As a participant in the start-up world I am always trying to gauge the supply and demand function. How many companies are being funded, by whom, in what segments and with how much capital? The trending topic in the start-up market is Seeds. Lots of Seeds. Angels are back with a vengeance after lying low following the Dot Com bust. The Financial Meltdown in October, 2008 didn’t dampen the Seed investment environment, but rather, energized it. The Seed investment became the bridge between a pure start-up and a Series A round with VCs. While VCs were licking their wounds, focusing on the Portfolios and looking for later stage deals with less “risk”, the Angels and Seed investors stepped in and filled the gap. Alumni from successful companies such as Google, EBay, Paypal, and others have the money and experience to help companies gets started.
Seed investing is becoming a more organized and structured form of investment. Angels like Ron Conway, Peter Thiel, Chris Dixon, Chris Sacca Jeff Bezos and Serge Brin have been active investors for some time. Ron Conway has morphed in SV Angel and perennial Angels Peter Thiel, Sean Parner and Dave McClure have Formed Founders Fund. The newest entry is Mike Maples taking a Partner and renaming his Angel fund Floodgate (I think Floodgate is apropos of the Seed funding environment in general). Programs such as Techstars and Y Combinator, among others, have emerged to add a boost to the Seed scene. These programs hatch batches of enterprising and hungry little chicks.
Some VCs have jumped into the Seed space by forming their own seed programs. Spark has Start@Spark which has resulted in 3 new investments in the last 12 months. Our average seed has turned out to be larger than we expected at around $500k because that’s what was needed to get to the point where a larger round could be raised. Other VCs have introduced various programs for seeding companies ranging from free room and board to $250k loans. Seeds are becoming more competitive and growing in size. Seeds of $1mm are not uncommon.
Most of the seeds are for either Consumer Internet start-ups or suppliers of software or services to enable established companies to address the Consumer Internet. There are also seeds going to start-ups tapping into emerging ecosystems such as those of Apple’s iPhone, Facebook and Twitter. These companies don’t require a lot capital to bring a product or service to market so Seed funding is an effective way to get started. It seems the Seed is the new Series A and the Series A is the new Series B. Ideally, the Seed round is “friendly” in that it is either a convertible loan or minimally dilutive without bells and whistle terms.
So what does the boom in Seed funding mean? First, it means smallish amounts of cash available to Entrepreneurs with good ideas. Second, it means Investors with small amounts of money and large amounts of experience are available to fund and mentor new companies. Third, it means more competition for VCs at the seed stage. Fourth, it means a bumper crop of start-ups with funding from $250k to $1mm entering the market. Lastly, there will be a long line at the VC counter as Seed investments line up for follow-on funding.
I, for one, have been impressed with both the quantity and quality of companies receiving Seed funding. Most of the activity is occurring in the Valley. New York, due to its Media prowess; and, Boston with its Academic and High Tech pedigree, are also making the scene. VCs should be welcoming the presence of the expanding Seed investment community. What’s not to like about having the chance to invest in a start-up that has a working product and some early momentum. In other words, it’s nice to see the “Dogs eating the Dog food” before you invest. VCs can work with Angles and Seed Funds as feeders and Farm teams. VCs can also team with Seed investors in hybrid deals that include Angel terms and VC follow-on investment potential. I think the service performed by the Seed investors is valuable and helps fill a gap in the market between self-funding and Series A.
The less pleasant byproduct of the boom in Seed investing will be a fairly high mortality rate among Seeded companies. Looking on the bright side- it’s far better to fail quickly than to fail slowly. Seed funding will run out sooner than a Series A if the company is on the wrong track. As the bar for funding is lowered and more companies are started, the quest for follow-on funding will be intense. By their nature, Seed funds and Start-up programs are not designed to provide substantial funding beyond the start-up phase. That means VCs will be called on to take the baton from the Seed investor and fund the companies to the Promised Land. Some companies will be acquired before a VC round is needed. While the total purchase price might not be huge, the Entrepreneur’s result could be sweet. For those Entrepreneurs wanting to go big, the VC route is likely to follow the Seed funding.
The result of the current boom in Seed funding will be a bumper crop of start-ups. Many won’t make it but some will go on to become valuable companies. For Investors and Entrepreneurs alike, it is important they keep the bar high, the friction low, raise enough capital to hit a major milestone, treat the Seed round as a bridge to a larger VC round relative to terms and timing, and compromise on spending but not on the size of the opportunity. In the end, the quality of the team, market opportunity and product differentiation are what matters- no matter how you get started.
