By Ivan Nikkhoo, Founder & Managing Partner of Navigate Ventures
Securing rounds of VC funding is a critical milestone for any fintech startup looking to turn innovative ideas into reality, fuel growth and create value.
While market conditions have tightened since 2022, early-stage capital is still available for backable teams and visionary disruptors who are trying to solve a big industry problem. There is also ample late stage capital variable once these companies are at scale. However, growth-stage fintech startups face challenges in securing funding and often underestimate the time required to get from the series A round to the growth round. This leads to a growing funding gap affecting the global fintech startup ecosystem.
So, why is growth-stage fundraising proving such a challenge for founders, and how can we prevent the capital gap from increasing further?
Underestimating the time to raise
Achieving the required metrics to raise a growth round is getting more difficult as investor demands have risen. And herein lies the problem. Most founders still mistakenly base their Series B plans on their Series A experience. The current average period between the series A and growth rounds is currently about 31 months. As most funding rounds are based on 20-24 month cycles, many of these companies end up funding themselves as they run out of capital and runway. This issue is further exacerbated by lack of venture debt due to failure of SVB, Signature Bank, among others, as well as the availability of growth capital outside of Silicon Valley.
Series B, however, is a different beast altogether. The first of the so-called ‘growth’ rounds, Series B raises are designed to turbocharge growth and expansion. The cheque sizes dwarf those made at Series A; hence, investor expectations are fundamentally different and have risen considerably as markets have tightened.
Growth investors look for specific metrics to determine the viability of a potential investment. First and foremost is the quality of the team. Then, demonstrating proven product market fit, repeatable sales model and a large and growing market. Once it is determined that these conditions are met, the focus will be on unit economics including burn, churn, average contract value (ACV), revenue growth and run-rate, customer acquisition cost (CAC) trends, and gross margin, all of which are relatively straightforward to demonstrate. There are also a number of newer, sector specific metrics that some investors look at as well.
Investors will then carefully scrutinise the business model, the total addressable market, the growth trajectory and the company’s ability to continue to acquire and maintain quality clients. In the case of fintech startups, they’ll also pay close attention to the wider regulatory landscape, cross-border operational challenges and the likelihood that these external factors could derail a startup’s growth trajectory.
Strong startups are running out of cash
Just 25% of startups make it to Series B, and even high-promise startups with strong fundamentals can face a lengthy journey to close their growth round, leaving competent founders who have hired good teams, achieved product/market fit and made smart strategic decisions struggling for runway and cash. This challenge is particularly pronounced in fintech, where founders are currently contending with a significant market correction following years of over-cooked valuations.
With the time between Series A and B the longest in 12 years, these founders face the huge challenge of striving for rapid growth and profitability while desperately trying to conserve cash. This near-impossible task often forces founders towards drastic cost-cutting. While measures such as reducing headcount or trimming product features can boost the balance sheet in the near term, there’s always the risk that they could damage the company’s longer-term health or stymie its overarching mission.
Eventually, founders may feel they have no choice but to move the goalposts for their raise, accepting a lower valuation of their business and giving up more equity to the incoming investors (which will also cause problems during future rounds) or approaching investors who may not be the best fit for the company and its strategic aims.
Additional capital without dilution
However, there’s one pathway through the funding gap that tends to go unexplored by founders – a Series A extension round.
An extension round allows a startup to raise a small round from its existing and specialised investors based on the same terms of the Series A to extend its runway and be more prepared for a proper growth round. This can be an attractive option for any founder who still enjoys the unwavering belief and support of their early-stage investors. These VCs don’t want to see promising young fintech companies go under, particularly if they’ve already demonstrated proven product/market fit and a repeatable sales model.
The challenge is that executing an extension round relies on the ready availability of this capital. There are many reasons why a willing VC may be unable to fund an extension round. Hence, it can be extremely difficult for fintech founders to secure the full amount they need for a Series A extension round from their existing VCs.
Fortunately, markets are good at finding novel solutions to emerging pain points. We’re now seeing a handful of VCs looking to specifically target extension rounds, between Seed and A, or A and growth rounds. Working in partnership with a startup’s existing investor, they work to plug the capital shortfall and create a solution that delivers value for all parties.
Post-Series A/pre-growth stage investors must be diligent and highly selective as their chosen investments must go on to raise Series B rounds at the expected higher valuation in a predetermined period of time in order for them to deliver the expected return and risk/reward profile. Nevertheless, their growing presence in the market creates a hitherto untapped opportunity for the founders of high-potential fintechs as they look to navigate the funding gap without compromising on their business plan.
Extension rounds must become an established part of the investment lifecycle
The most common reason for startup failure is running out of cash. With no sign that the difficult economic and market conditions are ending, ambitious fintech founders must adjust to the realities of the current climate and develop business plans that anticipate a much longer pathway towards growth stage funding.
At the same time, the global venture community needs to create more attractive options for fintech founders who need a bit more time and capital to get to Series B, rather than forcing them to cut costs or experience significant dilution. The Series A extension round offers a proven bridge across the funding gap – it’s time we spread the word.
