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Seed Round Dynamics
A friend of mine just completed a very successful fundraise for an institutionally led seed-round of capital. Increasingly, these seem to be the most common ways that venture-funded companies get started.
What’s interesting is that this entrepreneur has raised $30M+ in venture capital before and knows the VC process intimately, but remarked to me midway through “this process is completely different from every other fundraise I’ve been a part of.”
It’s different across a few dimensions, but it comes down to the fact that most seed rounds are multi-party optimization exercises. In a given $1.5M round, there are often 2, 3, or more “funds” that are investing between $200K – $700K. Also included in the round are typically 2 sorts of high-quality angels – those that really know the founders and are let into the round because of relationship, and those that are more value-added in nature, usually because of the brand credibility they bring or deep domain knowledge. As an entrepreneur, you’d be willing to spend a bit extra time getting those angels across the finish line, even if their $’s aren’t that big. In some cases, these rounds come together very quickly and easily, but in most, it takes a bit of time, and feels a bit like this:
No fundraise is completely predictable. Actually, most are very unpredictable. But at the risk of being too formulaic, here is one possible roadmap I’d recommend for raising this sort of a round.
- This assumes that you are “ready” for the round to happen. Figuring that out is the subject of another blog post. This also assumes that you have a reasonable “ask” in terms of dollars, valuation expectation, etc
- Overall, I believe in very limited staging of a process. As Paul Graham as written, it’s a “breadth first” process, then you triage your list in a probability weighted way. So, even though I’m proposing a sequence of steps, the reality is that it should feel a lot more like a big parallel process
OK, so, here is a broad process:
- Line up support. Know who people are going to call as a reference – your prior bosses, obvious people in the ecosystem that would have a strong POV on you or your idea, etc. Pre-wire them so that when the calls come, they are ready and/or you are least know what they are likely to think.
- Get commitments from those who know you. These are the angels that are your closest mentors/references or individuals that you want to have affiliated with the company. The idea is to get a small but solid commitment from these people, so that when you have your first conversation with a lead, it doesn’t feel like you are starting from scratch, and there is built in credibility.
- The way to mechanically do this is to just get these individuals to feel comfortable with at least an investment of x ($25K or something) and then remind them “only say yes if you are willing to have people ask you about it. There is nothing more damaging that having a VC call an angel and have them say “actually, I’m not really committed”.
- You can give people the option to back out. Make it clear the commitment is “assuming reasonable terms and a round at least X” so they don’t fear that they are investing on potential dumb terms or an underfunded round. This is kind of the equivalent of “I’m in as long as you have a lead” but sounds a lot better. You want to be able to say “they are in, assuming reasonable terms. Feel free to call them”
- Find a lead investor: These are funds that are willing to stick their neck out and be the first “yes” and issue a term sheet. There are ways to do this without a lead, but I’ll ignore that for now. Some thoughts
- There are tons of seed funds, but way fewer than you would think actually lead.
- Leads tend to do fewer than 6 investments/year/partner (and I’d argue, ideally, much less than this). If they are higher velocity, I’d question whether they’d be able/willing to lead. There are some exception, however.
- This takes longer than you think, unfortunately. Leads usually do work, real due diligence and reference calls, but that’s because they are going to lead. But a good lead shows forward progress pretty transparently and can do their work in a couple weeks. If someone isn’t showing that kind of interest, de-prioritize.
- Be willing to travel a little. I think it’s helpful to get some feedback in fundraising, so it’s worthwhile to hit a few markets like BOS, NYC, and SF. It’s less likely to find a lead outside your core geography, but it does happen, and it ends up being pretty unpredictable who really does get excited or doesn’t. I also think that getting some market feedback is helpful from investors that have a different vantage point than you.
- Triage appropriately. As my partner Lee often says, fundraising is about searching for true believers, not convincing skeptics. This is particularly true at the earliest stages. It’s easy to spend too much time focusing on skeptics.
- Slightly behind lead conversations is value-added non-lead investors. Think of these as additional arrows in your quiver. These groups can augment the network of your lead, provide additional support capital if you need an extension, and hopefully be helpful. Prioritize these groups for value add, but keep in mind, these groups tend to be more clubby and care more about who else is in and social proof.
- Have good news to share along the course of the fundraise, if possible. Even small pieces of data like small-scale tests, new hires/advisors, etc. Unfortunately, fundraising is much easier when there is a sense of momentum behind you, so do what you can to create some momentum. Investors tend to exhibit lemming-like behavior. You can’t really change that, so accept it and try to make it work for you.
- When you get a term sheet, you can do some work to optimize the deal. Expect this to take a bit longer than you think. In my opinion, the goal at the seed round is to get a fair deal done quickly with the right partners, not to maximize valuation or terms. If you have a term sheet or two, you have a finite window to convert it to a deal – so do it pretty quickly. Time kills all deals.
I didn’t want to be too prescriptive here, so happy to get into more details in the comments if folks have specific questions.
Fundraising tends to move slow until it moves fast. What you’ll find is that in the middle of the process, it might seem frustrating as some investors pass, some investors feign interest but don’t really dig in, or it just takes a while to get meetings with the key decision-makers. But push through it! Once a lead or two start to take serious interest, the chorus will change. The challenge with seed rounds is that multiple parties can invest, even without being the first “yes”. So unfortunately, it potentially rewards investors that hang around the hoop and then try to sneak in at the end (as lame as that seems). But once there is some demand for the round, the group of potential investors will swarm pretty quickly, because ultimately, many of these rounds end up way over-subscribed. Just keep plugging away, and remember it moves fast until it moves slow.
This might seem laborious, and it kind of is. Funny enough, raising a seed round might end up being as time consuming as raising a larger round because of the multi-party nature of the process. But if you manage it properly, you can go from start to a term sheet within 3-5 weeks, and to a close a few weeks after that. Sometimes it can take longer, but beware of being in the market too long because a lot of seed investors are pretty chatty and word gets around fast about a company’s struggles to raise capital. Some investors are independently minded and can see past that, but most investors tend to get hot and bothered about momentum and perceived traction. I’ll talk about seed stage “traction” in another post.