Taking the Pulse of the Seed Stage Market

Venture funding into startups dipped significantly in the first quarter of 2016…yet venture funds themselves raised more money than they have in a decade. So where does that leave us today, specifically as it relates to the seed stage market?

We looked at four factors — current seed stage availability, follow-on capital availability, the M&A market, and the historical economics of seed investing — to gauge where things stand today and help investors build a strategy for the current environment (Spoiler: We think the argument for allocating capital to the seed stage remains strong).

1. Seed Capital Availability

At first blush, a funding dip like the one experienced by the seed stage in the first quarter of 2016 seems disconcerting, especially for angel investors or micro VC funds simply interested in participating in (and not leading) deals. If others don’t show up and fill the round like expected, investors could conceivably be left holding the bag on a doomed investment.

The more likely reality is that the most recent 2 or 3 trailing quarters were simply a slight reversion to normal levels and the pace will continue at a strong clip for the foreseeable future. The last few years have seen funds focused on the seed stage raise a historically outsize amount of capital, much of which remains ready to deploy. And despite some handwringing early in the year about a sinking public market derailing the private market, much of that concern — rightly or wrongly — seems to have been brushed aside.

2. Follow-on Availability

If you have been following the seed stage market with any intensity for any period of time — 1 day or 1 decade — you’re sure to have heard about the almost-about-to-happen Series A crunch. Essentially, as record levels of capital have poured into the earliest stages — via accelerators, individual angels, and the hundreds of seed funds that have been raised in recent years — onlookers have feared that a capital mismatch would take place and a more than usual number of those seed funded startups would be left to wither and die on the vine.

To an extent, this started coming true late last year, as Mattermark data showed “graduation rates” (Seed funded companies that go on to raise Series A rounds) continuing their already downward trajectory in 2015.

Ultimately, the success of an early stage venture portfolio is dependent on whether companies within that portfolio are able to achieve exits via acquisition or IPO. When investing at the Seed stage, however, exits can take half a decade of more. This makes those graduation rates that we mentioned above a very important metric for early stage investors to track and have a handle on.

The concept is pretty simple. If companies in your portfolio continue raising capital, they continue to survive and are more likely to eventually experience some sort of liquidity event.

In Q1, a majority of the capital raised was concentrated among a few firms, most of whom invest across stages but allocate a investment dollars to mid and late stage companies. This bodes well for the current and upcoming crop of seed stage startups who will be in the market for further raises in 12–24 months time. Beyond that time frame, we look to our next factor…

3. The M&A Environment

Q1 2016 saw exactly zero venture backed IPOs. Add to that the fact that the software sector — where most venture capital flows — saw the lowest number of exits since 2011 and it is pretty clear that the M&A and IPO markets can’t get much worse then they are now. As we noted above, private follow-on rounds are great…but the real returns for investors come when some sort of liquidity event occurs. And while it is possible that the IPO window may remain firmly closed for the foreseeable future, other factors indicate we may be in for a pickup in M&A activity in the industry.

  1. The Facebook Effect — In recent years, Facebook has become as well known for its purchased properties — What’s App, Instagram, Oculus — as it has for its core app. This acquisitive approach gives the company the ability to buy the future (before it becomes too large and thus desires to stay independent) instead of building it. Large corporates are nothing if not copycats so expect to see a few others follow Facebook’s lead and step on the acquisition gas pedal here shortly.
  2. Corporate Venture on the Rise — This piggybacks on the Facebook Effect, as corporations have record levels of cash on hand and have realized that true innovation is unlikely to come from within. Since 2011, the amount of corporate venture capital — both in gross and relative terms — has steadily crept up. As those portfolios mature, it becomes more likely that corporate acquirers will be eyeing a few of the top performers.

4. The Economics of Being Early

This last factor is one that has not been significantly impacted by recent funding patterns but remains important nonetheless. Per data from Cambridge Associates, relative to other stages of the private venture market — and frankly to almost all other asset classes — the seed stage outperforms.

This outperformance was brought to back to the surface recently in a series of Tweets from Horsley Bridge Partners, a prominent LP who has backed many of the industry’s top firms. The firm analyzed over 5,500 realized deals from across their portfolio to understand the risks and rewards of early stage and late stage investing. To pull a page from venture darling Buzzfeed’s book…what they found will shock you! We will let the Tweets speak for themselves.

While we spoiled our conclusion above, it makes sense to reiterate here. Capital is available — both at the seed stage and in follow on rounds — for good companies and that availability will continue for the foreseeable future with the amount of dry powder sitting in the bank accounts of both early and late stage investors. On top of that, M&A headwinds are strong (well, stronger) than they have been and the economics continue to favor investors who back companies early in their lifecycle.

Originally published at institute.seedchange.com on April 28, 2016.

Why the Real Growth Comes Early

As yields in other asset classes have stagnated over the last few years, non-traditional venture investors have poured capital into late stage private companies — the so-called “Unicorns” — at an unprecedented pace. With what seemed like up and to the right growth and public declarations of profitability (or at least a reasonable line of sight to sustainability), these companies (and their investors) could do no wrong.

In recent periods, many companies in the billion dollar valuation club have run into issues. Zenefits, for example, fired its CEO amid allegations of skirting insurance laws and an unsavory company culture, companies like Snapchat and Dropbox have had their value marked down significantly by Fidelity, and reports about on-demand darlings like Instacart point to business models that lack long-term viability.

What seems to have remained true through all of the hoopla however, as outlined in a recent New York Times piece, is that investors who make the commitment to find and work with companies at the earliest stages — often called the Seed Stage — tend to see a majority of venture returns in spite of the skewed nature of headlines.

A few key quotes from the article:

The idea that early-stage investors can generate much larger returns has long been a core principle of venture capital: Get in early and grab a bigger stake in a company, with more opportunity for a larger return later, the thinking goes.

Early-stage investments have accounted for the lion’s share of the venture industry’s gains since 1994, according to Cambridge Associates, a research firm that studied the quarterly financial reports of dozens of venture firms. Since the dot-com boom of the late 1990s, between two-thirds and three-quarters of the industry’s returns have been generated by early-stage investments in any given year.

Early-stage investing has changed in recent years. The top-returning venture-capital investments in any given year were once dominated by just a handful of brand name, early-stage venture firms. That has shifted: Over the last decade, new venture firms have contributed to an increasing share of the best investments, according to Cambridge Associates.

“The tech market has massively expanded, and tech is now far more accessible all around the world,” said Theresa Hajer, a managing director at Cambridge Associates.

That is not to say investing at the earliest stages is without risk, of course Companies fail for a number of reasons — lack of market viability, personnel issues, and competitive forces — and those issues are certainly magnified at the seed stage where the margin for error is thinner.

Read the full article on the New York Times >>>

Originally published at institute.seedchange.com on March 17, 2016.

What Makes for a Successful Seed Round?

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.