Founder Tips for Seed Round Size and Valuation Determination for Raising Funding in 2022
- October 3, 2022
- by:Serhat Pala
Lately, almost three of the four seed-level early-stage companies I meet are have difficulty determining the amount of funding they want to raise. This difficulty is a common trait for European and US companies alike.
Here are a few observations from my latest interactions and my humble tips as a former founder (and with experience as a current investor).
1-) Do not try to raise a larger amount than you need:
The critical point about the above issue is “the amount you need.” Some of the feedback the founders have gotten lately, and these points are entirely valid.
Times are tough; raise as much as you can. That makes sense, but this was a bit of better advice last year, not anymore. The seed level has been tough to raise for several months, especially as investors want to keep dry powder to support their Series A and beyond the portfolio. For the seed level, they want to see either significant momentum that shows a feasible path to Series A, signs of a survivable company that can bootstrap if needed, or want to get a great deal with the valuation on a good company. And in none of those cases, it is favorable for the founders from a dilution perspective.
Raise funding as much as possible so you can focus on your business and not have to raise funding for a long time. As a former founder, this makes so much sense to me since the least favorite thing for any founder in building a business (except those that make raising funding their actual business) is to look for investors. Yet when you raise funding, you have to consider the impact of dilution on your existing shareholders (including yourself). Generally, after your seed funding, you expect to have 12-18 months of runway to reach your next set of milestones and significant inflection points. You don’t have to get to the position of Series A, but get to a point where getting the Series A (or not) will be predictable, and you will have a solid plan.
2-) Your seed valuation is not a goal but a tool.
Unfortunately, it is a common mistake for many founders to get stuck on the seed funding valuation. Don’t get me wrong, valuation at the seed level is important, but there are other important things. Your Seed Level is a tool to get to Series A, and get there strong. It is not a goal itself.
By getting stuck on the valuation, you might be trading off several essential things, like closing your seed level fast and with more than one potential lead investor competing for the opportunity.
As founders, potentially the most significant dilution + exit liquidity decrease happens at the Series A level. Most founders do not realize that during Series A, Venture Capital firms use various tools such as “liquidation preference” (Founders, if you don’t know what this term is, please research the Venture Capital terms and what they mean). So use your seed level funding round for what it is as the best way to get to your next step Series A. Do not do anything that could put you at a disadvantage with your Series A
With seed, getting the best strategic investors (venture capital or angel investor) should be your primary goal. Instead of having to work with investors that will accept your valuation at a higher level, have investors compete for your great valuation so you can choose the ones that will serve your purpose. Don’t forget, just like promising founders and companies, good investors have options too. Unless seed is the last round you will be raising, you are using the seed level to get to your next stop strong.
3-) The amount you raise and the valuation you seek are interrelated.
This relation is not a general rule but a best practice to keep in mind. You are doing what you are doing as a founder because you expect to be successful. And more likely than not, you will need to at least raise a Series A (or Series B) before you exit. That means you will have to go through at least three or even four rounds.
This Finerva article summarizes very informative research done by Radicle mining data from 8000 funding rounds and outlines how much dilution generally takes place at each funding round. In summary, averages look like these:
Series A 20-25%
Series B 15-20%
Series C 12-15%
So if a founder team finds themselves trying to raise $3mil on a $7mil pre-money valuation at the seed round, they may be diluting themselves too much. They should have a very good reason for doing what they are doing.
I can add more points and tips to these observations, but the above takes care of the most important ones.
So seed level company founders, please think with the long term in mind. If you are going to succeed, you probably have at least five more years to exit and are going to raise at least two more rounds after this.