Scott: What are the differences (pros/cons) of going to a VC firm (vs. Angel group) for seed financing?
Since most traditional venture funds make initial investments of several million dollars or more, seed financings are typically viewed, and treated, quite differently than "standard" venture investments by VCs. Many VCs that do invest in seed financings (and the percentage of VCs that do has increased materially the past couple years) are typically making passive investments in management teams that they like, and that are targeting attractive markets. The hope is that a small portion of these seed stage companies will eventually be a fit for the traditional portfolio, and the venture firm that participated in the seed round may have a leg up in the next financing. So, as a seed-stage company looking for money, you can expect that most VCs will probably take a much more hands-off role with your company than with one of their traditional investment. The positives of taking seed funding from VCs may include:
Branding/Credibility: Having a venture fund listed as one of your investors may provide some additional credibility to your company and, if the fund commits early, may provide you with a fundraising boost as you try to close out your financing. In addition, some funds that lead seed investments may be comfortable structuring the terms of the investment, which provides credibility to “soft circled” capital.
Stress-Testing the Business Case: While your business may not be ready for a traditional institutional round of financing, venture investors will likely ask you many of the same questions that they would ask slightly later stage companies. Thinking through these answers, as well as developing some of the Key Performance Indicators (KPIs) that venture investors are asking about, may help prepare you for the next stage in your company’s growth.
Smoother Path to the Next Financing: If you’re business is doing well and you’ve kept your venture investors up to speed with your progress, it may make raising your next round a lot easier. Many angel groups are not equipped for larger follow-on equity or bridge financings (in the event the business needs more capital to hit next level milestones). In addition, many VC’s can usher introductions to a vast network of firms they have co-invested with in the past, for capital diversification.
Domain experience: While some angel groups do have participants with domain experience or investments in similar types of businesses, that is not necessarily the case. Many VC funds will have the benefit of multiple investments in your industry, which results in historical perspectives and potential introductions to relevant advisors/management team hires in the future.
The biggest downside to having VCs participate in your round is the risk of negative “signaling” in the future. What happens if the venture investor in your seed round isn’t interested in investing in your company’s subsequent rounds? Many entrepreneurs worry that that will “signal” to the market (i.e. other venture investors) that there may be something “wrong” with the company. There are a couple questions an entrepreneur can ask/research to determine how much “signaling” may be an issue.
Is the VC’s commitment an “investment” or a “placeholder”? The more meaningful the commitment is as a % of the fund, the more outsiders will potentially view the lack of follow-on investment as a negative signal. (For example, a $50k investment from a $300 million fund, versus a $500k investment from a $100 million fund.)
You should also try to find out how often the venture fund invests in subsequent rounds. If the follow-on investment percentage is high, the lack of a subsequent investment could be seen as a bigger negative.
Overall, there are a number of benefits to having venture investors in your seed round, but with all your investors, take the time and do your homework to mitigate any risks.
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