De-Risking Your Startup With Every Funding Round: The Investor Perspective

De-risking your startup with every funding round is a crucial step in convincing investors of its value. Most founders make the glaring mistake of focusing on metrics and the traction the startup is demonstrating. Numbers are good, but investors want to see more than just that.

They want to see how you’re progressively and systematically eliminating the next risk with every new round. Keep in mind that at least 75% of venture-backed companies fail. Investors must rely on the remaining 25% to cover their losses and returns, and they’re looking for the next unicorn.

When evaluating your pitch, know what your audience is focusing on. While founders focus on a higher valuation to impress investors and venture capitalists, the latter are more concerned about risk. Your numbers should project risk removal. That’s how you can hope to secure that elusive check.

Direct your efforts toward the specific risks founders expect you to tackle at every growth/funding stage. A higher valuation is simply the result of each hurdle you cross, and it follows organically. Each risk is a potential pitfall that could cause the business to fail, and investors scrutinize it carefully.

Risk at the Pre-Seed Stage

At the pre-seed stage, the risk factor centers on the problem. When de-risking your startup, you’ll ask: Is this problem a real, painful issue that customers are seeking a solution for? Your next question should be whether you can successfully build a workable solution.

Statistics reveal that close to 42% of startups fail because founders misread user interest and their pain points. Having an excellent idea is only the starting point. You need to ensure that the solution you’re developing offers real value to customers.

Founders often make the mistake of failing to achieve product-market fit. You need to conduct extensive market research and validate customer interest before launching the product. Aside from being innovative and disruptive, the product should effectively solve the problem.

De-risking your startup at the pre-seed stage involves organizing surveys and testing a prototype on real users. You’ll record their feedback and incorporate it into the solution. At least 40% of users should be “very disappointed” if the product is discontinued. This is the crucial number.

Having a rudimentary plan for marketing the product and serving customers is an added positive that they will appreciate. While investor backing can help build and market products, it can’t compensate for a lack of demand. Ultimately, demand is essential for de-risking your startup.

Case Study: Quibi

A great example is Quibi, short for Quick Bites. The company raised an incredible $1.75B in funding but collapsed within 6 months of its launch. The mobile-first streaming service couldn’t capture and retain user interest beyond the early adopters.

The cofounders, Jeffrey Katzenberg and former HP CEO Meg Whitman, failed to account for the readily available free alternatives. They also overlooked the significance of integrating with social media accounts to enable content to go viral. Doing the opposite, they disabled sharing — a glaring mistake.

Your product should fall in the category of “absolutely-must-have” and not just “nice-to-have.” That’s how you’ll cross the product-market fit hurdle at the pre-seed stage. Once the product crosses into the “can’t-do-without” category, you have a real winner. And that brings us to the next pitfall.

Keep in mind that storytelling is everything in fundraising. In this regard, for a winning pitch deck to help you here, take a look at the template created by Peter Thiel, Silicon Valley legend (see it here), that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that founders worldwide are using to raise millions below.

Risk at the Seed Stage

De-risking your startup at the seed stage is progressing to the next step. When raising seed funding, you’re not just generating demand; it should be consistent. In other words, you need to demonstrate that you have returning customers. Your investors ask — can this product attract customers again?

The metrics in your pitch deck should signal a growing customer base and consistent engagement or usage. For instance, yours is a contract-centric product or a paid pilot with 10 to 20 users and a substantial waitlist. If your monthly retention rate exceeds 70%, you’re de-risking your startup.

These numbers indicate that the product is driving enough value that customers are willing to pay for it. They mark your transition from the “will this product solve a problem?” to “will customers pay for this product?” Essentially, it de-risks the go-to-market pitfall.

Do keep in mind that the 70% benchmark is an average across most industries, but it can also vary. For instance, the monthly retention rate of 70% to 85% might work for an early-stage SaaS startup. But, a later-stage SaaS company serving small and medium-sized businesses might want to aim for 93% – 97%.

Similarly, a sector like media and entertainment, where customers subscribe to content and have high engagement, sees 82% retention rates. However, an e-commerce, direct-to-customer company would typically have an optimal rate of 25% to 30%. High price sensitivity plays an important role.

A high monthly retention rate and low churn rates indicate an LTV: CAC ratio of at least 3:1. Here, LTV is the Life-Time Value, and the CAC is the Customer Acquisition Cost. This ratio indicates that the company is likely to generate more revenue than its costs to acquire customers.

Investors consider this a positive signal. It shows the company can become profitable without external funding.

Risk at the Series A Stage

By the time the startup reaches the Series A stage, it has a validated product-market fit and a robust customer base. It generates revenue regularly and has proven traction and unit economics. Founders typically aim to accelerate growth and scale by leveraging investor backing.

You’re likely seeking to raise between $2M and $15M to ramp up operations, backed by a substantiated business model. At this stage, de-risking your startup means proving that it can retain customers and sustain go-to-market numbers. But, at a larger scale.

When approaching investors, you’ll draft the Use of Funds slide to list goals, such as acquiring top talent. Other objectives may include refining product features, growing the product portfolio, and purchasing tools, equipment, and inventory.

Essentially, you’ll include the resources needed to enable the company to achieve its growth milestones. The average time frame for these milestones is usually one to two years, after which the company is ready for its next capital infusion. Namely, the Series B funding round.

So, what numbers do investors want to see? To demonstrate that you’re de-risking your startup, add metrics like $2M to $5M in Annual Recurring Revenue (ARR). You’ll also provide figures indicating 7% to 15% consistent month-over-month (MoM) growth.

Other than higher LTV: CAC ratios, capital efficiency with low burn rates, and unit economics, investors focus on the moat. They’ll scrutinize efficient distribution and the barriers to entry you’ve created with a proprietary edge. That’s another strategy for de-risking your startup.

What sets your brand and product range apart from the competition? — is not the only question. The more crucial issue is how hard it is for competitors to break into your market.

Risk at the Series B Stage

Post the series A stage, you’ve effectively demonstrated that the company is stable and can sustain accelerated growth. By the time you’re ready for the next Series B funding round, investors want to confirm your expansion potential. What are the factors essential for de-risking your startup?

Essentially, you’re de-risking the Total Addressable Market (TAM) by exploring new markets and customer segments. These markets include national or global locations, and this is a good time to explore exporting.

The company should maintain operational stability even as you ramp up production quickly. At the same time, your cost per unit should not increase proportionally. This indicates a default profitability trajectory.

The company is now poised to generate higher revenues and profits, as its infrastructure is stable. As for the numbers, investors are focused on a net revenue retention of 130%, which indicates a growing customer base. In fact, the growth is so substantial that it can offset any customer churn.

If you’re calculating the lifetime value to customer acquisition cost (LTV: CAC) ratio, aim for 3:1 to 5:1. This ratio indicates efficient unit economics. To raise a Series B funding round, the company should be generating annual recurring revenue of $10M to $20M.

Accordingly, your valuation should be around 8x to 12x the annual recurring revenue(ARR). Investors are likely to scrutinize your internal infrastructure during the due diligence. Your company should have the necessary workflows to handle a 10x increase in demand, sales, and revenue.

Other aspects essential to support growth include distribution networks, proven marketing and advertising strategies, and, most importantly, a top-notch team. Moreover, your management should be able to recruit and onboard new talent independently of the founder’s involvement.

All these signals indicate that you’re taking the necessary steps for de-risking your startup.

Risk at the Series C Stage and Beyond

Now that your company is ready for its Series C round, it has grown exponentially. Investors are likely concerned about whether it is stable enough to sustain that growth without collapsing. Your decisions are no longer about de-risking your startup, but de-risking a later-stage company facing unique hurdles.

Once you cross the Series B stage, the company has a proven product portfolio and stable sales and distribution channels. It has also demonstrated its ability to handle expansion and growth. The next step is typically an acquisition or an initial public offering (IPO).

Investors typically ask — Can the company continue scaling even if the founder steps away? Or, if they take on a lesser role in the management? Can the C-Suite executives on the board continue to build and accelerate efficiently? Do they have a track record of managing companies at the $500M+ level?

As for the metrics, you’ll demonstrate an annual recurring revenue (ARR) of $30M to $100M. This number indicates that the revenue is diversified, consistent, and high-grade. The revenue assures investors that the company does not need to raise capital and can continue operating without it.

Your numbers should also signal positive EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) in the last 12 to 18 months. Know that later-stage companies typically have a Gross Retention of 90%+ and Net Revenue Retention (NRR) of 120%+.

These numbers indicate a dominant market share and that your brand is one of the top 3 in the market. Churn rates are negligible because no other product range delivers comparable value. Most importantly, the proprietary moat creates effective barriers to the competition.

When raising funding at any stage, one of the core skills you should have is how to value your company. Check out this video, where I explain in detail.

What Investors Anticipate

At the Series C growth stage, investors are looking toward a profitable exit with a 3x to 5x return. You can expect de-risking your startup/later-stage company completely, thanks to unsolicited interest from potential acquirers. This factor establishes a minimum valuation for the company.

Now that the company is a market leader, the dynamics of investor expectations change. You’ll demonstrate that its business model is not just scalable but capable of generating attractive profits. Investors are also looking for a combined growth rate and profit margin of 40% or higher.

Moreover, they scrutinize your preparations for an IPO or M&A transaction. Accordingly, you’ll initiate compiling the documentation and paperwork required for both scenarios. Having navigated multiple funding rounds, most founders have the basics in order, such as data rooms, contracts, and more.

Just as Philipp Heltowig describes on the Dealmakers Podcast, their Series B and C rounds layered on the sophistication of their prep work. The due diligence prior to the acquisition of Cognigy was much more streamlined.

You should also be ready with corporate governance, audited financials, independent board members, and formal risk-assessment agencies to monitor activities.

Before We Sign Off!

De-risking your startup and demonstrating that you’ve overcome hurdles is not just for the company’s initial stages. With each funding and growth stage, you’ll tackle the next potential pitfall that can derail the company. Investors scrutinize your numbers and activities to detect stability and profitability.

They need assurance that their dollars are being put to good use and there’s proven potential for attractive returns. Also, remember that each time you eliminate a risk, it raises the company’s valuation organically.

You’ll get investor backing at favorable terms and conditions, not to mention the additional resources and guidance only top-tier investors can provide.

You may also find our free library of business templates interesting. There, you will find every single template you need to build and scale your business completely, all for free. See it here.