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Founders can be forgiven for feeling a bit of whiplash from the funding markets. Back in the famous “Hot Founder Summer” of 2021, funding markets were one big Miami Yacht Party: plugged-in founders could raise Seed Rounds while still employed, revenue was potentially a distraction (after all, why put a ceiling on a valuation) and it wasn’t unheard for the Series A proofpoint to be a great closing party for the Seed Round.
Fast forward to 2023 and “every startup needs 3 years of runway at all times”, “VC was just a ZIRP phenomenon” and Miami is so hot that even the coral is moving to cooler climates.
Meanwhile the Series A market went from being a gimme to an extraordinarily high hurdle for almost all fintech firms. But good news! The lights of risk-seeking investors are starting to peek into the forever-runway tunnel of darkness. In the last couple of months, we’ve seen a handful of fintech firms, including within our portfolio, capture the elusive Series A term sheet. If you’re willing to put in the (extreme) effort, you too can raise a Series A (assuming you generate revenue, can tell a good story, and are willing to do many, many pitches).
Given that many of the fundraise announcements that one reads about in the news are often quite stale, we wanted to share more real-time observations for founders who are thinking about tackling this very challenging phase of the market. At a high level:
The sample size here is very small and the market does seem to be warming up, so the experience for a founder kicking off the process now might not be as challenging. But from what we’ve seen so far, the process takes longer, requires more polish, longer negotiation periods, and more extensive diligence than it has in years.
The Job is Fundraising
The duration of the Series A process is running significantly longer than at any point since we started Restive Ventures in 2018. The companies in our portfolio that have raised started speaking to investors in early 2023. They spoke to several dozen funds and it took 3-4 months to receive verbal offers. It took another month before they signed written term-sheets. Diligence processes can then be expected to last another 4-8 weeks. That means that we are looking at a 6 month process from initial conversations to cash in the bank. As such, planning is critical.
Since the investment process at funds appears to have slowed down dramatically, it’s important to have marketing materials early in the process. This includes presentation decks, financial models and organized comprehensive data rooms. These long processes also mean that teams are having to dedicate management time to keeping these documents up to date, integrating feedback from investors, and controlling access.
Given how sensitive these processes are, founders also need to remain disciplined in how they manage investor relations, including cutting off investors who aren’t moving quickly enough or become too demanding. We haven’t seen too much “bad behavior,” but many funds still are not motivated to do deals and can take advantage of the timelines to ask for more and more information. Founders need to consider how much they feel comfortable sharing and for how long.
Turning Words into Money
Interestingly, the post-offer negotiation and diligence process is much longer than we typically see. Investors are willing to provide firms with weeks to review term sheets and negotiate many elements of the term sheet, including price and governance requests. In years past, that would have created a clear incentive on the founder to shop a term sheet. It seems as though investors also realize how long these processes are taking and are allowing for a more constructive dialogue at this last stage - rather than trying to press their advantages with founders.
This might be a good strategy: it’s allowing founders to get comfortable with less well-known funds and for new funds to edge in on the turf of some of the big multi-stage names of the last few years. “I’ve never heard of that fund” is becoming less disparaging and more of a competitive threat for some of the bigger players in our industry.
As far as pricing, we’re seeing the market stabilizing back to pre-2019 norms of 10-15x of forward revenue (take the last month, annualize it, and multiply it by 10-15). Growth expectations are around or (ideally) above 30% m-o-m growth, on average, for the last few months. (Note that if a process runs for 6 months you’ll need to be able to maintain that growth for the duration of the process.) As always, revenue quality matters. Volatile and hard-to-sustain revenue, such as interest income and commission revenue is less valuable than more durable revenue streams like SaaS fees and payments-related income.
As far as sizing, expect 20-30% dilution (of course, everyone will want their pro-rata once you secure a lead!) and a top-up on the ESOP.
What we have NOT seen is structured financing terms at the Series A, such as liquidity preferences or onerous governance terms. If an investor is asking for this at the Series A, they are likely taking advantage of you and not adhering to market standards.
Finally, be aware of public comps. If you’re a consumer fintech business or an insuretech firm, the public comps are terrible. If you don’t want to be anchored to those, you do need to be able to draw a clear distinction between the nature of your eventual earnings and a company that might look really similar to yours and whose public stock is unloved.
Business Skillz Actually Matter
What hasn’t changed: founders still need to clearly elaborate a vision for investors in their marketing materials and personal communications that allows new investors to easily understand where the business is now and where it’s going. In addition, they need to be clear with their capital plans, which could include hiring plans, compensation strategy, office locations and marketing expense. One obvious impact of “raising with revenue” (which wasn’t always necessary in years past) is that there is something tangible for investors to dig into now. They expect founders to understand the business they have and what’s possible - but the challenge of communicating what’s possible, while being constrained by the current reality makes founder and team communications even more important.
Key details that you must know better than anyone: what’s current revenue, how fast is it growing, what are your customer acquisition costs, what are servicing costs of that revenue and what are the levers that you, the founder, can pull to make the business grow faster or slower, more efficient or less efficient. If you don’t know those details and how changing a key input like “investment capital” changes the output, it’s going to be impossible to bring investors along with you in this market.
Finally, don’t dwell on getting the “right names” in. Investors (and founders) tend to overstate the power of the investors' brands. That “brand” is almost entirely derivative of the outcomes of the founders and companies in which they invest. And some of the biggest funds of the last decade are currently sitting on giant funds that no longer pencil out, scared of the future and held back by giant globally-dispersed processes. As a result, they are sitting on the sidelines and waiting for decacorns while passing over really great businesses that may be mere unicorns. You don’t need scaredy-cats in your cap table. You need workers. And the people investing at the Series A, in this market, are working hard and taking chances. Go out there and take their money. Odds are that some of the funds you’ve “never heard of” will be the dominant “brands” in 10 years.
Because they invested in you.
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