March 19, 2013

CB Insights published this report on the relatively performance of seed VC’s and non seed VC’s.  It’s pretty interesting.

Some quick thoughts.

1. There is a danger in looking at averages.  Venture tends to be a game of asymmetric outcomes, and it’s not just the companies, but also the investors in those companies.  In the report, the claim is that seed rounds with larger VC’s fare better in terms of their percentage probability of raising their next round of financing.  The stat here is 54% if the round has a seed VC, and 59% if the round has a large VC and seed VC.  However, the best seed funds far outperform this statistic.  Anecdotal data is that the best seed funds that we work with often see a 60%+ hit rate for outside-led follow-on rounds (our number is in the 70%+ range).  As in all things in venture, the best performers are what matters, and I would love to see how this data stacks up for the top tier funds.  My guess is that the top-tier seed funds would do better.

2. There are two strategies for seed investing among larger funds.  One strategy is to do relatively few seed investments, and to treat those more or less similarly to a full-scale investment.  The lead partner feels like their reputation is on the line, and the company went through what is more or less a full process. I would expect those scenarios to have a pretty high hit-rate of seed to follow-on, probably in-line with the top-tier seed funds.  The second strategy is to do many many seed investments and see what sticks.  This is the classic case of a large VC building a basket of options.  This happens a bit less these days than it used to, but it’s still fairly common and opens the door to meaningful signaling risk.  And I can tell you for sure that the hit rate of those seeds is far below the 54% mark, even for very good funds. How does one tell which bucket you are in if you are a founder? See my post here.

3. I didn’t look that closely at the report, so I’m unsure about 2 things regarding the data (but perhaps the answer is there somewhere).  The first is what is included in a “follow-on” round?  Even in an option seed scenario, there is usually some sort of a second bite at an apple or seed extension.  And usually, if it’s a matter of a few hundred thousand dollars, the big VC will participate in that round.  Is a $1M seed extension counted as a successful follow-on round?  If the big VC is in the seed and writes another $100K check in the seed extension, I could see that still being counted favorably because a) it is a follow-on round and b) there is a big VC in that round. The second question is how complete this data is.  A number of large VCs make seed bets under different entities, so it’s not immediately obvious whether they are investors (unless you are an industry insider, in which case, it’s widely known).  Also, many seed investments never make it onto a larger funds website until they do raise another round of financing, which again could skew the data.  That said, perhaps CB Insights found a way to adjust for these, it just wasn’t immediately obvious to me.

Quick parting thoughts for entrepreneurs:

1. The report does show that even if it’s completely accurate, you are better off taking money from a seed focused VC fund.  This makes sense, as it’s helpful to have other folks around the table who do seed investing for a living, have relevant expertise, and have the time and incentives to really help you to win.

2. Signaling risk is an issue. It’s not a complete deal killer, but it’s not a non-issue.  We often invest with larger funds and have a great partnership with quite a few of them.  The right fund can create a bunch of leverage through their portfolio support services, deep relationships in specific industries, and ability to quickly add more capital to a company if things are working. But, I generally encourage entrepreneurs to make sure that they are being considered as close to a “full scale” investment as possible, even if it means going through a bit more of a rigorous process to get the initial “yes”.

3. Like the companies we invest in, the performance of the funds that participate in the early-stage ecosystem will exhibit a power-law. The best funds will outperform, the average funds will underperform.  It’s important to be considered one of “the best” in some sector or sub-category of any market, whether you are an investor or company. Sarah Lacy has a nice write-up on that here.

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