Companies receiving seed financing exclusively from Seed VC funds are almost half as likely to raise follow-on financing as those raising seed financing from larger VC funds.

After our Series A Crunch Report calculated that more than 1000 companies would be orphaned as the result of the supply-demand imbalance for Series A funding, much of the conversation and angst was around which startups would fail.

However, besides companies, it looks like seed venture capital investors themselves may be impacted.

Why?

Because the data shows that companies that receive seed funding from larger, multi-stage venture capital firms attract follow-on funding at a higher rate than companies that are just funded by seed or micro-VCs.  Let’s let that sink in for a moment as this flies in the face of most of the anecdotes on this topic to-date.

First, we’re defining a Seed VC fund as one with < $100M assets under management and that invests primarily in seed stage financing transactions. The conventional wisdom on the Seed VC vs. multi-stage VC (herein referred to as big VCs) was that big VCs who participate in seed rounds are not good for companies longer-term.  While many have opined on this, two of the more prominent viewpoints were articulated by Chris Dixon (formerly of Founder Collective and now Andreessen Horowitz) and David Hornik (August Capital).

First, let’s look at Chris’ arguments. When he was part of a seed fund, Founder Collective, Chris argued that taking money from a a big VC was problematic for a couple of main reasons.

  • Signaling risk – If the big VC doesn’t follow-on, folks wonder why.  As Chris wrote at the time, “if this top VC that has hundreds of millions of dollars and knows this company the best doesn’t want to invest, why would I?”
  • Lower valuations – “Even in the good scenario when the VC does wants to follow on, you are likely to get a lower valuation than you would have had you taken money from other sources of funding (angels, micro-VCs like Y-combinator).”
Chris acknowledged at the time that he was talking his own book and over time, Chris’ stance on big VC seed investments did soften.  We’d imagine now that he is part of Andreessen Horowitz that his sentiments may be very different.  And while Chris’ argument against big VCs investing in seed rounds were about terms and fundraising prospects, David Hornik argued that the reasons not to take Seed VC money from a big VC came down to the attention and nurturing that a micro-VC can provide.  He wrote:

As a general matter, early stage entrepreneurs don’t just need money, they need help and advice. And if help is no longer part of what you get from your seed investors, I believe the likely success of those investments will diminish.

 

Worse yet, taking seed investment from traditional venture investors can be counter-productive. It is impossible to imagine how a VC firm that is investing in dozens of early stage startups can find the time to be helpful while also working with their more traditional portfolio. You may get a little of their money and a little of their reputation, but you will get it at the expense of any real help in building your business.

Both Chris’ and David’s arguments sound reasonable, rational and well-constructed.  The problem is that the actual data doesn’t line up at all with the conclusions they’ve drawn.

In the initial Series A Crunch report, we found that Seed VC investments or those seed investments in which a VC participated had a higher rate of receiving follow-on investment than seed investments which were strictly participated in by angel investors.  For seed rounds with VC participation, the rate at which companies received follow-on investment was 46.7% while seed rounds comprised only of angels had follow-on rates of 35.4%.

 

Based on the above, seed rounds in which VCs participate are better, but what the statistic above didn’t reveal was whether there was a difference in follow-on rate based on the type of VC participating in the seed round.  And diving into that data is where we see that VCs who invest only at the seed stage (Seed VCs) fare quite poorly.

In transactions where a Seed VC and a Big VC (multi-stage) partner up, the rate of follow-on investment is highest at 59%.  When only a Big VC fund participates in a Seed round, the follow-on rate dips but remains nearby at 54%.

However, when only a Seed VC fund participates in a seed financing, the rate of follow-on drops significantly and stands at only 32%.

What does this all mean?

First, it is clear based on the data that having a Big VC fund participate in your seed round not only doesn’t have deleterious impacts on your ability to raise follow-on financing, but relative to only Seed VC investor rounds, it actually appears beneficial.

While it is conceivable (albeit very unlikely) that the companies being funded by Seed VCs don’t require follow-on capital beyond the seed funding, the data indicates that many companies who need follow-on investment simply cannot actually get it. While raising follow-on investment is by no stretch a guarantee of success, the inability to raise follow-on financing means those companies will die or be orphaned. In the medium- to longer-term, it also means that many of the Seed VC funds backing them may face issues as well.  Since venture capital returns tend to follow a Power Law, this is not all that surprising.  A handful of Seed venture capital funds will ultimately drive the vast majority of returns. Lake Wobegon this is not.

In talking with LPs we work with, some of the issues that they’ve shared with us about Seed VC funds they’ve met with,.

  • An oversupply of Seed VC funds - Raising a micro VC fund of $5 or $25 or $50 million has become more common and relatively easier (vs raising a multi-hundred million fund). While LPs in the larger VC funds have to be endowments and pension funds who can write large checks, Seed VC funds have many other funding options. They may raise from institutional LPs but given the lower fundraising amounts, money from wealthy individuals, family offices, etc is also fair game and seems to be plentiful for teams with the right pedigree, the right story, etc.
  • Largely undifferentiated - The theses of these Seed VC funds (primarily technology-focused) are generally remarkably similar.  The thesis tends to have at its center that technology companies can be built more cost-effectively and cheaply today. To this, they add views on specific sectors or geographies which they feel are underserved.
  • Belief in the proprietary dealflow myth - As Naval Ravikant of AngelList has argued many times, this concept is really dead (outside of perhaps the top 20 VC firms).  And smart LPs seem to know this. Yet many Seed VC funds appear to hold onto a belief that their new, still nascent fund will have access to deals that others will not.
  • Relationships with follow-on investors are weak – Outside of the top Seed VC investors, many Seed VCs appear to have few to no ties to sources of follow-on capital and therefore are unable to really help portfolio companies raise additional financing.
The low follow-on rate calculated above also suggests that the idea that the individualized attention a Seed VC fund can provide is of uncertain value in changing the trajectory of a young portfolio company.

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  • http://en-gb.facebook.com/people/Nic-Brisbourne/608641437 Nic Brisbourne

    It would be interesting to see what percentage of deals solely funded by the top 20 micro VCs get follow on financing. Given the large number of second rate micro VC firms this figure is the one that truly compares with the 54% and 59% that follow on rates for companies that take seed money from multi-stage VCs.

    I would bet there are few companies that couldn’t get financing from a top 20 micro-VC that had the option of taking money from multi-stage VC, and conversely there are a lot of companies that get funded by second tier micro VCs which are symptomatic of the micro-VC bubble. This latter are irrelevant for companies that have the option of money from a multi-stage VC or micro-VCs.

  • Adrian

    In the world I live, the “conventional wisdom” is that if one can get a big name VC one gets a big name VC, period. So not sure what the big finding is. Bigger VC’s get first dibs on better deals. Does that mean that small VC’s or angels don’t get any good deals? NO!

    Also completing the next round is not necessarily a guarantee of success. It is always easy ex-post to point to the moment when one should have stopped investing but ex-ante is a different story. A certain part of the delta may be explained by VC’s “adopting” their deals and continuing to invest when they shouldn’t have. In other words freshly evaluated companies may have to pass a higher threshold of quality that the ones already in the portfolio.

  • http://twitter.com/Samirkaji samir kaji

    Would be hard to really draw that out as tiering Micro-VC’s at this juncture is almost next to impossible outside of maybe a handful firms (i.e. Floodgate, Lerer, etc.).

    Most Micro-VC’s have been formed over the past 12-24 months – and with most investments into seed stage companies that haven’t exited, there’s not much to say “VC X is 1st tier, VC Y is 2nd”.

    That being said, it is true that some Micro-VC’s certainly have better relationships with Lifecycle firms than others.

  • Ashvin Lakshmikantha

    This is interesting, but it still doesn’t cover the founder angle.

    Suppose that big VC demands 80% stake for first round funding, while angel investors ask for 20%. In that case, statistically the founders stake (after the second round) will be still higher going after angel investors than signing up with a large VC. When founders do the math trying to maximize their own valuation, it may still be attractive to choose an angel investor over large VC.

    What I would like to see is the typical stakes that large VCs and Angel investors command at the first round and demonstrate from the founders angle (i.e., the valuations of the founders are better with large VCs) that it is beneficial to them to choose large VC.

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  • Johannes Suriya Bhakdi

    Big VCs, at least in NY and Silicon Valley, also ask for 20% or even less in their seed rounds (100k-500k).

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  • rimalovski

    I’d love to know more about the companies that did get big VC funding. Were they more mature in some dimension (post-revenue, higher level of users/engagement, etc) or did they have stronger teams or serial entrepreneurs at the helm, and thus were able to attract said big name VC? The point being that not all seed investments are created equal. Seed stage companies getting funded these days span from those with nascent ideas to simple prototypes/betas to those with large and engaged audiences driving real revenue. My anecdotal evidence would suggest that those seed stage companies attracting big VC participation at the seed stage have some combination of stronger/more experienced teams and/or are more mature businesses than the others.

  • http://www.cbinsights.com/ CB Insights

    Nic,

    It’s an interesting point but who the top 20 micro-VCs are is not really proven out yet (as Samir points out below). And while we suspect everyone “in the biz” has their anecdotal thoughts on who the best micro-VCs are, there is inordinate amounts of hype around some firms where the early performance doesn’t really suggest they are all that good.

    Just take a look at our top seed VC investors by follow-on investment rate and LaunchCapital of Boston leads the list. If we had asked folks in the business, I suspect very very few would have listed them.

    Here is a link to that top Seed investors post – http://www.cbinsights.com/blog/trends/top-seed-venture-capital-investors

    Thanks for reading and for the comment.

    Best,
    The CB Insights team

  • http://www.cbinsights.com/ CB Insights

    Samir,

    Thanks for the comment. Agree that it’s tough at this point to assess micro-VC performance. As we commented to Nic’s point above, it’s made even harder by the amount of hype in the market.

    There are, however, several seed VC funds who’ve been around for a bit so even though it might be early to assess their portfolio on the exit front, it is possible to see if their rate of follow-on investment in portfolio companies is better/worse than similar micro VC peers or the strength of their investment syndicate network.

    On follow-on investment rates, some unfamiliar firms like Launch Capital lead among micro VCs. http://www.cbinsights.com/blog/trends/top-seed-venture-capital-investors

    Thanks again for the comment.

    Best,
    The CB Insights team

  • http://www.cbinsights.com/ CB Insights

    Frank,

    Thanks for the comment.

    This seems to suggest that the larger VCs have access to better dealflow, i.e. the more fundable startups (serial entrepreneur, more traction, etc). If that’s the case, are the seed venture capital firms just getting table scraps?

    If the larger VCs are fishing in a better pond, what are the implications for Seed venture investors? If they have access to worse dealflow, is the risk they are taking commensurate with the returns they might achieve (especially given dilution in later rounds)? It also throws the whole “proprietary dealflow” idea that Seed VC investors offer up pretty questionable, no?

    Thanks again for reading and for your comment. Look forward to your thoughts on the above.

    Best,
    The CB Insights team

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