It’s the end of the seed as we know it
Multi-stage to the left of me, angels to the right, here I am, stuck in this seed round with you (ok that’s it for the 80s song references).
Over the past 24 months a gargantuan volume of cash has flooded into the venture asset class (something that’s changing right now). This capital flow has had a wide ranging assortment of second order effects. Larger fund sizes, more liquidity (resulting in higher expectations), and lower perceived risk up and down the capital stack.
These three forces are having a particularly interesting effect on the frontier of venture… seed. An old GP joke was that no one became a seed investor by choice — the real money was in the fees for larger funds as so few funds actually returned meaningful carry. Today it seems that everyone wants in on the action. But why?
Sequoia used to say it was because running a seed practice was at the heart of the craft of venture capital. If you can’t win there, how can you expect to win later? But with larger fund sizes do senior GPs want to spend their time on seed stage businesses with all their problems and challenges? Absolutely not. It’s much easier to write a 100m cheque from your global growth equity fund.
As fund sizes have gotten larger and deployment cycles shorter there are more and more demands on funds to deploy capital and there’s only so many businesses out there that you can funnel a 100m cheque into.
The business model for these funds is to pack as much cash as possible into the winners. When you’ve got a 2b fund it’s not about the 3m you returned 100x on — it’s about the 100m position that returns 10x. As more and more funds grow bigger and bigger, the competition heats up. It gets harder and harder to stuff your winners with cash. You have to try to get access rights to the party earlier and get yourself on more guest lists.
To see more of these companies sooner you also need to bulk up your teams with hungry junior investors. The best of whom will be highly sought after. And what do junior investors want to do? Make investments.
What’s the lowest risk increasing type of investment that you would rather not deal with as a big fund GP? Seed. So your new larger team of minimal-carry drawing investors are happy to take the bargain of the grind provided they get their names on a few deals in the hopes that one is a banger and they get to move up the firm totem pole.
This is further exacerbated in the current volatile market environment where the closer a business is to IPO the less attractive it is for investment. Seed allows you to think about an 10+ year liquidity horizon. No one can predict that far out so you don’t have to worry about it. Bringing a deal to your investment committee with a planned IPO in 2024? You best believe you’ll have a grumpy partner that ‘remembers the last downmarket’ and won’t want to take the risk on a big cheque.
This all creates the environment for a lot more multi-stage funds pushing further into the earliest stages of investing.
On the other side, liquidity for founders, execs and early employees is creating a new class of angels and micro funds — and they’re growing in number by the day.
There’s a high social status and kudos associated with being an angel. There’s a belief that founders pick the partner, not the fund. For angels it’s amplified. You’re selling a very clear product — yourself. You’re also not constrained by required ownership % or strict portfolio construction. You can be a friend to all, enemy to none. It’s a good time.
Micro funds that don’t lead sit in this same category, expert advice and sector specific help from a neutral party — it’s a compelling offering. These new micro funds are serious powerhouses who can bring a lot of value for founders. Provided these funds can still get their allocations and hit some rippers, their small size gives good promise of strong returns.
Underpinning all of this is the reduction in perceived risk. Historical data tells us that most seed funds are bad investments. The outliers more than make up for it but there’s probably less than 10 seed funds in the whole of Europe that have ever returned 5x Net Cash to their LPs (Europe just hasn’t had the exits yet).
I believe this will change. But seed is by definition high risk. The companies I had the highest hopes for at the start of my investing career have shut down. The ones that I was always worried about are ripping. Building startups is really really hard and when you’re talking to two people with a Figma prototype, the probability of that business returning your fund is, at best, 5%. It’s the dilemma of the seed investor. You obviously want all your investments to be successful. But you know most of them will fail. Does that business model still work with all these new players?
Is there space for that lead seed model anymore with pressure from all sides? Index can roll out a team of in-house GTM and talent experts, a16z can have Marc Andreessen fly founders for a lunch in Nobu, Malibu. Micro funds and angels are flexible on ownership and cheque size to ensure a piece of the action.
When you don’t have the fees to spend on the services, the celeb status to woo, or the flexibility to squeeze in, what is the edge? And more importantly what do founders want?
There’s no definitive answer to that last question as every founder is unique. But when there’s compelling arguments from multiple fronts it really comes down to who’s got the best sales pitch and how does that resonate. What’s this pitch from a seed fund?
For Frontline it’s international expansion and the human in your corner. For Point Nine it’s a history of picking unicorns and a focus on b2b SaaS and marketplaces. For Kindred it’s high conviction and equitable venture via founder-shared carry. We’re all selling products and the market we’re selling into has a lot of new players pushing their wares.
Ultimately a lot of this is marketing though. The real outlier funds will be the ones going to the edges and finding the founders that others can’t, or won’t bother to see the light inside them. It’s being the sherpa to answer the phone late at night when everything is going to shit. It’s got to be that each investment truly matters for the fund and that the investor has a strong personal connection with the founders. It’s a grind that will require a lot of adaptability, but there is a place for it.
There’s a lot of change coming though. And if you’re not already adapting, you’re probably dying.
