Dissecting A Great Post On The Seed Stage

Manu Kumar of K9 Ventures posted an excellent, long but to-the-point, well-written post last night. (I’m only writing this b/c I had so many reactions that wouldn’t fit in a comments section.) If you are in the micro-VC world as an investor or LP, it’s something that should be bookmarked and re-read over and over. Here’s the link (click here). In this post, I wanted to call out a few quotes and go into them a bit more and explain why, from my POV, they’re critical:

The Cost of Startups: Kumar writes that…

while the infrastructure cost and startup costs may have declined, the operating costs have increased.

It’s a common refrain to hear people say that it costs much less to start a company, and even in a correction, that price won’t go up. It may likely go down. However, right now in the Bay Area, the other cost inputs (rent, salary, etc.) are spiking very high, and those costs are one factor driving up seed prices, in addition to the oversupply of capital.

What’s In A Name? Kumar writes…

Seed is not the first round of financing any more

We have distinct stages now: Pre-Seed, Seed, and Post-Seed, all coming before the classic bigger firms get involved. There are exceptions, of course, but it’s not uncommon to see a company go through all these rounds to get to a point to pitch the Big VC firm. Furthermore, each of these stages is also “institutionalized,” meaning that each check is a pool of other peoples’ money that has a business model attached to it, and therefore needs even more outsized returns to make for a viable fund.

Boiling A Frog. Kumar writes…

Almost like boiling a frog the micro-VCs who started out as “super angels” (See my post from 2011 on Investor Nomenclature and the Venture Spiral) writing $25K – $100K checks with personal money, are now managing funds which are $40M – $140M in size, some with multiple partners and are writing checks which are $750K – $1.5M. The change in thinking is a natural and logical thing. The catch however is that some of these funds and their GPs haven’t admitted to themselves and to founders and to LPs that their thinking has indeed changed (as it should). They are either in a state of denial or haven’t had the time to adjust their messaging yet.

This is absolutely happening, and one of my favorite lines in the post. These are the new Series A funds, but how it’s presented to founders and LPs may inadvertently not be the same.

How To Define Pre-Seed? Kumar writes…

the Pre-Seed round, where the startup raises closer to $500K, could flirt with $1M possibly.

Yes. He also wonders if GPs at smaller funds break ranks to go fill this “Pre-Seed” hole.

How Nomenclature Influences. Kumar writes…

Too many founders still think that. And then they see stuff in the press about how Company X and Company Y raised $2M in their seed round and start to think that that’s the amount that they should raise too.

The mimicry effect here is powerful. It’s very rare to meet a great founder who wants to raise a small, modest round early to test things, and it’s hard to stay disciplined when things can get oversubscribed given the excess of capital in the stage.

Beware “The Venture Spiral.” Kumar writes:

Moving up stream is a natural evolution of a venture fund, especially as you get more money and more partners. I refer to this as The Venture Spiral (blog post from 2008). Reflect on the stage you’re investing at and be sure that you’re staying within the bands of your competency (and ergo not riding the spiral up to a level of incompetency).

This resonates with me personally. I have been doing pre-, regular, and post-seed deals, and participating in a few As. But sometimes I worry about whether I can actually do a proper A round one day. From the outside, investing all looks the same, but when you’re doing it, you realize how different it is. Not comparable, and it’s hard to be a true multi-stage investor. Very few are excellent at it, but there is a temptation to raise more money as a GP as your previous funds go well.

What’s An LP To Do? Kumar writes:

Your early stage investment portfolio may no longer really be early stage

It’s harder for some more established funds to inform their LPs that they’re investing later and later in rounds, and the blurring of lines around the nomenclature can confuse things further. Some don’t care to ask, but Kumar is raising a great point: In a 10-year fund, an LP may sign up for “early-stage” exposure, but what does that mean as things have changed from 2012 to 2015?

The Deck Won’t Reshuffle. There’ll Be A New Deck. Kumar writes…

Micro-VCs are the new Series A investors…there will still be a new crop of Pre-Seed funds that will emerge…There is an opportunity for LPs to pick the right Pre-Seed stage funds, but I certainly don’t envy their job as it’s not going to be an easy task.

This is something I’ve lived unknowingly for two years. If I were an LP, I’d have no idea who to pick to invest in. When people ask “How are your investments going?” I usually answer “Great, but ask me in 5-7 years.” The truth is, we don’t know, and it takes time, and today’s environment expects two-year-to-billion-dollar status trajectories. The whole thing is much more random and haphazard than anyone (especially LPs) would care to admit.

Why Do Funds Get Bigger? Kumar writes…

The management fee structure provides a perverse incentive to GPs to increase the size of their funds.

Yep. On top of this, GPs can “stack funds” and earn fees on many funds at the same time. This makes what a firm like USV does even more impressive — staying under $200M and sometimes even raising less in a subsequent vintage.

Again, here is the whole post, which should be bookmarked and read and read again. Thanks to Manu for contributing this, he has helped me a lot in the past and this post continues to do the same.