Follow me @samirkaji for my random, sometimes relevant thoughts on the world of early stage venture and start-ups.
The recent TechCrunch article illustrated a stark downward movement in the total number of venture deals completed over the past few years, something that those intimately close to the venture market have experienced first-hand.
The data supporting this shift may surprise some when seeing that annual deployed capital has increased over the same period. There are many fairly obvious reasons for this, including venture investors concentrating capital into “winners”, protracting exit cycles forcing funds to reserve more capital for follow-ons, and larger fund sizes leading to traditional VC’s investing later in company life cycles.
As the chart below illustrates, the data is especially harsh on the seed stage funding market, with number of seed deals done per quarter dropping nearly 50% from the highs in 2015.
On the surface, this feels even more counterintuitive than the broader venture deal trend when looking at the growth in new seed fund focused venture fund managers since 2015. The chart below illustrates this growth (Note this is as of 5/11. We’ll be publishing the year-end numbers in January, and I expect the number of seed funds closed to be greater than 2016 figures).
So what’s really happening within seed?
1) Relative to traditional venture, the seed fund market exhibits stronger collegial tendencies, and it’s not atypical to have seed rounds with multiple seed fund participants. According to PitchBook data, the average number of seed funds in a seed round in 2017 was 4.8, meaning an average seed round completed in 2017 had nearly 5 seed funds participating! This speaks directly to the growth in size of seed rounds, but also to the reality that the majority of seed funds won’t or can’t lead seed rounds.
2) The data for seed rounds has always been a bit opaque, especially with very small rounds, many of which are not disclosed. As such, I think the absolute number of seed rounds completed this year is likely quite depressed from deals actually done (however it doesn’t negate the downward as opacity has always been an issue).
3) It’s important to note that PitchBook’s seed round definition is limited to companies that are <2 years in age that raise a pre-Series A round. As seed fund investors have continued to pile into late seed/post-seed, it’s not atypical for companies to be forced to wait 2 years or more for a substantial seed round, and alternative sources of capital in the meantime (crowdfunding/bootstrapping/accelerator funding), many of which aren’t disclosed. Additionally, many companies raise multiple seed rounds prior to a traditional Series A round, some of which come after 2 years in existence.
4) Gray area around terminology. In the past, there were clear lines between seed and Series A, Series A and Series B, etc. Today, these lines are less defined as many “seed” rounds that are completed are effectively what we would have historically considered Series A deals despite the seed moniker. And many of these rounds are years after company incorporation.
Let’s now turn our attention to 2018. While I doubt we’ll see a complete reversal to 2015 seed round figures, I am hopeful that we’ll experience some thawing in the seed round market next year.
Projected rise in “Pre-seed” rounds
Most define pre-seed as pre-product/limited traction rounds that are sized at $1MM or less. As others have written about recently, there appears to be a ripe opportunity for investors at the pre-seed level, where valuations and round sizes are much more reasonable for small seed funds (and where I think small funds should be playing more).
However, the past couple of years have evidenced seed funds focusing later in the seed stack, regardless of fund size. I think (hope) this will change as smaller seed funds place more weight on initial ownership and taking a lead position, something that’s most likely only earlier in the seed stack.
To note, 48% of new seed fund managers in 2017 raised funds that currently are sub-$25MM (a trend I expect to continue in 2018 as institutional limited partner capital for new entrants without established track records continues to dry). Assuming the recently renewed interest toward pre-seed continues, we should see more seed firms become pre-seed focused like Bee Partners, Wonder Ventures, and Precursor Ventures. This should in theory reduce the concentration of capital into few deals within seed.
Continued growth in new seed funds
As noted by the chart above, the growth in new seed funds has been nothing short of staggering, and despite what could be a more complicated fundraising environment, I’m expecting another robust year for new seed funds in 2018. According to Preqin, there are 590 first time venture firms globally IN market today fundraising. While the long term outlook of these firms is expected to a normal venture power law curve (and I believe we’re headed for consolidation), the short-medium term effect for founders is a greater number of potential seed funders.
Growth in Non-Coastal markets
As the importance of technology has become widely recognized across markets, we’ve seen the continued evolution of technology hubs outside of the coasts. Areas such as Austin, Seattle, Atlanta, Chicago, and other non-coastal cities are maturing rapidly. In the past, institutional seed financing in these areas were non-existent as opportunities to invest were limited. As the barriers of building a non-coastal technology company has come down dramatically over the last few years (and in many cases comes with distinct advantages), we’re seeing more non-coastal focused seed funds. As such, I expect seed activity in non-coastal areas to ramp up significantly in 2018.
For founders: While the seed data is viscerally concerning and should be taken seriously, I think the careful analysis of the landscape reveals a much rosier picture for the year ahead.