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Seed investments from big VCs

image Chris Dixon has a post up on Silicon Alley Insider arguing that it is dangerous for startups to take seed investments from big venture funds (thanks to @robinklein for the pointer).  His argument has two parts:

  1. If the seed VC decides not to invest in the Series A it will scare other VCs off
  2. If the seed VC does decide to invest in the Series A their inside track will get them a better valuation than in a more open competition

I agree that taking seed investment from a VC brings these risks with it, but there are also some benefits.  Namely you get the public endorsement from that VC at an earlier stage, you get to work closely with them for longer, and you will have a better chance of securing them as Series A investors.

There is no right and wrong here, my point is just that there are pros and cons on both sides.

Where the cons start to outweigh the cons is if the VC has a large number of seed investments (and it is large seed investment programmes that Chris is mostly taking issue with).  In this scenario the large VC won’t have the bandwidth to give much love to all their seed companies and they will most likely be expecting to fund only a fraction of them at Series A.

On the other hand, if you are the only seed investment from a top name investor in a given year that will make you more attractive to other VCs.  If you go on to play the game well (and have negotiated your documents properly) you will then find it easier to generate competition amongst investors to lead your Series A.

That is twice in two days I’ve cited Chris, and I can’t remember the last time I did that for anyone.  He writes and thinks extremely well.

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October 13th, 2009 | Category: Startup general interest, Venture Capital
  • chrispadfield
    I think companies should be looking at the motivation of the VC. If the VC is just doing seed investments as a put option, then they should be avoided - VCs should not be doing this; but instead take the Sequoia approach of being an LP in a specalist seed incubator like Ycombinator which still gives them that put option without screwing up the company's chance of raising money elsewhere.

    If the VC does the seed investment either because they are structured to take a majority (of the succesful) seed investments the whole way, or because they are doing a rare seed investment because the love the management/market/tech then that is fine.

    The other thing I have seen that has caused problems down the line is a big VC doing a seed investment at valuations considerably higher than the market rate paid by angels or specalist seed funds. This is fine if the VC continues to back the company but if not can cause huge down rounds - which are particularly painful if the large VC has put in downside protection - which they generally will.
  • What specifically are the differences between taking a seed round from VC and then dealing with a Series A round vs. taking an A round from VC and then dealing with the B round?

    Isn't it much the same with all rounds? If a VC doesn't want to come in, it can create a problem for the company.

    I think what we should look at is the data. How many VCs didn't follow their seed round and how many VCs didn't follow their A round. That would indeed be interesting to see and maybe we can learn something from that.

    I get the point in principle, but would like to see the data to understand how often this happens.
  • I agree, data would be interesting. The key difference between seed and series A is of course the weight of money. Most angels don't have the capacity to play at series A making VC the only choice.
  • chrispadfield
    There are also not that many VCs with big enough funds to do A-rounds as put options; the amount of money is too large.
  • Just because one VC decides not to invest does not mean the start up will not secure venture capital from another company. Some of our investments have been passed over by other investors, but that does not mean we will pass them over too. We judge each investment on its merits, not on whether some other company has knocked it back. We are confident in our investments and if the proposition meet our criteria then we will invest in it.
  • chrispadfield
    There is however a big difference between other investors who have access to the same information as you do, and an investor who has worked with the company for a year. The later not investing - is very different than just another VC turning down the deal.
  • Maybe "There is no right and wrong here" from the VC point of view. From the founder POV, it's all wrong.

    Regardless of what's pre-negotiated, I've never had a smooth time transitioning big-fund seed rounds into the next financing. An ex post facto demand for super pro rata rights is almost universal.
  • You are right that the only reason big funds make seed investments is so they have a good shot at the Series A if they want it - whether documented or not - and will get prickly if denied. That will make it rough for founders and may well be a situation best avoided.
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