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Excellent post. I wanted to strongly second the notion that we can and do (at FRC) stay very engaged with our companies using modern tools - email, blogs, wikis, etc. We also find that the community of all our seed stage CEOs (and CTOs) help each other through several mechanisms we've created. So some of the workload is crowd sourced. This lets us do as many deals as we have without (we hope) giving less help to each of them.
What's interesting to me is that many seed-stage entrepreneurs are not necessarily looking for active investment from a seed-stage VC. The appeal is more of a clean, efficient deal with the right amount of dollars.
In some ways, this kind of "softer relationship" seed transaction might make more sense. If the seed VC is not *that* involved, it might diminish the signaling effect that is one of the major challenges with these kinds of deals.
In any case, as you noted, angel deals are not without their own risks and challenges. Entrepreneurs should just spend some time understanding the nuances of both options.
But if in situation B) the VC isn't that involved, the founders have less dedicated help and so may be less likely to make it to the next round - but the founders preserve some degree of optionality and can find a new lead for Series A.
This is an interesting game-theory conundrum. The VC has no incentive to go for B) from where I stand, except if he's very very busy and has a strategy of doing a lot of seed deals and maybe can't help the company out that much anyways (no background for example).
For the founders, it seems there are two good situations - 1) seed-stage VC is involved AND he is very helpful/bright/well-networked and can tangibly help the startup get to the next level or 2) seed-stage VC is not involved
Worst situation for the founders : seed-stage VC is involved and from a reputable, big firm but for whatever reason cannot help the startup meaningfully
So my conclusion is, from the founder side - make a very careful assessment of I) how involved your VC will be and II) exactly how much value you think he/she can add before doing a seed. This sounds obvious but many of my peers will attest - it can be a tough decision to turn down a quick termsheet and delay getting back to building the company!
Either the VC can spend the time and can actually help, or the they're dis-involved. It's the middle-of-the-road that is the most dangerous.
And, I can totally appreciate the need to get back to building the business.
I say this because it's easy to confuse Entrepreneurs when we say we're funding Seed stage when really what we're saying is we're funding StartUp stage but putting in less cash for it (costs have fallen). Ok let me explain...,
Seed stage in my view is defined as a stage whereby the company has not yet proven itself (little or no market traction, little or no sales) but has a great prototype, plan or team (or all of the above) in place. Typically the purpose of the Seed funding is to gain market traction (prove itself), release product, etc.., Typically this costs anywhere from $150k up to $500k. That in my view is Seed, and Seed represents a higher threshold of RISK which most VCs don't invest in (and for a number of reasons).
StartUp stage is funding to expand the company beyond its seed stage, perhaps with a refined product, larger market target etc..., Often referred to as "Series A funding" where the RISK is less because the company already has some traction. Typical StartUp investments $500k up to $2.5M
But what defines StartUp vs Seed funding is NOT the value of the money being invested. Its the stage and level of the RISK. Correct me if I'm wrong Mark, but VCs are not Seed RISK investors (and for good reason) so when they are saying they are funding Seed stage, typically what this means is they are funding StartUp stage companies (with traction or proven product) with lower amounts of capital which are now similar or equal to previous Seed stage capital amounts.
In other words, they still want to see market traction and evidence of success with the product before they fund it. Foursquare is an example of a StartUp funding at $1.5M not Seed. I think it would be great for fostering innovation if VCs funded at the Seed RISK stage, but I don't see this happening. I see smaller capital being put in, but it's still StartUp stage (at least as far as the RISK threshold is concerned).
I'm not aware of many VCs who really fund Seed stage per se, but do see a few of the smarter more agile VCs investing in StartUp stage with less funds (most VCs won't go in for less than $1M). But their RISK threshold has not reduced.
At least this is my understanding, please enlighten me if VCs are in fact lowering their RISK thresholds by investing in genuine Seed stage companies.
I would be more than happy to be wrong!
The reality is that VCs have moved to earlier stages (your definition of seed). It is partly for competitive reasons because super angels or early-stage funds were getting in and making it harder to then get in on the A round. Also, because many of these companies stay very capital efficient some are getting launched with large VC rounds (e.g. FourSquare). A company like FourSquare would have probably raised $3-5 million in a prior era. The fact that they raise less money (on competitive terms as per Fred's post) is a great thing.
One final comment. There are many of us: FRC, True, Founders Fund, myself and others who actually ENJOY being with the company in the early stages.
Also, you seem to hesitate just a little around whether you see it as negative when the VC who does the seed is not doing to the next round. So, isn't it still a bit of a risk?
Not to give you the wrong impression. There's still a gap that you are addressing with these deals, but I'm not sure I believe this really closes it.
Clearly you can't have unlimited numbers of investments, but as I point out First Round Capital and True Ventures seem to be able to manage in this new model. Check out their websites and you'll see a large portfolio.
WRT signaling if the VC doesn't follow, let me not mince words - it's a problem. But I wanted to point out that where it was previously almost a deal breaker for me I've come to realize that it's more nuanced. I'm looking at a GREAT company right now that has been orphaned by it's seed VC. I think they just never built the right model and don't have the right interests to support the company. I have to imagine a few other VCs are starting to think like me - I'm never that clever that I'm out in front ;-)
If a firm is set up to do Series A deals, your seed deal won't get the attention you probably want, and you'll have a harder time raising a Series A from an outside investor.
Firms like FRC get around this by explicitly committing to only doing seed-stage deals.
The paradox here is that it is better to raise seed funding from someone who can't do a Series A than it is to raise it from someone who can.
I agree that it's not VC vs. angel but rather the individuals investment track record and that of the firm. My firm, for example, doesn't have a historic record of seed deals until I joined but THEY DO have a reputation for not quitting companies easily when things get difficult.
If I were still an entrepreneur my preference would to raise from someone who could do the next round provided they didn't have a reputation for bailing out unnecessarily. That way if you hit an unexpected nuclear Winter you've at least got capital on your sidelines.
If you can convince a great VC to devote the time to a seed stage deal, I think it's a great idea. It's just been that historically, bigger VCs that did seed deals took the option approach, as opposed to the high-involvement approach.
If you can get a good seed/A investor who is willing to put in the time AND will stick with you in tough times, that is truly the best of both worlds.
(I can't imagine ever starting a company before all these helpful startup blogs.... whatever did Steve Jobs do when he wanted to learn about startups? Read a book? How painful!)
1) The process of finding your investors, and pitching the idea will get you in front of industry insiders who can help you define your product and pricing
2) You will feel more personally committed to make every $ count
3) You will get a much better deal than any VC or angel will give you. And I only say this because I have seen the terms put by some of the names you mention...
4) You will retain control over the direction of the company, which is crucial in this early stage
1. Having 20 people can make administration hard and can lead to problems in down markets when 4 or 5 want to participate and many people move too slowly.
2. Having 20 people can scare away potential future VCs who worry about the downside of having too many individuals involved. I just received a call from an angel a couple of months ago trying to get my support to help her sue her company because they were doing another round of financing during difficult times. She didn't want the company to raise more capital and she didn't want to put it in herself. Not that I blame her, but it is experiences like this that scare away some VCs.
3. Getting too high a valuation from angels can be poisonous. If you don't grow into your valuation you can run into problems getting professional money later. VCs are reluctant to want to come in and cram down your uncle, aunt and father-in-law. So sometimes when they hear that a prerevenue company did a $10 million post money angel round they just don't even bother putting time into evaluating the company.
4. Control is important, but so is advice on how to build out the company. It is a finely balanced tension, I know. You want control but you want sparring partners. The best VCs allow you the room to run and operate.
But ... you guys rock so I'm sure you're not feeling my points personally. I just don't want other readers to not hear both sides of the argument. Thanks for your contributions to the debate.
With that said , I reserve my right to challenge your opinion over cold beers someday :-)
Per my comment http://bit.ly/IBJw2 on Nic's blog, 'An ex post facto demand for super pro rata rights is almost universal.'
I have to go with guilty until proven innocent on 100M+ funds that invest in seed deals. FRC and True have proven their good faith in this regard. Few others are even fence sitters.
And yes, I'm reading this instead of watching the miserable Eagles game. If we lose to the Raiders...I don't even know what I'd do...ugh.
That said, if the company was killing it and the team wanted to sell I would also look for other options to make it win-win to not sell early.
re: Eagles, yes, I'm embarrassed. It was a very disappointing showing.
As someone running an active, large angel group (with wonderful members like Dharmesh Shah) and a couple of small VC co-investment funds, I’d make the following points:
1. Many VCs in my experience do some level of seed investing. However, most VC firms “sweet spot” is later in the company building cycle. This is due to increasing fund sizes over the last 10 years, making it is harder to write small checks and devote the time to seed/early stage. Its also a function of comfort zone; seed/early stage investing/company building requires different risk tolerance and often skills, as you navigate very uncertain waters.
2. Often (not always), the larger VC firms seed deals tend to be with entrepreneurs they know and have made money on before. The seed deal may/may not involve help incubating the business in their office. Nothing right or wrong with this; just an observation.
3. Overlaid with the above trends, the cost of customer discovery/validation along with product development has dramatically come down for many web based and tech enabled businesses. (Maybe not necessarily so for really hard engineering problems, like building the next gen database, router, network security discovery tool, etc)
4. This has widened the seed/early stage capital gap. In response you see angel groups morphing their models to build a brand, reputation, and sustainability to service this area. That is what we have done at CommonAngels; another example on the west coast would be Band of Angels.
5. In addition, you have seen a new set of VC firms raising < $200M, sometimes considerably less, with the stated strategy of investing in seed/early stage. FRC, True, USV, Maples, etc are all examples. Very good firms who will work actively with seed stage entrepreneurs.
6. The larger firms are all thinking about what their seed stage strategy should be; this is nothing new, its just that we are in a particular point in the cycle where more attention is being directed at this. Some are increasing their seed deal velocity, others formally announcing programs. Both Chris and Mark’s comments are relevant and accurate, and I advise entrepreneurs to think carefully about the pros/cons of taking money from these programs. Personal relationships are so important.
Chris
One item I put in my deal was a 30 day exclusive negotiation period after which it opened up. Key for me in any case was a long history with the VC - so it wasn't a cold deal in any case.
I don't understand the main objection about "what if the initial VC won't fund" the key is to make sure you have the right to go out and be able to say, "I got a term sheet but wasn't happy about it." The fact is if the initial VC won't fund under any circumstances there's a very good chance the deal should be killed - and if you as an entrpreneur don't agree you should always be able to raise Angel and buy the VC out and you're no worse off.
Great post!
If anyone wants to know more on this topic please click on the "Pitching a VC" tab above and I wrote two posts on angel funding.
There is a school of thought that a first time entrepreneur who hasn't yet proven herself should basically take any money they can get.
Get your company off the ground with anyone who is willing to take a bet on you and be picky with your second startup effort.
What are you thoughts on this? Maybe you can put on the entrepreneurial side of the table hat for this one?
Cheers,
Ryan
comments :)
great post mark & interesting set of perspectives to discuss.
Consider the dilemma. I can sit here and tell you that my idea is the greatest idea since sliced bread but most VCs will say great, where's the prototype or are you cash flow positive yet? I had one group from Nashville, TN that checked the "concept only" box tell me that they expected to exit in two years and only invest in companies much farther along that didn't require additional rounds of funding. Even when the VC/Angel says they invest in anything, they may only be casting a wide net, giving lip service to the stuff outside their pattern of investing, in hopes of not missing the next Google.
What if your prototype needs more than what one person can provide? We're developing a next generation massively multiplayer game. Creating a prototype that clearly defines how we are different from say World of Warcraft requires a minimum level of functionality from a small but diverse team of people. I'm in need of art, programming, sound and writing and while I can do some of that work, I'm not good enough at all of it to build a passable prototype that won't get summarily dismissed. (I have no artistic skills in me at all) Hence, the need for a small seed round of funding.
I have yet to meet people in the midwest that are willing to help get a company such as mine off the ground, the first investor if you will. If your prototype can't be built by one or two people in a garage after your real job hours then there's simply no way your business gets off the ground. Perhaps the midwest is so conservative and I'm in the wrong place; I don't know. Where's the VC/Angel money that is simply there for these high risk very early stage companies? I'm afraid too many ideas simply die on the vine because the owners were not lucky enough to get in front of the right investors. Why hasn't this sort of investing been institutionalized? The process of finding an investor right now seems incredibly inefficient. All of the different types of investors are mixed in together making it incredibly difficult find the right type of investor, to the point where if you do find one, you can only think that it was pure luck and persistence that got you there. There has to be an easier way.
Was my suggestion brash?
Yes, I did approach other VC's. But the truth is it would take much longer to build the company and networks from scratch than to collaborate with an existing portfolio company with years of experience and connections. It would benefit me too, rather than me competing with him and maybe pushing him out of business. It could trigger a defense mechanism of frivolous lawsuits from companies that won't accept that technology moves forward - not backwards. Besides, I think diplomacy is a better gesture than the 'thrill' some business owners may have of leaving a trail of broken companies behind... I am in business and feel no joy when others fail, although it doesn't block me from doing my own thing.