The Current State of “Seed” Investing

After sharing a couple quotes about the seed VC ecosystem on twitter, I figured I’d write a longer post so that founders might better understand what they should expect from “seed” investors when raising their first institutional round of capital. I’m highlighting a few quotes below that I’ve overheard recently (just in the last few weeks). They’re indicative of the current environment, as well as the natural cyclical evolution of the venture ecosystem.

“Seed” VC #1: “Could you please send a 12 month cohort analysis?”

Translation: How much do the users / customers that have signed up in the past year engage with your product / service? The assumption is that you’ve had a product in market for at least a year.

“Seed” VC #2: “We’re a [seed] fund that invests behind product market fit.”

Translation: We mainly invest in companies that are already showing significant measurable growth.

“Seed” VC #3: “We don’t really take a close look at SaaS companies that are doing under 100k in MRR anymore. Similar for marketplace or lending businesses doing under 100k in monthly GMV.”

Translation: We mainly invest in companies that are showing growth on non-trivial base numbers…ie. 100k+ in revenue per month.

I often meet founders that are surprised or discouraged by these statements, but really they’re just pitching the wrong firms without knowing it. What these comments represent is a fundamental shift in the way the seed funds of the last decade view their core business.

In a podcast we’re producing (stay tuned, coming soon!), Naval Ravikant explained to us recently that what the “seed” funds do today is actually equivalent to what Series B investing used to be in the nineties and oughts. In the decades leading up to 2010, Seed / Angel was for the initial idea, Series A for building out the product, Series B for launching and marketing the product, Series C for scaling it. In the late oughts, a number of angels and VCs raised institutional funds for the first time (ie. Floodgate, First Round, Lowercase, SoftTech, etc). They were true first institutional money at the seed stage, and they all did extremely well. Since 2010, these same smart seed funds, and there are lots of them, had the opportunity to raise much larger funds - just a handful chose not to. The lure of management fees, paid as a percentage of assets under management over 10 years, is a powerful incentive. Now these same seed VCs are managing funds that tend to be at least $100M or more in size, and thus most are no longer in the traditional seed business.

Why don’t these former seed investors just call themselves Series A or Series B investors (ie. what they actually are)? Naval explained that the “seed” funds today actually have no incentive to re-brand, even though they’ve raised much larger funds and have moved up the VC stack (ie. Series A, B, etc). The reason he explained is simple: Because they’ve all positioned themselves as first institutional money in, and it’s uncomfortable to go back to their LPs (their investors) and explain that their business has fundamentally changed. Some of these seed investors will turn out to be great Series A and Series B investors. Some won’t.

What does this mean for early-stage founders? It means that more often than not, although you’re pitching a VC firm that has “seed investor” branded on the door, their fund size indicates that they’re actually a Series A or Series B investor, which is consistent with some of the quotes as well as Naval’s explanation above. It doesn’t mean that your product or business is broken, just that it hasn’t really gotten started yet, and you need to find investors that understand that and are comfortable investing before there is meaningful data or product-market fit.

Of course, there are always exceptions. If you’re a successful founder with meaningful previous exits, for example, then you’ll likely have no problem raising millions out of the gate from “seed” investors. Some of the quotes above could also just be VC code for he/she doesn’t like your startup all that much.

But for everyone else, particularly first-time founders, where do you go to raise initial capital? The good news is that the market for startup capital tends to be extremely competitive and efficient, and investors are already sniffing this opportunity out. There’s a new group of investors that are thrilled to watch the previous cohort of seed investors cycle out by raising larger funds and move into what is traditionally considered Series A and Series B investing. In the wake of this previous cohort, new angel investors, accelerators, and now “pre-seed” funds are filling these new early-stage capital gaps.

Why are we calling ourselves “pre-seed” VCs? Primarily because “seed” investors aren’t going to willfully re-brand themselves and so this is the best term we’ve got at the moment, which we realize isn’t great. Nonetheless, these new pre-seed funds (as well as angels and accelerators) are the VCs that most true early-stage founders should focus on pitching and partnering with when they’re just getting going.

What exactly does Notation Capital do? We’re actually first institutional money in. We lead these initial rounds of financing. There is no project or team that’s “too early” for us. We get a kick out of working with founders at this formative, messy stage, and we believe we can be good partners during this period. Last but not least, we can introduce you to fantastic “seed” investors when you’re raising your Series B :-)