How I Think About Seed Investing As A VC

Last week saw an explosion of discussion around seed investing, including plenty of negative comments around VCs as seed investors.  While I agree that many VCs are crummy seed investors, I think there are some that are excellent seed investors.  This prompted me to write a post titled AngelList Boulder and Some Thoughts on Seed Investing where I promised to write up some of my thoughts on how and why VCs could be good seed investors.

Before I got around to starting, there were three excellent posts that, if you are interested in this topic, are must reads.  They are:

All three of these posts lay out clear points of view on the authors seed strategy.  And importantly, Mark encourages all entrepreneurs to make sure they understand a VC’s seed strategy before taking money, which I strongly agree with.

Before I start talking about good and bad VC seed strategies, I thought I’d explain mine.  For context, about 25% of the investments we make at Foundry Group are seed investments.  But before Foundry Group, my partners and I were involved in many seed investments, both at Mobius Venture Capital. In addition, I’ve made many seed investments as an angel investor in two time periods,1994-1996 and 2006-2007, and seen many more through my involvement as a co-founder of TechStars.  Our strategy has evolved from this experience and is different from my angel investor strategy (which I’ve explained in my post Suggestions for Angel Investors.)

As a VC, I do not differentiate between a seed investment and any other investment that I make.  At Foundry Group, we are comfortable investing as little as $250k in a round (a seed investment for us) all the way up to $10m in a round.  We think about each investment – whether it’s $250k or $10m – the same way, and commit to participating in the business for the long term.

Specifically, our seed investments are not “options on the next round.”  We price our seed rounds as equity investments, always lead or co-lead (as Fred describes in Lead Investors, Dipshit Companies, and Funding Every Entrepreneur), and treat them the same way we would with a $10m investment.

I have three partners and all of us are involved in all of our investments.  So, when we make a seed investment, it gets everyone’s attention.  We try hard not to smother it with love, but we recognize that we usually each have something unique to add to a seed investment and try to help accordingly.  As a result, we are all emotionally involved in the investment (a phrase you’ll see in later posts about this topic) which I believe is both beneficial to the entrepreneur and extremely important to the VC firm.

When we make a seed investment, we fully expect to invest at least the same amount that we invested in the seed round without thinking hard about it.  One of our strongly held beliefs is that it often takes several years for a company to find its mojo and we are willing to work through the challenging first few years.  As a result, we don’t believe that there is a particularly critical “go forward or not” decision point immediately following the seed round.  Now, this doesn’t mean that the follow on round is blindly done – we are very internally critical of the progress a company is (or isn’t) making, but we try to firmly put ourselves on the side of the entrepreneur in this discussion and work together when things start off slowly, or differently, than expected.

At Foundry Group, we describe ourselves as being “syndication agnostic”.  This means we are completely indifferent as to whether we fund something ourselves or with other VCs (e.g. each are equally happy situations.)  In addition, we are equally delighted to co-invest with angels and super angels, or not.  Basically, we are happy in any case, are making a decision to invest independent of anyone else, and defer to the entrepreneur on who they want to have involved.

Finally, we are deliberate about the areas we invest in (our “themes”).  We see a ton of seed investment opportunities, but only invest in a few.  Many of the opportunities we see are outside of our themes.  We have consciously decided to only invest in areas we know well and think we can be meaningfully additive to and constrain our focus to these themes (although the themes expand and evolve with our experience.)  This lens allows us to spend the vast majority of our time on companies we are either investors in or likely to be investors in, and limits our time “exploring lots of things that have a low probability of being an investment for us.”

Taking Mark’s lead from his post, I’m going to put up a more specific post on the Foundry Group blog that lays this out in a very specific way.  I’ll also follow this post with some examples, as I’ve got seven to choose from: AdMeld, Gnip, Lijit, Mandlebrot, Next Big Sound, Standing Cloud, and Trada.  And, in case you are wondering, here are two recent examples of how seed investments blossom: AdMeld Raised $15 Million Round from Norwest Venture Partners and Time Warner and Trada Raises $5.75 Million Round From Google Ventures.

  • glad to hear your input on the topic, Brad.

    looking forward to your specifics on the Foundry Group blog – examining your portfolio i see a few commonalities, but i'm interested to hear how you group them into which themes.

  • Hi Brad – I've been keeping up with all of the posts over the past few weeks, and the explosion last week on this topic.

    One thing I haven't heard much about is equity sold during a seed-deal.

    I *think* Mark Suster has said on "This week in VC" that you should expect to undergo a 25% dilution, give or take, at any round. I guess this parses to a seed round…
    Jason Calacanis, who has made a few impulse buys during live pitches on "This week in startups" has offered 2 or 3 pitching entrepreneurs $X for 20%
    Fred Wilson has mentioned that he gave $X for Y% to Etsy's founder, who was hesitant to take all $X dollars and instead took a fraction (I'm not sure if this actual deal qualified as a seed, but it sounded like it did)

    Should an entrepreneur expect that kind of dilution at the seed stage?

    Looking forward to your thoughts! S.

  • I am glad you see investments as investments, not options on the next round. The more up front and clear all parties can be, the better. Options in the next round can lead to weird incentives.

    Small edit needed: your link to Mark's post points to Dave's post.

  • All things being equal a good product or service is still the same whether the investment opportunity is a few hundred thousand or a few million. Locating the innovative products is the hard bit, not writing the cheques, there is always an abundance of money. For any investor to be stubborn about investment size seems silly, apart from the fact that the fund may need to answer to their investors.

  • The seed debate seems to be raging around the option point (among others). I'm a lawyer not a finance maven, but your post seems to suggest that optionality is driven by the intent of the investor at the time of the investment (and perhaps her behavior throughout the period of the investment) , But isn't optionality inherent in all investments (albeit it is more visible in some cases than others). If you make the seed investment, you will, in all likelihood, be faced with a choice when it comes time to do the A round. How does the fact that you invested with an intent to grow the business rather than with the intent to make a decision later eliminate the option value of the seed investment? Don't "A" rounds have optionality and signaling issues too? If you are in the A you will, in all likelihood, have to decide if you want to play in the B round, and it is a pretty bad signal if you don't. The big difference is that A rounds are way more baked than seed rounds so the risk that once you are in the A you wont play in the B is much lower than the risk that once you are in the see you wont play in the A. Isn't the important difference between VC seed deals and angel seed deals that many (most) angels can only participate in the A round to very a limited extent because they don't have the funds for it, so they never had an option to begin with? This, not the purity of their motives is what eliminates optionality and signaling from their investments and does not eliminate it from yours, right?

    • I think you are hitting on an important nuance around the optionality debate. It's also something that will emerge as an interesting topic in the next 24 months. There's a premise that many of the companies will need a relatively small amount of capital (e.g. “capital efficient startups”) which means that the post-seed financing dynamics is different than it historically has been (as Series A/ B may be small.) I'll write a longer post about this as I don't think it's a simple issue and many entrepreneurs, especially one's that find themselves struggling post the seed round, will have interesting issues here.

      Another argument is that post-seed mortality should happen for many companies, which is an entirely different issue. In my experience, there are many companies that struggle to find their footing through the seed round, don't become “a hot deal”, but definitely are in a very interesting place with an interesting team and would benefit (or even deserve) more time. Again, an interesting dynamic that I think hasn't been well thought through or investigated by many.

      Of course, signaling is irrelevant in a company that finds its footing quickly and starts cranking out of the gate. These companies will raise their post seed rounds almost all the time regardless of the signaling issues (e.g. angels not following).