The role of a Seed Stage VC

Seed stage VCs come in all shapes and sizes. Some, like 500 Startups, write small cheques into a large number of companies. Others, like Mantella Venture Partners make a small number of investments but get heavily involved in each of them (not sure if this is still true, but Mantella used to have all its portfolio companies in its office. That’s hands on involvement…).

Now, the best entrepreneurs can choose who to raise money from. As a result, they look for things beyond money in choosing who to partner with. Usually they’re looking for some differentiated access (network), differentiated expertise, or both. Knowing this, the best seed VCs will specialize in a few areas in order to stand out.

When I was a VC I only did SaaS and e-commerce. Both of those businesses are heavily data and metrics-driven, and hence lend themselves well to what I know how to do (I did have one location-based zombie game sneak into my portfolio. But again, that’s heavily data-driven). Matt Golden of Golden Venture Partners is 100% mobile-focused. That gives him an edge over more generalized investors.

So, depending on what you’re looking for, you will call on your VC to add value in different ways. But I believe all seed stage VCs serve one common purpose. And I believe that by focusing on that purpose they have a higher chance of creating value for their LPs. That purpose is to get their seed stage companies Series A funded. It sounds simple, but let’s explore this.

If you raise angel capital you maintain optionality. You still get to decide whether to get on the VC train. You get to decide whether you want to shoot for a lower probability but larger outcome, or a smaller, more likely one. But, as soon as you have raised from an institutional investor of any size, they will want you to go big.

Yes, smaller seed funds have more flexibility. But those smaller exits are not great, even for smaller funds. The smaller exits happen faster. And then those returns get sent back to LPs and don’t get to keep compounding over time. This results in a nice short term win, but compromises long term fund returns (if you’re interested in how VC funds make money, read this post on venture math).

The best seed VCs realize this and focus their efforts on getting portfolio companies Series A ready. What does Series A ready mean? That varies depending on industry. But if we take a generic internet application, then Series A ready means:

  • A product in market with validation (either early revenues or failing that, strong engagement metrics)
  • Lots of data that the investor can rely upon to validate that their capital can be deployed profitably:
    • Data on cost to acquire a customer
    • Data on the scalability of marketing channels
    • Churn data (rate at which you lose customers)
    • Engagement data to verify if this application is truly sticky
  • A clear vision for how this can become a meaningful venture-scale company
  • A founding leader with the passion and ambition to make this vision come true

There are three reasons why getting Series A funded is so important:

  • More capital: This is the obvious one. Seed rounds are small. If you want to go for it, you need more money than seed stage investors can provide.
  • You to get to build a company:  When you have seed funding you don’t have a company. You have a project that you then turn into a product. Only if you validate that you’ve built something that a large market wants should you think about building a company around that product. That’s what Series A (and up) funding is for.
  • You access true domain partners: Even specialized seed stage VCs can only go so deep in your sector because the cheques they write are not big enough to warrant the time investment. As a seed VC, you make more investments than follow on investors and so need to be broader in scope. Follow on investors, by contrast, make 1 or 2 investments per year per partner. Many will develop a thesis about a market opportunity, then go talk to every player in the market to find the one that best fits that thesis.

My friends at Omsignal are a perfect example of this. We seed-funded them at Real Ventures. We didn’t know all that much about wearables (especially weaving intelligence into a shirt). But we did not know a lot about great founders (and I had worked with both of those founders at a previous startup back in the day). In contrast, Bessemer Venture Partners went deep into this space and talked to all the players – both startups and big corporate types that might have a role to play over the long term. When they came to look at Omsignal they brought a ton of expertise and contacts to the table and led a $10M round in the company this past Summer.

What this means is that Omsignal now has the capital to build a real company and to go after their long term vision. Real (their seed VC) now has a partner at the table who can help create an outcome that they could never achieve alone. That’s why getting companies series A funded is so important. That to me should be the #1 leading indicator of success for seed funds: the % of portfolio companies that get Series A funded by great lead investors.

  • Exactly. Same for Angels that get into seed deals.
    (2 of my recent angel deals are close to announcing really nice A rounds, and I couldn’t be happier)

    • Good to hear. not all angels share that perspective. Many have objectives that don’t align well with VC

      • What sorts of divergence/disagreements, if you could elaborate?

        • Many angels want companies to get to cash flow break even quickly. This is not generally what vcs want

        • But few angels get to have that much influence further into the evolution of a startup, no?

        • It’s not the angels have blocking rights per se. But if you’re aligned with your investors it just creates friction and slows things down. In the worst case they could refuse to sign a unanimous shareholders agreement, contact other investors to get them onside, etc.