Once upon a time, startup ecosystems (if they could even really be called that) outside of Silicon Valley had only a handful of local VC funds writing checks. Without AngelList, LinkedIn, Twitter, Accelerators, good videoconferencing, and the many other recent developments that have reduced geographic friction in startup capital flows, those funds effectively “owned” their cities, including most of the startup lawyers in those cities. For more on this, see: Local v. Out-of-State VCs.
Raising “angel” money in that era often meant needing close connections (family, professional) to very high net worth individuals willing to make big bets on you until you were ready for one of the few local funds to take you under their wing. If you were one of those lucky few chosen, those local VC funds would then, once they were out of their own capital, show you off to one of their trusted out-of-state growth capital funds.
The pipeline was narrowly defined, and choice was minimal: local angels (or friends and family), then local VC, then out-of-state growth capital.
Times have changed.
Today, angel groups are much bigger, organized, and collaborative across city and state lines. Seed funds — which weren’t really even much of a concept a few years ago — will write checks of a few hundred thousand to a few million dollars for rounds that may have been called Series A 3–5 years ago, but are now “seed” rounds. Prominent accelerators have themselves joined the mix, writing their own 6-figure checks and serving as valuable filters / signaling mechanisms to reduce the search costs of investors.
This “seed ecosystem” of organized angels, flexible seed funds, and accelerators has not only increased the amount of “pre-VC” capital available to startups, but very importantly, it has significantly reduced the leverage that local VC funds have over their local startup ecosystems.
As I wrote in Optionality: Always have a Plan B, sunk money has very different incentives from future money. A seed fund/angel that has mostly maxed out the amount of capital it can fund you with has every incentive to help you find a great Series A lead at a great valuation; they are quite aligned with the common stock. However, a VC fund that wrote you a small seed check but wants to lead your Series A has very different incentives. The “seed ecosystem” wants to maximize your Series A options, while a VC fund wants to minimize them, until it gets the deal it wants.
Foreign capital will usually require some heightened level of de-risking or credible signaling before it will cross state lines. It’s much less risky to rely on my local referral sources, and “monitor” my portfolio where I can drop in by the office whenever I need to. If I’m going to write a check a thousand miles away, I need a little more reason to do so. In that regard, it’s well-known that there is a “flipping” point beyond which the pool of capital available to a startup moves from being mostly local to much more national: that point is somewhere between $1M-$2MM ARR (it used to be higher).
Historically, reaching that flipping point was almost impossible without local VC, and this effectively kept startup ecosystems captive to their local funds. The new seed ecosystem, with its ability to often fund 7-figure rounds all on its own, has changed that. Now, if a desirable startup wants to, it can often raise $1–2MM in seed capital without taking a single traditional VC check, then use that to hit the “flipping” point, after which the number of VCs it can talk to goes up considerably.
Of course, this dynamic is not always so clean cut. Many VCs have wisely developed symbiotic relationships with this seed ecosystem for the obvious reason that it can serve as a pipeline when startups are ready for bigger checks. That is a smart move. What we’ve also seen is that VCs are playing much “nicer” in seed rounds than they used to, as an acknowledgement of their reduced control over the market. Years ago you much more often saw VCs condition a $250K or $500K check on a side letter giving them the right to lead your Series A. That is increasingly becoming an anachronism, and for good reason.
At the same time that AngelList, accelerators, LinkedIn networks, and other signaling / communication mechanisms for startups are giving foreign capital more “visibility” into other ecosystems, allowing it to invest earlier and more geographically dispersed, the emergent seed ecosystem is also increasingly allowing local startups to “go national” without having to commit themselves to a particular VC fund. The obvious winners in this new world are entrepreneurs and investors willing to be open and flexible with how they fund companies. The losers are the traditional investors who haven’t understood that the old game is gone, and it’s not coming back.
Originally published at Silicon Hills Lawyer.