Don’t tell your frugal grandpa, but these days, you can’t do much with the typical $2 million seed round.
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When enterprise cloud startups meet with us, one of the first questions we ask is: How much capital do you need?
The companies we meet with are typically pre-product with small teams, around two to 10 people. They almost invariably say they need a $2 million seed round, for the simple reason that, today, just about all seed rounds are $2 million.
Our next question is: What can you accomplish with $2 million? If they’re honest, they’ll say, “Not enough.”
We then tell them that we agree. In our experience, $2 million is a little light. At this point, more often than not, they’ll breathe a sigh of relief and say, “Yeah, by our calculations we really need $5 million to get to the next stage.”
So, this raises the question: Why even raise a seed round?
Don’t tell your frugal grandpa, but these days, you can’t do much with $2 million — not in the enterprise cloud realm, anyway. These companies are attempting to build very important products for the enterprise. They are trying to solve weighty problems for business, and getting to their first product offering requires the help of experienced, high-quality engineers who (news flash) do not work for free. There are also early sales and marketing challenges that these startups need to get right.
And yet, so many startups are still stuck on the $2 million seed round. That’s what the market expects, so that’s what they’re conditioned to ask for — instead of the larger amount that they really need.
We need a rethink here. In fact, there is no longer a Classic Series A market. That’s because the capital requirements for today’s enterprise cloud companies are a lot different than they were 15 years ago, when cloud companies first burst onto the enterprise computing scene.
In theory, new cloud companies need a lot less capital to get off the ground due to lower upfront startup costs, cheaper technology and a wider range of distribution options. OK, fine. But it’s still hugely important to get the right pieces in place and build a solid foundation. And no matter what anyone says, that does not come cheap.
So, how much is the right amount? For early stage cloud business application companies, we believe the real capital requirement is about $5 million. That’s how much you need to hire seasoned executives, prove out an acceptable level of customer success and really start to refine your customer-acquisition model.
But here’s the other problem: The traditional Series A firms are now so large that they need to put much more money to work — a minimum of $10 million. So, that sweet spot between $2 million and $10 million is not really being addressed in the venture world.
And it needs to be addressed. Today you have that headless syndicate of $2 million to $3 million seed rounds composed of 12 different angels and a few seed funds that have already invested in 70 other startups. This is not a great situation for startups. After all, most of these investors aren’t signing up to provide hands-on advice or help with the hiring of key employees.
Plus, $2 million is just not enough capital to build out a product and team that’s ready for prime time. For enterprise cloud startups, the seed round is simply not that effective or efficient.
So, what’s the solution? My advice is to simply skip the seed round.
That’s not to say there isn’t a place for seed funds and angels. Of course there is! In fact, as a managing partner at a Classic Series A firm, I welcome these investors, because they can play a critical role and add extremely complementary value to the Classic Series A syndicate.
At the same time, they also understand that $2 million is not sufficient for today’s cloud startups. We want leading seed firms and value-added angels to join us as co-investors so they can avoid the headless syndicate syndrome and help provide cloud startups with the capital the really need.
The reality is that today’s venture capital market is not really optimized for early stage enterprise business companies. At one end of the spectrum, seed investors are not in a position to provide the long-term capital or board-level support that startups need.
At the other end, traditional venture firms have grown in size and have raised progressively larger funds. As a result, they are looking to write bigger checks of $10 million and above. That means they require startups to have a considerable level of traction and be further along in their development before making an investment.
This is why we need a return to Classic Series A investing.
What the market really needs are venture capital firms that are truly built for early stage investing, and that are led by seasoned operating partners who themselves have been entrepreneurs, who are connected to the top players in the cloud market, and who can provide that kind of insight and advice needed to build global, category-leading companies.
More than ever, enterprise cloud companies need honest-to-goodness Series A investors that can help them accelerate growth and maximize their true potential.