What are investors looking for in Series A?

Rak Garg is a principal at Bain Capital Ventures where he leads early-stage investments in developer tools, data infrastructure, cybersecurity and enterprise software.

A year ago, developer-focused software companies were being funded at huge valuations, buoyed by the prospect of blockbuster IPOs like those from Snowflake, HashiCorp and Confluent. Now, with the market downturn, raising capital for a dev-tools startup is much more difficult. But it’s not impossible.

After meeting hundreds of developer-tools startups and talking to dozens of fellow investors over the last several months, I’ve noticed a common characteristic among founders who have raised successful Series A rounds: They’re great at telling their companies’ stories. Of course, it takes more than a way with words to raise capital, and in this column, I’ll delve into a practical, step-by-step guide founders can use to move successfully from seed to Series A.

Before we get started, it’s important to set expectations. The average Series A price for dev-tools companies is falling, and valuations are down across the board. The median Series A round for a developer-tooling company was $47.5 million in Q3 2022, the lowest it has been since the beginning of 2021.

Seed rounds are raised to validate a problem and create an early solution. Series A rounds are used to bring a solution to market, get a few customers to care and see early signs of monetizing that solution. As an investor in many developer-first businesses, including Docker, Redis and Startree, these five metrics are what I look for:

Developers are in the driver’s seat at most tech-first companies, and capturing their imagination will dramatically increase your GTM efficiency.

User growth

The most important metric VCs want to see is non-linear organic growth of your product’s user base, including usage expansion within specific teams. So try to provide at least a month of weekly and/or daily data.

If you’re running an open source company and user count is therefore hard to instrument, instead show usage growth through proxies like downloads or in-product engagement.

Remember, not all users are created equal. A company looks stronger if its users are from modern, engineering-first companies such as Robinhood, Confluent, Databricks and Airbnb.

Revenue

Revenue is taking an increasingly important role in Series A fundraising conversations. It’s not actually the amount of revenue that matters, it’s the quality. You could raise a stellar Series A at $100,000, $500,000 or $5 million ARR. Investors point to current revenue as a leading indicator of what revenue could look like as your company grows.

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Want to make it to your Series A?

Version One Ventures is an early-stage fund investing in outstanding consumer internet, SaaS and mobile entrepreneurs. Its portfolio includes successful platform companies like AngelList, Clarity, IndieGoGo, and Figure1, as well as many others. I recently talked with Version One’s Boris Wertz and Angela Kingyens about what they look for when investing in platform businesses. Read below for five key factors for early-stage platforms and what it takes for your company to raise its Series A.

Q: What do you look for when investing in marketplace platforms?

A: We look at several key factors. First is the size of the potential market, and then we look at the company’s growth rate and how quickly it can capture a strong share of that market.

Another key factor is whether the business has strong network effects. Does the value to each user increase as you get more users on board? Are users evangelizing the platform to organically bring more consumers and producers on board?

We also look closely at whether the platform is extensible over time, either vertically or horizontally into other markets. Think about what Uber has done expanding from just black cabs into other ride services like UberX or Airbnb’s ambitions to facilitate not just the hotel stay but the entire travel experience.

The frequency of transactions is another important metric for any platform business. We looked at one company that positioned itself as a search and booking platform for veterinarians. On the surface the idea sounds like it might work well because it’s a similar business to a few proven winners. But people many not go through the process of looking for a veterinarian nearly as often as they do for other services like home repair or cleaning services, so the frequency just isn’t there.

That’s why we also shy away from platforms that deal in one-and-done transactions. The transaction isn’t repeatable – the platform might help connect you with that the other party, but after that there’s less incentive for the customer or producer to return again.

Finally, we look at whether the platform has positioned itself as part of the payment flow. As Benchmark’s Bill Gurley noted in his “10 Factors to Consider When Evaluating Digital Marketplaces,” being part of the payment flow makes it much easier to generate a reasonable return on the value your platform creates.

Q: So for seed-stage companies looking to raise a Series A round, what do they need to demonstrate to you to convince you to invest?

A: Well the first thing is that they need to demonstrate a Minimum Viable Product (MVP). After that, they need to show active engagement from users.

Q: When you talk about engagement, do you mean like Fred Wilson’s classic engagement pyramid?

A: Exactly. In Wilson’s framework, 1% of users produce content, 9% of users curate content, and 90% of users consume content in some fashion. If a platform can show engagement that’s significantly higher in one of the first two categories, it’ll get our attention. For the long-term success of the business, this is non-trivial. The entrepreneur needs to show that they understand what it is that keeps users coming back day after day, week after week, month after month.

We also look at if the platform has a high composition of dual users, meaning users who act as both producers and consumers. Think of people both producing and consuming content on Facebook or Twitter, or sellers on Etsy who also tend to be some of its biggest buyers.

Q: What about platforms that have good engagement but are struggling to balance the ratio of producers and consumers they need to get to critical mass? We do work with platform clients around pricing models and incentive structures to help them balance their consumer and producer user base. What role does that play for you?

A: The platform needs to understand how its users interact and figure out how best to encourage the right balance of consumers and producers. Its incentive and pricing structures are a core part of that and makes a big difference in the platform’s long-term growth potential and whether or not it can get that initial core group of users that it needs to hit critical mass.

Q: What else do you look for in companies approaching their Series A?

A: The quality of users is a big one.

If the platform can get users in a high value market like Figure1, which is like Instagram for Doctors. It has a huge number of organic users who really value a private network of doctor-generated content. So for them, the size of the network might be smaller than, say, Facebook, but the network effects within that community are strong.

Q: Thanks a lot, team! We’ll look forward to Part 2 of this discussion, leading into growth challenges and indicators for companies approaching their Series B and beyond.

Want to learn more about Version One Ventures? Click here.

Filed under: Platform Innovation | Topics: investing, marketplaces, platforms, Venture Capital

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