Making Sense of Seed Investment Data

There were a number of interesting articles published over the last week in response to Mattermark and CB Insight’s data around early stage financing activity. In particular, a number of people commented on what looks like a dramatic rise and fall in seed deal volume over the past four years coupled with an increase in seed investment dollars.

As a team, we’ve been thinking about what has been going on in the seed market in recent years. Are we in the midst of major transition? Have things settled to the point that there is a new normal? Should alarm bells be sounding, or is it business as usual?

Answer first: we think that the seed market has settled somewhat, so charts like these don’t really cause much alarm but are generally consistent with what we’ve been seeing. Couple thoughts.

First: It’s impossible to accurately chart the level of angel and seed activity over time. The data sources are not at all robust, so while the trend may be directionally accurate, the levels are not. And I’m not saying they are off by 20%, I think it’s close to an order of magnitude off. Here’s an obvious gut-check. Almost all series A’s have some prior funding round, so that would be either seed or angel (usually both). I also would argue that as an overall market, at least 2/3 of seed funded companies fail to get to series A. Based on this, you would expect that the steady-state level of seed + series A deals for any period of time would be at least 3x the number of series A’s. As you can see in the data, this isn’t anywhere close to the case.

Furthermore, I generally find that almost all the companies I consider for an institutional seed round has raised some angel capital in the past. So the number of angel rounds should be some multiple of the number of seed rounds. Again, this is far from what you see in the data, where there are actually fewer angel rounds than seed rounds. The bottom line is that I would completely ignore the absolute level of investment activity reported, but I think the trends can be illustrative.

Second: So what does the trend show? It shows that there was a rise in seed funding activity followed by a decline several years ago. This was caused by the so-called “series A crunch” where many seeds failed to raise series A’s, causing seed investors to buckle down and invest more carefully. That’s kind of old news – the number of seed deals simply lagged the performance of seed investments made in 2012 and 2013. On absolute terms, I think we still have a healthy level of seed investing activity. Based on the Mattermark data (which might be inaccurate but hopefully is internally consistent), it looks like we are currently in an environment of similar investment activity as late 2010 and 2011, which I would characterize as bullish but not frenzied.

Third: The definition and dynamics of seed rounds have changed. In our view, seed rounds are the new normal for most early stage software based companies. What’s also the new normal is that the majority of seed funded companies raise some money before their seed round from angels. But because of the capital efficiency of building and launching software products, what these companies are able to achieve prior to a seed round is pretty broad. Internally, we talk about he “broadening definition of seed”. Seed rounds can look like a company that is pre-product or has an early product prototype. But in some cases, companies are able to launch a product that grows to tens of thousands of dollars in monthly revenue or more through modest initial investment.   This means that “seed rounds” should end up looking pretty different, and can become confused with A rounds pretty easily.

So, what does this mean for founders? Here’s what I’d take away:

  1. The size and purpose of financing rounds have been shifting. For a really good summary of this, just read Jason Calcanis’ recent post here:
  2. The market for raising seed money today is pretty solid, so there isn’t really a reason to be worried or concerned by the shape of these graphs. Sentiment among seed investors isn’t excessively optimistic, but they aren’t overly bearish either.  There is plenty of appetite for good seed-stage investment opportunities. Also, remember that in good or bad times, promising companies get financed and can have a terrific start.
  3. The parameters of seed rounds have broadened. Overall, I’d say that most companies should plan on a financing path where they raise <$500K from angels first, followed by $1-$3M in funding from an institutional seed investor. But although I think these are reasonable guidelines, there will be many many outliers. Just like some series A’s are $4M and some at $15M, there will also be a broad range of seed rounds. Don’t sweat this. The goal for any financing round is simply to get your company to the next major value-accretive milestone. You should raise enough to accomplish this for your own company, and know that others will probably do things pretty differently.

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