Anatomy of our $5 million seed round
A version of this post was originally published on VentureBeat here.
This week my company, Pingboard, announced a $5mm round of funding.
More than 1,000 customers globally use Pingboard to power their live org chart, including companies like GoFundMe, Udemy, Sequoia Capital, Khan Academy, and the Linux Foundation.
You probably hear about startups raising this type of funding all the time in the tech press, but under the surface, these rounds are not always what they seem.
For example, our latest raise was $2.5 million, not $5 million. It appears in our SEC filing as $5 million because we had $2.5 million in convertible notes from our prior round which converted into equity alongside this new $2.5 million round.
In fact, this was our third $2.5 million round:
- Seed 1 (2014): We raised $2.5mm, to get started
- Seed 2 (2016): We raised $2.5mm, once we found product-market fit
- Seed 3 (2018): Today, we raised $2.5mm, to expand the product and growth
As a repeat founder and occasional angel investor, I’ve realized this scenario happens quite often because “seed” is no longer a round of funding, but rather a phase that startups go through; a phase when startups must “build not just product-market fit, but a real company”, as Hunter Walk at Homebrew wrote recently.
For this round, we chose to work with Active Capital, a new fund based in Texas led by Pat Matthews and Pat Condon, because they agree wholeheartedly with the funding and operating strategy I describe below.
How most SaaS Companies should be funded
Earlier this year, I considered raising a typical Silicon Valley series A. Over the course of a couple weeks, I met with partners at about two dozen top tier VCs to pitch them on Pingboard.
It was clear that Silicon Valley VCs are looking to invest in rocketships. A rocketship will either get you to the moon or crash, and that’s the model most venture capitalists want to put their money behind. The Power Law of venture capital mandates that investors categorize you as either a 1 or a 0 as quickly as possible.
Unfortunately, this approach is not ideal for companies like mine — or most SaaS companies. SaaS companies’ capital requirements and trajectory require a different approach. We may become rocketships, but our gestation cycle is longer.
Most SaaS companies are building a flywheel, not a rocketship. A flywheel spins faster and faster the harder you push on it. It may slow down temporarily when things don’t go as planned, but it won’t crash — flywheels keep spinning.
SaaS companies do not require large amounts of capital all at once in order to fund expensive R&D, brand marketing, or giant sales teams. Instead, we require small amounts of capital over an extended period of time, in order to experiment and continuously push harder on the things that work.
This is why most SaaS companies today should raise several smaller rounds of funding during their “seed phase” before raising a series A. The ideal funding for a SaaS company looks closer to an IV drip than a shot of adrenaline to the heart. We need more funding sources that understand this.
There’s also a personal side to choosing a funding model
If you’ve built a rocketship and you’re confident you’ve made the right calculations to get to the moon, grab ahold and don’t let go! Still, you will probably crash eventually, and traditional venture capitalists will tell you that’s okay. They’ll tell you that by “failing fast” you will get more “at bats” starting more companies, increasing your chances of finding your rocketship one day.
While this math works for VCs, it’s a different story for entrepreneurs. As a founder, you put your entire life into your company, sacrificing money, health, family, friends — and when you fail, you walk away smarter and with hard won battle scars, but also burnt out, broke, and unsure if you should try again.
All this happens while the VC has a dozen more companies just like yours in their portfolio, needing just one to reach the moon.
Luckily, there are other ways to build a successful company.
The Touch Zero Operating Model
I recommend treating each round of funding as if it’s your last. Put your company on a path to profitability before you run out of money. The companies I’ve built have never had a “fume date”. A fume date is the date at which the bank account goes below $0 and you either go out of business or have to raise more money.
Instead we have a Touch Zero Date, which is the basis of my whole operating strategy. A Touch Zero Date is the moment when two key data points align: we reach $0 in the bank account and profitability. That means we don’t go out of business or need to raise more money; we are always in control of our own destiny.
We use the Touch Zero Operating Model to manage our business. We measure everything and use data to model how to scale our growth investments and revenue so that we touch $0 and reach profitability at the same time.
Why is our goal to run out of money and reach profitability at the same time?
If we operate on a plan with a large cash buffer, we’re sitting on cash and growing slower than we otherwise could. And if we operate on a plan that has us dipping below $0, we die. It’s as simple as that. We tune this model weekly as we try new things and get more data.
If things go well, we may raise more money and reset the plan, pushing back the touch $0 date, just as we are doing today. If we grow slower, we’ll conserve cash and make sure we reach profitability while we make adjustments.
During fundraising, I did not feel aligned with most VCs when I told them about my Touch Zero Operating Model. In fact, many emphatically said they would want me to change my approach if they invested.
They wanted me to invest more money at a faster pace to accelerate growth and aim for milestones that would theoretically earn us the opportunity to raise another round of funding. Then, we’d repeat the cycle again and again.
As an investor myself, I’ve seen too many startups not reach those milestones and suddenly find themselves in a tight financial situation where they have to raise cash on terrible terms to survive.
When this happens, VCs end up owning more of the company than the founders ever expected. Most VCs aren’t taking unfair advantage of the situation (although some do), they are just doing their job. Founders have to understand the risks if they choose to get on the VC treadmill.
Build your company, your way
There are many ways to build a very large company. I encourage you to figure out what type of company you want to build and do it your way. You don’t have to play by someone else’s rules. Entrepreneurs get to write and rewrite the rules, including the rules of financing.
I predict we’ll see new financing models over the next few years that recognize that company stage and phase no longer align with traditional venture fundraising strategies.
I am going to keep writing about my way to build companies and I hope you will share yours, too.
