2023 is going to be a very risky year for seed stage startups to accept capital from multi-stage funds (unless they commit to owning 20% of the company). Explanation below.
- Multi-stage firms are now
much more cautiouswhen writing Series A checks. But they also cannot stay idle all year and are happy to make seed investments (call options)
- Even in the boom times of 2020 and 2021, multi-stage firms do not lead most of the Series As for their seed portfolio companies. Based on my experience, I estimate that
only 1 in 5 seed investments from multi-stage firms end up becoming lead Series A checks
- But 1 in 5 was in the good times. Panic has now set in and
the bar to raise a Series A has been raised substantially. 1 in 5 may now be 1 in 7.
When diligencing multi-stage investors, founders should ask the investor how often (in 2022) they led the Series A in companies where they had previously invested in the seed
- You typically need 30+ investor meetings to raise a Series A. If your chance of raising from your existing investor is now only 15%, you’ll need them to make a lot of introductions to other firms as well. But
multi-stage firms cannot credibly make introductions to other multi-stage firms(who will ask themselves "why should I be so lucky to be given the opportunity to invest?")
Even seemingly high conviction investments can be dangerous.For example, if a multi-stage firm leads a $3M seed round at a $17M post-money valuation with a $2.4M check, the founder may perceive this to be a high conviction decision by the lead (and it may be at the time). However, $2.4M only results in 14% ownership — well below the 20% threshold most funds want for core positions. If the company does not demonstrate strong early traction, the lead may decide to not increase their ownership to 20%. Although this has always been a risk, it was less of a concern in previous years where capital was plentiful. But in a market dominated by fear, this perceived negative signaling can scare off other firms and can be fatal for the startup
Startups that are doing moderately well are at most risk. Existing investors will always want to lean in to top performing startups. But middle-of-the-pack companies face clear multi-stage signaling risk in 2023
- Moreover, for a $1B multi-stage fund, $2.4M is only 0.24% of fund size. What looks like investor conviction (”we want to take most of the seed round and leave some room for angels”) is actually only a trivial dollar value for the fund. They can mentally write it off, leaving you high and dry.
TLDR: unless a multi-stage firm commits to owning 20% of your company after the seed round, it may be dangerous to accept an investment from them. Seed funds are better positioned to make introductions to a broad base of Series A firms, significantly increasing your chances of raising in this environment