May 5, 2014

Seed stage investing has developed significantly over the past 7 years that I’ve been in VC. What started as a rogue, almost anti-VC strategy has become very common. It’d pretty standard for entrepreneurs to contemplate raising an “institutional seed round” prior to approaching VC’s for series A rounds. Many have said that the institutional seed is the new series A.

This is rational because seed investing makes sense for companies that can have capital efficient beginnings. The challenge for those in the market of seed investing is that the barriers to entry in seed are relatively low. The main reason is that it just doesn’t take that much capital to get started. A lot of folks can pull together a few million bucks from high net worth individuals and start operating as a “seed fund”. One could go about writing dozens and dozens of $20K checks, catch a winner, and then build on that to gradually raise more money.  Accelerators and crowd-funding are encroaching on this territory as well.  On top of that, you are also seeing funds that used to be classic series A and B funds struggle to raise capital, and so go down-market to write more seed checks.

This is why the market has become so confusing, and why there seems to be a wealth of seed investors. But some winners have emerged, and I’d argue that their position is pretty well cemented. How do they do it? Three things.

1. Leadership. The seed stage is filled with folks who follow. It’s extremely common for me to talk to an entrepreneur that has tons of demand for their round, but is actually looking for someone to lead, set terms, and be the anchor investor in a $1-$2M seed round. If you think about the number of investors that have capacity to invest $500K+ and lead a round, the number of seed funds dwindles to single-digits (in the east coast). It’s a very different skill set, and requires a LOT more conviction (and more capital). Entrepreneurs are also going to be a lot more discerning about who is going to be a major investor in their round and potentially take a board seat or board observer seat. The market doesn’t need another seed fund that rides along with other investors or hangs around the hoop until a hot investor validates an opportunity then tries to get in.

2. Early. The complaint I’ve been hearing more and more is that many “seed” funds are only investing in companies that already have traction. I totally don’t get it. I find that the market leading seed funds, and the up-and-comers I respect get into deals very early. In our portfolio, over 1/3 of our investments happen pre-product. When I think about some of the other market leaders in seed, I see a similar commitment to being true seed-stage investors and get in early.

3. Gravity. After the investment happens, the best VC’s continue to distinguish themselves by the way they work with their portfolio and impact their outcomes. This is particularly hard for seed funds because a) most seed funds invest in quite a lot of companies and b) the funds are smaller and it’s impractical to hire an army of folks like bigger funds like A16Z.

Despite these challenges, the funds that show leadership in this space find ways to exhibit gravity around their firm and portfolio in a way that founders really appreciate. There are a few ways to do this. Firms like First Round and others have created small “Platform” teams to add leverage beyond the human capital of the GPs. We’ve started to do the same by being the first VC in Boston to hire a top-notch full time person dedicated to platform and community. Related to this, some firms also find ways to create stronger connective tissue between portfolio companies, so that there is collective strength in being part of the same network (SV Angel is the classic example of a firm that does this with a very large portfolio). Finally, a lot of gravity can simply be achieved through focus, which is something that most seed VC’s lack. It’s extraordinarily hard to be a focused, active investor in a company if you are making 8+ investments a year per investor or more. It’s much more practical to concentrate your capital and time in a smaller number of companies where you have high conviction and the skills and ability to make a meaningful difference.

The seed VC market will continue to mature and change.  But I do think that as things progress, we’ll see more and more separation between the really strong players and everyone else.  And I’m pretty convinced that the winners will distinguish themselves through these dimensions above, even as new players come and go and new innovations continue to change the early-stage financing market.

  • andrewparker

    I agree those are three important characteristics… but isn’t the single most important characteristic deal taste? For example, the seed fund list in Uber’s first round looks pretty good to me: and that required A) good taste to know to say “yes” and B) access, which is a sum of the characteristics you described above (plus some others… like amiability).

    • robchogo

      Yeah, deal selection is probably the most important thing, as I’ve said in prior posts.

      I was focusing this more on firm-wide strategy and approach to the market over time, vs investment skill of the individual which does ultimately trump everything.

  • Atai Konushaliev

    I think each VC need to define what they actually mean by “seed stage” and what they see appropriate for seed stage, something like ‘minimal requirements’, because when you visit various VC firms websites they say that they make seed rounds and that they would be glad to hear your idea, but then it turns out they expected something more close to Series A and it can be very confusing for startup entrepreneurs. This is another argument in favor a need for a project like the one that I currently actively working on called Miki (look for it on AngelList).

    • Atai Konushaliev

      Also, do VC’s somehow collect feedback on they work? Especially the negative ones are very valuable… (I’ve just provided one in previous comment)

  • William Mougayar

    This is a great post Rob, right on.

    Why do you believe that the ability of seed stage funds to affect outcomes is tied to the “army of folks”? I think the VC can affect outcomes by working directly with the startup.

    And I have a question: – If you lead a $500K seed round, what X amount do you typically allocate on reserve for subsequent follow-ons?

    • robchogo

      Some firms have an army of support staff to help portfolio companies.

      And usually, funds do reserve a percentage of their capital for follow-on rounds

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