Topic: Fundraising

A startup’s potential scale is bound by its future market size, and consequently “what is your market size?” is one of the determining questions that most VCs ask early stage entrepreneurs.

Why does market size matter? 
How to estimate your market size? 
What is the exact definition of market size? 
When should market size be estimated for? 

If you only take a few things from this article: 

• Big companies can only exist in big markets. 
• Estimate market size using a bottom-up approach not top-down. In other words, multiply the number of customers by the average revenue per customer per year (which you can estimate through multiplying transaction volume by price).
• Present your total addressable market and your future revenue for 5+ years into the future. 

At Pear we consider an entrepreneur’s clarity of thought and enduring ambition as more important than the market size number in a pitch deck. The objective of market sizing is to demonstrate that you are targeting a big market opportunity that you understand deeply. Startups have many unknowns and market sizing is a rough estimation, so keep it simple. 

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1. Why does market size matter?

Big companies can only exist in big markets. 

Founder perspective: If you want to build a company that has a DoorDash-sized impact on the world then make sure to commit yourself to a sufficiently large market opportunity. 

Investor perspective: If you want to raise capital from VCs then you need to convince them that your company will generate an exit value that returns their fund. In your pitch you should aim to convey that your startup has the potential to capture at least hundreds of millions of dollars of high-margin revenue within the next decade, within a multiple billion dollar market. 

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2. How to estimate market size?

Use the bottom-up approach to estimate market size. Multiply the number of customers by the average revenue per customer per year. 

There are top-down and bottom-up approaches to estimating market size. The bottom-up approach is more convincing because its uses assumptions that are substantiated through other aspects of your pitch, such as customer definition, revenue model, and GTM. VCs also prefer bottom-up because the underlying assumptions can be tested and validated. Ideally you will only use top-down to sanity check the magnitude of your bottom-up estimate.

Keep your method simple and easy to explain. The underlying assumptions for market sizing will remain rough until you have ascertained your exact target customers and revenue model, so avoid undue complexity. 

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3. What is the exact definition of market size?

There is no single definition of market size. Early stage companies typically present three estimates for TAM / SAM / SOM. I encourage you to skip the acronyms and present bottom-up estimates for your total addressable market and your revenue in 5+ years. 

We surveyed 30 VCs to better understand how other investors evaluate a startup’s potential scale. We learned that earlier stage investors tend to prefer market sizing presented as TAM / SAM / SOM, whereas later stage investors care more about recent revenue growth as well as estimates for future revenue. 

• Seed VCs generally value TAM estimates more because they have limited additional information to inform decisions. We heard from seed investors that: “TAM / SAM / SOM works fine as long as the methodology is clear.” 
• Series A VCs told us that they care more about future revenue even when looking at seed stage startups: “A bottom-up build of future revenue is more useful than basing SOM on a hypothetical % share of TAM or SAM.”
• Growth-stage VCs pay less attention to market sizing and we heard that: “TAM is a crude indicator. Revenue growth is a better signal. It’s hard to grow 200% at scale if there’s a small TAM.”

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The textbook definitions for TAM / SAM / SOM are vague.

You might have seen TAM / SAM / SOM in an article or a pitch deck. If you Google these acronyms and read a few articles then you’ll likely find varying fuzzy explanations (one example depicted below). Pitch decks often include a market sizing illustrated as three bold numbers within three concentric circles, without context or assumptions. Such minimalism saves one from committing to definitions that we might be unsure about, but it also forfeits this opportunity to present a compelling narrative that convinces investors. 

Based on our survey of 30 VCs, it seems that many investors do not know the exact definitions either. So when presenting your market sizing, explicitly state your methodology rather than assume universal definitions.  (These survey results also had me wondering whether later stage VCs are more honest about their knowledge gaps! )

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The textbook estimation approach for TAM / SAM / SOM is TOP DOWN ⚠️

Marketing textbooks generally describe the TAM / SAM / SOM approach as: first estimate your largest possible market for $ TAM, of which estimate a narrower proportion that fits your company for $ SAM, and then estimate the % market share you can reach to get to $ SOM. However, the % market share assumption is often an unsubstantiated afterthought, which results in a meaningless estimate for your company’s potential revenue. This approach encourages top-down thinking and is unconvincing. 

The most consistent feedback in our VC survey was to dissuade founders from presenting their future revenue based on % market share of a large addressable market. So, what’s a better approach?

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Present bottom-up estimates for your total addressable market and for your revenue in 5 years.

The market sizing definitions stated below are based on consensus across surveyed VCs. However, interpretation still varies so state your assumptions. Also, enough with the acronyms — replace the jargon with more meaningful descriptors. 

Some of the surveyed VCs encouraged founders to drop the conceptual distinction between TAM and SAM. However, opinions on this topic were mixed. Instead of presenting both TAM and SAM, you could communicate your plan for incremental expansion across customer segments and products.

eg. Start with an initial wedge of selling product A into customer segment X. Then expand through cross-selling product B into the same customer segment X. Followed by expanding further through selling products A and B to a new customer segment Y.

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4. When should market size be estimated for?

Estimate your market size for 5+ years into the future. 

Surveyed VCs most commonly wanted to see market size estimates for 5 years into the future. If your company is many years away from IPO and/or riding a longterm industry trend (eg. transition to electric vehicles) then it’s more appropriate to estimate 7-10 years into the future. 

A significant proportion of the VCs surveyed also prefer to see market size now as well as 5 years into the future. If you’re targeting a rapidly growing existing market then you can highlight that growth through presenting both now and in 5 years.

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Guidance on the underlying assumptions

Now that you understand how to estimate your market size, you need to source the underlying assumptions to feed into the bottom-up equations. You can follow the following steps to arrive at assumptions for calculating total addressable market, initial addressable market, and future revenue.

1) # of Customers

1.1) Define your customers

Precisely focus on the customer segment that will contribute the majority of your potential revenue. 

eg. While DoorDash could claim that every person in the US could potentially order food online, a more convincing segment might be: “Americans in the age range of 25-40, who are employed, and eat out at least once per week.”

If level of demand and/or willingness to pay varies significantly across your customer-base then you should capture such variation in your estimation through customer segmentation. Though keep it simple and only consider segments that will contribute significant revenue. 

eg. Market sizing assumptions can differ significantly between SMB and Enterprise customers. If we’re selling a product into both then we should segment the market. (100K SMBs x 5 seats x $10K per seat = $5B) + (1K Enterprises x 100 seats x $20K per seat = $2B) = $7B total.

1.2) Estimate the total number of customers

The most relevant data sources vary by business category, eg.

• Consumer: If you can define your target customer (or user) segment in terms of socio-demographics then use the US Census Bureau data on US Population.
• Vertical-specific B2B: You can identify the number of relevant companies within an industry vertical using US Census Bureau data on US Companies.
• Enterprise: If you your future revenue will be concentrated in big enterprise accounts then identify what proportion of companies within the Fortune100 or Fortune500 would buy for your product.

Additional example data sources:

• Research reports (eg. Gartner, Forrester, McKinsey, BCG)
• Government agencies (eg. Bureau of Labor Statistics, Bureau of Economic Analysis, US SBA, trade.gov, Bureau of Transportation, Dept of Housing, US Dept of Agriculture)
• Industry bodies (eg. National Business Group on Health, National Restaurant Association, National Association of Realtors)
• NGOs (eg. UN Dept of Economic & Social Affairs, UN World Tourism)
• S-1s of companies in your category

1.3) Estimate the number of customers you could acquire in 5 years

You will acquire only a proportion of total customers We need to estimate a realistic number of customers captured by around the time you IPO, so 5-10 years from today. Its best to build this bottom-up through considering how many new customers you’ll be able to acquire (and retain) per year over the next 5-10 years.

Sense check your implied market share. Look at the market shares of existing dominant players in your category and in adjacent categories. Also consider strength of network effects, how entrenched established players are, and ease of distribution (eg. capturing 10% of the Fortune100 is more realistic than capturing 10% of 100,000 SMBs). 

Our expectations for high market shares are often anchored in the dominant consumer-facing FAANGs, yet many other categories are more fragmented or under-penetrated. Pitch decks often state a 10% potential market share. Yet when tech companies IPO they have typically only attained a 0.1% to 2% share of their addressable market. See the chart below based on data in S-1s of recent tech IPOs.

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2) $ Avg Revenue per Customer per Year

2.1) Select your revenue model

Identify the most relevant revenue model for your business. You might foresee multiple revenue streams, however its best to keep it simple and focus the market sizing on your core revenue stream.  See the table below for examples (though this is not an exhaustive list).

Each revenue model is split into transaction volume multiplied by pricing.

2.2) Estimate Transaction Volume

This requires you to understand your target customer’s behavior. (eg. How many product will they consumer per year, How much data storage will they require, How many seats per company, etc.)

2.3) Estimate Pricing

Pricing is an artform worthy of volumes, and in practice you might chose to implement multi-tiered pricing differentiation to maximize your profits. But again, for estimating market size, minimize the complexity. 

There are three main approaches to pricing. Value-based pricing is generally the best approach. 

• Value-based: Estimate how much value your customer attains from your product, and charge a proportion of that value. You can charge more through: (i) creating greater value for your customer; and/or (ii) heightening your customer’s perception of that value creation. Attribution is as important as the actual impact of your product. A rule as thumb is that you can charge in the range of 10-30% of the value you create for your customer.
• Competitor-based: If your industry has pre-existing comparable products to yours then your customers are likely anchored in pre-existing price ranges. When pitching to VCs you might need to explain why your product has a premium or a discount to comparable products.
• Cost-based: Estimate the cost to deliver your product and add a margin. Fixed costs are generally low in tech companies, and this is more relevant to operationally intensive and/or asset heavy companies.

How to best apply these approaches varies by the business category, eg.  

• B2B SaaS: Value-based pricing is the optimal approach to determine your customer willingness to pay. (eg. If your products increase your customer’s profits by $1M per year on a perpetual basis then you can charge a $100-300K per year subscription fee.)
• Consumer: Anchoring to the price of adjacent products often informs the attainable price, unless your brand is highly differentiated. This also applies to consumer fintech. (See this article)
• Healthcare: B2B healthcare solutions sold to payers or employers usually have a fee per member per month revenue model, and you can charge a proportion of the cost savings you deliver. D2C healthcare solutions usually a fee for service or a monthly subscription revenue model, and ideally you identify relevant reimbursement CPT codes. Healthcare also includes several more complex pricing models. 
• Marketplaces: The % take rate in a marketplace is driven by how much demand you can drive to your customer and how much easier you make it to run their business, as well as how competitive your market is. (See Lenny’s newsletter)

Now multiple those assumptions out. Hopefully you arrive at a big number for the addressable market. If not then revisit your assumptions as well as your overall vision. 

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Additional Tips 

• Think long-term and dream big. Most successful startups create or change markets, so you should estimate hypothetical demand for your product in 5-10 years, not just existing demand. Also consider how you will expand average revenue per customer through solving additional problems for your target customers.
• Global market size is rarely relevant. If your strategy is US-focused then state an addressable market for the US only. If you’re starting in a smaller country and your strategy focuses on multiple similar countries then state an addressable market for those countries and be ready to explain your international go-top-market plan.
• Ensure that the revenue you are presenting is annual. (eg. If there are 10M potential customers for your product and they might buy your product every two years on average, then you have 5M target customers per year. 
• For marketplaces, include take rate in the market size calculation rather than presenting overall GMV. For financial products, include fees rather than presenting total transaction value or AUM. If your B2B startup is helping your customer to increase their profits, then you can only charge a proportion of that impact. 
• Read S-1s of public companies with similar customers or products as your company. Search the SEC database for a public company of interest and open their ‘S-1 Prospectus’. S-1s are a goldmine of information and provide insights well beyond market sizing. 

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About Pear VC

Pear partners with entrepreneurs from day zero to build category-defining companies. Our team has founded eight companies and invested early in startups now worth over $80B, including DoorDash, Gusto, Aurora Solar, Branch, and Guardant Health. We use this knowledge to provide founders with hands-on support in product, growth, recruiting, and fundraising. If you’re building a category defining company then reach out to our team.

This post is Part 4 of our four-part series on What It Takes To Go from 0 to 1.

Let’s assume you’re a SaaS company that’s now raised some seed money. You’ve raised from us and you have two customers, and the founder has done all the sales. 

Now your task is to prove two things:

1. someone who is not you can sell your product
2. you can optimize and scale that process 

This usually involves building a sales team or setting up a reliable marketing channel. The test for this stage is whether you have a reliable formula for your growth. That is, you should be able to confidently say, “if I do X, I will get Y new customers / users / revenue.”

Pure growth is not enough. You can be growing super fast, but if you have no retention, we know that growth will die. Again, you may be tempted to buy a bunch of ads right before your raise to spike your growth for two months, but smart investors know that that’s not real growth. 

You may be surprised to learn that pure revenue is also not enough. We have found that post-money valuation of series A companies and their monthly recurring revenue is not correlated at all:

If product love is the one thing that matters most to us at 0.5 stage, what is it for the 1 stage? That you’re going to be a “big company.” We are looking for predictors of success. You can think about it as the “second derivative” of your growth. 

In this stage, we want to make sure that people not only love your product, but that they love it enough to pay you enough money to make it profitable to grow. 

Even if you’re at only 200K in MRR, if we can see that you’ve gone from one person using your product to 20 people using your product, and those people are using you every day and they can’t live without you, you’re probably a great company, like Slack! They didn’t need to have 1 million in ARR for investors to know that people loved that product and that it was going to stick around.

Series A investors are going to look at your scale metrics, like LTV (lifetime value) to CAC (cost of customer acquisition).

To get to Series A from the seed stage (or from 0.5 to 1), the most important thing you need to do, as a seed founder, is to make a plan and measure your progress. Determine where you want to be in four quarters, then walk backwards and figure out what you need to achieve that. 

Look at everything you need to do. 

For example, if you want to be at $1 million ARR, with some amount of cash for six months at the end of Q4, you might determine that you need to hit $100K in revenue by Q2. You probably are also going to need enough leads by Q2. If this is a SaaS business, you may want to hire a salesperson for that. And if you have all these customers, you’ll likely want to support them and keep them happy, so you might have to hire a customer success person in Q3. To have something to sell in the first place to get to that Q2 revenue, you might need to have an MVP by the end of Q1 that requires hiring a certain amount of engineers.

You’ll need to do all this math to find out what that plan all costs and how much cash you need to have for it. It is likely you’ll need to iterate on this plan, which is why you also need to measure everything as you proceed. What gets measured gets done, and the bonus is that it’s easier to measure things at the seed stage! We love data driven CEO’s, and we even encourage founders to display their key metrics to everybody in their company. When you go out to raise our series A, you can just take your dashboard to the investors!

Once you have a plan, and you have your measurements, you’ll need to put those two together to figure out whether you’re on track or not. This sounds very simple, but we’ve had many founders suddenly call us with three months of cash left out of the blue. Force yourself to send reports to yourself, to your team and to your investors. When you do that, you’re actually committing to something, and that makes you true to the plan. 

Here at Pear, we make every one of our seed companies run through a planning exercise at the very beginning of our partnership with them, and we review the plan every quarter. When our founders are in trouble, we review it every week, so we can figure out what our goals are and what we need to hit. 

Final Stretch: Don’t Mess Up the Actual Fundraising

Fundraising is a little like selling a house. If you’re trying to sell a house, but you don’t have your inspections complete and you haven’t cleaned up the lawn, you’re probably going to get a lower final price than if you’d done all your work—even if you’ve got a great house!

Put another way: no matter how great your numbers look, you still need to have a great pitch. You have to actually communicate with data. You have to have a rational ask.

Remember, there are much fewer Series A funds out there than angels and seed funds, so the stakes are higher with each meeting, and it’s much slower and more complex. You can’t hand wave. You need to have concrete, quantitative answers, and investors are going to take several weeks to get back to you. It could take longer. The good ones do it fast, but it’s not 30 minutes. 

Also, think through your process. Don’t contact 20 series A investors at once with your initial pitch. Stagger your pitches so you can iterate and revise between each, and save your top choice investors for last, after you’ve gotten feedback from the others.

This brings us to our final piece of advice for this process: diligence who you work with! We’ve seen founders get desperate and take money from investors they shouldn’t. We’ve done that personally on our own entrepreneurial journeys. It’s absolutely painful. You have to know who you’re fundraising from.

If you’re considering us as partners on this long journey, we hope you’ll take the time to get to know us, just as much as we promise to take the time to get to know you. 

This post is Part 3 of our four-part series on What It Takes To Go from 0 to 1.

To review: at 0, you have a big idea. At 0.5, you have a product that you, as the founder, can sell, and you’re seeking seed stage financing. 

What we’re looking for here is product love. For us, all that matters is — do people absolutely love this product? Is there a group of people out there who can’t live without this product? 

Your product needs to be at least 10x better than anything out there, and ideally, you can show us that this group is willing to pay for it. To us, it doesn’t matter at this point exactly how much they’re willing to pay, and to some extent, even if they’re not willing, it could still be okay. We really want to see the love most of all.

Now, we do use some metrics and signals to try to determine that level of “love,” and it actually has nothing to do with how much revenue you have, nor acquisition.

Qualitatively, a good rule of thumb is that when a company is at 0.5 stage, they are no longer changing their website (or sales Powerpoint, or app) to acquire and retain a new customer. They’ve found a value proposition that works. 

For a SaaS company, we generally want to see some very happy customers. 

For a consumer company, it’s all about retention. 

If you’re building an app, for example, you might be tempted to put your app out there and get as many downloads as possible. Maybe you’ll think about buying ads to juice those download numbers. To us, none of it matters unless you’re retaining the user. From our perspective, buying ads to inflate your downloads is just throwing money down the drain. 

The top 10 apps, all of which are huge companies, retain their users at 60% after a year. The crappy ones retain under 10%. It goes to show that the hard part of a consumer app is to keep somebody using it for a long time. If you can do it, it’s a good sign that you’ve got that product love we’re looking for.

Another important signal we look at for consumer businesses is your retention of super fans—people who are dying for your product. A good example of this was Pinterest. Early on, Pinterest users were on the site all the time and they were obsessed. 

So, we’re not just looking at retention of the average user, but also retention of those super fans. We want to see how much those super fans love you.

To navigate this stage, you’ll need a rapid experimentation mentality, cycling through as many new hypotheses as possible to land on the right value proposition. Make your operations scrappy and fast. Build and kill features, get to the simplest MVP possible.

To sum: be fast and listen to the data. Do not fall for fake signals. Remember the only real thing that matters is: do people (truly) love your product?

This post is Part 2 of our four part series on What It Takes To Go from 0 to 1.

Let’s say you’re at 0 and you’re thinking about starting a company. You’ve got an idea. 

The first thing you need to do—if you’re committed to going down the path of venture financing—is to figure out if you are in a big enough market for venture financing. 

If you’re not in a big enough market, and you go down the venture path, the money will unfortunately end up hurting you. Your company won’t scale with the capital, even though you might have built a great company if you hadn’t fundraised. 

There are a few ways to go about determining if you’re in a big enough market. One is a bottoms up analysis. But, as you may have heard, if you’re creating a new market, like Airbnb and Uber, you really won’t know how big the market is. These companies are typically the ones that turn out to be “unicorns.”

From what we have seen, the one thing that such companies all have in common is that the founder has great ambition. They don’t just want to make a quick exit or a lot of money. They want to fundamentally change something that they think is broken, or they just really want to make it big. 

There’s a fire in them, and it shows in their presentation. To be honest, there is a little, “We know it when we see it,” but we’ll try our best to describe what it looks like here.

The Difference Between a Good and Great Founder

So, let’s assume a company comes to us, and they’re pre-seed. Maybe they don’t have a product yet, and they want to sell lead gen software for real estate brokers. 

A bottoms up analysis would sound like this: “We’re going to be able to charge people $5 a month. There’s about 2 million real estate brokers in the US, so we’re going to hit 120 million in revenue in a given year if we sell to everybody.” 

We’ll know immediately that that’s a small company, because you have to sell to everybody, and we would need an 8x multiple to get to 1 billion. 

Of course, no smart founder would come and show us that. They would probably say something more like, “I’m going to charge $50.” Then the numbers get bigger, which looks nice, and then it’s our job to figure out if we believe that you’re actually going to be able to charge $50. We’ll ask questions around that. But at least now we know it’s a big market. 

The CEO’s of a potential “unicorn,” however, approach this differently. They say something more like, “Listen, real estate is broken and I’m going to build a marketplace where most transactions happen. Maybe I’m going to build a SaaS enabled marketplace and I’m going to sell some software, but fundamentally, I’m going to take a percentage of all the transactions in real estate.” 

We start thinking: “Hey, we want to back this person, they’re going to change real estate. They’re not just selling a tool to somebody.” 

We’ll admit this is very subtle, but it’s critical because it determines what type of company you can become. 

The point is, if you want to start this path, your ambitions need to be big.

When we see a founder with ambition of this scale, our job is to figure out if we believe that this person can attract the talented co-founders and early team members they’ll need to execute and actually achieve those big ambitions.

This post is Part 1 of our four-part series on What It Takes To Go from 0 to 1.

You may have heard that seed funds have grown significantly in the past decade, and that there are many more angel investors these days, plus incubators and accelerators. 

While this is exciting, what it also means for you is that getting to Series A is harder than ever. That’s because the same VC’s from more than 10 years ago are still the only ones offering Series A financing.

Take for example, a fund like Accel. The number of Series A companies that they fund has remained more or less constant. But now, there are more startups graduating from incubators and seed funds—so there is more competition for Series A funding than there was 10 years ago.

To put it into perspective: if you consider 2012 numbers, 631,817 new companies were started. Of those, only 4,671 received seed funding. Then, only 1,153 made it to Series A. That’s 0.18%. If you were a high school hockey player, you would have a higher chance of making it to the NHL. 

Moreover, the rounds themselves have shifted. The valuations of seed and Series A companies have (way) more than doubled in the last decade. This is because the companies that get funded are now older and farther along—meaning that the journey is also now longer.

Even with all this, we know that your goal as a founder is not merely to make it to Series A. You have ambitions to build a category-defining company. As you probably know, our world likes to refer to such companies as “unicorns,” defined as companies with valuations of at least $1 billion.

In 2012, there were only 22 unicorns—that’s 0.004%. Perspective again: that’s 10x harder than being a high school basketball player trying to make it to the NBA (where your odds are 0.03%).

The Startup Journey

Now, all these numbers are not to discourage you as a founder! We simply want you to know the reality of just how hard this journey is before you embark on it. We think you should know exactly what you’re getting into. 

All that said, we’re committed to helping more founders get there, and we want to share what, in our opinion, it takes to do it. 

As much as the funding landscape might have changed, the startup journey itself has not changed all that much in the last 10 years.

At 0, you are in the idea stage. We would call this the “pre-seed” stage.

At 0.5, you have a product that you, as the founder, can sell. We call this “seed.”

At 1, you have a valuable product that a team can predictively sell, without the founder.

At Pear, we consider ourselves 0 to 1 venture capital. We partner with entrepreneurs from day zero to build category defining companies. 

You might be thinking: so many other VC funds have said all that too, but then they keep telling us that we’re “too early” or asking for “traction.” 

So what do we really mean when we say day zero? What are we actually looking for? And what is this 0 to 1 you keep talking about? How do I actually get to 1? 

Taken from Mar’s much-loved talk, we think this philosophy will shed some much needed granular and specific light on all of these questions!  

You can also read the original deck here: pear.vc/landscape or watch Mar’s original talk here: youtube.com/watch?v=B0seWrrz3Dg.

The Series

PART 1 — The Big Picture
It’s hard to get financing when you’re in the 0 to 1 stage. Even harder to become a category-defining company. We think it’s important to really understand why that’s true. You should know exactly what you’re getting into and be prepared for the reality of how hard this journey is before you embark on it.

PART 2 — Step 0: Make sure you’re in a big enough market for venture financing
Did you know you might not even need venture capital? We’ll break down what “big enough market” means quantitatively and qualitatively, and how you can communicate that effectively to venture capitalists.

PART 3 — From 0 to 0.5: Show us product love
At 0, you have a big idea. At 0.5, you have a product that you can sell and you’re ready for seed stage financing. What we look for at this stage is product love. Believe it or not, there are quite specific signals for this that we’ll explain here.

PART 4 — From 0.5 to 1: Prove that you can systematically sell your product
You’re readying yourself for Series A now. Your task is to prove two things: (1) someone who is not you can sell your product (2) you can optimize and scale that process. The most important thing you need to do is make a plan and measure your progress. We’ll walk you through it.

How active are investors?
What are you seeing at Pear?
How do you reconcile competitive rounds with lower valuation and less activity?
How do I know if I should raise now?
How can I show that I am a good company? Are investors looking at metrics and indicators differently?
How should I build a plan?
Is this a good time to *start* a company?
Bottom Line

Alongside our founders in the past few weeks, the Pear team has been figuring out how fundraising now “works” in our new world. While taking meetings over Zoom, we inevitably get urgent questions like these:

• Are you still funding start-ups? How active are investors? Are they looking at metrics and indicators differently?
• Are valuations lower? Any trends on where valuations are going?
• What are you seeing at Pear in terms of seed-funding right now?
• Is this a good time for me to fundraise? Should I wait until 2021?

Here’s what we know so far, two months into shelter-in-place in the Bay.

As with any COVID related advice, there is still a great deal of uncertainty out there and things are changing very quickly day-to-day. Our answers here are intended as extra data points to help your decision making.

How active are investors?

Early data from Q1 suggests investment activity is down (note: this only includes 2–3 weeks of US shelter-in-place).

• Crunchbase Q1 2020 Global VC Report: dollars invested quarter over quarter dropped 27% (includes angels, pre-seed and seed deals)
• CB-Insights Research Brief April 2020: seed deals are down 27% from Q4’19 and 43% from Q1’19, but median seed deal size is staying flat at $2.4M
• Axios: “Investment activity is off approximately 25% from pre-pandemic levels” (according to April & May Pitchbook data)

Although the last 25% drop number seems bad, you can interpret it another way: investment activity in April 2020 was not zero. It was 75% that of April 2019 and that’s still a big number (~$2B per week). So, if you are a founder, know that venture capitalists are still investing.

Financing rounds are taking longer to close. NFX put out a survey comparing the opinions of VCs and founders on the current financing climate. A whopping 88.5% of founders reported that VCs were slower in responding or not responding at all. However, note that in early April, most of us were busy with our portfolio. We would guess that if the survey were run today, the 88.5% number would be lower.

Good companies are still raising money. Just in the last eight weeks, very large growth financings have been reported, such as Robinhood and Carta and of course, the ultra-competitive $12M seed round of Clubhouse.

What are you seeing at Pear?

• Investments feel less rushed, though our own sample set is small, and we are still moving fairly fast.
• Valuations are a bit lower but we still don’t have enough data around valuations. We have many investor anecdotes, but we will not have statistically significant data until the end of the Q2 when financial data companies, law firms and others publish their results.
• Great companies are still getting multiple term sheets. Some of our portfolio companies have multiple Series A term sheets, with competitive terms and valuations similar to those of early in the year. We have also been involved in competitive Seed financings — where we’ve gotten our own taste of how hard it is to pitch yourself via Zoom!

How do you reconcile competitive rounds with lower valuation and less activity?

This is what is happening.

Investors all have a certain bar in terms of committing to an investment, but we are also all very different. One investor may absolutely care about unit economics, while the other one is more focused on team or absolute revenue.

Back in January, in the midst of the “good times,” a company with only a few of these good attributes could have had an easy time getting to a competitive financing. Today, the bar for getting to a yes from an investor has come up (we have noticed that the very best investors tend to always have a high bar).

So for you as a founder, it means the following: adjust your bar. If you are a great company you will be able to raise money at good terms.

How do I know if I should raise now?

This advice is fundamentally driven by the company’s health. We have given advice to our portfolio ranging from “raise money now” to “it would be suicide to fundraise now.” The company’s health may be affected by COVID-19 but ultimately it will go back to those “good company attributes”: positive unit economics, efficient growth, short payback times, a team that can execute, a big market opportunity…

This coming recession has not affected everyone equally. Some companies have been badly hit and some have benefitted, and some are in the middle. Depending on where you are, you may want a different strategy. Here are some scenarios:

(1) You are in a terribly hit space like travel or retail. No matter how great your business was, your business is zero now, and it will be hard to fundraise. If you have to fundraise, you should be ready to accept lower terms than your last round (e.g., Airbnb). If have cash and can weather the storm, cut costs to a bare minimum and wait for the market to come back. If you don’t think the market can come back, you need to change what you are doing.

(2) You are in a market with tailwinds and your business is blowing up, like online education or remote work. This may be exactly the right time to go out and get some capital to scale. In this situation, we believe that even if your unit economics and growth efficiency are not great, you can still fundraise easily (maybe not from the top, but there is still a lot of FOMO).

(3) You are in the middle scenario—your market is not terrible but not great. You are expecting your top line revenue to go down ~10–35%. You will need to do a bit more homework. Cut costs, focus on building your product and on improving unit economics and growth/sales engine efficiency (see this Sequoia post on targets for building a new plan). Ideally you have enough cash to make your company more efficient and show a couple of quarters of growth before you need to go out fundraising.

Remember, good companies can always fundraise, so the question can be turned into — “How can I show that I am a good company?”

How can I show that I am a good company? Are investors looking at metrics and indicators differently?

The metrics that matter don’t change: big market, strong unit economics, efficient growth. You can read more about this in Mar’s deck on the seed landscape in 2019. Good investors know that it is always a good idea to invest in these structurally good companies.

Showing some growth is still important. You will definitely get a break on not hitting your pre-COVID growth numbers, but you won’t get a free pass. It is important to show that you have quality growth (even if it is still small).

How should I build a plan?

It is absolutely crucial that you are aware of the macro-situation. If you are following the situation online, you know that nobody knows what will happen with certainty. Everything depends on how the population behaves or whether we will have new therapies or a vaccine.

You need to tell us investors that you are ready to succeed in the event of the worst-case scenario. For example, if you are a travel company counting on the market to rebound in July and you show a straight curve to the right, we will likely question it.

We want to know that you have a plan in case there is a second shelter-in-place. We want to back founders that are aware and a bit paranoid. Don’t just say “We are through with the worst” or “People will start traveling again soon, no problem.”

Is this a good time to *start* a company?

The short answer is yes.

There will be long term effects from being sheltered at home for 60 days. It has already affected all industries: consumer, industrials, retail, medicine, enterprise… It has affected all of us individually and we have become accustomed to new ways of living. We will be more open to remote work, telemedicine and home deliveries.

We see this as a great opportunity for a founder to build a company that takes advantage of this mindset and behavior change. As a seed company, you can spend the next two years plotting the ideal product that takes advantage of this new macro.

Recently a founder told us, “I can’t get a corporate job now — I need to continue to build my company. There is so much opportunity now to create new defining companies.”

This is the founder we want to back, the founder that cannot wait to build companies.

Bottom Line

Things seem to have slowed a bit, but the good companies are still raising money (competitively) and we are not seeing many changes in the valuation.

As a founder, focus on building a company with strong unit economics and efficient growth. This is true always, but it will ring even truer now.