Seed rounds are dead

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This is my second post (albeit later than I’d hoped!) on the state of Q2 2018 seed-stage fundraising.  The first one focused on crypto is here  (although it’s changed even more since I last wrote; altcoins are starting to moon again, and I’m sure everyone will leave Consensus this week on a high).

Here’s what’s happening in the equity world (from my perspective):

1. Token sales in the crypto-world do affect “equity” raises.

(I put “equity” in quotes because I include convertible notes and convertible securities in this category.)

Part of this is driven by the fact that VCs who can buy into tokens were spending a lot of time looking at token deals for a while, removing some investors from the “equity market.”

2. As blockchain companies are moving back to the equity world to do their pre-seed fundraises, this has shifted investor attention back into the equity world.

A number of companies that would have done a token sale a few months ago are now doing equity rounds instead.  Part of this is driven by how the SEC is thinking about regulations in this space.  Part of this is driven by the traction bar rising amongst blockchain companies – the bar is now higher in order to do a large token sale.  In other words, last year, you didn’t really need anything to do a token sale and this year you do!  (wow, what a concept…)

Now that there are more companies flooding the equity market (via all these blockchain ideas),  there is increased competition for startups seeking investor-dollars in the traditional equity world.  This leads me to point #3.

3. The bar for raising a seed round is increasing and so is the bar for raising a pre-seed round.

I allude to this here,  and Charles Hudson did as well here.  Because the gap between pre-seed and seed levels is increasing, there are a couple of approaches to this.  For some funds, it makes more sense to come in at the same entry point, but they need to be willing to carry their companies longer (i.e. inject more capital into the company) before their companies get to the next stage.  This is both greater risk and reward – pre-seed funds can gain more ownership in companies by putting more money into the businesses at lower valuations.

For other funds, it might mean waiting until there are more investors who are interested in the opportunity.  For others yet, it might mean waiting longer for results or traction.

For us, we are not increasing our check size to carry our companies,. Effectively, when we do bet very early as first check-in, we are now investing at lower valuations.  This is because there is increased risk that these companies will not make it to the next stage, so the price is affected accordingly.  In other cases, if companies are looking for the pre-seed valuations of last year, we’re often investing alongside investors or they’re further along.  In other words, we are not changing our strategy to accommodate changes in the market, but price is reflected in these deals.

Caveat: this is different for blockchain companies.  As these start to enter the equity market, there are a lot of investors who will fund these companies at a very early stage – even seed investors who typically don’t do other pre-seed deals will bet here.  This is great for blockchain entrepreneurs, so we see higher valuations in this space.  That being said, because there is also a LOT of competition amongst blockchain companies now, we are also passing a lot, too.  While we are open to paying up a bit, we won’t pay up as much as other investors.

In general, given how cheap it is to start a company and how few pre-seed investors there are, I think it makes sense to bootstrap to some level of revenue traction before fundraising.  At least, this is what I would do if I were starting a product-company today.

4. Seed rounds are dead

These days, pre-seed, seed, and post-seed stages all kind of blend together, honestly.  While each has different traction “requirements,” investors will often invest in multiple stages of these. Even though many people say the post-seed round is the old A, the interesting thing is that these rounds are not being done by series A investors.  Series A investors are still doing series A rounds even if they are much larger rounds that require more traction now.  Post-seed rounds are being done by seed investors.

This is interesting because it means that “seed” investors will look at a broader stage than they used to.  In fact, Hunter Walk wrote about this greater seed stage here.

In looking at this phenomenon, though, we see that seed rounds are dead (in most cases).

Certainly, if you raise early stage money from a large fund, then you’ve pulled together a round; so, yes, that is a round.  But, the vast majority of startups these days will not be able to raise money from large seed funds who lead  (And that’s ok!).  Most companies these days will be doing party rounds with some permutation of angels, friends & family, and microfunds and at multiple times.

Because most startups will end up raising tranches of money from multiple parties, many startups will use convertible securities (SAFEs / KISSes) or  convertible notes.  And often, these tranches here and there are done at different valuation caps, e.g. $200k on $3m.  Then, you make some progress and raise another $400k on $5m. And this continues.  Effectively, there’s no such thing as a “round” anymore.  These are seed tranches.  

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Originally posted by zechs

Now, a lot of big funds will tell you not to do tranches.  The truth is that spending a lot of time trying to raise bits of money here and there is not ideal and takes a lot of time. Frankly speaking, sometimes you have no choice and are not able to raise a big chunk all at once.  And that’s life!  The best entrepreneurs will try every avenue for fundraising – big funds, small funds, angels, friends & family – and will roll with their best options and will keep making progress until they either don’t need investors anymore OR they are able to raise a big round once they’ve proven out the business.  Sometimes the most value-add investors are only able to write small checks.  There are a bunch of angels and microfunds I really respect and from whom I would take money any day, even though they are only writing small checks.

Being able to raise in tranches is actually a good option to have because it gives entrepreneurs more flexibility in how they raise.  Gone are the days where you need to sit around for a lead to decide in 2 months if they want to put $500k into your company.  In many cases if you raise $100k here and there, it may even be faster for you to raise $500k from smaller parties on convertible notes and securities than to wait around for a large fund (depending on the fund).  Tranches also create a forcing function for investors; if you only have $200k available at $3m, then that makes an investor move faster than raising a $1m round at $5m when you’re just starting your raise.

To me, it’s a good thing for entrepreneurs that seed rounds are dead.

There are also a bunch of investors who will push back on raising in tranches saying, “Yeah, but entrepreneurs end up giving away a lot of their cap table because they don’t know how much they are actually being diluted down with their various SAFES and notes.” I’ve heard this argument many times from friends of mine at big firms.  Frankly speaking, whether you’re raising in tranches or not, you should ALWAYS know what you are signing before you sign (valuation aside, there are many other terms you should be aware of).  You should always know what percentage of your company you’re selling to investors.  Take the time to do the calculations or find someone who can help you with this.  This is not rocket science, and being unable to use a spreadsheet (or find someone to use a spreadsheet) is a poor argument for why someone should not raise in tranches.

I think this increased optionality for entrepreneurs is always a good thing.

RIP seed rounds.

5. Crowdfunding is starting to take off

This is less of a Q2 observation and more of a 2018 observation.

A question I often get is whether crowdfunding is looked down upon by VCs at later stages.  In general, from what I’ve seen, no.  I’ve backed a handful of startups who have done crowdfunding before us, and they’ve gotten funding later from well known VCs.  Building on my overall point in #4, your job as a CEO is to keep the lights on however you can.  If it means that you’re going to raise money from crowdfunding, then that’s great.

Crowdfunding especially works well if you have a consumer product and you have built up an audience who loves you.  When you think about it, this is the best form of funding – taking money from customers both as customers and investors.  I’ve seen some of our companies raise a few hundred thousand dollars from their customers in just 2 days.  Crowdfunding is legit and can move big money and also be valuable in shaping your product.

Just my purview.

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