more on that in a moment.)
Startups were able to raise more with less, and it was a fun time to watch. Venture investors told us quietly that they were seeing revenue multiples for startups scale into the three-digit range, meaning that — as Y Combinator’s head of accelerator recently told us — a company with a mere $3 million in revenue could find itself valued as a unicorn. Such were the times, and those times are theoretically behind us.
This brings us to today.
To get to grips with the present day, we thankfully have some good historical data to parse. Point 9 Capital’s SaaS Funding Napkin (you know, “back of the”) series, a regular digest of target metrics for seed, Series A and Series B software startups, provides us a yearly look at venture norms. The collected dataset, tracking SaaS Funding Napkins from 2016 through 2022, shows just how much things have changed in the last half-decade or so. (Present-year data was sourced from deals through July, with more weight given to more recent transactions.)
Matthew O’Riordan, a co-founder at Ably, did the world a solid by collecting data from the series into a single spreadsheet. What it shows is illustrative:
- Startups are bigger at seed: The upper revenue threshold for seed rounds rose from $600,000 in 2016 to $1 million in 2022.
- Startups now vary more at Series A: The lower revenue bound for Series A companies fell to $500,000 in 2022 from $1.2 million in 2016, while the upper threshold changed more modestly from $3.0 million six years ago to $2.5 million this year.
- Startups are now smaller at Series B: In 2016, the revenue bounds for a normal Series B at a software startup were $4.2 million on the small side and $9.6 million on the upper end. In 2022, the same dataset notes a $3 million minimum and a $5 million upper limit.
- At each stage, growth of 200% to 300% is the norm.
We can tell from the above that there’s still ample money at the earliest stages of startup life (seed), meaning that startups get a bit bigger at that stage today. Series As are now more diluted as funding rounds go — those thresholds are moving and getting smaller overall. This means that startups are able to raise a Series A with less proven progress than before. Finally, Series Bs are happening either far earlier or simply with lower expectations than before.
What hasn’t changed are expectations around the pace of growth. For example, the 2019 SaaS Funding Napkin noted 300% growth for seed, 300% for Series A deals and 250% for Series B transactions as the norm. That’s just about where we are in 2022.
This raises an important question: If growth expectations are the same and the boundaries between rounds aren’t as stiff (you can get to Series A and B today with less revenue than in 2016, as we noted above), how much have things really changed?
Perhaps the answer is efficiency. The Napkin series added a capital efficiency metric to its dataset this year, which fits the purported mood. It could be the case that investors are not changing their growth norms but are rather tightening standards around burn.
If so, the change could preclude many companies that raised last year from the private capital markets while keeping the taps flowing for the rest. We could be seeing a bifurcation of startups in the market today: Those that are more efficient (able to raise and staring down a venture capital market packed with cash) and those that are less efficient (unable to raise and effectively starving to death while the capital grain siloes are bursting at the seams).
It’s a messy set of data to try to collect into new rules of thumb. Perhaps what makes the most sense is to avoid the seed/Series A/Series B demarcations entirely. After all, the upper bound for revenue scale at the seed stage is double the minimum for a Series A, and the upper limit for Series As and lower limit for Series Bs are close enough to be the same number. From this, we can perhaps infer that startup investors are more focused on company-specific results than the application of hard norms to round definitions.
The only real constant that we can find is that growth expectations remain stiff. As best we can tell, the new conventional wisdom for startups is effectively the impossible: Grow like all hell and also don’t lose too much money. Other than that, raising capital in 2022 is drop-dead simple.