Series A investment: when, how, who? [Know your VC]

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In the growth cycle of a startup the Series A round can be a critical hurdle, but investors say there is a lot startups can do to prepare.

Series A investment is the first round of investment from a venture capital firm, and comes after seed funding from family and friends, incubators and angel investors. While not strictly defined by numbers, Series A investments in Egypt, for example, usually amount to $1-1.5 million, while in cities such as Dubai they tend to be larger.

Figuring out when to raise, how much and on what terms, combined with the process of negotiating with venture capital firms, are new challenges for a beginning entrepreneur.

How much money do you need?

During a Cairo Angels’ community talk on the topic in June, Algebra Ventures partner Ziad Mokhtar said that in order to decide how much to raise the entrepreneur should look at the minimal amount that is required to reach a certain milestone in the business plan.

Egyptian investor Neveen El-Tahri told Wamda an entrepreneur should have a 12-18 month financial plan ready, covering the cost of running the company during this time and the projected growth in terms of hires and revenue, and have their own metrics for how to reach that growth.

Prove it works

In order to secure a Series A investment the entrepreneur must show a proof of concept.

For El-Tahri, whose 138 Pyramids invests more in ‘brick and mortar’ companies rather than tech, this includes a thorough market analysis that indicates there is demand for the product. She wanted to see growth in “tangible results” such as sales, staff expansion and contracts.

Mokhtar said the proof of concept was more important than the growth the company had realized at that stage. “Prove it works small, before growing big,” he said.

He was more interested in the actual penetration rate of the company in a small target group, over the overall size of the company. Engagement and traction were more important than revenue, and should show a consistent trend over 9-12 months.

Setting a value

El-Tahri warned against putting too much emphasis on a valuation. “Often an entrepreneur has a pre-set idea about the value of his or her company, which might cause bumps with an investor.”

They shouldn’t be preoccupied with the company’s value during the early stages, instead focusing on “knowing how to grow”.

“An investor wants to invest the least amount of money, because it’s an early, risky stage. It wants to know how the company will grow. This causes a gap,” she said.

But the company value would be based on what the money is raised for.

“Series A investment negotiations surround one equation: how much money is needed to reach a certain milestone, and how much equity is that worth?” Mokhtar said.

Choosing wisely

Knowing what kind of investor you want and need is part of the preparation cycle ahead of gaining a Series A investment, and will also improve an entrepreneur’s negotiating position.

El-Tahri said there were different investors in the market, so an entrepreneur had to assess their different value propositions. “It’s not just financial,” she said, as some would contribute the right kind of knowledge or contacts.

Talking to more than one investor is critical to be aware of the options available and once a conversation starts it’s important that both sides make their expectations clear early on.

Shareholders

Having a single very large shareholder, or a fragmented number of investors before securing a Series A round will complicate the negotiating process.

Mokhtar said it showed confidence in a company when previous investors or management itself reinvested, and this would encourage a prospective VC investor.

For El-Tahri, there must be clarity between ownership and management, which ought to be strictly separated.

An example of questions over ownership and management can be seen in the Egyptian startup El Wafeyat, where investing cofounders Con O’Donnell and Ashraf Maklad scaled back their ownership stakes in favour of the three other cofounders who could put more time into the business. One later stepped out of the management entirely as there was no clear role for him.

Perspectives

For entrepreneurs it can seem as if there is little money available, while those on the other side point to the rising number of investors across the Middle East which are interested in startup investing.

El-Tahri thinks there is room for everyone and investors are not competing over startups, rather helping and complementing each other.

Amidst the challenges one may face, Mokhtar encouraged entrepreneurs “to remember that starting a business is probably the hardest thing you’ll ever do in your life, and expect that at some point every entrepreneur will feel the desire to quit”.

Feature image via Morguefile.

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