Seed Investment Strategy

August 8, 2017
8 min read
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Since mid-2015, investments into Seed-stage companies have been decreasing with the reduction in transactions (40 percent drop) outpacing the reduction in dollars (24 percent drop). Early funding is critical for founders to quit their day jobs to go full-time, build out the initial product and team, and attract first customers. Without the capital at the genesis, there can’t be growing startups for Series A investors to back. Furthermore, there are signs that the later-stage investors are moving out of Seed, following a flurry of capital from large firms the last few years. Just last week, Kleiner Perkins Caufield & Byers shuttered its Seed program, KPCB Edge, after just two years. Moving into late 2017 and 2018, it will be more difficult for an ever-increasing supply of entrepreneurs to raise capital.

However, there is no reason for entrepreneurs or later stage investors looking for Seed deals to fret. The difference between the decrease in transactions and dollars is an encouraging sign that better companies are receiving more capital, as opposed to the previous trend that “anybody can go out and raise a Seed round.” Previously, the crowded Seed landscape meant that it was harder to separate from the pack, as the best startups had early competition from overfunded companies and couldn’t differentiate right away to prove their solutions and technologies would be more valid down the road. This created price wars, battles over customers, and the inability to attract later capital by making Series A investors wary of entering a seemingly competitive market.

As an early-stage company looking for capital, it is critical to find the RIGHT type of funding partner for your needs. This is more important than valuation and many other terms on a term sheet, since you will be working with the investor for at least the next five years.

There are three main buckets of support that entrepreneurs need when raising a Seed round.

First, some founders are only looking for capital. In reality, this strategy should be reserved for those that have started a company before or worked at a successful early-stage startup. It is easy to be confident and hard for some to admit when they need help, but there are so many unforeseen needs and issues in starting a company that first-time founders would be wise to look for additional support beyond capital.

Second, some founders want investors with a deep network in a specific industry or within a job level (for instance, knowing a lot of CTOs). In this case, the founder should specifically target a funding source with direct, relevant experience in said industry. As a founder, it is critical to do your homework on potential investors and ensure they can provide warm intros to the people they claim.

Third, many founders know that they want and need help to build their company. Look for investors that promise their time and have a track record of helping their portfolio companies. One signal here and a good diligence question is to ask how much the investor reserves for follow-on capital for each investment. If this number is above 3x, then you know they are committed to being a partner for the long haul. Most important is to interview current founders of portfolio companies. Many investors will claim to add a lot of value and provide a lot of time, but that is not often the case. Current founders in the portfolio will tell you if the investor backs up what they say.

In the Seed stage, there are a variety of funding sources available, both from professional investors and elsewhere.

Non-Institutional Capital

Friends & Family and Angels: The first source entrepreneurs generally look to is Friends & Family. This is generally money that is more about supporting the entrepreneur as opposed to making a wise investment decision. Angel investing exists in many forms of Solo Angels, Super Angels, and Angel Groups. These investors have diverse processes from simply writing a check in the first meeting to a formal application process and presentations. Sometimes it can feel like death by a thousand cuts, as the vast majority of angels write very small checks, and so you need to have a LOT of meetings to secure your round.  

Crowdfunding: Companies can raise money for consumer products on crowdfunding sites like Indiegogo from customers who want the product and are willing to pre-pay to have access and help make it a reality. A successful campaign is a good signal that the entrepreneur is on to something, and helpful in further fundraising. However, often a successful fundraising campaign means the company needs to raise outside capital to fulfill the orders from the crowdfunding campaign, so buyer beware.  And … it’s a full-time job to manage a campaign, so do your homework before launch.

Accelerators, Incubators, and Grants: Additionally, the past decade has seen a rise in accelerators and incubators. Some are independent (such as Y Combinator), some are associated with a company (Google Launchpad), and some are associated with universities or municipalities (UC Berkeley’s SkyDeck). Some accelerators and incubators (though not all) provide capital in exchange for equity, plus easy exposure to other investors. Additionally, there are numerous grants that might come from a university, a municipality, or an organization (such as SBIR). We believe that the bloom is off the rose of accelerators, and it’s no guarantee that you’ll raise a round after Demo Day, so take care when choosing to enter into a program that can potentially be quite expensive.

Institutional Strategies

Now let’s move to institutional investors with that framing in mind.

Late-Stage VC (Seed crunch): First, let’s think about multi-stage investors that invest at the Seed. Oftentimes, they are buying “optionality” in order to invest at the next round of funding. Generally, the big firms that invest in the Seed won’t even announce the investment, let alone provide the startup with much of anything other than perhaps a vanity metric that they raised money from a VC. Typically, these firms are too focused on supporting their more mature investments. They might even be making the investment to “get smart” on a particular industry or technology, to get prepared and educated to make the right bet at the Series A, which might not be the company they invested in at the Seed.

Diverse Seed Approach: Second, we’ll turn to firms that exclusively invest at the Seed (though might invest later on). The majority of firms operating at the Seed are taking a “spray and pray” approach. They will invest in somewhere between 15-50 companies per year with smaller check sizes ($50k-$250k). They will not lead, take a board seat, and oftentimes not guarantee reserves. This is a similar approach to accelerators; they are placing a lot of bets, will only provide follow-on to the companies they deem worth providing the money to, and oftentimes are not even able to keep their pro rata. This means that if they invest in a smashing success, their dilution will be very high as the company raises more money, meaning their returns will look more like those of an Angel investor, highly diluted by the time the company exits or IPOs.

Dedicated Seed Approach: The final category is the rarest: Seed investors with a concentrated portfolio that lead rounds, provide a high amount of value-add and attention, and have dedicated reserves. This is the approach we take at Bee Partners and we believe it is a great option for founders. Secure a decades-long partner at inception that will pour time and money into your endeavor in a concentrated way.

In terms of the three types of value-add, every source can provide the capital, and many the network. However, ONLY the dedicated Seed approach can provide the time and assistance in  a long-term relationship craved by many founders, both first-timers as well as experienced. The commonality among all of the sources OTHER THAN the dedicated approach is this:

  1. They take a broad investment approach, betting on the law of large numbers more than picking only the best. (Possible exceptions are Friends & Family and Angels.)
  2. They will not invest at the later rounds. (Possible exceptions are Super Angels and large Incubators.)
  3. They won’t be there to give you a hug when times are tough. (No exceptions.)

At Bee Partners, we help these companies wade through the struggles of the earliest stages of building a company and a team. With this support, we have been able to more than double the industry average of raising a Series A for our portfolio companies. Once the company raises the A, they continue to receive attention from us, but now are receiving a ton of help from their other investors, whereas previously they only received attention from Bee Partners. Once a company raises their Series A, the chance of success increases from 2.4 percent to 17 percent. By the time the company raises its Series B, the probability of success increases to 56 percent. The strategy of providing value-add and reserving 3-4x for follow-on capital through at least the Series B allows us to help companies get to later rounds of funding, thereby living by our very ideal—to “Be(e) Partners” with our founders from entry to exit and beyond.

Once we enter into this journey with entrepreneurs, we use our time, mountain of resources, and deep network to help them navigate the basic challenges of starting a company that all companies encounter, and get them to a level of relative stability at the Series A. We believe the Seed rounds of 2017, just as those since 2007, still have an enormous lack of commitment and too much spreading of risk, which is why we are high conviction and only pick companies and founders we thoroughly believe in who are looking to develop a partnership with their investors. If this description fits you as an entrepreneur, please reach out to us, we’d love to talk.


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