2016 VC Half-Thoughts: Seed Companies Aren’t Being Overfunded, They’re Being Prematurely Funded

In the spirit of clearing out some half-formed thoughts, I wanted to share my response to venture LPs who ask about the effect of “so much money” flowing into the seed space and how we think about its competitive impact upon our fund Homebrew.

[Context regarding our fund’s strategy is important here: we make 8-10 seed stage investments per year, where we’re leading or co-leading the round and stepping up to serve as a committed, proactive investor for the company in the years to come, typically serving on a Board or otherwise spending time ongoing with the founders until, say, Series B. Most of our investments are listed on our website.]

So, we actually don’t think most new funds or seed investors are competitive with Homebrew in the traditional sense of “we’re all looking at the same deals and need to ‘win’ deals away from new funds.” There’s a few reasons for this, namely, there are actually very few funds like ours – seed stage, focused on leading rounds, committing sweat and reputation ongoing alongside capital, started by ex-operators, institutional LPs so we have follow-on capital, in-firm resources to coach on recruiting strategies and tight with the next round of VC partners.

Given this, from a performance standpoint we focus on communicating who were are to talented founders, exceeding their expectations post-investment and continuing to improve our ability to identify the most promising (and best fit for us) opportunities from the talented teams we meet each day, knowing that we’re still going to be wrong a lot of the time. So, yes, we have “competition” but our business seems to be less about competition at the “winning the deal” stage and more at “seeing the deal.” That is, how do we ensure Homebrew is among a small group of firms that talented founders seek to connect with early in, or prior to, their fundraising process.

At the same time, there is a marketplace impact from the swelling of capital looking to invest in seed stage companies, even if most of that capital is in sub-$500k checks and non-lead positions — ie their models aren’t directly competitive with ours. And it’s probably one of the biggest differences in seed investing when you compare 2006 vs 2016. Namely, seed stage companies clear the market faster, even when they’re very early in their development. 

This is especially – perhaps even maddeningly true – when the teams pattern match – ie engineers from top companies or degrees from top schools. These startups are still very often able to raise $1m-$2m on a relatively unproven hypothesis with little accomplished. When there was less money at the middle and bottom of the pyramid for seed, these teams might have raised a smaller friends & family or angel round to work for 3-9 months on their companies. During this time top seed funds would get a chance to see their businesses evolve and build relationships with the team. That’s not to say there ten years ago there weren’t plenty of rounds raised on a demo but those tended to be truly exceptional founders or displays of technology prowess, not “hey, we’re two engineers who worked at XYZ company together and we have an idea.”

So what’s the impact upon Homebrew? Well, when we see a company at this stage we assume their round is going to get done. Maybe not from the quality of investors they were originally seeking or the terms they proposed, but we can’t always get a second bite at the apple. The resultant hastening of the market funding means that, at time, we have to decide whether we want to pay seed prices for pre-seed risk. We tend to pass on these types of companies when the technology is undifferentiated or the value proposition to the potential customer is unclear. Or there’s not a missionary zeal from the founding team as to why they’re pursuing this goal.

Basically the tldr regarding all the new money in seed is that we don’t feel like it impacts our strategy overall but it does pull some percentage of companies out of market prematurely that we otherwise would have gotten the chance to see evolve. The additional cash isn’t leading to overfunding so much as it is premature funding.

Related:

2016 VC Half-Thoughts: The Industry Has Shifted Back to Investing in Technology, Not Business Models