The Summer Solstice And Seed Stage Squeeze

If you’ve been following my tweets lately, you’ve read some of my quick musings on the state of the seed market this summer. In short, in my 6.5 years of investing in the seed stage, I have never seen activity levels like I’m seeing today. Granted, 6.5 years is not a long arc – I have not experienced a prolonged down market as a private investor.

Despite that lack of experience, I am fortunate in that I have direct access to many of the greatest VC leaders and franchises for mentorship and guidance. This year, I’ve casually asked them about the 2019 “environment” and they all reply with some version of the following: They’ve never seen anything like this, they’re concerned about the cycle, but yet, in all of their paranoid analyses (and these people are successful because of that paranoia), they do not see what stops this momentum. They’ve all accepted that this is a new world of capital abundance and that the pistons driving the global economy are technology and network effects.

Back in 2017, Fred Wilson noted the strategic importance of the seed stage, writing:

Seed is really hard. You lose way more than you win. You wait the longest for liquidity. You lose influence as larger investors come into the cap table and start throwing their weight around. It is where most people start out. Making angel investments, raising small seed funds. They learn the business and many see better economics higher up in the food chain and head there as soon as they can. If you hit one or two right, you can make a fortune in seed. But those bets take a long time to get liquid. And if you don’t hit one or two right, you end up with a mediocre portfolio.

The seed “territory” is critical, indeed, and now that folks realize how important it is, there is a fight for that turf. When I put all of this together, what I see is: In the Bay Area, the seed stage is getting squeezed from all sides during this summer solstice of

1/ Bottoms-Up Competition – Seed funds are getting scooped by the well-heeled alumni of today’s web scale companies. Those employees and operators, who often have some book wealth now (or are running syndicates on AngelList or acting as a scout for another fund) can easily dump $50K-$100K into one of their ex-colleague’s new startups, or put this money into their friend’s new startup, or their friend’s new hot deal. That amount can rise to $500-750K pretty quickly for a pre-seed round. Most seed funds are not even a consideration in these ad hoc “angel rounds.”

2/ Lateral Competition – The number of “seed” funds has also grown during this boon. Samir Kaji from First Republic has been writing on this for years. More and more seed capital has flooded into the market, making the situation for funding seed rounds ~$2M-ish total size more competitive. When more capital is chasing the same set, entry prices go up and returns are likely to go down.

3/ Top-Down Competition – As I’ve tweeted about a few weeks ago, many of those pre-seeded founders with sophisticated technology backgrounds will often talk to larger VC platform funds and be able to raise more money for less dilution (since large platform VCs are typically more price-insensitive at seed) and get the benefit of the brand halo and network of said VC firm. On this dimension, most seed funds can’t even compete on network, brand, or the cost of capital.

4/ Orthogonal Competition –  I recently tweeted about a new breed of early-stage technology investor that has its roots in public equities (hedge funds, long/short, etc.) who have over decades built up a big book of business, large teams of analysts and researchers, and most critically data models to make investment inferences. Many of these new data-driven funds are hiring experienced VCs across early stages and building outposts in the Bay Area. It may be easy to mock these moves as “touristy,” but these fund managers didn’t build empires by being silly — they were strategic over the long-term and methodical. Like VC platforms, these funds could potentially be either as price-insensitive and/or provide more value via portfolio and market insights than a typical seed fund can. They have to deliver on this promise, though.

A lot has changed since when I wrote my first check in 2013. We all now know how big the stakes are. We know that technology and network effects (like marketplaces or in software) drive the world economy. We know private markets hold the key to 100x or even 1,000x multiples. We know global markets are open — today, for example, everyone in Malaysia could be a DAU for Zoom. We know the web and mobile internet have hit critical mass and embedded into our lives. We know that relationships with these creators is of tantamount importance — look at how influential an accelerator like Y Combinator is on its batch members, not just during the batch but years after. Early stages are where relationships are formed, and those early investors can earn the right to invest more, block out their competitors, and other advantages.

As a result, now in 2019 with these new phenomena, traditional seed funds need to reexamine what their offerings are, where their deal flow comes from, what their portfolio construction needs to be as fund sizes creep up, what entry prices they’re willing to stomach, and what this 360-degree of competition means for their businesses. For better or worse, I am sticking to my own knitting in what I know and have done over the first 6.5 years — focusing on earlier, smaller rounds (as I have since 2013), focusing on meeting people through tight networks, building long-term relationships, being disciplined about entry prices, increasing the time diversity of the new fund we’ll crack open soon, and having a long-term view about how many funds over the decades I want to deploy.