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Seed, Series A, Series B: Why the wrong funding can kill your company

By on March 25, 2010
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Not all investors are the same. A seed investor is looking for something very different from a Series B investor.

Get the wrong investor for your stage of development, and it can kill your business stone dead.

Seed Investment

Seed investment is for angels and very early stage investors. It is typically less than $1 million, and may be as low as $50,000.

At this stage, a company that will get funding will have a great team (at least one or two people who are backable due to track record, specific expertise or, very rarely, a blinding idea) and a market that is interesting. They will often not have a product (particularly in the Internet space) but will have a clear idea of the kind of thing they will build with the money.

At this stage, a formal business plan with three year projections is not very useful, although you will probably have to create one anyway. It can be a helpful exercise in forcing you to codify your thoughts on the future plans for the company, but the one truth about it is that you will deviate from it.

But a good angel or seed investor will be much more focused on the key metrics that will determine whether your business will succeed or fail. For example, they may not care whether you make £1 million profit in year three or £3 million (because the one thing we all know about a start-up is that it won’t follow its business plan), but they will care, passionately, about how you will ensure that your customer acquisition cost is less than the lifetime value of your customer, or whether you have finances to fund at least two iterations of your product, or some other metric that is at the core of your business.

The purpose of seed funding is to help the company develop a product to fit its market niche. It may go through a couple of radically different iterations as the entrepreneur discovers what customers really want. As the business becomes clearer on what products will work in the market, it might be time for the next round.

 

Series A

The amount raised in a series A is falling, particularly for Internet-based companies. As so many services can be outsourced, bought in where necessary or hosted in the cloud and scaled according to demand, the need for upfront capital is correspondingly reduced.

Series A is likely to be anywhere from £500,000 to £3 million. Its purpose is to take an existing product, team and market niche and tweak them until they are firing on all cylinders. This may involve hiring new staff, adjusting the pricing structure or business model of the core product or adding new features.

The ideal outcome from Series A would be build to a successful, profitable business that could survive on its own. Many founders may, at this point, choose to continue to grow organically over time. But if they want to move faster – much faster – then they might raise Series B.

 

Series B

Series B funding is rocket fuel for companies. It may be anything from £5 million upwards, and its purpose is to take the company into the stratosphere.

Its time for Series B when all the stars are in alignment. The core team has executed well so far, the product is successful and the market is clamouring for more. Series B is not about taking risks, or experimentation. It’s about taking something that works and scaling it as fast as possible.

This can often be a tricky time for founders. It’s when entrepreneurialism gives way to execution, which often means that investors want experienced executives at the helm. It’s a time of transition for the company when many of the things that made the company successful in the first place – disruption, innovation, underdog status – may no longer be required.

 

The failures

Raising Series B (or C, D, E) before your company is ready for it can be disastrous for a company. (If you don’t believe me, read this fascinating account of the demise of Friendster for a case study).

And it’s even more challenging for games companies. For any games company that is not a pure start-up, the structure is all wrong.

On most metrics, in their core development business, most games businesses are at Series B stage. They have a proven team, relationships with clients and they have a long track record of delivering AAA games to their clients.

The problem is that, as I posted yesterday, Games-As-A-Product is not exciting for VCs. So developers approach investors with a new business idea: perhaps a social game, an iPhone business, a freemium model.

But this is a seed idea. An idea which needs hardly any money to get off the ground. Investors offer seed amounts of money, and ask for seed amounts of equity.

But games companies are Series B companies in their core business. They don;t understand how an investor can see so little value, can offer such a small amount of money.

Both are right. Investors are taking seed risk in a Series B company. Entrepreneurs have a Series B company, and don’t want to be diluted to give seed returns.

My solution: Don;t raise money. Reinvest profits in your seed ideas (i.e. be your own angel.) Only when your scalable, Games as a Service business has reached Series B size should you raise money.

By which time, you probably won’t need it.

About Nicholas Lovell

Nicholas is the founder of Gamesbrief, a blog dedicated to the business of games. It aims to be informative, authoritative and above all helpful to developers grappling with business strategy. He is the author of a growing list of books about making money in the games industry and other digital media, including How to Publish a Game and Design Rules for Free-to-Play Games, and Penguin-published title The Curve: thecurveonline.com
  • Great write-up! I was fairly confused about the difference between these terms before, not anymore!

  • Very nice post. As you could have guessed from yesterday's comment, I generally agree with the conclusion.