The State of Seed Stage Investing
NOVEMBER 9TH, 2020
It’s often helpful to take a step back and review the early-stage venture investment landscape, including where we’re at today and the trends that carried us to our present market dynamics. This analysis helps us look forward.
Starting with a look back. From 2005 to 2012, as company formation costs fell due to a variety of technological drivers, paired with renewed interest in tech startup investing following the dot-com bust, we saw institutional capital want more exposure to private market technology risk. We are now more than a decade past the emergence of the first wave of seed-specific institutional firms that benefited from these tailwinds, including True Ventures, Baseline, First Round, Foundry, SV Angel, etc.
The successes of the first-wave seed funds bred more seed funds, a lot more seed funds. While the rate of non-seed funds raised each year has been relatively stable for the past 15 years, the rate of seed funds raised jumped dramatically. During the first-wave of institutional seed funds, an average of 58 seed funds were raised each year, but from 2010 to 2017, that number spiked to 137. When viewed in the context of the broader venture industry, nearly 100% of the post-2010 growth in the number of funds raised was driven by new seed funds, not Series-A or growth funds. Since 2011, 60% of funds raised in a given year have been seed funds, more than double the rate from the preceding decade.
This massive expansion of in-market seed funds created a differentiation problem. LPs and founders alike were hearing the same pitch from several hundred seed funds. The difficulty of successful differentiation in the eyes of LPs was compounded by the fact that, over the same time period, fund deployment periods dropped from 5 years to 3 years. Thus, LPs were not only hearing more seed fund pitches from new seed funds, they were also hearing more pitches from existing funds raising follow-on funds at an ever increasing rate.
The need for differentiation led to the sector-specific wave of seed firms that first emerged from 2012 to 2015. Funds like Bolt (2013) and Root Ventures (2015) became known for hardware, Forerunner (2012) and NfX (2015) became known for consumer, Acceleprise became known for SaaS (2012) and so on. We also saw some of the generalist first-wave seed funds transition up the capital stack to generalist series A+ firms during this period.
“If it feels like there are thousands of new investors in the industry, particularly seed investors, that’s because there are.”
Which brings us to today. The deployment periods for many seed funds have become as short as 18 months. There is a sector-specific seed fund for every sector imaginable. Traditional Series-A firms have grown into full-stack shops with massive $1B+ funds to invest, capable of taking companies from Series-A to IPO. Seed funds have become the primary top of funnel deal flow sources for the full-stack investors, many of whom view participation the best sector-specific seed investors as signal. The size of the most successful seed funds has gotten bigger, and it’s not uncommon to see $100M+ seed funds. This makes the return math difficult, because these funds need to write $2-$3M checks to put the amount of capital to work necessary to generate 3–4x net return on a fund of that size.
There was a high degree of investment syndication among seed stage investors during the first-wave of seed stage funds. Fund sizes were too small to fill out entire rounds, and many investors were relatively unsophisticated about leading early stage investments, so they liked to move in packs. Today, this dynamic has completely reversed. The most competitive seed stage opportunities are not syndicated because larger fund sizes necessitate that seed investors write larger checks (typically the entire round). At the same time seed stage investors have gotten much more sophisticated and don’t need to act like lemmings. In this sort of environment investors that have based their deal flow on syndication with other investors will struggle.
Now for the good news.
It’s more competitive than before for seed investors, making it harder to get into great investment opportunities … but startups on the whole have become more valuable over that same time period. The number of billion-dollar exits has grown approximately 8x since the emergence of the first-wave seed funds. A large driver of this is the maturation of the venture investing landscape. Founders now have access to high quality sophisticated investors at the seed stage followed by full-stack funds providing support all the way to IPO. The rate of increase of billion-dollar exits suggests that we’re only scratching the surface relative to the value creation this new, mature venture capital industry can generate.
Today, I believe relationships with founders is the most important point of differentiation that helps investors get into top-tier seed stage opportunities. Investors who invest in getting to know founders personally, and become active/helpful prior to making an investment will be more successful. Seed stage firms that build an informed predictive thesis relative to where sectors are heading and become experts on every aspect of those sectors, can compete by being top-of-mind for founders in those sectors, find outbound opportunities earlier due to focus, and use their expertise to be helpful to founders prior to making an investment.
There have never been more opportunities to invest in 20-30x ‘return the fund’ type deals at the seed stage. You just have to know how to get into them.
