A constant question we at ICONIQ Growth hear from Series A companies is “exactly what does it take to raise a Series B financing in this environment?”

CEOs are understandably confused by the way the Series B investment process relates to the answer to this question. It is conventional wisdom that early-stage investors care about the quality of the team, the size of the market into which the team is selling, and the demand for the company’s product. When the fundraising process begins, however, the information requested by Series B investors tends to be a set of financial metrics that seems only vaguely related to these core issues.  

In addition to my role as a Partner at ICONIQ Growth, I am a Board Partner at a seed fund (Cowboy Ventures) and a coach for a number of CEOs, so I spend quite a bit of time with early-stage CEOs.  These folks routinely express frustration that they are being asked for picayune financial details of a company that often has only a handful of existing customers. The purpose of this post is to unravel this mystery, detail the most important metrics that investors at this stage look at, and explain what is really behind the requested data.

Investors care about the addressable market, team and demand for the product. Market sizing, however, should be a core competency of investment firms and therefore is not typically part of the data requested from the company. Similarly, the quality of the team is assessed by some combination of the interaction in investor meetings, reference checks and performance of the company to date, and, accordingly, there is no direct data requested from the company on this topic. Therefore, the data requested is primarily intended to resolve the market’s acceptance of the company’s product. Succinctly put, the data are proof points of demand.

Our perspective

ICONIQ Growth often begins partnering with companies between $1m and $10m ARR, generally considered Series B investing.  We’ve partnered with dozens of companies at this stage [1] including Snowflake, Drata and most recently Writer. We believe that now is an ideal moment to redouble our efforts in Series B investing in part because so many firms have retreated from this round of financing [2]. We are convinced that Series B investing is a terrific opportunity to partner with great companies and propel them on their journey, and I have recently become a partner at ICONIQ Growth with a focus on making more investments at this stage.

At ICONIQ Growth we have built significant capabilities to help founders scale their companies and build enduring businesses. For example, we have published proprietary insights detailing what it takes for a SaaS company to scale from <$10M to IPO from a metrics standpoint using extensive data across companies within and outside our portfolio here. The cliff notes version for early-stage CEOs, is that for B2B Saas companies with less than $10m ARR, the key metrics investors focus on are: ARR growth, net revenue retention and gross margin.

At least doubling ARR over the prior year

In this new age of efficient growth, we have found that some companies are more focused on their efficiency than their growth. As described below and in more detail here, it is vital to be efficient. Even in this market, however, ARR growth rate and new logo velocity are the most reliable indicators of product market fit, and it is therefore difficult for sub $10 million dollar run rate companies to raise venture capital that are not doubling year over year.

According to our published data the median year over year (YoY) growth rate for companies in our study at sub $25m ARR is 125% while the top quartile is 240%, and for companies between $5m and $10m, the median YoY growth is 165%. Investors won’t need to see a full 24 months for a year-on-year comparison, however, 3 months of 7% monthly growth isn’t really going to be enough, whereas 8 months of 15% monthly growth becomes very interesting.

Investors prefer to see sequential growth, meaning that each successive month is adding more net new ARR than the preceding month. At ICONIQ Growth we also look to see whether the number of new customers is increasing on a month over month basis, which we refer to as logo velocity.  If the pace of sales is accelerating, that signals to investors that there is increasing demand for a company’s product in a large market. There are certainly reasons, such as seasonality or turnover of a small sales team, that can impede the attainment of linear compounding growth, and in such cases, it is important for the CEO to be able to articulate a reason why that’s the case.

Contracted ARR (CARR) is another signal of demand. During the software boom at the beginning of the decade, CARR was often relied upon by investors in lieu of ARR with little to no discount.  In today’s climate, however, investors will apply a meaningful discount to CARR and will devote considerable scrutiny to the lag between the CARR and ARR.

Built into the notion of ARR growth is the question of repeatability. As the CEO describes the business, it is vital to articulate how they are assembling the people, processes and systems to build on the business’ early success. The platonic ideal B2B Saas company has a pipeline of qualified leads, but not enough salespeople to talk to them and are raising money to fund the lag between hiring new salespeople and having them sell more than they incrementally cost.  Very few companies are fortunate enough to have such a clear story, but it is a helpful model for CEOs to use when describing how they will deploy the proceeds of the Series B raise. Obviously, a company with a dozen customers paying $100k each is going to tell a far different story regarding repeatability then a company with 100 customers paying $10k each, but in either case, the investor is looking to understand how additional funding will be devoted to building more of something that is working rather than something untested. Repeatability need not be confined to the go to market function. Another credible source of repeatability is that a company has penetrated a certain customer segment with its first product and has uncovered tremendous pent up demand for an adjacent product that requires additional resources to be built.

Net revenue retention (NRR) is> 100%

Investors want to see that once customers start buying a company’s product, they continue to buy it and buy even more. There’s no better way of showing love than spending more money. The ability to expand within an account shows both that customers are buying into the product vision of the company and that the company will be able to grow at a lower cost going forward. The median NRR for sub $25m ARR companies according to our publications above is 105% while the top quartile retains at a rate of 125%.  This metric has the tendency to remain relatively similar over various stages of a company’s life, so it will receive real scrutiny at this stage.  One framing of this question investors use is whether the company has a “land and expand” type motion where the initial customer opportunity leads to greater dollars over time. These are obviously the most favored for investors as they are more durable.

While increased revenue is the strongest signal of customer satisfaction, usage metrics such as daily or weekly active users inside an enterprise can be leading indicators of customer adoption.  At ICONIQ Growth we have found these metrics to be useful predictors of churn and/or expansion dollars and we prefer CEOs who are able to use this data to tell their growth story.  For product led growth companies, evidence that the product spreads across personas and then outside an enterprise into various partners and vendors is also a good proxy that a single customer can beget additional business.

Gross margins > 70%

Gross margin is a slightly more fickle metric than ARR growth and NRR in that it tends to be more a disqualifier than a metric that is highly correlated to the quality of a company below $10m ARR.  At scale investors expect B2B software companies’ product gross margins to end up above 80% so while the actual gross margin at this point of a company’s journey can be caused by a wide variety of factors, if gross margin is below 70% the CEO should expect to be able to explain how the margins will improve over time or, if not, why.  The real crux of this inquiry is that investors want to be sure that the company is getting paid only for the software and not for the services with which it is bundled.  However, this is not a hard and fast rule.  For example, when ICONIQ Growth first partnered with Snowflake, gross margins were approximately 35% but we understood why that was the case and the company could clearly articulate a path toward more normalized gross margins, which Snowflake has since been able to achieve.

Efficiency matters

While the metrics regarding the efficiency of a company are less important at this stage, they are still a critical part of any Series B investment.  One of ICONIQ Growth’s latest reports is “The New Era of Efficient Growth” so we obviously care quite a bit about this topic.  At sub $10m ARR, however, it is more about the company’s ability to grow efficiently as opposed to its history of doing so.

As detailed in our reports, the public markets are absolutely looking for and rewarding companies that can grow rapidly with minimal cost.  This in turn drives the behavior of both later stage investors and strategic acquirers. Accordingly, it will be vital for companies raising a Series B to present plans for effective growth.  One way for CEOs to think about this is the company’s net magic number which is the current quarter’s net new ARR divided by the prior quarter’s sales and marketing opex.  This metric is designed to measure the net revenue generation against sales and marketing operating costs, while accounting for the lag of a typical sales cycle.  For sub $25m ARR companies, the median net magic number is 0.8 while the top quartile is 1.7[1]. To the extent that there are meaningful differences between the present state of these metrics and the planned future state, it will be incumbent on the CEO to articulate how these changes will take place and what the drivers of these changes will be.

The simplest of these metrics is ARR per FTE where better companies sub $25m ARR are above $100k.  With more difficult engineering exercises, the expectation is less that the company will be performing at the top quartile of $135k ARR per FTE and more that there is a trendline to follow where, as the company grows, that number can approach $200k.  Of course, these numbers change dramatically in the company’s earliest days.  For sub $5m ARR companies, the median is only $55k while the top quartile is $75k. Other indicators of efficiency include the cash burn to ARR ratio also known as the “burn multiple” and the net magic number described above.

Concluding thoughts

Product market fit (PMF) has been defined as discovering a market that is desperate for your product. At Series B, investors look for signs of that desperation in the data.  While early indicators of success do not necessarily mean that a company has truly discovered PMF, it is difficult to convince investors that PMF has been found without the supporting metrics.

For a CEO who spends their time building great products, landing customers, and hiring great people, the rate of revenue growth on a month-to-month basis might seem like a random inquiry.  This type of signal, however, when combined with a series of other information, helps shape an investor’s view of the degree of pull for a company’s product. A core aspect of the CEO’s job during the fundraising is to provide the color behind the data, explaining why the data varies from core benchmarks and to speak to the initiatives the company has taken and will take that are going to cause those outputs to continue to improve.

Terms and conditions. This post gives metrics intended for B2B Saas companies.  Obviously in areas like Fintech and Consumer, where ICONIQ Growth also partners, the relevant metrics are quite different.  Additionally, even within B2B Saas there are differences, such as in infrastructure companies where gross margins tend to be lower in the early days and monetization can meaningfully lag behind usage.  Most investors are aware of these differences and so this is not intended to be a one size fits all list. Also, while this post focuses on some of the core aspects of demand for a product, it doesn’t discuss the defensibility of that demand and how the product fits into the larger ecosystem which are also part of the investor inquiry.

If you want to know how your company stacks up, we are happy to run some analysis on your metrics.  You can email me at twang@iconiqcapital.com. Of course, we’d like to use the initial observations as the beginning of a dialogue, but this is not a requirement.  We’re happy to simply ship you the results.