Sramana Mitra: There are 70,000 seed investments a year and only about 1,200 to 1,500 venture investments. There is a huge Series A gap that people have to deal with. How do you recommend the seed investors as well as the entrepreneurs who are raising seed money mitigate the gap?
Don Hutchinson: You’re going to be in a very competitive process to gain that Series A. In all likelihood, a venture fund will be a normal part of your future if you’re the kind of company that you and I are talking about. You got to have the characteristics that will appeal to that audience, although there is still room for opportunities.
We’ve seen a great increase and interest in Blockchain, Bitcoin, and all types of cyber currency. That would be something where a smart team could opportunistically act very quickly and will probably have a reasonable shot at funding. The downside is other people will follow suit. These opportunity-driven circumstances don’t open long, but they do provide an alternative to a more traditional business approach.
Is what you’re doing meaningfully better? Is this something that recipients would respond very favorably? Is there a clear path that establishes this to be a profitable activity? We don’t have to be profitable today. We don’t necessarily have to be profitable tomorrow. But we have to see that we will make money.
Sramana Mitra: Some of the metrics that we’re seeing is that Series A investors are asking for minimum of a million dollar ARR when it comes to SaaS deals and a certain amount of velocity in how people are acquiring customers. Those metrics need to be in place before a Series A round can be raised. Entrepreneurs need to be aware that however much seed money they end up raising, Series A still remains beyond their reach if they don’t reach those metrics.
Don Hutchinson: In all likelihood. There will always be exceptions. Those metrics are partly setup to help the processing of opportunities on the venture side. If you are looking at getting into Berkeley or Stanford, they face the unenviable task of turning away 80% of their applicants – the majority of whom would be perfectly well-qualified. Part of what we see on venture is how do we categorize applicants in ways that naturally deplete the numbers.
In the case of schools, you’re looking at GPA. You’re looking at test scores. Those help level the field before they look at other characteristics such as involvement in extracurricular activities. I would say that when an associate says something like a million dollar ARR, they’re using it to help themselves knock down the numbers of people coming at them.
If you watch what they do, they don’t necessarily adhere to these specifics. These are guidelines. Like if a student says, “My heart is set on Berkeley.” If their GPA is 2.3, that’s probably not going to work.
Sramana Mitra: I have a slightly different question, which I think is worth discussing. I know a lot of people have given up so much equity already in the seed stage. Maybe they have done pre-seed and seed and they’ve raised $400,000 and they’ve given up 17% of the company.
They still have to raise a post-seed or a pre-Series A before they’re ready for Series A. By the time they’re done with four rounds of financing, they’d have given up 30% of the company. How do you deal with this?
Don Hutchinson: There’re a couple of things. The problem you’re talking about is what inspired the whole idea of notes. The argument was this way, you don’t have to focus on price. In all likelihood, it was less than the amount of dilution the founders would suffer. Investors have said, “Thanks, but no thanks.” We’re taking the risk and we’re going to get a modest discount against what a Series A gets for a highly de-risked opportunity.
That brought along the concept of cap. You had cap notes and several evolutions on that. Essentially, cap notes are one way. The note is an impediment to attract equity-oriented seed investors but they’ve generally been accepted. In effect, the cap is viewed as pre-money on an eventual conversion.