Month: April 2016

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of venture capital.  Paul Arnold, founder of seed stage firm Switch.VC and I wrote recently about the impact of seed funds in securing follow-on financing. That post aimed to help founders pick the seed-stage funds most likely to help them secure later financing. This second post adds detail and perspective for seed-stage focused General and Limited Partners. Leveraging data from CB Insights, we created League Tables that identify seed funds with the top follow-on rates each year. With the current array of emerging managers and compressed fundraising cycles, GPs and LPs must use intermediate measures to benchmark fund performance—cash-on-cash returns simply aren’t known until it’s too late. Measures like Internal Rate of Return (IRR) and Total Value of Paid in Capital (TVPI) are used to grade funds in their middle years. We believe that follow-on rates are also a core metric and critical to understand a young fund’s performance. High follow-on rates are fairly well correlated with high Investment Multiples and IRR. While benchmarks for Internal Rate of Return and Investment Multiples are readily available, the data for follow-on funding has been fairly limited. GP’S AND LP’S: FOLLOW-ON RATES MATTER GENERAL PARTNERS General Partners want to know how to drive fund results in early years. They want to track whether they are performing and need to measure the early signs of long-term returns. And most managers are seeking to build a long term franchise with successive funds. How should a GP drive follow-on results? Aside from picking good companies and making them more valuable, they need to be systematic in helping secure the next round. This means preparing startup founders for their next raise, clarifying financing milestones, and building rapport between founders and the best downstream investors. GPs should know when a deal is right for other firms and build a reputation for bringing them the deals they want to get into. Follow-on investments validate a seed fund’s early bets. It’s evidence for your strategy. And in a rough-and-tumble year like 2016, it shows that your portfolio and approach is strong enough to navigate a tighter market. LIMITED PARTNERS Limited Partners want to know which new fund managers will be tomorrow’s winners. As Cambridge Associates writes, for the last 10 years, “40–70% of total gains were claimed by new and emerging managers, a clear signal to investors to maintain more constant exposure to this cohort.” But identifying the best new managers is not easy—the best can come from unexpected backgrounds and with completely novel strategies—and many LPs say they struggle to separate signal from noise. In this context, a high follow-on investment rate...

This is a re-post from an article Paul Arnold and I from Switch Ventures authored for CB Insights. Follow me @samirkaji for my random, sometimes relevant musings about the world of VC and startups. Institutional seed capital is an invaluable source for startups. As the number of institutional seed-stage firms, often referred to as micro VCs, has ballooned, founders have many choices of seed investors. According to our database, there are nearly 350 micro VC firms in the US that focus on bridging the gap between angel funding and Series A rounds. This influx of seed capital makes the decision process for founders difficult. A founder must pick investors that not only can help the company reach critical milestones, but also help them secure their next round. Why follow-on rates matter Follow-on rate is strong evidence that an investor is not only adept at picking good companies and adding value to their portfolio companies’ operations, but also at guiding a company to downstream investors for the next round of financing. Note that most micro VC firms only participate as a lead or co-lead in the seed round. Founders want to build big, iconic companies. To scale and capture a big market usually requires an escalating series of capital investments. The biggest hits almost always follow this path. While exceptions like Veeva exist, it remains rare to build a company of scale without securing many rounds of financing. Today, follow-on rates matter more than ever. The economic reset that we’re experiencing has created choppy waters for all stages of startup funding. Macro instabilities caused many investors to pull back on capital deployment (and valuations), and to require more traction before investing. Micro vs. traditional fund performance We analyzed follow-on rates for seed-stage VCs using data from CB Insights. Since larger seed-extension rounds often serve as Series A rounds, we considered a follow-on round to be when a subsequent financing was greater than $2.5 million, regardless of how the round is otherwise labeled. We netted out any companies that were acquired prior to additional funding. The table below lists follow-on rates for institutional seed-stage investors for vintage years 2010–2014 (2015 was statistically irrelevant as most seed rounds offer 12–18 months of runway). Traditional venture funds are those that employ a strategy around investing in seed-stage companies (i.e. Formation8, Crosslink Capital, Founders Fund, etc). Several fascinating insights stand out to us from the data above. Micro and traditional VC have nearly identical follow-on rates. Despite some founders’ sense that it’s best to raise seed from the larger funds, the evidence doesn’t bear it out. Institutional micro VCs are securing follow-on for their portfolio with at least the...