Since 2011, Bullpen and Vator have put together an annual venture capital event to gather the old guard investors and new to understand the changing and evolving venture landscape.
The very first conference four years ago, called Venture Shift, covered topics such as “How angels and super angels/micro-cap VCs are changing the landscape” to “Has the traditional VC industry been forced to pivot?” By 2012, we explored questions such as “The Series A crunch” and “What’s the new venture hit?” And in 2013, we examined the newly-enacted JOBS Act, and started questioning the value of accelerators, noting that there was an accelerator bubble.
Editor's Note: We are hosting our second annual Post Seed (#postseedconf) event on Dec. 1 at Ruby Skye in San Francisco. The event - which we expect to draw more than 500 attendees - kicks off at 8 am and ends around 5 pm. We're excited to have Cory Johnson, anchor at Bloomberg West, broadcasting live from 7 am to 11 am PST. It should be a riveting day! Register here: Post Seed 2015.
The re-naming aligned with our view that the industry was no longer shifting, but in fact, had settled and a new paradigm had emerged. Just like an early morning dew that disappears to reveal a crevasse or smoke that clears from a fire, exposing a large gaping hole in an edifice, a wider gap between the initial seed round and Series A rounds, and within it a flurry of new investment strategies and activity, became apparent in the venture landscape.
This gap was formed by a new generation of investors, who by virtue of emerging en-masse, threw traditional early-stage strategies and valuations on their head. This gap was formed by VCs encouraging startups to raise larger Seed rounds to meet the ever-demanding proof points needed to get a Series A.
"Consider raising a larger seed round to give yourself more runway to rack up more proof points before your A," wrote Josh Kopelman, partner at First Round.
As it happened, this once discrete Seed round became either a very big round, as Kopelman advised, or a series of them. Seed was now a process, as Duncan Davidson, partner at Bullpen Capital, observed.
A process that lives in this stage called Post Seed.
We agreed the event would be called Post Seed, and Venture51 became our new partner. Semil Shah, who advises Bullpen, has become very instrumental in helping to shape the conference. He suggested we all write about “why” we’re hosting the conference.
Venture no longer a cottage industry
The "why" for me is easy: Venture is no longer a cottage industry, and it’s changing how we need to think about the seed-to early-stage rounds. As I mentioned in this piece "Why private markets are where public markets were circa 1980", the private markets (or venture capital industry) have a lot of similarities to the public markets circa 1980’s when the public stock market opened up significantly to the average investor.
In 1980, about 17% of US households owned public stocks, up from 4% in 1949. Today, half of US households own stocks. I see the same dynamics happening in the startup asset class, as more US households participate and share in the investment opportunities in the startup ecosystem. Today, I estimate less than 1% of US households own equity in a startup.
As new investors come in, I’m particularly interested in the stage in which they’re most active by unit volume, rather than dollar volume: The later stage (with increased activity from hedge funds, mutual funds and new firms, such as Coatue) qualifies. But these stages have seen interest in the past, particularly during a bull market. The newer Post Seed stage is especially interesting because it's where many newly-formed VCs have started to form.
These new venture firms are akin to the mutual funds that proliferated in the 80’s. Along with the advent of discount brokers, both the newly-minted stewards and lower investment costs made it less risky and affordable for more investors to get into the public stock markets. In like vein, the increased professional stewards of venture funds - many of whom were active angel investors that institutionalized their efforts – and lower barriers to entry provided by crowdfunding platforms, are opening the once opaque world of venture investing to the masses.
It is exciting as it is scary, as it is wrought with more imminent perils, I fear, than opportunity.
Option buying strategy at the early stage
Probably the most pressing question for early-stage investors today is whether option buying in seed- to early-stage investments is the new normal. A quick survey of investors shows that pre-money valuations for seed and A rounds are two to three times higher than 10 years ago, and un-capped convertible notes are proliferating.
Valuations are being thrown out the door just for an option to get in on the perceived best deals.
Is this option-buying strategy the new normal? Are we getting to the point where entrepreneurs can say to investors: “I’ll gladly pay you Tuesday for a billion hamburgers today?” In other words, “I’ll gladly save you a seat at the next round, if you give me money today, for umm... zero equity in this round.” How much do valuations even matter if everyone is just buying options and, for that matter, just disregarding them by punting on the analysis? Is this the new normal? Or is it just an over-heated market?
The other question to answer is if expectations are rising for rounds, should we just call a spade a spade?
If today’s Seed rounds are equivalent to yesterday’s Series A rounds, aren’t Seed investors just the new Series A investors? If today’s Series A investors expect more from a startup before funding them, aren’t they just doing Series B rounds? Many have already pointed this out. Even in 2014, Manu Kumar of K9 Ventures, who found his $500k investments fell short of the amount needed for startups to meet the new Seed criteria, started calling his heretofore Seed round a Pre-Seed round.
In the midst of this all, many investors still market themselves as Series A investors or Seed investors, sometimes even referring to themselves as “traditional” Series A investors. This is, I believe, a function of the industry holding onto past ways in case we revert to the mean while at the same time accommodating the influx of capital, which has expanded the round sizes 2 to 3x. An average seed deal can now see $5M raised, and an A deal can see $25 million raised.
Even so, when an entrepreneur raises a seed round, which they can do with ease today, they'd do themselves and Series A investors justice if they understood the proof points they need. Josh Kopelman of First Round has a great essay on that.
But this can all change if the market dynamics change. So would it make sense to just re-define the rounds by calling them what they are versus the arbitrary letters that define the linear process of financing rounds? After all, don't many companies that go from Seed to Series A, go back to Seed, then back to A?
Why bother calling them A, B and C and just define the stage, such as alpha product, team formation, product market fit, early revenue, recurring revenue, growth, scale and pre-IPO?
Can we all start using the same vernacular?
Here's my re-defining of rounds, based on input from several investors whom I surveyed:
Name: Alpha Round or Pre-Seed
Criteria: Used to build alpha product and initial team
Name: Product Market Round or Seed
Criteria: Used to fine-tune product market fit/traction with one/few markets/customers
Name: Early Traction Round or Post Seed
Criteria: Used to grow proof point metrics: engagement, revenue, virality
Name: Proof Points Round or Series A
Size: $6M to $25M
Criteria: Well-defined product/Solid Proof points in (but not all) either team, revenue, data - engagement/virality
The changing expectations around what it takes to land a Series A round is why we'll have a panel of investors sharing their thoughts on what today's promising startups looked like at Series A. Todd Francis, Partner at Shasta Ventures, has a great post on this, titled: What did Billion Dollar Companies look like at Series A?
When the music stops?
The other topic that is top of mind for me is what happens when the music stops? We've already seen hints of market fatigue, a crack in the damn, a slow leak in this bubble. Ronny Kerr wrote about Square's IPO going pear-shaped as its estimated IPO price falls 30% below its last market valuation in the private markets. Steve Loeb also noted that Fidelity Investments marked down SnapChat's valuation by 25%, suggesting the investment firm preferred to take a conservative valuation of the hot startup.
But Mike Moritz, of Sequoia Capital, said it best in his Financial Times Op-Ed piece: A handful of these businesses will become the great, enduring companies of tomorrow. But a good number seem the flimsiest of edifices. Forget the fact that some of these valuations are illusory because the most recent investors have structured their investments as debt in all but name, meaning that they will stand to profit even if the company is worth far less."
It is gripping that the convertible note used in the early stages are helping the early-stage option strategy proliferate and at the same time used at the later stages as a risk mitigater for the downside. What this reveals to me is that heretofore public market investors jumped in at the IPO, when much of the risk was attenuated and economic value creation was more certain.
Now it seems public market investors are getting in at the earliest of stages and latest, where the risk is far more pronounced.
Welcome to Post Seed, the new era of venture investing.
(image source: golocalprov.com)