The art of (Cherry) picking a seed investor
Choosing the right investor for the debut phase — a.k.a. seed phase — of your entrepreneurial journey is essential.
And picking the right investor is more than just receiving a check. It’s a relationship and, one at Cherry, we believe is for the long haul. A solid investor-founder dynamic can be a powerful asset, truly paving the way for a successful business evolution.
Yet, new market dynamics in recent years have made a founder’s search for the right investors less straightforward, leading entrepreneurs to pick someone they’ve only known a brief amount of time (sometimes just hours), although they’ll likely work together for the next five to ten years.
The purpose of this post is to shed some light on current market dynamics while putting forth a few arguments that you, as entrepreneurs, should consider when picking an investor at seed stage.
Let’s get started.
What we observe today
Mega seed deals resulting from multi-stage funds going after seed investments.
It’s undeniable that seed-stage capital has been free flowing in recent years. While raising seed funding used to take weeks if not months, competitive deals are now closed within a matter of days with valuations going through the roof.
So, where is this seed funding boom coming from? What is fueling it? The argument here is that funds from all stages now have their sights on seed. As a result, these tectonic movements are creating a hypercompetitive environment and inflating both round size and valuations compared to the maturity of the companies seeking funding.
I’ve observed two fundamental dynamics igniting this:
Bottom-up push: Across Europe, we’ve witnessed rapid professionalisation of business angels activity and proliferation of micro-funds, both writing bigger checks than before.
Top-down pressure: Multi-stage funds are going in earlier than ever before.
Multi-stage funds — including growth funds — that used to focus exclusively on Series A and B rounds are putting more conscious efforts to come in at seed stage. For instance, we’re seeing a pattern where multi-stage funds hire a dedicated person whose mandates are to do seed deals exclusively, sometimes focusing in particular geographies.
All of this has turned what used to be a seed-focused playground into everyone’s playground. And who says more demand for a fixed supply says higher prices…
Why this isn’t in the best interest of founders
As a founder, high prices for your first financing rounds sounds exciting, right?! More money, less dilution, right?! Yay?!
Well, pas tout à fait…
There are definitely some pros in going for a multi-stage fund: its brand is attractive, it validates your nascent project, and it can propel you into a seemingly exclusive category of the ecosystem right from day 1.
However, going with such a fund could considerably increase your risk profile. So, that’s something you should be aware of.
Misalignment of interests…
When a very large fund takes a seed bet, it often has little to no intention to make a great return out of that bet. Why? Fund economics simply doesn’t allow for that.
For instance, a €1M check is only 0.2% of a €500M fund. Venture capital is all about taking risks that can be rewarded by a single company returning the fund. This misalignment of interests here also means you’re likely to receive less commitment and involvement from a later-stage fund as their capital at stake is much smaller with you than with their other regular, bigger Series A and B bets which are the ones that really have a shot at being fund returners for that given fund. Christoph Janz expands on that in his 2016 post: “If a large fund writes a tiny check (i.e. tiny relative to the size of the fund), there’s almost zero chance that the investment will move the needle for the fund”.
This is a paramount difference compared to seed-focused funds whose core mission is precisely to help you secure a killer Series A as a next step and help you long-term.
…Leading to signalling risk
It might sound very attractive to have a deep-pocket fund betting on you so early as it can suggest — falsely, though — you won’t even need to go out fundraising for the next round. But, in fact, it makes you subject to a high signalling risk: What those funds really do by placing seed bets is buy themselves cheap optionality for the next round, shall your company do (really) well.
As Chris Dixon already explained 11 years (!) ago: “ … investor signaling has a huge effect on venture financing dynamics.” He further explains that if a big name legacy firm wants to invest, so will every other investor. But if that firm doesn’t want to follow on, “You’re probably dead.”
This means you set the bar for higher expectations and you must be extremely confident you will reach the traction you need ahead of your Series A as this is when data scrutiny occurs. While seed investing is more about team and market bets — and arguably a leap of faith — Series A and beyond become more of a traction bet.
In a nutshell:
If it goes well, great!
If it goes bad, it goes really bad…
We all know the entrepreneurial journey, especially early on, is a rollercoaster. You’ll need investors that are ready to commit to helping you navigate the downs to bring you high up.
Why go for a seed-stage fund
Being a seed-focused investor at a European seed-stage fund, my view is naturally slightly biased here, but I’ll try to remain as objective as possible :)
The operational drive of seed funds is quite specific to that category. By specializing ourselves (and by ourselves, I mean seed funds generally speaking, not just here at Cherry) into what it takes to take a company from 0 from 1, we have an in-depth understanding of the associated operational challenges. These can include finding the first key hires (who are the most crucial ones), identifying the right go-to-market strategy, finding product-market fit, defining your company’s values and building a culture in line with that, getting your KPI reporting and finances right from the start, and much more. It is the prime mission of seed funds to work hand-in-hand with you to nail those topics.
The level of involvement you can get from seed funds is unprecedented compared to VC funds from other categories because the interests are much more aligned. When a seed fund writes a check for a lead or a co-lead position, it most likely means you’ve got the whole fund behind you, 100% convinced and committed. There’s only a handful of bets that a Seed fund can place, which means they will be 100% on board in helping you shape the success and future of your company.
TL;DR: The economics of smaller funds is such as they are incentivized to help you become a $1bn company.
That’s also reflected in their involvement helping you secure a top notch Series A round (and beyond). If there’s one skill seed funds master, it is the Series A roadshow prep & sprint! Because that’s at the very core of their value proposition.
It’s all about commitment…
You have probably heard it before: an investors’ relationships lasts longer than a marriage. Because you don’t know what the future holds, make sure you look in the same direction, for better or worse :)
Picking a highly committed and dedicated seed fund ensures you, as a founder, will always have a partner who understands how to handle critical topics specific to a company’s early days by your side
