How to deal with the Series A crunch

Since CBInsights released its report in December, conversations have accelerated about the pending “Series A Crunch.” With headlines declaring that more than 1,000 seeded startups will soon be orphaned, it’s only natural that startups are concerned about the future funding landscape.

While experts may differ on the implications or severity of the Series A Crunch, the numbers provided by CBInsights are straightforward. Seed financing grew from 89 fundings in Q1 2009 to more than 500 in Q3 2012. However, Series A fundings have remained fairly stable over this time. That means there are a lot more seeded startups out there: an excess demand for a limited supply of Series A financings.

I recently had lunch with an entrepreneur who asked what he should do. As I’m assuming this is a common question heard in huddled discussions in offices from San Francisco to Boston, here’s my advice on how to navigate today’s financing waters:

If you haven’t raised your seed round yet…

If you’re looking to raise your seed round, aim for more money than you had originally planned. Traditionally, I’ve advised startups to raise enough money to sustain them for 18 months. However, you should lengthen your runway in anticipation of having a harder time closing a Series A round. Startups should now be looking for seed funding to last them 24-36 months. For example, a startup of mine just raised a $3 million seed round.

In addition to looking for a large seed round, startups may need to put more thought into who’s funding them. For starters, it’s important to avoid party rounds in this kind of environment. Not having a lead investor in your seed round can make it tougher to pull together a bridge round or follow-on financing down the road, since no single investor feels in charge or vested in your success.

Do your homework on potential investors. You’ll increase your chances of getting funded beyond the seed round if you take money from VCs that are known to be patient investors and have enough funds reserved for follow-on investments. As an example, Version One has more than 50% of its funds reserved for follow-on financing.

If you have raised your seed round and are trying to raise a Series A round in the next 6-12 months

If you fall into this category, you should know that plenty of companies are raising Series A funds. However, you’ll most likely see more competition over the next year.

Your first step should be an honest assessment of your company’s chances to get Series A financing. Ask for brutally honest feedback from your seed round investors, advisors, and any other investors you know and trust.

The Series A Crunch has been compared to Darwinian natural selection, thinning out the weaker startups. In this environment, the startups that will struggle the most to get Series A financing will either:

a) Not have enough traction

b) Not have the right team

c) Not have a large enough market

So, if you find yourself falling into one of the three categories above, what can you do? Your chances will be rather limited to close a Series A deal – as a result, you need to get creative:

1. Lengthen your runway by cutting your burn rate: You’ll need to give yourself enough time to get to profitability or get traction in the market. Take a close look at your burn rate and determine where you can make cuts. Do you need to cut salaries or head count and start sharing office space?

2. Look for alternative sources of capital: VCs are not the only game in town and it is possible to fund your company without them. For example, look for strategic investors or another angel round. I even heard of one startup who successfully raised money from its suppliers.

Final thoughts
With more companies seeking Series A financing this year, it’s time to get smart. It may go without saying but the more runway you have, the greater your opportunity to gain traction and attract funds. Don’t be discouraged by talk of the Series A Crunch, but be realistic about your situation and plan accordingly.

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  • http://twitter.com/JoshMullineaux JoshMullineaux

    Excellent article and some practical advice on how to think about the crunch and why it’s real. I’ve been telling my friends who are about to raise seed rounds to think about raising larger rounds as well. One piece that will be interesting to watch in the coming months/years is what happens to the talent pool? If the series A crunch is bad enough does that mean the talent crunch becomes less of an issue?