David Beisel’s Perspective on Digital Change
How to Evaluate Firms for a Seed VC Syndicate
There are essentially two distinct basic strategies for startup entrepreneurs to raise a seed round of capital:
- Subscription approach – An entrepreneur sets a structure (usually a convertible note) and recruits individual angel investors who subscribe to the round, all without a term-driving lead investor.
- Term-driving investor approach – An entrepreneur finds a lead (quasi-)institutional venture investor to price and set the structure/dynamics of the round, working together to bring in additional syndicate partners (either/both other funds and individual angels).
(Sometimes the subscription approach works to include venture capital firms, but only for very “hot” company or in a competitive environment, like at a Y-combinator demo day. )
Reaching a decision between the above two options is a post for another day, but when entrepreneurs select the latter route, they are then faced with the daunting task of navigating the murky waters of the myriad of firms who at least market themselves as active seed venture capital investors. While we’ve seen an increasing amount of information and transparency about the players in this market, it can be challenging to embark on a set of meetings raising seed venture capital without a structure to think about potential funders. Every firm, whether it follows a dedicated seed venture strategy or a full life-cycle approach or somewhere in between, has a set of qualities that affect how they would fit into a seed venture round syndicate:
- Check size – Some firms have a typical seed check size which is their standard bite size (as low as five-figures as high as seven-), some are agnostic therefore very flexible because it’s just about the option on the following round, and some have different processes/decision-making for different check sizes within a seed round. Unfortunately, this figure is rarely if ever on a firm’s website, and must be asked during the first meeting.
- Willingness to lead – This leadership dynamic is important especially when talking with seed-only focused funds, as many have an explicit strategy of only participating in a round coming together with a third-party lead syndicate VC partner. I’ve seen many entrepreneurs can find themselves with numerous parties “interested to follow” but without a firm willing to catalyze the process. There is some correlation here, but not complete alignment, to check size (i.e. larger check writers have a greater tendency to lead rounds).
- Active partner involvement level of lead partner post-financing – Venture firms approach involvement after a seed round wildly differently. For larger life-cycle firms which make a myriad of seed investments, partner involvement can be little to none after a seed round. Or, it can be meaningful if the company “counts” as a full investment within their partnership dynamics. Similarly, for smaller dedicated seed firms, partner involvement can vary depending on strategy. In both cases, the amount of time spent is generally inversely proportional to the number of new seed investments the firm does a whole each year.
- Board seat requirements – Partner involvement post seed financing can, but doesn’t always, require codification with a board seat. The board seat dance at the seed stage can be challenge on either direction, with occasionally no firms wanting to designate someone’s time for the role and sometimes more than one looking for an official board role that isn’t a fit at this stage. This dimension moves in similar direction as the previous point of partner involvement (i.e. more time spent translates into more desire for board seat), but some firms are satisfied with “in-between” measures like official board observer status and defined information rights.
- Additional systematic value-add after investment – Strategic venture investors can add a unique set of benefits, firms with large portfolios have network effects where many institute systematic sharing among the companies, some larger VCs offer a range of “full-service” including PR and recruiting and other functions. There are many ways that venture firms can help their portfolio seed CEOs in lieu of or in addition to partner involvement which can be a real plus but isn’t immediately obvious.
- Geography – It’s always easiest for an investor to make an investment in her own backyard, and especially at the seed stage with partner involvement, geography becomes a more acute issue. So as a general rule, seed-stage firms have more of a tendency than larger firms to follow a strategy which limits geography to a particular city or region. Of all the firm attributes, geographic preference one is the easiest to discern from a portfolio company list on a VC’s website. But actions speak louder than words – sometimes VC firms would like to market geographic focus or agnosticism, but in practice it deviates. No matter what a VC says, the proverbial bar is higher in making an investment outside their typical geography, however that’s defined.
- Sector-focus (or lack of it) – Like geography, sector focus can be more readily gleaned from a portfolio-company list than from other marketing, with the two sometimes meaningfully differing. Where a firm has been and where it wants to go are two different things. Some funds promote themselves as completely focusing on a particular space, while others take a broader approach. It’s important for the partner and firm to have some background in the area of a new investment, but extremely heavy investor concentration in particular space can have both risks in addition to rewards for an entrepreneur.
- Follow-on capital and strategy – Many people have covered this topic in the blogosphere about the perils of venture firms’ signaling in follow-on financing subsequent to seed rounds. It’s not worth rehashing here, other than to say that signaling issue of larger life-cycle VCs is real. Period. We’ve seen it directly in our portfolio companies raising successive rounds. That being said, there are indeed clear benefits to having deep pockets at the table immediately from the seed round. I think that the most important aspect of this issue is for a venture firm to state a clear follow-on approach and be consistent in implementing it. The most trouble comes when a player’s intentions are unknown (or undefined) or inconsistently applied so that there are surprises in the subsequent follow-on process.
- Conflicts of interest in existing portfolio – Especially given that some seed-only funds follow a rapid deployment strategy in making dozens of investments annually, competitive conflicts of new investments and even existing investments with others within a portfolio can be a real factor. Some firms are lax about these conflicts (which indeed are sometimes inevitable when startups pivot), while others are very strict about not having more than one company in a general space. But I have observed VC firms intentionally invest in competitive offerings.
- Prestige – Nobody explicitly talks about it because it’s implied: prestige matters. It matters in a lot of things all the way from recruiting to especially in attracting that next round of financing. On the margin, higher-prestige seed investors attract higher quality Series A investors.
- Institutional LPs and standard VC fund structure – Why their investors’ fund structure matters to an entrepreneur isn’t immediately obvious. The more the traditional plain-vanilla the structure of the VC fund, the more consistently financially motivated the investors are going to behave. That is not to say that these VCs are not going to behave badly… just that even the bad behavior should be consistent in trying maximize return. So at least you know the driving force motivating actions. Whereas less formalized sources or non-traditional structures of capital can sometimes (yet only sometimes) risk exerting more erroneous and erratic non-financially motivated behavior. This dimension is about structural bounds and consistency in investor actors and avoiding surprises further down the road.
- Personal dynamics – Last on this list but certainly not least, as it’s about answering the extremely important question: do you want to work with both the person and partnership on the other side of the table? Are you merely holding your nose because the money is green or do you truly want to work alongside this person for the months and years to come?
Dedicated seed firms often have a fairly set and consistent answer to most of these questions, as participating in seed rounds is their bread and butter. But it’s surprising that it’s not always the case. And sometimes larger life-cycle VCs ones aren’t as consistent in their approach to the above because the exact parameters of a seed investment aren’t clearly defined internally.
Putting together a seed VC syndicate of one or more firms is like fitting together many puzzle pieces. There are different “right” attributes for a startup’s round depending on the situation, and then those characteristics can be assembled by selection one firm which most closely matches or by aggregating a series of participants which bring a couple of those attributes to the table. The key in building the optimal seed VC syndicate is to figure out what qualities should be present and then construct a scenario which includes them with one or more partners. Without doing easy homework and asking the right questions up front, entrepreneurs can miss out on including valuable investors in the round -or- add too many non-valuable or “redundant” constituents which just complicate the composition and communication going forward.