This is a re-post from an article Paul Arnold and I from Switch Ventures authored for CB Insights.
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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 same rate.
- Having a mix of both leads to dramatically higher follow-on rates. The best option is clearly to have both, with follow-on likelihood more than doubling when a seed round involves both micro and traditional funds in the investing syndicate. Also, despitesignaling risk that many founders fear when a large VC participates in their seed round, it’s largely mitigated when a micro VC is also included in the round.
- There is a drop in 2012. Given the robust seed and Series A funding levels in 2013–2014, we were surprised to see follow-on rates drop so precipitously for companies that raised institutional seed financing in 2012. While alarming, we believe much of it can be explained by the evolution of the seed market, where we saw growth in smaller seed extensions and bridges. More companies in 2012–14 received second (and third) seed rounds of under $2.5 million, which weren’t counted. As such, we don’t think that the lower follow-on rates necessarily reflect higher startup mortality rates.
The Best Micro-VC Funds by Follow-on Rate
Perhaps the more important question for a founder is this: Which micro VCs have had the highest follow-on rates — in other words, which firms have historically provided the best odds of securing the next round?
Top micro VC investors with at least 15 seed-stage investments
Probably as important as overall follow-on rate is the quality of follow-on financing. Attracting follow-on financing from top traditional venture funds, which have large bases of capital and high historic success rates, undeniably increases the long-term probability of success for a startup. While determining the top traditional venture firms is admittedly subjective, we used the CB Insights list of “smart money” investors for our analysis.
Top smart money follow-on rates — subsequent round > $2.5M
The next table looks at follow-in rates when the subsequent round is actually defined as a Series A and is not just a subsequent seed round larger than $2.5M.
Top smart money follow-on rates — subsequent round is ‘Series A’
Attracting follow-on capital to enable scale is critical. As an entrepreneur, it’s important to consider your seed stage syndicate’s ability to help you raise your next round.