Should You Be Bullish on Seed Stage Investing?

The Silicon Valley Venture Capitalist Confidence Index, a quarterly survey of top VCs in the Bay Area, released its Q2 findings this week and noted a downtick in overall investor confidence for the second consecutive period, bringing the index to its lowest level in 2 years.

VC Confidence

Much of the concern over the state of the early stage market seems to stem from “frothy valuations” and an influx of capital from non-traditional venture investors (think Goldman Sachs and other large financial firms).

Some investors, however, remained upbeat about the state of the private technology market.

Igor M. Sill, Geneva Venture Management

“I sense that continued new IPO activity and cash-rich treasuries at Amazon, Apple, Cisco, eBay, EMC, HP, Microsoft, Oracle,
Salesforce will yield high valuation acquisitions of venture-backed startups. Shareholders are embracing acquisitions that promise greater market share and growth opportunities.”

Paul Holland, Foundation Capital:

More and more extremely talented young people are forgoing jobs in large companies in favor of starting new businesses at a pace and scale unheard of in the history of the Silicon Valley. The stage is set for the continuation of one of the longest sustained periods of expansion in the Valley’s history.”

The investors in the USF survey above generally represent growth stage firms and invest in late stage deals, which often possesses different characteristics than the seed stage market as different types of investors – institutions and individuals – assess the risk-return equation differently up and down the venture stack and allocate capital differently.

So what does investor sentiment look like at the early stage, where individual investors have the ability to meaningfully participate in rounds for highly promising companies who are in the early stages of finding product-market fit?

The VisibleVC  and Hyde Park AngelsInvestor Sentiment Index, which is taken by over 100 VCs and Angels active at the seed stage – showed that respondents are very bullish on the quality of companies at the seed stage, with a “Company Quality Score” of 92 (100 is the best).

“The talk of a bubble in the startup world has been intensifying over the last few years with many people publicly anticipating a major shakeup. The doom and gloom outlook that makes headlines and drives clicks doesn’t seem to be shared by our group of survey respondents, at least in the near term.” – The Sentiment Index from VisibleVC

Despite the fact there may not be enough capital to accommodate all of these companies successfully raising a Series A round (there never is, no matter what market cycle we are in), investible companies with compelling products and strong traction will continue to have access to funding.

So should investors be bullish on investing in the seed stage market? We have identified three key drivers that contribute to an optimistic case for the future Seed Stage market and for investors active at the stage.

The funding cycle has changed significantly

In 2010, YCombinator’s Paul Graham predicted a future where financing at the early stage is continuous, not discrete.

“The future [of funding] is no fixed amount, no fixed closing date, and no lead.”

Many other investors, like Paul Martino of Bullpen Capital have echoed this sentiment as well.

In the years since, fewer and fewer companies have followed the typical VC fundraising trajectory. Well-known companies like Mattermark and Nuzzle have raised second seed rounds in an effort to shorten their fundraising process and buy themselves time to continue strong their strong growth trajectories and raise institutional rounds with terms that work for them.

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Writing and talking about the impending Series A crunch may drive clicks for media outlets but displays a fundamental misunderstanding of the way many high growth, early stage companies are raising money in the current environment.

Early stage backers are more capable of investing in follow-on rounds.

Early stage investors – whether funds or individual angels tend to have the most alignment with the vision of a founding team since they are around in the beginning stages of a company’s life. In the past, however, investors who have invested early have often been shut out of later rounds simply because they did not have enough capital to participate. This is changing in a couple different ways and has made it so that investors who get in early on companies can continue to support them over the long term and also maintain significant ownership in the company and reap the full benefits of a successful exit down the road.

1. Since 2011 the median size of institutional seed funds has increased by 66%, meaning that seed funds can now retain more capital to invest in the most successful companies they back early.

Seed Fund Size

2. Alternative funding vehicles – like SPVs through online funding platforms – have emerged, making it possible for groups of individual angels from different geographic to pool capital in order to participate in late stage rounds for successful companies.

Companies are disrupting entire industries…not having to create new ones.

As Paul Holland of Foundation Capital noted in the SVVCCI Survey, technology has invaded every industry and vertical to the point where every company, established and starting up, needs to think of itself as a technology company.

For the first time in the history of Silicon Valley, the largest sources of growth are coming from entrepreneurs *disrupting* existing businesses (transportation, finance, food, media) versus creating new industries like lasers and semiconductors. These existing markets are several orders of magnitude larger than the original markets that formed the basis of growth in the early Silicon Valley.

A quick look at successfully funded SEEDCHANGE-listed companies shows this to be true. For example, the prosthetic limb market is well-established – in Europe and the United States alone there are over 5 million people amputees that require prosthetic limbs. So for UNYQ, a company listed by SEEDCHANGE in 2014, the market already existed, it became a matter of  providing a better experience for amputees by leveraging 3-D printing technology to create a better, more fashionable prosthetic limb. This is something that the company has done successfully in recent periods, culminating with the announcement of their multilayer partnership with publicly traded 3D Systems earlier this year.

Making short-term projections for the early stage market as a whole can be a fool’s errand. As some in the survey noted, the Fed could raise rates or other macro concerns could come to pass, causing capital to move away from he market for a period. What does seem to be becoming more clear as time goes on is that a larger share of innovative products and ideas are coming from early stage companies who will end up changing the business landscape regardless of which market cycle they are founded in, providing strong returns for their investors in the process.