July 31, 2017

Navigating the growth round in today's economy

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While there is a plethora of advice on the Internet on raising early stage venture rounds, there is relatively little around raising the growth round. There are many similarities between the two processes, but there are also many differences. The strategy for raising a growth round should be tailored appropriately.

The current market for growth-stage financing is nuanced. There is significant liquidity for top performing companies led by high-profile serial entrepreneurs or those in a select few “hot” sectors of the day. However, for many others, the picture is a bit different. For instance, the bar for Series B and C rounds in the enterprise space appears to be getting higher given the large number of companies that have raised Seed and Series A funding over past few years. The prevalence of structured deals at the later stages is also increasing. Further, companies that demonstrate solid business fundamentals or organizational dynamics as outlined in this article would be well prepared to raise financing successfully in any market.

So what strategy and tactics should a company consider when preparing to raise a growth-stage round in today’s environment? Let’s explore the differences from raising earlier-stage financing based on our experience both as an existing investor and partner to portfolio companies looking to raise follow-on growth rounds, as well as a prospective investor engaging with companies raising such rounds.

Finding the Right Fit and Decoding Investor Criteria

Earlier-stage venture rounds (such as Seed and Series A) are typically raised as you work through and demonstrate product-market fit. Raising a successful growth round is premised on evidence of emerging organizational and business maturity along several dimensions, in addition to key headline areas such as large perceived addressable market (TAM/SAM), strong team, solid growth in traction numbers and achievement of sustainable unit economics.

At growth stage, companies have typically figured out an initial product-market fit, are generating baseline revenues and are growing the business and organization quickly. Investors at this stage are typically looking to understand how well the company is geared to continue to scale up rapidly for years, and eventually deliver solid returns. As such, many initiatives that help drive towards a successful growth financing coincide with those that position your company well for sustainable long-term growth.

Business repeatability is one of the most critical aspects that growth investors look for. For many companies, this takes the form of a repeatable sales model — one where the organization has moved ahead of dependency on one or a few individuals to drive sales. Companies with a repeatable sales model demonstrate they can scale marketing leads and add sales staff at consistent productivity levels, while maintaining a steady customer experience and reasonable unit economics. A repeatable sales process is bedrock to a scalable business.

Gauging when you have achieved repeatability is highly subjective, and varies significantly by the nature of the business, competitive dynamics, sales model and market velocity. Some businesses may begin to demonstrate repeatability at low, single-digit million annual revenues, while others may begin to demonstrate it around $10M ARR. In some exceptional markets with high velocity, this may not happen until after achieving significantly higher traction. As an example, enterprise infrastructure companies selling to Fortune 500 customers typically begin to demonstrate repeatability at a larger scale than application SaaS startups focused on SMB customers, given lumpy contracts and longer sales cycles for the former.

In today’s hypercompetitive world, relatively few businesses start with an initial product that clearly has a large TAM from inception. However, successful growth stage businesses demonstrate a well-oiled machine at the core — such as one core product, geography, vertical or type of customer — along with sprouting seeds of future growth in other dimensions. In our experience, many successful ventures start with dominating one baseline market. The initial market may not appear large, but successfully tapping into concentric circles of future growth potential can create an expansive market.

Beyond the innate horsepower of the team and its understanding of the market, growth investors also look for signs of evolving team maturity. The best management teams at this stage are well rounded. An important phase growth-stage companies go through is that of blending in deeply experienced professionals and domain experts seamlessly into a management team and culture that in the initial days may be driven primarily by the entrepreneurial founders. As technology goes deeper into industry verticals, and as ventures have increasing levels of offline and operational components, getting this right gains even more importance. Once you are past the initial product-market fit, consider methodically augmenting your management team’s entrepreneurial energy with those who have “done it before” and/or have deep domain expertise.

Focusing on customer delight is one of the simplest, yet most important pieces of advice most entrepreneurs receive. Investors will talk to a lot of customers — both during their initial survey of the market as well as commercial diligence. They will not only talk to the reference you provide, but will also conduct a variety of back-channel checks. What customers say about your company and team will have direct and perhaps disproportionate bearing on the outcome of your process. Investments in a superlative customer success team and customer experience management tools early on — of course, in addition to a great product — will pay off well. Ensure you have happy customers that will vouch for you.

Growth investors come in a wide variety of shapes and sizes. Some invest large checks seeking venture-style returns (and are willing to take the corresponding venture-style risk), while others look for more moderate risk/return profiles. The former may look for aggressive growth, market leadership potential, a large scalable market and potential for 10x+ returns via IPO if things go well. The latter may focus on path to profitability (while still seeking strong growth), cash flow potential, a more assured path to 3–4x return via M&A, and well-protected downside. Both types will look at unit economics carefully. There is an entire continuum of investor styles between these two ends of the spectrum. In addition, many growth investors are sector and thesis driven. Look to partner with investors whose style aligns with your own aspirations, risk tolerance, business vision, and company cadence. Those investors would be more likely to invest, and you would benefit from the mutual fit, and their advice and depth once they invest. Focus your energy on the right investor set.

Preparing for Your Growth Round

Beyond the strategic aspects above, there are other tactics as you prepare in the months leading up to your growth round. To make the most of your efforts, make time to:

  • Prepare your team and systems for a significantly higher level of rigor starting at least 9–12 months in advance of your first growth round. Most great executives keep a close track of a variety of KPI metrics as they scale a business. Investors look at companies from an outside-in perspective, and may seek a different set of metrics than the ones you are actively tracking, Make sure you know what those are for your industry and sector, and are able to see the key business drivers from an investor perspective
  • Ensure that the CEO and key management team members have a visceral understanding of key growth drivers and unit economics for the business at a granular level, e.g., by geography, product, channel, are able to articulate how strategic decisions relate to each of these factors
  • Demonstrate the ability to build and execute plans. While high-growth businesses are inherently hard to forecast, growth-stage management teams need to show they can achieve an increasing degree of fidelity in achieving plans relative to the early stages of the business, where more variance is accepted and expected. This is a discipline that will pay off well beyond the tactics of raising financing
  • Be seen — have a cadence of impactful press releases, conference visibility and media mentions, and ensure appropriate coverage on deals platforms such as CB Insights, Mattermark and Pitchbook. Many top growth stage investors are now using deal discovery tools that tap into public signals to identify, track and prioritize high potential companies to connect with. These tools typically track indicators such as financing cadence, employee growth, executive background, customer names, web metrics and media coverage
  • Make sure you have an executive(s) on your management team with deep expertise in growth metrics and later stage deals — or bring someone in who does. This executive could be the CFO, a strategic finance executive, or a former deal maker who can put your company on a new set of radars. The role of this person is primarily strategic and forward looking, and distinct from reporting or controllership, which is a separate role best staffed with a different leader. Investors’ interaction with this executive, and the quality of metrics/reporting systems could disproportionately impact their perception of a company

Closing the Deal

If your company is headed in the right direction, investors will begin reaching out to you well before you start raising the growth round. This dynamic may be different for many entrepreneurs relative to their early rounds, where they had to do most of the legwork to find the right investors and reach out to them. Many investors will do that work at this stage. However, it is important to build a relatively wide funnel of investors and engage with them over a period of time to discover a mutual fit. For growth investors, the funnel from meeting to funding could be as leaky as it is for early stage investors. Investors will connect with a large number of promising companies, and do their in-depth assessment and due diligence later.

Stay in touch with investors who reached out to you, as well as larger investors you may have engaged with during prior rounds. We have also seen some entrepreneurs send periodic updates on business progress to a select group — which is a good way to keep in touch and keep the relationships warm. In our experience, the best deals are the ones where the investor and entrepreneur get to know each other over a period of time, as the weeks during the fundraise could be frenzied and may not provide ample opportunity for this.

When it comes time to negotiate the deal, do not get fixated on the valuation number alone. Take a careful look at the entire deal, the quality of the investment firm, and the specific investor you’d be working with. At the later stages, we are seeing more structured deals that involve terms such as guaranteed IRRs, warrants and multiple/tiered liquidation preferences. Some structures focus on generating a baseline return to protect the downside, while others provide investors mechanisms to double down on the upside. Evaluate the pros and cons of these carefully, and get expert advice if needed

Be prepared for the diligence process to take significantly longer than prior venture rounds. Even though you’ll hear of outlier cases where growth rounds get closed in a couple of weeks, that’s simply not how a vast majority of them get done. Most sophisticated growth investors will conduct in-depth commercial diligence and financial/legal due diligence. Be patient through the process as investors go through customer conversations and reference checks, various analyses and internal approval cycles. Have one or more trusted lieutenants working with you on this and coordinating with the rest of the company.

If you can find the right match and invest the time needed to close the deal, you are well on your way to the next stage in your company’s growth.