Last year was a challenging year, marked with unprecedented turbulence particularly for companies seeking funding. The pandemic affected the investment landscape as the world went remote. This year and the coming years look to be promising in the venture capital world.
Some interesting trends have emerged, especially with the phenomena of big venture capital firms investing in seed-stage startups. Let’s take a closer look at what’s happens, the advantages and disadvantages of receiving big VC funding versus seed-stage investors, and how founded companies are responding.
What is Venture Capital?
Venture capital firms are typically run by a few partners that have raised a large sum of money from a group of limited partners (LP). These firms invest on their behalf. They focus on investing in startups and small businesses that show the potential for exponential growth, with the tradeoff being that they are highly risky.
These firms usually have 7-10 years to make those investments and generate a return. The end goal is that venture capital is used for an eventual IPO or acquisition of the startup. Most of their investments will end up failing, but VC firms hope to have one or two winners out of the bunch.
Trends in Venture Capital
Investing in the next Uber or Stack is the goal of every venture capital fund. With how competitive the market is today, getting access to that promising Series A is necessary for success. The strategy of getting a piece of the business early makes these deals important since the checks they write aren’t large enough to make a difference economically.
The first quarter of 2021 was marked with global venture funding hitting an all-time high of $125 billion. This is the first single quarter to have reached more than $100 billion according to data from Crunchbase.
Unicorn startups, which are private companies that have a value of $1 billion or more, have also increased. An average of two new unicorns each working day was created in this first quarter, which is remarkably higher than all previous quarters.
Technology startups, such as those in the fintech industry had strong growth, stemming from the pandemic. Additionally, the acquisition markets are strong.
During the first quarter of 2021, there were $4.1 billion dollars were invested into seed-stage venture deals. That’s compared to $3.9 billion dollars during the first quarter of 2020. While this is not significantly higher, the numbers have held up during the pandemic.
When founders seek to raise seed rounds, they have typically turned to investors. What’s happening more often now is that these seed-stage startups have more options. Big VC firms are getting in the game. These large venture capital funds are signing deals with limited dilution, bigger checks, and the chance to put a legacy brand name on their project.
Companies receiving Seed Funding has been rising
A seed round is defined as a founding round this the company’s first round and raises less than $4,000,000. When the initial rounds grow above this amount, these are considered Series A funding.
Seed funding by big VC firms is not something that has occurred overnight.
The numbers have been rising for quite a while actually. CrunchBase provides data on over 180,000 startups and their funding activity. Their dataset confirms that this major trend has existed for years.
It is hard to say what the cause of this seek funding acceleration is. Big VC firms may have realized that entering into a company at an earlier stage may help them with maintaining more shares at later stages. Or there might be more people who are starting their company, leading to an increased supply of high-quality startups.
The low-interest-rate market environment could be leading investors to look for high returns in other places such as these venture capital firms.
Since the 2008 market crash, the U.S. economy has slowly but surely improved. This is worth mentioning as it’s probably one of the reasons for VC firms to increasingly invest in seed-stage startups.
Another trend that’s seen in these VC seed investments is that they tend to be bigger. When VC firms participate in seed rounds, they are usually two or three times larger than seed rounds than they aren’t participating.
Subsequently, the second rounds of these VC-backed rounds are also larger. Though this appears to be the case because the initial found was bigger. This appears to be the case regardless of who funded the first round with similarly sized first rounds to the second round.
The follow-up investments by these VC firms don’t appear to make a difference, however. Companies that receive a follow-on investment are about the same percentage for those companies that take a seed round from a VC firm and those that don’t. It is unclear why this seems to be the case as the logical reasoning would be that having the backing of a well-funding, established institution would lead to being able to raise money later with ease.
Examples of Seed-Stage Investing
You don’t have to look that far to see examples of seed-stage funding by big VC firms. Accel invested in Slack several years ago when it was in its seed stage. As we all know, Slack turned out to be a big winner in the technology space elevated by the effects of the pandemic. Currently, Accel makes over 15 seed investments each year.
Dropbox, Airbnb, and Stripe all received seed investments from mega-fund, Sequoia. Other notable seed-stage companies they invested in include Evervault, Veil, Oso Security, and Re:Store.
In 2013, GGV Capital implemented a seed strategy. Chinese AI company, Lingochamp was their first bet. The company has raised $72 million dollars in 2018 from its U.S. IPO. They have done more than 43 seed deals since.
Another VC firm that has a specific seed strategy is Sequoia Capital. Their scout program is designed to find early-stage talent to invest in. There are $180 million dollars available in the fund. The former hedge fund turned VC, Coatue Management has allocated $700 million towards finding these young startups.
Here is a rundown of some of the biggest VC firms in Silicon Valley that are involved in seed-stage funding:
- First Capital – One of the best known in the valley that’s involved in seed-stage funding. Entrepreneurs who cut deals with them often have positive things to say. Uber, Square, and Warby Parker are among their success stories.
- Homebrew – Hunter Walk and Satay Patel run Homebrew which has gained a solid reputation from both the investment and entrepreneur communities. Shyp and The Skimm are among their success stories.
- Y Combinator – Known for generating success story, after success story, they serve as a pre-eminent startup incubator. Y Combinator has been around for over a decade with names including Dropbox, Gusto, and Airbnb to showcase their relevance.
- Felicis Ventures – Former Google employee, Aydin Senkut started this VC fund. They quickly found success in a short amount with names including Shopify, Fitbit, and Dollar Shave Club.
- Softech VC – This VC firm was among the first in the valley to get into the early-stage funding game. Fitbit and Wildfire are some of their best-known investments.
- Andreesen Horowitz – A16Z invests at multiple stages and has a reputation for being very friendly towards entrepreneurs. Airbnb, Box, and Lyft are a few of their most well-known investments.
- Founders Fund – Peter Thiel could be considered one of the best investors of his generation. Their portfolio includes a multitude of well-known companies including Facebook, SpaceX, and Palantir.
- Floodgate – This VC firm generally makes the list when “top investor lists” are made. With past success with names like Twitter, Lyft, and Chegg, this fact shouldn’t be found surprising.
- Greylock – This VC firm has a great reputation among the startup community and has invested in great brands including Airbnb, LinkedIn, and Workday.
- NFX Guild – James Currier, Gigi Levy-Weiss, and Stan Chudnovsky run this VC firm. Top investors in Silicon Valley will all attend their NFX demo days. Honor and Honeybook are some of their previous seed investments.
- Social Capital – Chamath Palihapitiya, a former Facebook exec, runs this multi-stage fund. They might be one of the newer players in the game, but they’ve grown in status quickly. Box, Yammer, and Slack are some of their past seed-stage investments.
- Lowercase Capital – Founded by Chris Sacca, they invest in multiple stages and have found success with some of the best tech companies found today. Twilio, Open SNS, and Twitter are previous success stories.
- SV Angel – Ron Conway founded this VC firm that is known for investing in startups that eventually IPO. Groupon, Twilio, and Twitter are among the names that prove their success record.
Pros of Going with Big VC Firms
From a business in Africa to firms in the heart of Silicon Valley, finding investors is important to their future growth. It looks like big venture capitalists will continue to get their share of investing in seed-stage startups.
This activity has many advantages for startups that are in their seed stage. These larger funds can re-invest when the company starts its Series A fundraising process. Founders have more time to build and foster their relationships with these big firms.
Partnering with a big VC firm can account for some positive effects on the association. For example, the brand recognition that it brings will provide almost instantaneous credibility. This is especially helpful in the hiring process. It can also help founders who want introductions to their portfolio companies. These companies are often potential customers of these startups.
Founders who don’t have as much experience will also find benefits to receiving capital from a large, well-known firm. They can get connected to experts and resources to help with the problems that many first-time founders face. When they are struggling to get their first customer, making the right hires early on, and dealing with issues like founder break-ups are among the scenarios that most inexperienced founders will face.
Working with a large VC firm can also give you access to a number of different resources. Whether it is regarding legal, tax, or other matters, they can provide the support that is critical during this early stage of the company.
The portfolios in these seed funds are usually very focused and small compared to others. This means that the partner has more stage in the game.
Cons of Choosing Big VC Firms
Not every seed-stage founder should be trying to get the attention of a big VC firm to broker a deal. One of the potential risks of partnering with a large fund is that you could receive less attention. A business that’s at this early stage isn’t profitable yet and some of these big firms might be so focused on their investments, that they are largely ignored.
Another problem could arise if you the big VC firm decides not to participate in your Series A financing. Other investors may wrongly believe that the company hasn’t lived up to expectations. In effect, this could make it very hard to raise your next round of funding.
Y Combinator startup, Glide largely made its decision to decline an offer from Sequoia because of this. Instead, they chose to work with First Round Capital.
You don’t carry this risk when you work with a seed fund. That is because seed funds typically don’t participate in the next round of funding because of limited funds.
In the venture capital industry, the expectation is that your business scales and grows rapidly because they want to see a return on their investment as quickly as possible. It doesn’t matter if your startup is based in an African county or had a record amount of new customer activity.
These firms want to see their founded companies either acquired or enter the public exchanges. This adds a great deal of stress to founders, who are already facing a lot of pressure.
One item that isn’t always known up-front about some VC deals is that they may not release all the funds at once. Some may release it over a period of time. They may even have certain clauses that require your startup to reach certain metrics before receiving funding.
That makes sense from the investor’s perspective, however, as a founder, it can be frustrating.
Deciding between big VC firms and Seed Stage Investing
As the trends have shown, big VC firms will continue to invest in seed-stage startups. The decision to take an investment from one of these firms is ultimately the choice of the founder. The alternative is to find seed-stage investors who will typically only participate in this stage of funding.
Consider the advantages and disadvantages that taking money from a big VC firm may have. If you’re a founder who needs access to connections or experienced advice, it could make all the sense in the world to consider an offer. Otherwise, you could be better off in the long run when it comes to subsequent funding to work with seed-stage investors.
In either case, taking the due diligence to review more than the term sheet from a VC firm is important. The reputation, track record, and expertise of the VC firm are all important consideration factors.
