At Metal, one of our focus areas has been in-depth research on the investing behaviours of venture investors. Across historical data, one prominent trend is that venture investors love to invest in patterns that they believe will deliver returns. For instance, investors that invest in HR Tech once or twice are significantly more likely to make additional investments in that particular area (relative to investors that haven't done any prior work in the space). This unfolds an important truth about venture investments:
When Investor X makes an investment in a specific vertical, that event serves as evidence that the investor views that space favourably. Put differently, investors that have made multiple investments in HR Tech are more likely than others to make further investments in that space.
Understanding Opportunity Spaces
In order to identify similar companies, one layer of complexity lies in understanding what exactly qualifies as "similar". As an example, a company that builds a hyperlocal marketplace for senior care is actually strikingly similar to one that develops a hyperlocal marketplace for gardeners.
Traditional sectors would categorize the former within healthcare and the latter within home care. In reality, however, both companies have a super similar business model (built around enabling users to earn money by delivering basic services within their neighbourhood).
In the long term, with the right quantum of training data, AI models will get really good at identifying similar companies. Alongside similarity in business models, another important layer of complexity involves the broader investing thesis that a given company falls under.
Collectively, similarity in business models and overlapping investing thesis come together to form what we refer to as an"opportunity space". Investors that have historically invested in the same opportunity space as a given company are ultimately the "most likely" financing partners.
Metal's Investor Ranking Models
At the very core of Metal's technology lies our investor ranking model. With the right quantum of training data, our model has the ability to identify the "most likely" investors for a given Company -- the model uses data points derived from on a unique combination of industry and user generated information. An early version of our ranking model is already live on the platform, enabling users to identify investors that are a particularly strong fit for their company and round.
Ultimately, we believe that the overall venture industry will benefit from AI models that can identify which investors are most likely to lean in on specific types of companies and/or rounds.
Founders that zoom in on the right type of "most likely" investors are often able to close rounds with a higher level of certainty than those adopting a "spray-and-pray" approach. All else being equal, pursuing high-relevance investors reduces the time it takes to close, improves overall odds of a successful close, and eliminates the need to talk to a very large number of investors.
After observing 1,000+ raises across numerous sectors, we see two different approaches toward fundraising, resulting in very different types of experiences for founders.
The first approach is what we refer to as "spray and pray" -- a state in which founders try to access and pursue any investor(s) that they can easily access (with some high-level directional focus on investors that are "early stage" or "late stage"). With this approach, founders don't have a clearly defined qualification criteria, and are generally relying on hearsay.
The second approach is what we refer to as "high precision" -- a state in which founders first form a specific qualification criteria and then use data to identify investors that meet that. With this approach, founders are laser focused on identifying investors that are the “most likely” partners for their Company.
With fundraising, there is no one approach that fits all companies. There are, however, strong reasons for why banking on empirical precision to identify the "most likely" investors enhances the odds of a successful raise. The below post draws on contrasting patterns that we hear about from founders in each category.
Can’t get intros vs. forward motion
In the spray and pray category, founders often experience very low conversion rates with introduction requests. This often gets attributed to the absence of a strong network, which, in turn, prompts founders to move toward cold emails.
In the high precision camp, founders see a clear forward motion -- they are able to access investors (with at least 5-25% of their intro requests converting into actual introductions). These founders are able to get some form of clear feedback from investors and are able to move forward with key decisions on their strategy.
Our perspective is that landing intros with investors is particularly hard when targeting firms that don’t really invest in the type of opportunity that your Company offers.
Low vs high funnel conversion rates
In the spray and pray category, founders report low conversion rates at every step of the fundraising pipeline. From investors that are identified to ones that take first calls, conversion rates remain low. From ones that take first calls to those that move to due diligence, the conversion is again low. This sometimes leads to a misdiagnosis, often around the business not being ready for the next raise.
In the high precision camp, founders report high conversion rates. In any sales process, a super targeted approach yields high(er) conversion. This is particularly true for fundraising as investors that have a track record of investing in the sort of opportunity that your Company brings have a much higher likelihood of wanting to engage.
Stalled process vs high-velocity
For investors, a key part of the job is to learn about different industries and business models to sharpen their thinking on what the future holds. As such, investors are generally open to taking calls, and are not always decisive or upfront about their level of excitement. Founders in the spray and pray category often experience a “stalled” process, which is neither moving forward nor ending in a clear pass.
In contrast, founders in the high precision camp experience a clear velocity in the process. We believe this is often because the investors they engage with are genuinely interested in the business, are familiar with the space, and are therefore able to arrive at a PoV in a reasonable time-frame.
For most founders, Series A will be the first “priced” round whereby the Company’s valuation is explicitly determined before new investors purchase shares. Most Series A rounds are led by well-known institutional investors that have previously had significant investment experience.
It is commonly believed that the market for Series A financing has been particularly tough after the market downturn of 2022. To challenge this view, several industry observers have explained that the contraction is a “return to the normal” whereby venture activity has returned to the same levels as before the ZIRP eta. Historical data on venture activity corroborates this viewpoint.
Stage Expectations
At Series A, investors evaluate investment opportunities based on growth and traction metrics. Most investors expect a detailed data room that clearly lays out key trends in the financial, growth and traction performance of the Company. The specific nature of the metrics and the content for the data room varies significantly by sector and by business model.
Ultimately, Series A rounds are focused on a compelling forward-looking growth narrative. Historical growth matters to the extent that it can be used as a proxy to project future growth.
At the lower end. SaaS companies have successfully raised Series A rounds with only $0.5-1m in annualized run rate (with 100-150% year-over-year growth). On the upper end, companies have shown $3-3.5m in annualized revenue run rate (with 500%+ year-over-year growth). These benchmarks vary significantly based on business models, sectors and geography.
Stage Objectives
At Series A, companies are raising capital to double down on a validated market opportunity. At this stage, capital is typically deployed to achieve 3-5x revenue growth (over a 12-24 month time-frame).
For operations-heavy businesses, demonstrating the right level of progress on unit economics will be a key objective. For B2B SaaS companies, top-line growth will be a critical evaluation criteria. In most scenarios, founders will want to set measurable objectives for the round that will qualify the Company for the next stage.
Round Size & Valuations
Based on industry benchmarks and our market research, Series A rounds for B2B SaaS companies in the US range from $5-20m (with the median coalescing around $10m). The below chart from Carta provides an overview of median round sizes from 2020-23:
Valuations and round sizes at Series A have remained fairly consistent in recent years. We do, however, see significant fluctuations across sectors:
Optionality at Series A
At Series A, founders have a lot more optionality than they do at Pre-Seed, but a lot less than at Seed. This is because a fairly limited number of investment firms specialize at Series A. The below chart shows the total number of active investors in the US that specialize at Series A:
The above chart draws on US-based investors that are actively investing, that have made at least 10 lifetime investments, and that have made at least 25% or more of their total investments in the specific stage mentioned above (to qualify as a stage specialist).
Investor Types at Series A
Unlike other rounds, VC firms tend to play a much bigger role at Series A than they do at Pre-Seed or Seed. About 60% of all venture investments at Series A are from VC firms.
Intuitively, the above data makes sense given that round sizes are larger at Series A, requiring a deeper and more nuanced ability to navigate the risk-reward dynamics.
Investors to Target
At Series A, the biggest challenge is to find a lead investor that can then coalesce other investors into the round. Based on data shown above, the number of investors participating in Series A rounds tends to be much larger than those leading.
Founders, therefore, need to start their search with a focus on identifying the right lead investor. For founders, a common pitfall to avoid is the inclination to engage non-lead investors in a Series A process when the Company hasn’t yet secured a lead for the round.
Summary
Series A is different from prior rounds – there is generally less optionality, investors lean in heavily on traction and operating data, and finding a lead is particularly important given the round size. In navigating these dynamics, a strong focus on being super targeted on the “most likely” investors gives founders an important edge.
As a round type, pre-seed dates back to the very beginning of venture capital. In recent years, however, pre-seed has become the fastest growing round type, responsible for 20%+ of all venture rounds globally. In the below post, we look to understand pre-seed from an empirical perspective.
Stage Expectations
At pre-seed, investors have varying expectations – accelerators commonly invest in companies that do not yet have revenue or product. Other venture investors tend to expect some form of market validation or an early prototype.
Demand validation can often take the form of pre-orders or rigorous customer feedback. The quality and extent of customer feedback often varies considerably, depending on the nature and the type of product.
For hardware companies, pre-orders or contracted revenue is often used for demand validation. In the software category, a small set of engaged freemium users or paying customers is typically a strong indicator for latent demand.
At pre-seed, the bet is primarily on the team, the market opportunity, and some evidence evidence of latent demand. A well-defined prototype coupled with some early evidence of latent demand are often the primary expectations at pre-seed.
Stage Objectives
Most commonly, pre-seed rounds provide capital for founders to build a product and achieve preliminary market traction. These two outcomes typically qualify companies for a seed round, which then provides larger amounts of capital to further develop the product and grow the business.
At pre-seed, founders should have crystal clarity on their objectives for the raise. This should be laid out clearly in the initial deck, often with an advanced level of detail. In some sectors, the objective from the pre-seed round may be different, and may require founders to first develop an understanding of what they need to get to the next round.
Round Size & Valuations
According to Carta, which provides software for cap table management, a vast majority of pre-seed rounds in the US tend to be in the $1-2m range.
As per Angel’s List, which powers the cap table solutions for thousands of startups, pre-seed rounds in the US have been raised at the $5-10m valuation.
The above charts show round size and valuations at an industry level. These vary significantly based on sector, geography and the overall opportunity.
Activity Levels at Pre-seed
Over the past two decades, pre-seed rounds have transitioned from being quite rare to becoming extremely common. In recent years, there have been more pre-seed financings globally than there have been Series A rounds. Pre-seed is now the second most common type of venture round (second only to seed).
Growth in the pre-seed category is driven primarily by fund managers looking to invest in companies at the earliest stages when valuations are the lowest. Historically, venture returns have been highly concentrated at the earliest stages, resulting in incrementally larger numbers of pre-seed rounds with each passing year.
Limited Optionality at Pre-seed
A closer look at the data reveals that pre-seed activity is highly concentrated within a small pool of investors. Specifically, while pre-seed rounds take place in larger numbers than Series A financings, the total number of investors specializing at pre-seed is about one-third that of Series A.
The distinctive element at pre-seed is that there is a small number of investors that specialize at pre-seed. Each of these investors is making a large number of investments each year to spread out the high risk at pre-seed across a broader distribution of companies. This trend is consistent with our understanding that pre-seed investments tend to be experimental in nature (with failure rates typically ranging in the 50-90% of all financings).
The above landscape makes it critical for founders to rely on data, and not on hearsay, to correctly identify investors that specialize at pre-seed.
Investor Types at Pre-seed
Another distinctive element at pre-seed is that accelerators are responsible for >35%+ of all pre-seed rounds globally.
For first-time founders, accelerators also play a crucial role in creating an enabling environment that allows companies to benefit from network effects and embark on a shared learning journey. This is often seen with large accelerators, such as YCombinator and Techstars. The sheer size of such accelerators creates network effects that allow companies to learn from one another and to use the community to secure their early customers.
Sector Overview at Preseed
At pre-seed, most investors tend to be open to a broad spectrum of sectors; however, most investors have a clear concentration in specific areas. This concentration is sometimes due to market forces whereby they receive deal flow from companies in a given sector.
More commonly, however, the concentration of investments in specific sectors is linked to an accelerator’s strategy whereby they are excited about a given opportunity space and are concentrating their capital deployment in that space. The below chart shows the overall distribution of pre-seed activity from 2019-24 across sectors:
Investors to Target
It is fairly common for pre-seed founders to pursue seed-stage investors. Similarly, seed-stage founders also commonly engage with pre-seed investors. A stage mismatch is among the most common reasons for why investment discussions may not result in a positive decision.
At pre-seed, founders need to be laser-focused on investors that have three characteristics:
Summary
Being laser-focused on the right type of investors is the highest leverage activity in a fundraising process. With the right set of “most likely” investors, founders report higher conversion rates at every step of the funnel. Such investors are a lot more likely than others to review online applications, take introduction requests and meet with founders.
Instead of relying on hearsay, founders across the board are now taking an empirical approach to raising their next round. At Metal, we are seeing customers use our platform in novel ways to discover the “most likely” partners for their company and round construct.
Before pursuing an investor, founders need to run a “qualifying process” to ensure that the prospective partner is a strong fit. A rigorous process to identify, research and qualify investors is the highest leverage activity within fundraising, one that improves conversion rates.
The below post focuses exclusively on identifying the “most likely” investors, and does not cover the qualifying process. In the identification process, there are six core principles at play.
Focusing on “Stage Specialists” vs “Stage Tourists”
Founders often confuse pre-seed and seed investors as one and the same. The common perception is that these are just stage names that do not carry much significance. In reality, investors have vastly different expectations at preseed versus at seed, and most investors that specialize at seed do not specialize at pre-seed. Readers that are looking to understand investor expectations at each stage can read more here.
First Round tends to invest early, but they are really seed-stage investors, and not pre-seed partners. Since they specialize at the seed stage, they are “seed specialists” and “pre-seed tourists”.
By definition, stage specialists are investors that specialize in a given stage. Stage tourists are ones that invest in that stage opportunistically in outlier or unique opportunities.
The first challenge for founders is to identify a set of “stage specialists” for their specific stage. This is easily achievable by filtering investors based on the percentage of investments that they have made in a given stage. The key thing is to not settle for ambiguous tags applied to investors in the absence of any underlying data.
Distinguishing Between “Sector Familiarity” and “Sector Concentration”
For venture investments, the landscape varies substantially from one sector to another. Some sectors have very strong and ongoing venture activity (I.e. B2B Software) while others have fewer investments in total (I.e. Industrials or Robotics).
For any given sector, there are two types of investors –
- Investors that are familiar with the sector
- Investors that are concentrating investments within the sector
Investors that fall in the (1) category can be identified using a simple filter that identifies all investors that have made a minimum number of investments in a given sector. Investors that fall in the (2) category can be identified by filtering for investors that have made a minimum percentage of investments in a given sector.
Investors that are familiar with a given sector are those that have previously invested in that space and are familiar with it. Investors that are concentrating in a given sector typically have a strong thesis for that opportunity space and may sometimes be stronger partners.
As an example, Khosla Ventures is a well-known VC firm that has been concentrating investments in the healthcare sector. To date, they have made 27% of all investments within healthcare. Within healthcare, about half of all investments are in two specific sub-sectors: Drug Discovery (24%) and Therapeutics (29%).
It is fairly likely that Khosla has a clear and strong thesis in these sub-sectors, which may sometimes make them a particularly strong partner for healthcare companies building in these spaces.
Finally, at the pre-seed stage, most investors tend to be sector agnostic. This is primarily due to the investment model of venture investors at the pre-seed stage.
Finding Geographically Relevant Investors
Most users are either overly restrictive by focusing on only those investors that are based in their specific country, or are too liberal and end up pursuing investors that don’t focus on their geography.
- For founders in countries that have a highly developed venture ecosystem (I.e. US), the right approach is to identify investors that have made a healthy percentage of their investments in North America. This typically includes a large number of investors across Europe and Asia that love investing in US companies.
- In developing countries, a recommended approach is to identify investors that have previously invested in similar geographies. As an example, founders building in Egypt may want to identify investors that have made at least “3” investments in a cohort of similar geographies (I.e. Indonesia, Bangladesh, Pakistan, Egypt, etc.).
The key thing is to identify investors that are “geographically relevant” based on their prior investments. This is typically different from taking an overly restrictive approach whereby users are focusing only on those investors that are based in their country or region.
Tuning Into the Right Fund Size
Founders raising large rounds need to target a small set of VCs that have large fund sizes. For such founders, the options are fairly limited (as there is a very limited number of VCs with a fund size of $500m+). On the contrary, founders looking to add a small amount of capital ($<1m) to an existing round need to target micro VCs that write $100-300K follow-on checks.
The general rule of thumb is that most investors maintain a check size that is roughly 1-2% of the total fund size. As an example, investors with a fund size of $100M will typically write checks in the $100-200K range.
Depending on the round dynamics, founders can focus on investors that have a fund size that meets their round requirements. A fund size mismatch is often a primary reason for why investors are unable to lead or participate in rounds.
Zooming In on “Active” Investors
Similar to startups, venture funds tend to have a fluid nature. At any given point in time, only 10% of all venture funds are actively deploying capital. Founders, therefore, need to filter for and focus on investment firms that have made at least “1” investment in the past 3 or 6 months.
It is extremely common for founders to learn after a few calls that the fund is “barely active”, making only one or two investments each year. For funds that are operating in a “barely active” mode, the overall risk appetite is unique. Such funds will have behaviors that are a lot less predictable than ones that are actively and consistently deploying capital.
Focusing on Lead Candidates at Round Kickoff
Early on in the process of raising a round, founders need to first identify an “anchor” investor to lead the round. While most funds lead occasionally, there is a fairly limited pool of investors that frequently lead rounds, and that do not wait for a lead to come in before committing to invest.
When starting a round, founders need to focus on investors that have a history of leading. This is easiest to identify by looking at the percentage of investments that a given investor has historically led.
Final Thoughts
In summary, the six core principles defined above help build a clear criteria for the sort of round that founders want to raise. Based on the round requirements, founders then need to run a rigorous process to identify the right set of “most likely” investors. By targeting their efforts on the right set of investors, founders can significantly increase conversion rates at every step of the fundraising funnel.
A small subset of all VC firms tend to specialize in sectors. Such firms typically follow a clearly defined thesis on trends that will lead to growth in a given sector. In the early 2010s, one such trend was technology-driven marketplaces – this created many sector-focused VCs that specialized in marketplaces.
1. Sector Specialists as Domain Experts
Founders often report having high-context conversations with sector-focused VCs. These firms are often deeply knowledgeable about a given space and have the ability to bring domain expertise to investment discussions.
In a given fundraising process, founders should add at least a few sector-focused VCs that truly understand their sector. This is best achieved by pulling together a list of VC firms that have made 20%+ of their portfolio investments in your specific sector.
In some sectors (such as biotechnology), specialist investors are more important than in others. In most sectors, founders can have high-context conversations to sharpen their thinking by engaging with investors that truly and deeply understand their sector.
2. Geo Specialists in Developing Countries
Similar to sector VCs, geo specialists tend to bring deep expertise around a given geography. For founders in developing countries, such VCs have already overcome the biggest obstacle of being open to investing in their specific country. In such geographies, geo specialists can be an integral part of the fundraising process.
This is best achieved by pulling together a list of VC firms that have made 5%+ of their portfolio investments in your specific continent (along with at least a few investments in your country). Identifying VCs that have made at least “1” investment in a set of similar countries can be a great way to identify firms that may not have invested in your specific country, but are likely to be “open” to doing so.
