This was initially published on the Seedchange Institute.
This week, news leaked that the widely discussed (and mocked) San Francisco startup Clinkle was on the verge of shutting down, as key employees began heading to the door and the company still had little to no product traction despite the massive $25 million seed round it raised in 2013.
When Charlie O’Donnell of Brooklyn Bridge Ventures asked Twitter to name the largest seed round that actually worked out, respondents struggled to find a good answer with some noting other companies (like Color, who raised over $40 million in its 2011 seed round) that went big and then went nowhere.
So, if raising an outsize amount of capital right off the bat — giving companies a head start on competitors, the ability to offer enticing compensation to top talent and the potential to double down on successful growth channels — isn’t the answer, what does make a successful seed round?
To start, Upfront Ventures GP, Mark Suster has said numerous times that when the hors d’oeuvres tray is passed, take two…but don’t take the whole tray. Put differently, companies should raise enough to fund the growth that will allow them to get to their next major milestone while also adding in a slight buffer, if possible. This remains instructive advice for people on both sides of the table, as discipline is key in refining the product and go to market strategies of a young company.
Another prolific VC blogger, Tomasz Tunguz of Redpoint, has discussed the interplay of angel money and VC money in a seed stage deal and looked at how it impacts follow on funding. After analyzing Crunchbase data, Tunguz noted that startups with at least one VC in their seed round raise Series A rounds 64% more often than do angel-backed startups.
That said, the difference between the amount raised in Series A rounds between the two groups (those that had VCs backing the seed rounds and that didn’t) was not statistically significant. While it may be a bit easier to raise a large seed round with a VC backer (primarily because of differences in fund sized between VCs and angels), it doesn’t make any meaningful difference in a company’s ability to raise a Series A and continue as a going concern on the path to acquisition or IPO.
As Tunguz puts it, this data goes to show that a great entrepreneur and a great company can come from anywhere.
Historically, angel investors have looked to VCs for signal with the line of thinking being that VCs are professional investors, with networks to surface the best companies and tested frameworks for evaluating deals. The reality, as detailed in the Kauffmann Foundation’s seminal 20 year retrospective of VC as an asset class, is that a majority of VC firms failed to exceed returns available from the public markets, after fees and carry were paid.
In spite of this, the resource intensive nature of conducting research and diligence on the number of investment opportunities necessary to build a strong portfolio of early stage companies was onerous for individuals and made it so that following VCs into deals remained the best option.
Today, this has changed, as platforms like SEEDCHANGE offer the opportunity to enlist a team of professionals to conduct the necessary research and diligence so that you as an investor can be more efficient in determining whether a certain company is right for your portfolio. This means less time spent collecting information and more time spent time evaluating the true merits of the deal — how can this team, their product and their strategy compete in the market?
The true makeup of a successful seed round doesn’t come down only to money raised or terms of the deal. Success in the early stages so often comes down to people — entrepreneurs and investors alike — making it integral that a funding round be composed of investors who truly understand the core businesses they are investing and are committed to remaining engaged with the portfolio company as it grows over time.