Return of the Classic A Round

What a wild ride from 2013 to 2016 — we’ve experienced the proliferation of seed funds, micro-VC funds and post-seed funds; we’ve enjoyed the hospitality of Unicorn Fest and tourist (mutual) funds; yet we’ve also witnessed how fast the capital market can change and how unprepared some of us were.

No matter if it’s a blip or correction, now is probably a good time to reflect on what just happened and what’s about to come.

Stretched Seed

It’s no secret that the definition of Seed has been stretched. The Seed round is no longer a single event — it’s an ongoing process to get the company to a Series A. We now have pre-seed, small seed, seed, and post-seed. Putting labels aside, what happened?

Essentially,

1) cost of starting a company was getting cheaper → 2) lower entry to start investing in such tech companies → 3) super angels, microVC funds were formed to exploit such trend → 4) accelerators and crowdfunding sites made seed funding even more efficient, via standardized convertible note and online syndicates, respectively.

That leads to where we are now.

Credit: Rob Go at NextView on breaking down the history of Seed (and pre-seed).

For the past 2–3 years, raising your first $2M seemed easy, even though it was a drawn-out process. But by collecting a $200K convertible note here and a $500K there, you are likely to fund the company through multiple seed rounds… until you get to the Product Market Fit (PMF) promised land where you can demand a proper series A.

At least, that’s what you would hope.

In reality…

Too Big to Handle

What founders didn’t realize was — as the seed round got stretched (both the definition and round size), the majority of series A shops were busy swimming “downstream” — where they can take the least risk and demand more traction. In other words, conventional funds’ “series A” bar is getting higher, much higher.

But why? A big part is LPs have been putting more dough into these conventional “brand name funds” and thus ballooned their size. (Nobody likes to be ballooned… well, unless there are fees!)

Your typical series A shop used to manage around $300M per fund — but if the fund size is ballooned 3x, you can’t “afford” to write a classic series A check of $3–5M anymore. Instead, you will be looking for deals where you can put in $5–15M “Series A”. It’s VCs’ “innovator’s dilemma.”

Median Premoney Valuation over past 20 years

More money does not mean a better round for entrepreneurs. The $5–15M “series A” is essentially the new series B. And that leaves many companies either perpetually raising seed money or running out of steam before reaching their A rounds. These is a gap — a gap between seed founders’ expectation on post-seed financing and conventional fund’s ballooned “series A”.

I’m afraid the above gap is only to get larger. And it’s very unsettling.

  1. when most VCs are looking for sound traction and proven PMF, it becomes easier to “keep in touch” than to take the A round risk (first board seat) and to help the company to the next stage;
  2. many seed companies fall off this cliff, often not because they are bad companies, but because the (expectation) gap is increasing faster than both parties can internalize.

So…

Is Seed the new A?

Yes and no.

If you raised your $2–3M seed convertible through a party round with no lead investor taking a board seat — like most seed-funded companies in the past three years — you will have a much more difficult time overcoming the above gap, as it’s unclear who should step up when the company is treading water.

For years, founders have been making trade-offs between collecting money fast v.s. selecting investors as business partners/ board members. After talking with more founders, I expect that will change soon, favoring the return of the Classic A structure.

Return of the Classic A

Interestingly, venture capital mirrors to the startups it funds. Every 10–15 years, there is a major landscape shift which generates opportunities for new entrants. In the past 10 years, the gap between angel and Series A produced new franchises funds such as First Round, True Ventures and SoftTech. Now we are at the beginning of a new VC landscape shift — a gap between fragmented seed and ballooned A.

If we look at venture market as a business — an unfilled gap represents new opportunities. I expect these opportunities will be fulfilled by a new type of fund with such characteristics:

  • it’s nimble — unlike its predecessors, it has a very tight partnership;
  • it’s proactive — its startups’ trusted partner & the (often) first board member;
  • it’s a Classic A round — money for equity.

Many of us forget that both the venture capital industry and technology sector started from humble beginnings, only 50 years ago. Apple’s then-A-round was $500K for 15% of the company. Adjusted by inflation, that would be around $2M today.

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P.S. Most of the above observations were actually well documented over the past few years. Here, here and here. Giving the ongoing market correction/stand-off, I believe now is a perfect time to reflect on the new landscape. It’s likely we will see a return of the Classic A.

*if you enjoyed this post — it would mean a lot if you can recommend it to others. Feel free to say hi at jzhao AT granitevc.com :)