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The stages of tech investment demystified


June 2019


Adam Baron – Associate Director, BDO Growth Advisory

Adam has been advising growth stage companies for a number of years, with a strong focus on client relationships and satisfaction. Having originally trained as a barrister, his legal background gives the team an added dimension.

 


Looking for capital to fuel momentum and accelerate growth? Adam walks you through the three classic rounds of investor funding, and what each means for fast growth tech businesses.

With rapid growth and risk of disruption ever present across the tech industry, a fast growth tech business may only have a relatively short window in which to capitalise on its potential market advantage. Funding enables such businesses to move fast to make the most of their opportunity.

In such an environment, agility and responsiveness are of the essence – some seed funding can be granted in as little as two weeks, for example. So it’s imperative that tech founders are clued up on the key investment rounds, what is expected with each, and how to effectively plan for success at each stage. Here, we walk you through the three classic funding rounds: seed, Series A and Series B.

Seed funding

What is it and when does it happen?

The seed round sits at the beginning of your investment journey. Seed-stage funding is all about convincing investors to believe in the vision and concept for what the product and the business will be. Founders can then use the investment to push beyond this vision. Usually businesses at this stage are either pre-revenue or in their final stages of product development, and will therefore use the investment fund to enable revenue generation or product testing.

 

At this stage, investors do not expect the product to be monetised, but they are looking for something special or different in your offering: a clever business model, perhaps, or a stand out management team, or unique tech with some IP. Once this has been identified internally, you need to start gathering evidence, reaching out to investors – and hopefully landing the funding you need to fuel momentum.

 

Key considerations

Keep in mind that seed tech investors can see roughly 200 proposals a month, which may mean that some investors will have seen 10 similar products in the last 10 days. Here are three key ways to both demonstrate the attractiveness of your tech business and make sure it stands out from the crowd:

  1. Understand the market size and opportunity. Investors will want to see that you understand the market in which you operate and who the other players are, so that you can show what the problem currently is and why it isn’t being solved.
     
  2. Demonstrate your product is the solution. Once you have shown that you have a thorough understanding of the market, and why the current incumbents aren’t fixing the problems that exist within it, you can demonstrate why your solution is the answer and explain why it has a product market fit. Seed investors are backing tech businesses that have promise, and are likely to be able to address an issue that needs resolving. They might even have some IP already that does just that.

    Benefiting from that funding, of course, means relinquishing a certain level of equity and control, but founders should be prepared to weigh up the value of their equity in return for the benefit that the investor can bring to the long term growth prospects of the company.
     
  3. Ensure as a priority that the IP is protected. Once you have proven that you have a solution to the market’s problem, your company becomes a lot more valuable if you secure the IP that the company holds before launching the product to market. Investors will find protected IP highly attractive, and management should spend time choosing a good lawyer to help them with this.

Series A funding

What is it and when does it happen?

Once tech businesses have secured the first round of funding, the expectation is that this will fuel a rapid growth period – what’s often described as a business’ ‘venture stage’. By the time a business is ready to apply for Series A funding, the product should be monetised; tech businesses will likely have experienced revenue growth with levels of ARR between £500k and £1m. The company is unlikely to be profitable, and founders will be looking for additional investment in order to keep up that momentum and accelerate further growth.

Key considerations

For tech businesses in their venture stage, investors will expect founders to have moved beyond planning and concepting, to begin to prove the product-market fit. There are four key pillars that demonstrate this:

Revenue growth: At venture stage, tech businesses will see significant revenue growth from new customers and increasing ARPA (Average Revenue per Account) or MAU (Monthly Active Users). Investors looking for certainty in this round will be very reassured if you can demonstrate both solid sales and marketing processes designed to establish a clear pipeline that allows the business to continue growing. 

Increasing revenue returns: By the Series A funding stage, investors would expect tech businesses to not only be sourcing new customers, but for those existing customers to be renewing their licences and demonstrating loyalty to the business over competitor products.

Agility: Investors will be looking at tech businesses that have bigger companies using their software and challenging them to do different things with it. If tech businesses are able to demonstrate monthly recurring revenue, as well as project-based revenue, that will set them apart from the crowd. It will show that not only does the company have a product, it is also able to pivot along the way, which is vital in a high growth environment.

Forward thinking: Once an early-stage, fast-growth tech business has raised Series A funding, the growth is not going to stop there. A company will need to have a product road map to demonstrate to investors that it isn’t a one trick pony. Founders will be looking to Series B and beyond, as the tech business enters what is referred to as the ‘growth stage’. As this transition takes place, you need to show that you’re implementing some of the key milestones along the product roadmap, and that people are buying into it.

We’ve already talked about the importance of protecting the IP at seed stage, and that extends to each new feature or product the business adds to its offering as it grows. Protecting or patenting the tech creates a barrier to entry for competitors, and positions the product as the all-important ‘something different’ you’ve been aiming to demonstrate from seed stage.

Series B funding

What is it and when does it happen?

Series B funding is for those tech businesses that are looking to take everything they have learnt and acquired up until this point and make it work at real scale. While the previous rounds of funding have been based on vision, progress and revenue, this round will need solid figures and plans to support the next stage of growth and give investors the confidence that your tech business has an obvious pathway to profit which enables an investor to start thinking of the next stage in the company’s lifecycle, be it further growth, a buyer or even an IPO.

"The number of companies raising a Series B or “growth” round is halved again from those that raised at Series A, with an average of £5.51m invested for slightly less equity than earlier rounds, coming in at 15.5%."

By this time in a fast-growth tech business’ journey, there should be a significant number of customers or users requiring an equally sizeable team to manage. Management will need to show that they have invested previous funds raised well and are using it to successfully implement their product road map.

Founders usually raise a Series B in order to attract a talented team to serve the ever-changing needs of the business. This round of funding can help to facilitate  hires that will enable growth, expansion into different market segments, experiments with revenue streams, and can even support founders that wish to buy-out businesses that offer a competitive advantage. It is also at this stage that management may start to consider whether making acquisitions could be a more efficient way of enabling growth.

Key considerations

We’ve moved through the importance of revenue growth and hitting key milestones along your product roadmap. But when the only way is up, how else can founders set their tech businesses apart from others to secure the necessary funding at Series B?

Another way to prepare for the rapid scaling categorised by a tech business at this stage of growth is to prove the business can make it internationally. An international expansion plan is a sure way to demonstrate to investors that you’ve thought about future growth, as well as supporting the growth stage you are currently in. This can help investors to see that the word ‘international’ isn’t just a buzz word that management are using to gain investment – it is part of a plan that has been developed for how to scale outside the UK.

At any stage of your fundraising journey, a key factor to consider is tax effective structures including the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS). These schemes effectively share the investment risk with the government but none of the reward. If your business qualifies, then make sure you obtain the necessary documentation in advance which will open the pool of potential investors and may even make the opportunity more appealing. There are many other tax schemes that the government have in place that provide a share of your funding through incentives (the most common of which is R&D tax credits). You should ensure you consider the wide range of options throughout your tech business’s funding cycles. In the same way that we discussed choosing good legal advice at seed stage, having a good tax advisor on board early will help to ensure that the company is maximising the tax breaks available.

In the race to scale and expand in such a fast-moving sector, managing your funding rounds is key. How much equity you give away and choosing your investment partner can have very real impacts on the success of your tech business’ story.

Still have questions about investment stages for your tech business? Get in touch by emailing [email protected].

 

 

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