Yesterday, Founders Fund partner Brian Singerman, wrote a post called The Paradox of VC Seed Investing which referred to the risks of large VCs buying options in the Angel/Seed round. While I do agree with Brian’s position on large VC firms, I think his post oversimplifies the investment landscape and the players within it. More notably he seems to infer that a “VC” is a large fund, $400mm+ in size. I believe that this is an inaccurate definition, rather, a VC can be defined as an investor who manages capital on behalf of a group of limited partners. I also believe that the investing ecosystem has adjusted to accomodate specialists for each round of financing. The prime example of this is Super Angels/Micro VCs model that came in existence only few years ago and is growing at an unprecedented rate.
We can get some insight to the growth of each specialized sector using the NVCA data. According to the NVCA Q2 report 14 of the 38 new venture funds were less than $10.5mm in size which implies that these are Super Angel Funds. On the other side of the spectrum the top five new funds accounted for 80% of the funds raised. What’s left is a gap in the Seed VC stage. But before I explain further I’d like to outline each investment specialist and their role in the market.
Angels: Wealthy individuals who contribute $25 to $100k per deal. These investors are unlikely to participate in future rounds
Super Angels/Micro VC/Seed Funds: This is a professional investor or small team of investors who raise between $5mm and $20mm from LPs and use these funds to make passive investments in a large number of companies. Their investment size is $50 to $100k in the Angel Round and will often participate in the Seed and Series A round. Think 500 Startups, Bullet Time, Soft Tech VC.
Seed VC: These are institutional investors who raise between $25 and $200mm to active seed investments leading a $800k to $1.5mm round. Although the Seed VC has the right to participate in future rounds, their strategy isn’t to purchase an option. Rather, these companies do extensive due diligence on the founding team because they are establishing a partnership with portfolio company and have plans to follow-on throughout the lifecycle of the company. Our fund, High Country Venture, follows this model. Other Seed VCs are True Ventures and First Round Capital.
Early Stage VC: These are larger firms, usually between $100mm and $500mm in capital who lead the Series A through C rounds by writing $3 to $10mm checks. These firms will also be active investors, taking a board seat, and will have plans to invest throughout the lifecycle of the company. These VC firms follow the traditional VC model. Examples are Founders Fund, Union Square Ventures and Foundry Group.
Growth Stage Equity: These investment firms come in late stage and right big checks. They will lead a $20mm+ round in a company that has mitigated the majority of their risk, they simply need to put fuel on the fire. One could argue that the companies under consideration are companies, not startups. Growth stage investors also command a board seat and take an active role in helping the company go public or recruit potential suitors for acquisition. Examples of Growth Equity are Index Ventures, DCM and General Atlantic.
The Investment Ecosystem
I’d like to make the argument that there is a need for more Seed VC funds. According to the NVCA data, the percentage of seed funding has dropped relative to the total amount of investment dollars in the ecosystem. In 2009 seed funding was $1.8B representing 8.97% of the total dollars invested, while in 2011 this number fell to $1B which equates to 3.55% of the total market.
Now let’s compare this to the Angel Market. UNH Center for Venture research reported that the Angel Market in 2011 was $22.5B with 66,220 deals. This is over 22X greater than the size of the seed market.
In 2011, Fenwick and West released the results from a 2010 Seed Financing Survey focused on Internet and Digital Media. The survey results indicated that 74% of companies raised seed rounds from Angels/Seed Funds (not Seed VCs) who are unlikely to participate in the Series A. Only 45% of companies who raised seed funding went on the raise a Series A, a percentage which I fully expect to decrease as the angel market grows (28% since 2009) and the seed market declines (-42% since 2009).
What does all this mean?
It means there is a lack of specialists in the Seed Round. There is a need for the Seed VC. As previously mentioned, the NVCA data indicates that the funds being raised today are either Super Angels/Seed Funds or large Early/Growth Stage funds. How are companies going to raise the $1mm round which enables them to hit milestones and prove out their business model? Today their options are limited. As Barry Kramer, partner at Fenwick and West, puts it; “there is a non-trivial hurdle to get to Series B.”
The final point I would like to make is that Barry Singerman’s comment that “VC meddling is potentially very detrimental to a company’s early success” is preposterous. Is Josh Kopelman from FirstRound Capital “meddling” with a company’s success? Do you think the addition of True Ventures‘ network and partner input is detrimental? I would like to argue that a good Seed VC will add strategic value to an early stage company. At HCV we’ve made seed stage investments in 14 companies, 13 which are still operating today.
The bottom line is that the investment ecosystem needs more Seed Stage VCs to take an active role in helping young startups raise the next round and ultimately achieve their full potential. A startup is a process, and most young companies can’t afford to skip the achievements made in the Seed Round.