For those following this blog and the seed market over the past decade, you may have noticed that every year, we see increases across the board — more investors, newer funds, and funds that get larger. Much has been written about the fact that traditional seed stage funds have grown in size and dollars under management. Here, I wanted to step back and consider “why” this has happened from my vantage point. If you’re reading this looking for data and hard numbers, charts, and footnotes, you’ll be disappointed. Rather, this short blog is filled only with my own observations from being in the middle of the evolving seed market since 2013. So, with that Disclaimer, here are the main reasons seed stage firms have grown in size over the past decade, along with some risks and opportunities these conditions create:
1/ Catching Ambition – When some seed stage funds started, perhaps they didn’t know what their fund would turn into. Some are gone now, and some caught fire and the creators decided they wanted to grow into an investment firm, not just a fund. This is sort like when a tinkerer builds something for a few years but then it starts to work maybe 2-3 years later and they decide their want to intensify their approach to building around it.
2/ Financial Considerations – When investment firms grow, so do fees. But, I do not think this crop of seed funds is entirely motivated by more fees, but rather it’s industrial situations (which I’ll explain more below) that’s driving this. As valuations have gone up early, the cost of ownership has also risen, and in an early-stage fund where the loss ratio is likely to be much higher, high ownership has been increasingly important to these funds. Getting that ownership is one thing (and it costs more), but then defending it with reserves in future rounds is also increasingly important and another reason these funds have scaled up (usually with opportunity or overage vehicles).
3/ Industrial Atmosphere – I like to say that “tech” over the last decade went from being perceived as a vertical sector to now being horizontal, where tech has or will permeate most if not all industries. As a result, the venture industry has exploded — either to meet that opportunity, or because of low interest rates, or both. Over the past decade, many newer LPs (those who back VC funds) have entered the market, and as those LPs get more comfortable with their GPs, they may also want to put more money to work with them, especially when they get a taste of early stage returns. At the same time, the classic Series A funds and Sand Hill Road institutions have scaled up into the billions, creating more space at the early stage for seed firms to theoretically straddle the seed and Series A stages. There are also newer angels and new funds created almost weekly, so raising more capital as a seed fund can be a weapon to win deals.
4/ Social Forces – As seed stage funds grow and mature, the GPs grow and mature too. Seed funds often co-lead deal with another fund they enjoy working with. If their friends are growing, they may want to, as well. If it used to be traditional for each fund in a seed deal to co-lead with a $750K check 5-7 years ago, but now the check required for the same ownership level is now $1.5-2M per firm, funds may want to grow so they can keep co-investing with their peer group. Also, as investors themselves age, they may want to increase their ownership in a round as a reflection for what they feel they bring to the table, and they may want to concentrate their relationships in fewer, stronger opportunities — much like one may do in life with friendships, too.
These are the main four reasons behind *why* seed funds have grown in size over the last decade. With any change, these forces present risks and opportunities. The opportunity ahead is clear — more fees, more ability to own and defend that ownership, and having a storefront for pre-seed, seed, and Series A deal participation. In the right company, that can be life changing. There are risks, of course — new investors and funds are entering the market with smaller funds, novel Twitter strategies, and a hunger and desire to get ahead of the best founders. They may not only intercept the deals seed funds should be doing, but then may pass them along to the larger institutional funds, who are also happy to write a seed stage check, bypassing the traditional market. If the 2010’s were about the institutionalization of seed funds, I believe the next decade ahead will be a test of who can stake out their territory as these forces rise from the bottom and cram down from the top.