Evaluating the Risk — Reward Relationship Across Funding Rounds

Bharat Anant Blocked Unblock Follow Following Feb 29, 2016

What is the best startup funding round for investors? Let’s take a look from the risk-reward perspective:

Risk:

Failure rate defined as a startup failing to reach the next round of funding prior to ceasing operations.

From purely looking at failure rates, it is clear that the later funding rounds have a much lower risk level. However, this does not take into account the full picture.

Firstly, it should be stated that to reach a Series B a startup must first raise a Series A, and so on. From this perspective, a startup’s risk trajectory looks something like this:

A startup’s failure risk decreases as it grows. Another intricacy to note is that startup investments cannot typically be exited until a final sale or IPO because of liquidity issues within the market. Accordingly, “total risk of failure” on a startup investment is truly the compounded risk contained within every future round as well as the current round’s risk. For example:

If 1,000 companies complete their Series Seed funding rounds, the Series Seed average failure rate of 86% means that only 140 companies will close a Series A funding before failure. With the Series A average failure rate of 70%, only 42 of the remaining 140 will advance to a Series B and so on until just 24 of the original 1,000 startups have achieved success. When graphed, it looks like this:

Converting this view to look at the overall chance of success, the numbers are more blunt; only 2.4% of Series Seed, 17% of Series A, 56% of Series B, and 83% of Series C companies succeed to exit.

From this perspective it seems clear. We should be investing in late stage companies. But that is not the full story.