Many of us in the seed stage ecosystem have noticed a shift in the way seed rounds are coming together. Historically, seed rounds were syndicated among several different firms. Early seed funds and super-angels typically wrote $250-$500K checks, and rounds of $2–3M would be composed of 3–4 funds collaborating together along with a handful of angels. These funds would regularly share deal flow with one another and could share the work in supporting founders and helping to push the company forward.
Today, we are seeing less syndication of seed rounds and sharper elbows among many of the funds in the market. Instead of broadly syndicated rounds, we are seeing much more competition for fewer slots. I now typically see 2–3 funds involved in a seed round, but only 1–2 feeling like they really got the allocation they were looking for. In some cases, seed round are largely comprised on a single large fund, with a small remainder left for angels. This post will try to describe why this is happening and what repercussions are for founders and investors.
Why Is Seed Investing Becoming More Sharp Elbowed?
It is actually no surprised that the syndication-friendly nature of seed investing is changing. This segment of the market is basically mirroring other segments of the venture ecosystem which has operated this way for some time. 15–20 years ago, a standard series A deal was split between two funds that each took half the round. Today, most series A’s are led primarily by one fund that makes up the majority of the round, and there is fierce competition for that lead slot.
Similarly, the seed market is beginning to look like this too. This is driven by 1) the institutionalization of seed investing and 2) the increase in the fund size of seed VC funds. These two forces go hand in hand.
As funds have institutionalized, seed VC’s are increasingly focused on securing a meaningful ownership stake in the companies they invest in. More and more, I hear seed investors claim that they are increasingly religious about hitting their ownership target in the majority of rounds they are a part of. They are also increasingly focused on “leading” rounds, because funds that are institutionalizing get LP pressure around whether or not they lead.
At the same time, most of the thriving seed funds have increased their fund sizes significantly. As funds have gone from $15M to $60M to $120M or more, ownership becomes more and more important. The larger the fund, the larger the ownership needs to be for anyone investment to move the needle, and the less likely a fund is to break their “rule” and live with a smaller piece of a company.
There are also a number of seed funds that are actually $200M+ in size, so theoretically, their need for ownership should be twice as great as a $100M fund and 4X as great as a $50M fund. The larger the fund, the more likely they are to fiercely fight for their ownership target up front. The only exception is when a fund is actually a series A fund masquerading as a seed fund, and views their initial check merely as an option to buy more of the company later if things are working.
One counter-balancing force has been the increase in the size of seed rounds over the last 5 years. As rounds have gotten bigger, there is often still an opportunity for at least a couple funds to collaborate. This is why, as I said previously, most seed rounds today still have 2–3 institutional investors involved although it’s less likely that all three are equally happy about their allocations in the round.
Is This is Good or Bad for Founders?
Different people will have different points of view on whether this trend is good or bad. I think that for founders, the current state of the world is actually pretty good, but it’s a delicate equilibrium.
When there were 3–4 funds collaborating together, you got the benefit of shared support. But there wasn’t always a clear lead investor that really rolled up her sleeves to work with a company. Before seed funds institutionalized, most also made many more investments than they do today, so their time was spread across a larger portfolio. So, you got support from a wider range of investors, but that support was diffused.
Today, with one or two core investors, the breadth of support that a founder gets is more limited, but the funds that are leading should be more focused on your success. A founder can create a broader support network by allocating what’s left of their round to a larger number of angel investors who are likely to be just as helpful as a small check from a fund that feels like they got sub-par ownership. I think founders will also find that rounds will close faster, as investors will feel more pressure to move with conviction vs. hanging back and seeing how their favorite coinvestor friends feel about an opportunity.
But taken to the extreme, you would have rounds with only one lead and almost no one else on the cap table. In this case, you lose out on the breadth of support from your investors in both their network and their dollars. At the early stages of building a company, it is tremendously helpful to tap into a broad support network outside of your immediate circle. Having a few strong investors provides some of that support, in addition to their strategic counsel. Also, if things go sideways and you find yourself in need of a bridge or an internal lead for a seed extension, it’s helpful to have a few groups around the table capable of sharing the load rather than having a single fund feel like they are going out on a limb by themselves.
Repercussions for Investors
So, what are the repercussions of this change for investors in the ecosystem? I think there are two big ones.
The first is that I think the operating model of many funds will be stressed by this change. As each fund focuses more and more on winning a lead or co-lead slot in a syndicate, it will be more and more important to show that they can deliver on the value and responsibility of being a lead investor. Some funds have elaborate platforms or staff to support founders at this stage, but I’ve actually found that the most valuable asset for founders is the time, energy, and capabilities of their lead partner. The challenge is that most seed funds still make 5+ new investments per year per partner, which seems like too many to fully support founders.
Some funds have elevated or hired junior professionals to “partner” titles to try to address this. Although I think that it’s great to provide upward mobility in VC firms, I’m seeing more situations where founders are sold the opportunity to work with senior partner A, only to really get the time and attention to junior partner C. Overall, I think a lot of funds will need to adjust their staffing and investment models pretty significantly, or risk being perceived as a partner that is kind of “meh” in actually working with their companies.
The other repercussion for investors is that their sourcing model needs to shift. More so that other segments of VC, seed sourcing use to involve pretty heavy deal trading with other firms. Some funds (especially smaller ones that don’t often lead) seem to live off this process entirely, and are highly mechanical about comparing notes with other funds to make sure they have decent market coverage.
But as rounds become more competitive, there will be less sharing and the info that is spread between investors will be too stale to act upon. Investors will need to shift more and more of their efforts to building direct relationships with founders much earlier in their journey, and building a reputation of trust well before a fundraise begins. I think we may also see individual investors become much more focused and thematic to start to see opportunities before they become obvious, vs being generalists that are only focused on stage or geo. Regardless, no matter how a firm’s sourcing model changes, this will only amplify the time pressure described above and create more pressure on the funds to change their operating model.
Repercussions for Founders
Finally, what does this sharp elbowed behavior mean for founders? I think it’s reasonably good thing, but founders should proceed with caution.
The good, as mentioned before, is that founders will hopefully enjoy the benefits of a leveled-up investor market with more firms that act with conviction and more partners that feel the reputational need to really deliver on being a good lead investor. I think seed rounds will close faster, and I believe that you’ll see more appetite for funds getting involved in pre-seeds to secure a toe-hold in companies or in second-seeds to get another bite at the apple.
The caution is that the narrower your investor base, the more damaging it may be if you don’t pick correctly. It’s more important than ever to really reference your investors and make sure that they have an operating model to deliver on their brand promise. One should speak to multiple founders in an investor’s portfolio, and try to probe for situations where things didn’t go quite as planned. Founders should also really understand what the post-investment experience is going to look like with a VC, and how this fund will behave if things go sideways for the company. Because of the competitiveness of seed rounds, you’ll find yourself under more time pressure from investors to commit, so resist that pressure respectfully and do your due diligence on both your lead and the other one or two major investors that you will be bringing into your syndicate.