ROBGO.ORG

August 26, 2013

Over the past couple years, there has been an emerging bifurcation in the seed investing market. We’ve noticed this both in the industry broadly, as well as in the companies that we have invested in or seriously considered. Essentially, there are 2 flavors of seed rounds that are emerging (EXCLUDING seed extension rounds, which are a whole other story).  We’ve come to describe these as “Genesis Rounds” and “Institutional Seed” rounds. Basically, “Genesis Rounds” look like this:

  • <$600K, and sometimes, substantially less
  • Pre-product
  • No team aside from founders
  • Mostly angels with occassional participation from small/seed funds
  • Usually convertible note
  • Runway <12 months

“Institutional seed” rounds on the other hand tend to look like this:

  • >$750K.  More often these days, there are more like $1.5M or even more
  • Post-product, early customer data, somtimes real revenue
  • Several employees in addition to founders
  • Institutional seed investors or larger VC funds
  • Often priced equity, but often convertible note
  • Runway >12 months

Sometimes, companies only need to do one of these two rounds. But I’m finding that more often than not, companies need to raise both of these sorts of rounds before being able to raise a “traditional” VC-led series A. What I am finding interesting is watching the way valuations and difficulty of raising has changed for these different flavors of seed rounds.

8+ years ago, the “Institutional Seed” rounds didn’t really exist.  There were only a handful of funds doing seeds for a living, and thus, cobbling together enough angels to invest $1.5M in a round was very challenging for most.  Most seed rounds tended to look like “genesis rounds”. This market gap, coupled with the capital efficiency of software brought on the rise of seed funds.  This led to a period of seed stage exuberance, and that led to higher valuations, larger rounds, etc.

Over time, many seed rounds started to look like “institutional seed” rounds, even for companies that were very very raw and frankly, were not deserving of so much capital at such high prices. But ultimately, this has come to roost over the past several years as the series A Crunch has pummeled a bunch of these companies and their investors.  As a result, many seed funds have pulled back, started making later stage investments, and even focusing more on mini-Series A’s with a syndicate of seed funds.  What I’m seeing now is that “institutional seed rounds” tend to be bigger, and go into companies with much more meat on the bones.  These rounds also tend to get done on pretty high valuations (although lower than in the last couple years).

What this means for entrepreneurs today is that the “genesis rounds” are much harder to raise, especially if you are a relatively unproven founding team.  Yet, most companies need “genesis” capital to get off the ground, recruit your first couple team members, and start building something interesting.  As a seed investor, I think this actually has led to “genesis rounds” becoming more attractive.  Valuations are better, there is less competition, and if you knock it out of the park, the potential for a meaningful valuation step-up at the next round is much higher (which leads to less overall dilution for founders). I would say historically, the risk/reward of genesis rounds were not very good. The risks were not commensurate with the valuation relative to institutional seed rounds. But I think these might be coming closer into line, and I’m personally taking a closer look at more earlier and smaller rounds.

On top of all this is just personal preference, because I think the most rewarding part of VC is being part of the genesis of great companies.  That’s why I really try to never “pass” on an investment because it’s “too early”.  If it’s too early for a seed fund, then who the heck is it NOT too early for?

  • brendangbaker

    This is a great post. Agreed.

    I think there’s a lot of room for further thinking about this, especially around funding for exploration v funding for growth, and in what needs to be derisked at what stages. Disambiguation over all of this will be good for everyone, and a new standardization of stages is probably due.

    Aside: ‘too early’ is pretty much always code for ‘not good enough’ at an early stage.

    B

    • robchogo

      Thanks Brendan. Very validating since you are actually the guy who should have all the data about this trend :)

      I find too early as a spectrum driven by founder/Oppty fit. The better the fit, the greater the tolerance for “eary-ness”.

  • http://www.beepartners.vc/ Michael Berolzheimer

    Rob, great post. I’m thrilled to see ‘Genesis’ being used here, and it’s how I’ve been articulating Bee Partners’ eagerness to meet with founders early on in their thinking about financing their startup.

    Two additional comments, targeted towards entrepreneurs — Genesis rounds still need to be built carefully. First, try to raise from ~5-8 investors vs dozens. Doing so implies deeper pockets from those 5-8, which are important in the event the startup stumbles a bit and needs some fresh capital. Second, get investment PARTNERS on board. At the Genesis-stage, get all the feedback you can get, not just on product, but also on company building, strategy & financing alternatives. Pro-active investors at this stage can be a huge advantage, and they’ll want to support so long as the risk/reward (valuation) is appropriate.

    • robchogo

      agree

    • http://www.adamlieb.me/ Adam Lieb

      Michael is the first person I’ve ever heard the term Genesis round from. I liked it then and I like it now.

  • http://www.chriskurdziel.com/ Chris Kurdziel

    Love the term “genesis round” and the associated perspective around it.

    I wonder what portion of institutional seed rounds are for companies grown by former EIRs – seems like for some of these cases, the entrepreneur’s time as an EIR could count in lieu of a “genesis round” (though this case is probably closer to @brendangbaker:disqus’s point about funding for exploration than funding for growth). Might also explain why institutionals choose that approach over doing a genesis round and then an institutional round.

    • robchogo

      I think that’s true, but I also think that the EIR gig isn’t a great “product” for all founders, and is probably only a good option a minority of the time.

  • http://www.antoinedc.com/ Antoine

    Why would a funder want to raise money at a pre-product stage ? Most of the time building a mvp doesn’t need a lot of money, can be done without being involved full time on the project, and allow to have a concrete feedback from the market.

    • robchogo

      That isn’t true for all types of products. Also, it could require some capital to start to bring on a team or early employees, which may make sense very early on. Also, in some cases, creating a product that works doesn’t cost that much, but actually proving that there is fit in the market could require a bit of capital.

  • Kevink

    On the topic of your last sentence. I’m curious to see if there’s some limit to how early investments can be done. Pre-product? pre-initial ideas? pre-intent to do a startup?

    Over the last few decades it’s become viable to invest earlier and earlier–I wonder where the limit to that trend will be.

    Agree with Brendan that functional classification should happen for early stage rounds.

    • robchogo

      Well, a number of funds have “entrepreneurs in residence” that are in a way, pre-idea. I think if you get too early, it starts to not make sense to take investor money at all for a variety of reasons.

      • Kevink

        Completely agree. I think there’s room for something to fit in on the investor side that early–but we haven’t figured it out quite yet. Might look very different from traditional vc.

  • http://www.adamlieb.me/ Adam Lieb

    I’ve seen the exact same thing from many of my cohorts in Seattle and the bay. I have been calling “institutional seed” Seed Prime.

    I have noticed one interesting thing about second seed rounds (institutional seeds). There are a lot of companies who have just plain run out of money. For a seed investor you must be wading through a ton of these companies trying to find out who actually has meat on the bones. Everyone slaps a good face on it, but figuring out who is ready to approach efficiency/scale and who are still trying to figure it out, must be challenging.

  • http://stevecheney.com/ steve cheney

    Excellent post

  • mvfjb

    Rob – A great descriptor word; we’ve been fumbling around trying to clearly make that distinction. Given our mission here in Maine, we’re in a position to see lots of these Genesis rounds. It’s interesting that many founders at this stage learn a little and think they’re ready for the institutional Series A at this point, or at least the Institutional Seed; takes some educating. Finding an appropriate security with the right terms can also be a challenge for these Genesis rounds. Great post – thanks

  • http://www.MediaShares.com/ Gene Massey

    Some valuation info for seed investments here would have been very helpful

  • Bob Mason

    What’s the value of labels associated with rounds of financing when increasingly fundraising is become less “waterfall” and more iterative.

    For example, I have seen plenty of companies raise up to $100-250k from a small group of angels. They might then raise an incremental $500k as they go through an accelerator like Techstars. In the next 6-9 months then raise close to $1.5M with VC backing. Then they raise $3M+ as a “bridge” to their Series A. Each of these are up-rounds. Everyone is excited about the progress of the company. But it’s a bunch of incremental raises tied to specific milestones.

    Back in the day when we started Brightcove, Jeremy Allaire raised a full $5M Series A with a single fixed valuation. Though maybe a bit more stressful for the CEO, raising the same amount of capital spread over discrete points of progress creates better alignment for all parties and may in fact preserve more ownership for the founders.

    So to that end, do we even need labels? The process is still a bit formalized post-Series A, but you never know maybe we’re going to increasingly shift toward more and more dynamic rounds that are difficult to categorize.

    • robchogo

      Thanks Bob. I’m not advocating for labels, just observing a trend in financing patterns. I do think there is a major cost in too many incremental rounds so early. Each round takes time to raise, and even with all up rounds, can be pretty dilutive (although maybe not as dilutive as raising $5m out of the gates.

      • Bob Mason

        From my observation, most startups will have 3 fundraising events before Series A.

        I agree that the “cost” of fundraising for the company, particularly CEOs, is very high. So there is certainly an opportunity for investors with the right resources to get in early, write bigger checks and follow-through in quick increments.

        Of course, the earlier you invest, the higher the risk – so how one evaluates the opportunity and founders becomes critical.

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