Getting from A to B with Investors

The first round of financing was relatively easily. Now, your startup needs a larger infusion -- and the VCs expect a whole new set of answers

By Gabor Garai

Professional investors tend to view an initial round of investment in an early stage company as something of a shot in the dark. They may like the market and the people involved enough to put money in, but they understand that it's quite difficult to know for sure if the company will succeed.

Once the startup gets to the stage that it is needs follow-on financing, investors expect to see the light much more clearly than in the early days. The pressure for a clearer focus stems in significant measure from the growing seriousness of the financial investment. An A round of venture capital may well be $5 million or less. The B round is typically in excess of $10 million, and may hit $40 or $50 million.


  Clearly, the atmosphere around the B round is going to be different than the initial round -- and that means the investors' demands will be different. Entrepreneurs need to understand the key differences as they prepare to approach B-round investors.

What is it that "B" round investors most want to know? Here are the five most important questions you will need to answer:

Will the A-round investors be involved in the B round?

Obviously, prospective B-round investors like to see the initial investors participate in the next round, as a sign of ongoing confidence in the venture's future. The B investors understand that A-round investors often don't have the financial resources necessary to provide all the additional backing required. For the initial investors not to be involved waves a red flag to B-round investors, however, suggesting a problem of one sort or another.

How far along is recruitment of the management team?

Since the leadership is viewed by investors of all types as the most important component in a successful venture, B-investors will want to know the details of any venture's leading lights. At the early stages of a venture's development, the management team is nearly always incomplete. By the time an outfit seeks a B-round, the team should be close to completion, with serious candidates identified and negotiating for the unfilled spots.

What kind of momentum has the startup achieved?

Most specifically, the investors will be seeking evidence that the company's product or service has created some industry buzz. The company should be past the R&D phase and have at least prototypes in operation. Ideally, the company should have a real product and a sales team that is identifying prospects and following up on leads. Prospective B-round investors want very much to see actual sales, but failing that, want to see lists of prospects rated according to their likelihood of buying.

What do the financial projections look like?

For the A round, the financials are assumed to be rather amorphous. For the B round, investors want to see not only projected income, cash flow, and balance-sheet statements, but also a detailed and convincing "use of proceeds" projection. All this isn't to say B-round investors expect the financial projections to be highly accurate, since they almost never are, but rather a logical proxy for how the team is thinking.

What are the biggest holes that need to be plugged?

Prospective B-round investors appreciate that a company in need of follow-on financing likely isn't a well-oiled machine at this point. Aside from management-team gaps, the most common holes are in the sales organization. Prospective B-round investors want to see that the entrepreneurs understand where the holes are in the organization, and what the plan is for plugging up the holes.

Assuming you can answer all these questions satisfactorily for prospective B-round investors, you have a good shot at a serious hearing. Then, the challenge is to convince potential backers that your startup is at last ready to fulfill its true promise.

Gabor Garai is a partner in the Boston office of the national law firm Epstein Becker & Green, specializing in the financing and growth requirements of small and midsize companies.

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