The seed market for tech startups — particularly digital media, social, local, and mobile — is very active. Many companies are getting started and lots of investors are making seed investments.
Because of my involvement in the Boston and NYC ecosystem as a managing partner at CommonAngels, I’ve been asked by several entrepreneurs a very simple but loaded question: “How should I think about pulling together my seed round?”
To answer that here, it’s important to remember that every situation is unique. As I look at close to a dozen seed investments we have made in our fund, the composition varies. From angels only to micro VC with angels to multiple VCs and all the blends in between. Below are some of the things I think you need to consider if you’re raising:
- What do you really need? If you’re looking for business model advice, access to beta customers, access to the broader ecosystem, or help with recruiting, ask yourself: who can help you the most (and the follow on question, who will actually do so)
- Have a clear sense of your milestones and an operating plan that makes sense to achieve them. Spend time with your lead(s) investor agreeing on this up front.
- Have a lead investor. Someone who will take a leadership role in the deal. This is the person you directly negotiate with and who the other investors – VCs, micro cap funds, angels, angel groups – look to as the lead investor
- Don’t leave this to the last minute. Start to spend time with potential investors early. What is the chemistry like? Do they make introductions for you?
- Ask your fellow entrepreneurs. In both Boston and NYC, it’s a small ecosystem in early stage IT. Do your homework.
- Signaling risk is real. I know Mark Suster says everything is a signal – and I agree – but not all signals are equal. Understand the risk and the tradeoffs.
- Understand the risk/reward of a pre-negotiated deal (more on that later). On the one hand it may make a ton of sense; clear understanding of the milestones; you will get the time/attention of the VC firm; and you don’t need to worry about fund raising for the Series A (assuming you hit the milestones). On the other hand, you are taking the ability to maximize the price and terms of the Series A round off the table.
Based on my experience of running a micro cap VC fund, there are several nuances in seed scenarios I can share that might be helpful to you.
This is where several (more than 2) VC firms invest in the seed round.
Pros: you get access to a broader range of contacts and advice.
Cons: you probably won’t get the full time attention of the general partner
Series A dynamics: this is the most interesting question in these type of deals. By having several firms in the deal, if one doesn’t want to participate in the A round, then hopefully you have others to support you. On the other hand, if everyone wants to invest on the A round, how is each firm going to get their ownership position they want? (Most larger VC funds have target ownership ranges in a Series A – anywhere from 15% – 25%+). The math gets problematic.
Individual general partners
A VC firm may pass on a deal or the entrepreneurs may not want to take institutional money just yet (typically from a sizeable VC fund). However, the general partner really likes the entrepreneurs and deal, and wants to invest personally. The policy on doing this varies by firm – some firms don’t allow this; others do so long as its not a deal for the partnership. Often if the firm invests later, the GP’s investment is rolled into the firm’s investment
Pros: theoretically you can get access when needed to the partners knowledge and contacts…..without dealing with a big firm partnership. The signaling risk on the next round is lower than if the firm invested
Cons: your not really going to get that much attention and help unless it’s a deal that the partner really wants to line up for the next round. Just like any other angel investor, will they follow on if there is an insider led round before the A round?
Series A dynamics: the signaling risk is low and you will have the opportunity to pitch your A round to other firms
West coast/east coast
This is where you look to have high quality investors in your seed round from both coasts, often looking for a mix between Boston, California, and NYC. This is an important consideration where the ecosystem that you are in spans these cities. For example, if you are a media startup in Boston having investors in NYC that can plug you into the media and advertising agency ecosystems in NYC can be incredibly valuable. Most tech companies I’m invested in will at some stage look to California for customers and partnerships. Well connected Californian seed stage investors can help you open up doors.
Pre negotiated rounds
This is where a VC firm (typically 2) will fund your seed round but its “stapled” to the back of a pre negotiated Series A round. For example, “we will invest $500K in the seed round, and assuming these milestones are hit, we will led a $5M A round on these terms”
Pro: Because you have locked in you’re a round, you don’t need to spend months on the road trying to raise it
Cons: could you have gotten a better A round deal in the open market?
What does this all mean? If you are in the fortunate position of having investor interest in your seed round, you need to think about the composition of the round very carefully.