As the atomization of seed has become more mature, it is increasingly clear that history is repeating itself.
What I mean is that the things that played when seed VC became institutionalized is beginning to happen in the pre-seed market. And the words I am hearing from seed investors are nearly identical to the things I heard from series A and B investors 7-10 years ago.
- “Adverse selection”. Some seed investors think that companies that raise pre-seeds are often flawed. There must be some adverse selection if they are raising small amounts of capital at those prices. Conversely, there is a belief that there is no way a fund can invest in good companies at low prices and at such an early stage. That’s exactly what lifecycle funds said 7-10 years ago.
- “More traction”. Increasingly, you hear seed investors that want to see more traction prior to a seed round. This makes sense since seed funds have gotten bigger and the series A bar has gotten higher, which has pulled everything upwards. This has created a void for investors that are willing to take product/market fit risk. Similarly, there was a time when many series A’s happened pre-product, but that became much less common with the rise of seed VCs.
- “It’s a fad”. The pre-seed market seems like a bit of a disorganized mess. There are different ranges of prices, structures, and fund strategies, with new players popping up all the time. It doesn’t take that much money to get going as a pre-seed investor, so the barriers to entry are relatively low allowing many different groups to enter. This makes the market seem like a bit of a temporary fad. Meanwhile, the seed market is normalizing around larger, $2-4M seed-preferred financing rounds. I’ve heard multiple people talk about these rounds as a “proper seed”. It tends of scare me when a big part of what I do is described as “proper”. It means that we have moved from the disruptive part of the market to the potentially disrupted part.
This leads to a couple of questions and predictions.
First, I think a lot of seed funds are thinking through their own strategies in the pre-seed space. The approaches range from avoiding them entirely, to embracing them and doing a lot of pre-seeds. Ultimately, the question comes down to bandwidth. Does one do a lot of pre-seeds, but essentially see them as a basket of options and then pounce when on really starts working? Or does one only do seeds very selectively and treat them the same as a “normal” seed investment? This is identical to the questions series A and B funds have been asking themselves about seed investing for many years. FWIW, in my opinion, the best lifecycle funds continued to do seeds, but did so in modest volume. When they did make a seed investment, they treated them mostly like a larger series A investment, since it ended up taking a full slot of a partner’s time and attention. This led to reduced signalling risk and better outcomes for founders and their companies overall, vs a spray and pray or option strategy. FWIW, that’s the approach we have taken thus far at NextView, where we invest across the full spectrum of seed but consider each investment a full-scale commitment of the team’s time and effort.
Second, I think pre-seed funds will ultimately fall into three camps. One will be the people that are enamored by startup investing and just do it for kicks. They will come and go. The second will be the group that really wants to be a pre-seed investor, and will have success and stick to their knitting. These groups will be among the early entrants and will do great. Third will be the groups that are using pre-seed investing as a stepping stone to accumulate capital and raise larger and larger funds. Some of these groups will do fine, but I think the majority will see their performance degrade significantly as fund sizes increase and as they stray from what made them initially successful.
This is exactly what has happened so far with seed VC investing, and it is happening again.