Why the New Seed Might Be a Bad Seed

a11b43a89cd915ec4aae6b6d77b0431b34d7d006c6cb041926f4e5e7522c33de.jpg

About a year ago, I started hearing about the existence of a "pre-seed" round.  At first, it sounded ridiculous.  Actually, it still sounds ridiculous to me.  The term "seed" implies the very beginning to me.  If you can't go to "seed" investors for your very first investment because you're too early, that just seems weird to me.  

At Brooklyn Bridge Ventures, I want to be part of the first money to go into a company, no matter what you call it.  I do the same kind of rounds today that I was doing five years ago.  Two of the first deals I ever did at my previous fund were part of an $800k round of investment into Backupify, which recently sold to Datto, and an $850k round into GroupMe, just after they built a prototype at a Hackathon. They're at a similar stage to my investments now out of Brooklyn Bridge backing Tinybop pre-launch, Canary before their Indiegogo pre-sale, and VIXXENN with just an alpha site and a few stylists.

What's interesting is that those earlier rounds wouldn't be called seed rounds today--and many of the investors in those rounds wouldn't have necessarily participated in them now.  Fund size has a lot to do with it.  The larger your fund, the larger the checks you need to write and so putting $200k to work at a time doesn't make economic sense for many investors.  So whereas seed rounds five years ago may have been less than a million dollars on a pre-money valuation of three or four million, today's seed is up and over a million and usually closer to two million, with post money valuations nearing $10 million.

Josh Kopelman wrote recently that these rounds are much more entrepreneur friendly, especially in the wake of the "Series A Crunch".  In fact, he wrote a few things that I think there's another way to look at.  

"The problem is that the number of A rounds hasn't changed. That amount of Series A capital HAS NOT increased. So, if you have 4x the number of companies with seed funding, that's 4x the players competing for the same money… making it 4x harder to raise an A round than it was five years ago."

Does it make sense to think of the amount of Series A capital as static?  

New venture funds get raised all the time--and big ones, too.  If there were suddenly a flood of fantastic deals at Series A valuations--the cheapest valuation a big fund is likely to ever get in on, wouldn't VCs be doing them left and right?  So what if they put their fund to work earlier than expected?  Or maybe they just take some of that reserve capital for follow ons and put it to work now?  So what that they can't maintain their 20%?  If their entry valuation is that much lower because more dollars are in the Series A, they will still be able to make their return.  Do you think you make a better return by putting in a ton of money to buy expensive growth equity and maintain 20% or by being in a future IPO at a $15mm pre?  

I think the problem isn't the lack of Series A money--it's that there are 4 times the number of seed funded startups, but not four times the number of great ideas and great teams.  If there are four times the number of seed funds, the seed quality bar is much much lower--but what investor wants to say that to entrepreneurs?  It's so much easier to blame those stingy Series A guys as to why your startup isn't getting funded.  It's not our fault as seed investors and definitely not your fault as the entrepreneur that you didn't execute will on your idea which, honestly, was pretty mediocre to begin with.  

I believe that if you build great companies, someone will fund them.  The private market is pretty efficient that way--and to look at it otherwise is to reinforce the notion that everyone trying to start something, instead of joining the teams with the best ideas is a good thing for the market.  

Yay, participation trophies!

"Why not raise $2.5M in seed money instead of $1.5M to give yourself the best shot at perfecting this data? You should target 18 to 24 months of runway post Series Seed."

Sounds good, right?  It's a very compelling notion--only I think it glosses over some of the side effects.  First, we're not going from $1.5mm to $2.5mm.  We're going from the $500k-750k of yesteryear (four or five years ago) to $2.5mm today.  That's a huge jump, not only in terms of how much a founder will attempt to bite off and chew, but also in price.  You're ending up at a post-money valuation of $10mm versus $5mm.  

Is it the Series A funds that are moving the bar, requiring these bigger rounds, or are they just saying that if you've already spent a few million bucks and the post is $10mm, you should have accomplished more?  The more you raise and the higher the price, the more expectations people will have of you--so taking more money isn't without its downside.

Also, no founder who ever raised more money believes the limitation will distract their focus.  They're going to do the same thing, but just give it 24 months to take hold.  What $2.5mm seed round has lasted a company 24 months lately?  It's like cash in your wallet.  You just wind up spending it faster--and moving fast with lots of money, especially for a first time founder, is bound to be more mistake-prone and less focused.

If you're worried about the runway, try doing less things.  Focus on the one number or one goal that validates your model, instead of hiring a team of 12 to boost 15 key metrics.  

The other thing that worries me about this split between seed and pre-seed is that it institutionalizes the thinking that "seed" funds shouldn't be making half million dollar bets on two awesome people and half a barely-working prototype and that that mess is best left to the "pre-seed" folks.  We're all worried about the people who had a million or more to spend and didn't do anything amazing with it, but what about the bootstrappers and do a lot with a little types who haven't yet gotten any funding from anyone?  If you're too busy making sure everyone who gets funded at all has two million bucks at an $8 pre, are you missing out on the next big thing?

I think we are.  I don't think early stage investors are taking enough risk.  We need more crazy flyers where someone takes a shot on something unproven, and certainly gets paid for that with a low initial valuation, but rolls up their sleeves to help make it take off.

Otherwise, we should just call this new $2.5mm seed round what it really is: Series A circa 2006.  We'll ask for all the same metrics we used to in a Series A--some revenue, a full team, etc., and at least it will all make sense.  Then, I can go back to just being a Seed investor instead of figuring out whether it makes more sense to call it "Pre-Seed" or just "Soil".