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The Trend Back Towards Smaller Seed Rounds
When we started NextView 6 years ago, most seed rounds were relatively small. If a company raised $1M in a seed, that was pretty substantial. Our average round size in our first fund was about $1.2M. Actually, the average in the first half of the fund was quite a bit lower, but during this period (2011–2014) there was a pretty dramatic rise in seed stage valuations overall.
As we got into our second fund, the conventional wisdom was: 1) seed is the new series A, 2) traditional series A investors are investing later, 3) it pays off to raise more money so you have more runway and can get more done to overcome an inevitably higher series A bar.
As a result, the average round size increased meaningfully for the seed stage segment overall. $3M seed rounds were not at all uncommon, and our average seed round was over $2M. The actual profile of “seed stage” companies started to vary quite a bit as well. But for the purposes of this post, I’m focusing on true seed-stage companies, which I’d define as ones that are before product/market fit.
In the last 12 months though, I have noticed a healthy return to more modest seed rounds. Part of this is the emergence of “pre-seed” as a category, but I’ve also seen traditional institutional seed investors trending towards smaller initial rounds as well. And I think this is a really good trend for a few reasons.
One reason is that smaller seeds lead to more speed before PMF. This seems counter-intuitive, but it’s something I’ve seen in our own portfolio. Companies that raise less money seem to make more progress more quickly. I think this is because smaller seeds lead to smaller teams. Smaller teams tend to constrain the scope of a product to the core essence required to prove PMF. Smaller teams also make adjustments more quickly, and often bigger, less incremental adjustments. With bigger teams, you can get trapped into the sense that a product is almost working, and just needs a few more features or a bit more of X or Y. I notice smaller teams are less likely to think in this way, and more likely to try things and kill things and move on to new hypotheses. On top of all this, smaller seeds create a greater sense of urgency since resources are tight and runway is limited.
Another reason is that smaller seeds create a lot more flexibility if things don’t go perfectly. Again, this is a bit counter-intuitive. If you raised a smaller seed and haven’t over-extended yourself in team building, a few things are going in your favor if you need to raise a seed extension. First, if you want to keep the same team size, you can extend runway quite a bit (12–18 months or more) without raising a huge amount of money. Second, you can show a bit of aggressiveness if things are starting to work by raising a larger extension than you did in the original seed. Even though you aren’t raising an A, the message this sends the market is that things are working, and so you are going from a very lean pre-PMF stage to a more aggressive early growth stage. Third, the valuations are more likely to make sense for new investors, where you can raise your extension at a slight step-up, but the post-money or cap will still be reasonable for everyone involved. Fourth, you may be able to get your business to profitability with your next round, which is a really great place to be. It’s harder to do this if you built up a bigger and more expensive team out of the gates, but if you’ve landed on a product that is working but might not be quite right for VC money, you have more flexibility at this point to try to get the business to breakeven and take destiny into your own hands.
Dilution is the big question here. Raising a seed round half as big usually does not yield half the dilution at this early stage. But as valuations are becoming more rational, big seed rounds are increasingly more and more dilutive. Moreover, while your initial dilution matters, what matters more is the total dilution over the life of the company. Or put more simply, what matters is whether your seed capital helps you lock-in on great product market fit and sets you up on a trajectory for growth. Our own data is not completely exhaustive, but thus far, we’ve seen little or no evidence that larger seed rounds increase the chances that a pre-PMF company is successful.