Can there be too much seed money in an economy? There has been talk about the growth of a bubble in seed investing, based on the rise to prominence of new or expanding seed-stage funding vehicles. These pools – some organized as funds and some not – seek start-up deals in a range of, say, $250,000-$500,000, usually but not always in anticipation of a larger venture round if and when the underlying target has proven its potential. The rate at which these seed-funding platforms have been springing up has been noteworthy indeed, but whether the segment has become too big, or constitutes a bubble, should not be measured with conventional standards.
A loose and informal survey of the New York market, as an example – and assuming that capital advertised as available for action is in fact available and active – yields something like $100 million of seed liquidity in the aggregate, from seed funds, super-angels, or allocations specifically set aside for startup finance. Almost all of these have been launched – to varying degrees of formality – within the past 6-9 months. Considering the size of individual deals, this is a lot. The range previously referenced is not a hard rule, but using that as a general parameter, the current market in New York alone can absorb some 200-400 seed deals. And considering the returns that such investors would expect, the estimated pool size is also significant in regard to future value requirements. Factoring in the dilution of follow-on rounds, $100 million should probably produce around $2 billion in aggregate exit value (for all classes) in order to cover the hurdles of its funding sources.
By way of reference, Twitter’s most current capital round was valued at $1 billion, and this was and is one of the hottest venture backed properties around. Foursquare, a prominent New York venture-stage platform, was rumored to have entertained $100 million acquisition offers recently. The current vintage of seed funds, based on this couple of data points, has real work ahead of it… and there is also one other important issue to consider: all deals are not equally enticing going in. This is to say, the “best” deals are bound to be competitive, and with a large variety of money sources comes money competition. In short, the “best” deals are bound to be bid up in price, which adds to the exit value pressure already described.
But this is the conventional way of seeing things, based on conventional venture investing styles in a conventional capital market supported by institutional investors. There are important differences in seed investing, which go counter to convention. For starters, venture capital, private equity, and similarly organized funds are formal and committed partnerships that involve management fees and that must abide by partnership targets, whereas seed investing tends to be more discretionary, opportunistic, and, in short, less rigid. While there is a great deal of boasting and self-promotion by seed investors, the advertised capital is under much less pressure to be put to work. This casualness, this flexibility, is critical to investment discipline, and perhaps for the same reason seed investors are more apt to cooperate rather than compete, to coinvest and share deal flow, rather than bid prices up as though for scarce assets.
Returning, thus, to the opening question about the possibility of too much seed capital and the formation of a bubble in this segment, the answer is probably “no” and the very question may in fact be misplaced. Despite the math that was previously sketched out, and as long as these pools remain flexible and steer clear of contractual “overhang” issues that have burdened the more substantial funds recently, seed finance sources are not only immune to bubble-related risks, but serve a valuable cause for which we hope they will stick around:If startups are now being funded by super-angels, by dedicated seed investment vehicles, this is as it should be, as it should always have been, and is a good thing for risk mitigation and the future capital deployment of the bigger pools. Allocating vast sums to high-risk targets that have not yet been vetted and that have not yet proven themselves in any way, is not a sound investing practice for the institutional venture community. The proliferation of seed funds is a valuable buffer, a necessary precursor to the bigger rounds, which could prove to be a saving grace for the long-term viability of the venture capital sector.
Disclosure: No positions.