How to Raise Seed Capital: Top Enterprise Seed Investors Share How They Analyze Investment Opportunities and What Founders Should Expect in Fundraising

We at Emergence are very fortunate to partner closely with amazing entrepreneurs and top enterprise seed investors as we build iconic enterprise companies together. Working with top seed investors has instilled a healthy respect for the challenge that seed investors undertake when they invest in really early stage startups. Why is SaaS seed stage investing such a challenge? Because at the seed stage, there is simply very little evidence for an investor to justify an investment. Yet the top investors are able to consistently find and back great startups. In the interest of helping entrepreneurs, we hope to shine a light into an opaque process by curating answers from top enterprise seed partners into how they analyze investment opportunities.

1. Every seed investor says that the team is the most important factor for investment. What specific qualities do you look for in a founding team?

• Missionaries over Mercenaries. In other words, founders who have deep attachment or interest in the problem they are solving.
• Great communicators who have a clear vision and know the market and customer they are going after with clarity.
• Balanced teams (i.e. Hacker & Hustler (+ Hipster if possible) to be able to execute.
• Founders that are learning machines who also know their metrics well and are unafraid of challenging the investors’ assumptions (politely, of course)”.

Marvin Liao, Partner at 500 Startups

2. What are the top 3 questions that a founder needs to answer during a pitch?

• Why are you the right team to build this into a large business? I look for teams that deeply know their space and are thoughtful on why they will win and lose customers. They also should be able to tell me how the space will evolve over time and how they fit into that new landscape. Additionally, I try to validate their ability to execute, which is hard at this stage. I look for people who are organized, good communicators, respond quickly and know their metrics/numbers well. Lastly, I try to assess the CEO’s ability to recruit top talent. Have they made any key hires yet? Can they sell the vision well?
• Do your early customers love the product? At the seed stage, you may not have many customers yet (or maybe not any) but if you do, those customers need to be raving fans! Over invest in making sure your first customers are onboarded well, happy, engaged and advocates. Ideally those early customers are influencers in their specific market or customer type.
• Is the market big enough? Most funds want to see a market that is large enough for there to be a realistic path to $300M+ in ARR as a SaaS company. Understand how your business can get there. I tend to prefer a bottoms up analysis that looks at the number of potential customers and your projected pricing vs. a top down estimate.

Michael Cardamone, Managing Director at Acceleprise

3. How do you assess technology at the seed stage?

For most SaaS companies, technology risk at seed stage is minimal. The applications tend to be straightforward, there are rarely cutting edge algorithms or research in play, and most apps only need to support a few dozen or a few hundred users — so scaling is not an issue. As a result, we mostly skip tech due diligence despite having an engineer on our team.

When companies don’t succeed after a seed round, it’s almost always because they didn’t build the right product or didn’t know how to sell it, not because they couldn’t build what they set out to build. As a result, we typically focus our diligence on the business side of each company: is there evidence that customers want this product? Is this approach better than alternative approaches? Does the team know how to sell? And so on. On the engineering side, the main thing we look for is someone who we think would be able to recruit a good team — both because they understand how to evaluate talent, and because they seem like the kind of CTO that talented people would want to work with.

Leo Polovets, General Partner at Susa Ventures

4. What is one unexpected form of diligence that you like to do before an investment?

Like any good investor, we have developed a number of proprietary diligence methods. I can’t share them all but here are a few areas I like to explore in diligence:

• I like to walk through all the pricing changes a company has made to understand how the market values the company’s product. Pricing power is a strong early indicator of competitive advantage.
• When looking at companies with machine learning technology, I try to find out if the machine learning models perform well across slightly different data than was used to train those models — varying vocabulary, time, volume, etc.
• On the personal side, I think it’s very important to understand a founder’s upbringing to figure out their core passions, motivators and experience with different cultures. Sometimes you get to know someone over a meal, sometimes you find out about their interests by going deep into the web.

Ash Fontana, General Partner at Zetta Venture Partners

5. How do you assess product-market fit and business traction at the seed stage?

To put it as simple as possible, the health of a SaaS business is mainly determined by two factors: Customer lifetime value (CLTV) and customer acquisition costs (CAC). One could almost say that CAC and CLTV are for a SaaS company what wholesale price and sales price are for a retailer. Just like a merchant needs to buy products and sell them at a higher price, a SaaS business needs to acquire customers at costs that are lower than the customers’ lifetime value.

But early-stage SaaS companies which are still in public beta or just went live don’t have this data yet. Getting meaningful data on your CLTV takes time, since calculating it based on the monthly churn rate of your first few customer cohorts isn’t reliable. And it takes even more time until you get an idea of your CAC because you have to set up marketing programs, try various things, recruit and train sales people and so on, and of course improve the product, the on-boarding experience etc. along the way. I’d say it’ll take you at least 6–12 months following your product’s launch until you may have reasonably reliable data on CAC and CLTV if everything goes well — and much longer if you’ve got hiccups along the way.

As early-stage investors, we aim to invest in a company earlier than that so we have to look for other things — leading indicators for great CAC/CLTV ratios in the future, so to speak:

• Visitor-to-trial conversion rate. If it’s high, it indicates that your target audience is interested in your product. It also says a lot about your ability to communicate the value of your product clearly and with few words, which is essential for products that are sold online. And obviously, the higher your visitor-to-trial conversion rate is, the lower is your CAC, all other things being equal.
• Trial-to-paying-account conversion rate. An extremely important metric, for obvious reasons. If people pay for your product, that’s the best sign that you’re delivering real value to them. And again, higher conversion means lower CAC.
• Engagement and retention of your early users. It’s hard to get meaningful churn data within just a few months because companies often don’t terminate their accounts right away when they stop using a SaaS product, especially if your product has a low price point. Therefore we have to look at usage metrics such as daily or weekly logins and various application-specific metrics to find out if a product is really used by its customers, which of course is the basis for a viable business and high CLTV in the future.

Christoph Janz, Managing Director at Point Nine Capital

6. How should a founder think about valuation or valuation caps at the seed stage?

The hardest investment rounds to price are seed rounds. They’re incredibly situationally dependent:

• A founder that sold their last company for $400m or IPO’d might be able to raise a pre-seed round at $40m pre (not uncommon).
• A founder with little proof points might be lucky to raise anything at all, and $2m pre might be very generous.

All these pre-money numbers are crazy in the early days because they are all too high based on any sane metrics. There is no way your super early start-up is even worth $1m in the “real world,” let alone $6m! A few thousand lines of code and 1 paying customer is not worth $2m in any rational world. Unless. It’s a hint of something great to come.

Having said that, if you want to dig a layer deeper, what’s really “fair” is a price 1/3rd or less of what the next round investors will pay.

So let’s say you do raise money at $6m pre. Let’s call that $7m post. And let’s add in another $1m for dilution after the round, and call it an effective $8m post. Can you raise another round at $24m+ pre, say $30m+ post, in 18 months or less?

If so, $6m is fair.

If you back into this 3x for the next round for seed, 2x for the next round at Series A and beyond math…you’ll end up with a fair deal all around, that also accounts for risk.

Jason Lemkin, General Partner at SaaStr

7. What opportunities should founders take advantage of while pitching?

Most investors you meet through the pitching process have likely seen and invested in companies with some similarities to yours. When you meet people who have expertise and who you like, it’s OK to ask, “What challenges would you expect I might see in these next two years? If you invested, what could I deliver on to give my company the best chance of a Series A from my choice of firms?” When you can flip an investor from “evaluate” to “help” mode, you 1) have the chance to learn from some of their other portfolio companies’ failures and successes, 2) can lightly gauge that investor’s ability to help your specific business, and 3) show that you’re starting your company with a learner’s mindset.

Kevin Webb, Director at Webb Investment Network

8. What level of interaction should a founder expect from a seed investor post-fundraise?

I wouldn’t put every firm or person who participates in a seed round in the same bucket (as smaller checks will almost invariably mean less time from the investor) but you should expect your lead / major investors to carve out time on a regular basis to meet face-to-face beyond any formal board meetings that may be in place. Every fund and investor is different and there’s no right answer here, but I like to meet in person with my founders on a monthly basis for an hour and hold a bi-weekly 30 minute slot in case there’s anything urgent we need to discuss. Life moves pretty quickly in a brand new company and sometimes thing can change so fast that leaving a month between updates can feel like you’re hearing about a completely different business!

The important thing is that all these interactions should feel extremely valuable for both parties but they are absolutely second priority to running the business, and if at any point we need to skip or dial back the schedule then I’m generally very happy to accommodate. I also encourage my founders to ping me (call / text / Slack / other medium) as needed, and often find that the cadence of interactions increases around fundraising (where we get very involved with strategy, introductions, pitch refinement, etc), product launches, important hires, and other major milestones in the company’s life.

We are not here to run the business (if we find ourselves doing this then we’ve made a bad investment decision!) but rather act as a consigliere to the company, assisting with our network, expertise and experience.

Andy McLoughlin, Partner at SoftTech VC