Forget the Series A crunch, Series B is where startups really falter

Steven Loeb · February 14, 2018 · Short URL: https://vator.tv/n/4b03

Series B is the put-up or shut-up round

Ask entrepreneurs and they'll probably tell you that raising capital at any stage is difficult. No doubt each one has its share of challenges. At the seed stage, entrepreneurs have to sell the vision. At Series A, the company has to show they have a product and a target customer. But still the investor is betting on the team and vision. By Series B, that's where companies have to either put up or shut up. 

The challenge here is that the number of startups getting funded in the Series A-C stages are well below the ones getting funded in the angel and seed stages. This is a stark contrast from a decade ago.

In 2017, some 2,644 early stage startups received venture funding, accounting for 32.7 percent of all deals across all stages, according the 4Q 2017 PitchBook-NVCA Venture Monitor

Compare that to 3,793 startups that received angel and seed funding last year, or 47 percent of all venture deals. If you think about this as college admission rates, it's as if nearly 3800 kids graduated high school, but only 2600 slots are available across the colleges.

In 2006, this wasn't the case as under 500 startups were funded in the angel and seed rounds vs 1,750 getting Series A-C rounds. 

It's difficult to raise a Series B

Early-stage rounds -- everything from A, B, C -- are always tough to raise, though the media has typically focused on the Series A crunch. There was such a crunch that a new round or stage - post-seed - emerged to handle a lot of deals that couldn't get the coveted Series A.

But if Series A is tough, Series B is even tougher.   

"At the time of the B, a small number of companies may have proven that thesis beyond doubt: either growing quickly enough to command a huge price (huge and unquestionable success) or proving the initial hypothesis isn’t viable (certain failure). But most companies will find themselves having proven only certain parts of the go-to-market, but not all," Tomasz Tunguz, Partner at Redpoint Ventures, wrote in a blog post in 2017.

"Series B companies may have some subset of key metrics in attractive ranges. They might have half of a management team hired. They might have some great customer success, but some churned, too. At this point, the business is too far evolved to simply sell the dream, but not far enough along to raise on the metrics."

Fred Destin also wrote about this back in 2014, and came to a similar conclusion.

"Series B is hard for a simple reason: suspension of disbelief fades and is replaced by an increasingly cold, hard look at milestones and progress," he said. 

"Series B is the round where the rubber meets the road, where the promise has to be met with numbers and projections. Series B is the round where hard nosed investors drive ownership up before your company really starts to scale. Series B is the unloved valley of slow progress that precedes scaling. It's the no-man's land of the startup build phase."

So what do the numbers say? In a blog post in 2016, Guy Turner, Partner at Hyde Park Venture Partners, noted that while Series A rounds were steady in terms of volume and pricing, Series B rounds had dropped 30 to 50 percent.

This, he said, is a warning sign for those looking to raise their B round. 

"Welcome to the Series B crunch. Take advantage of the still-healthy Series A market and raise a nice sized round, but beware of too-high Series A valuations as Series B prices drop," he wrote.

"While getting stuck upside-down on valuation is part of the startup/venture game when things don’t go well, it is a crying shame when valuations get upside-down on high performing startups. This is a big risk in the current environment. Over the coming quarters, I would also expect the increasing pressure between Series A and B valuations, to put back pressure on Series A valuations as Series A investors’ forward expectations adjust."

While investors might be willing to take a chance on companies for their first few rounds, Series B is the round where startups must finally show they have what it takes. This is where the wheat is separated from the chaff, and only the best companies will make it. 

(Image source: pixabay.com)

Support VatorNews by Donating

Read more from our "Trends and news" series

More episodes