The Seed Surge: A Not-So-Perfect Storm

The Seed Surge. This term started appearing online in early 2015, and, in many ways, it sums up the essence of this past year.

2015 was a game-changing year, both for IrishAngels and for the angel investor community as a whole. The number of angel investors continued to expand and valuations reached their highest peaks yet, resulting in what some investors dubbed the “Seed Surge.”

Though popularized in 2015, the Seed Surge isn’t simply a 2015 phenomenon. In fact, it’s a culmination of nearly five years of trends surrounding valuations, angel investors, and tested assumptions.

We at IrishAngels were curious about the origins of the Seed Surge, so we did a bit of research.

In our opinion, it all began with angel investors.

Think back to 2012. The market was finally improving as the United States pulled out of the recession. People were ready to start investing again and were more willing to invest outside of the stock market. Investors forgave Wall Street, but they hadn’t fully forgotten. It was time for high net worth individuals to diversify their investment portfolios.

In 2009, the heart of the recession, there were 259,500 active angel investors, according to the Center for Venture Research at the University of New Hampshire. By 2014, that number jumped nearly 22% to 316,500 investors.

These angel investors were ready to put their money to work by investing in high growth potential startups. Investor groups began hunting for their unicorn, and valuations skyrocketed. Data from Pitchbook suggests that median pre-money valuations in the United States for Series A and seed funding increased between 1.75x and 2.2x from 2012–2015.

In seed funding specifically, 2015 was the year of the highest median valuation in history, $4 million, according to the Angel Institute at Willamette University’s HALO Report. That represents a 33% increase between 2014 and 2015.

The rise in valuations meant that startups began asking for more money in each round, so round sizes increased in turn. The data shows that seed funding rounds of $1-$2 million have increased by as much as 7x over the past 10 years. Between Q3 of 2014 and Q3 of 2015 alone, the size of seed rounds increased from $350,000 to $725,000

Up until now, this might seem like the perfect storm. More investors. Higher valuations. What could possibly be wrong with that?

Guy Turner of Hyde Park Angels sums it up quite well, “VCs assumed larger round sizes led to a commensurate increase in exit potential.”

That assumption didn’t hold when tested. Look at Snapchat. This social networking giant’s valuation just decreased by 25% after its Series F round according to its investor Fidelity Investments.

Though Snapchat is a later stage startup, that trend is just as apparent for Seed and Series A investors. The high valuations end up decreasing in subsequent rounds. It’s the price that these startups have to pay if they’d like to keep raising.

The Seed Surge, though touted by some as a founder’s dream, is generally not in the best interests of startups or investors. Indeed, it’s a not-so-perfect storm that can make exits more difficult and result in dilution for all parties involved.

Over-inflated valuations aren’t doing anyone any favors, and investors are catching on to that fact. Most investors agree that valuations are falling or will begin to fall soon. Simplistic though it may sound, what goes up really must come back down.

That truth has caused early stage investors to pause and reevaluate their priorities — just in time for the New Year.

In 2016, early stage investors must decide how to respond to the Seed Surge.

Though the mechanics of the Seed Surge can be complex, our solution at IrishAngels is simple. We have chosen to deepen our commitment to our members and to our portfolio companies.

We were founded to help Notre Dame related ventures thrive, and we’ll continue to do that by making smart investments at fair valuations.

With our mission and vision top of mind, we’re looking forward to our best year yet.

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