Investing in Startups in Series B

July 5, 2011

The Series B round of startups is generally their third cycle of financing. Once startups have proven their business models and are beginning to look forward toward raising funds for customer acquisition a new round of financing begins.

For investors this stage represents a time in the growth cycle of startups where risk begins to transform. There is always risk involved in startups and in investing, but as the company moves forward in its progression the risks tend to decrease. However, what also lessens significantly is the percentage of the company you will be able to take down with your investment, while correspondingly valuations are increasing.

As the rounds of financing progress, the startup’s valuation rises. In other words a two million dollar raise in Series A that may cost $0.50 a share, may rise to $1.00 a share in their Series B financing. Effectively doubling the valuation. What this means is that the more rounds of financing a company receives, the smaller the portions of the pie are to investors compared to the dollars invested. Much like the public markets, a lot of the sentiment is get in early when the risk runs hand in hand with opportunity.

With Series B companies you are looking for the beginnings of customer acquisition. The first consumers are beginning to enter the market and the company is beginning to ramp up towards a customer acquisition model.

    1. Customer Testimonials: At this stage in the businesses life, the amount of customers a startup has is generally limited. Despite the adage of “users first, revenue later” that embodies a lot of recent tech startups, most will have a limited user or customer base. Consumers drive business, and if they aren’t providing good feedback it may be a sign of deeper problems in the startup you are evaluating. Startups aren’t defined by the amount of users they have, but how the users engage the product/service.

    2. Industry Partner Testimonials: When doing due diligence for the startups you are looking to invest in, take time to interview companies they have listed as their strategic partners. Ask questions to understand the nature of their relationship and see where the strengths and weaknesses of the relationship are.

    3. Competitor Interviews: One key element that shouldn’t be overlooked when determining whether or not to invest in a startup is talking to their competitors. See what the established players are doing, or what other startup competitors are innovating in the same space. Knowing what your competitors or the competitors to your investments are doing helps to guide the structure of your investment.