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There Is No VC Seed Investing Signaling Problem

My partner Brad recently wrote a great post entitled “Addressing the VC Seed Investor Signaling Problem“. This, along with several larger funds reaching out to me to ask for advice about starting their own seed investing programs got me thinking about the hype surrounding the VC Seed Investor Signaling Problem. My conclustion:

THERE IS NO VC SEED INVESTING SIGNALING PROBLEM

As Mark Suster points out in two fantastic posts on the subject (here and here) signals abound in the investment world. And frankly, as signals go, this isn’t a particularly major one. I’m serious. There are a million reasons that an investor group may or may not be able to continue to support an investment, some of which relate to their view of the performance of your business and many of which have nothing to do with it.

The bigger issue with so many VCs jumping on the seed investing bandwagon – other than the obvious overy-hyped bandwagon jumping – is transparency and communication. And this is the advice I give to entrepreneurs and to the funds that have been reaching out to me. Know the goals of your investor’s seed investing program.

And live with the consequences.

At Foundry we view seed investing as we view non-seed investing. Our goal isn’t to seed a bunch of companies, pick the clear winners and abandon the rest. Instead we expect that some portion of our overall portfolio will start their lives as seed investments and, just as we do for every other company we’ve invested in, we’ll invest with our eyes wide open, have a thesis around our investment (“hope” is not a thesis, by the way) and work as hard as we can to help make these companies successful. Some won’t work out, but I suspect the ratio of seed investments not working will be similar to that of our non-seed investments. And as with any of our portfolio companies, if we feel it isn’t working out we’ll have an open and honest conversation with the company about how we’re seeing things, what we think we can do to turn things around and where we feel we need to get to in order to be excited about investing further.

And while I’m not a big fan of “spray and pray” seed investing, from an economic point of view I understand the strategy (maximize your exposure to as many positive random events as possible – Nassim Taleb would be proud!). And from an entrepreneur’s standpoint I can somewhat see why it may be attractive to participate in such a program (lower threshold to entry, more standardized deal, etc.). Like everything in life, one size doesn’t fit all and I’d be pretty pejorative to suggest that Foundry’s seed strategy is the only seed strategy worth pursuing (although it’s clearly the strategy my partners and I think is most likely to result in the best returns for our investors). My point here is that the issue isn’t one strategy vs. another it’s about transparency and respect for the entrepreneur. And by my way of thinking respect in this case means clearly communicating the goals of your seed program, the milestones you expect a company to reach to obtain follow on financing and what help an entrepreneur should expect along the way. From there everyone is free to make their own choice of who they want to work with and under what regime.

And for the record, I don’t at all like the “we’ll sell our investment back to the company” if we’re not supporting them with a future financing. If your VC requests that of you right after telling you they’re not going to continue to fund your business I’d suggest you offer them $1 for their trouble. And I’d be happy to suggest the proper finger to use when emphasizing the single dollar you had in mind…

September 16th, 2010     Categories: Uncategorized     Tags: ,
  • hdemott

    I tend to agree with you – and I wrote a lengthy comment on Brads blog when he posted on the subject.

    What it really comes down to is whether you are a sheep or not.

    If you are a sheep then there is a real signaling issue.

    If you do your own work, come to your own conclusions, make your own decisions – and have partners who are similar in their thinking and trusting in each other – then it doesn't make a damn bit of difference who is in the deal.

    I got into Pandora after Tim Westergren had been raising money for 5 years. The investors who were in there were Walden VC, Crosslink, Selby and Labrador. All of these are good investors – but none of them at the time was huge or one who signaled that others should follow. Now that it is successful, we have GGV, Greylock, and if the press is right Elevation. And those are just the guys who got in – the interest has been pretty wide.

    I was investing from a hedge fund in NYC – with no VC contacts. I would argue that I was a negative signal – a sure sign that the professionals had left the field.

    Go figure.

    I've written it before – in order to be truly successful in investing – you need to be willing to be wrong and alone.

    You never run into a signaling problem that way

  • sethlevine

    Amen. And the example is very illustrative. I think part of my strong reaction here relates to my unbelievable distaste for VCs that act as sheep (and lets face it – most do). We had a similar example to the Pandora story you relate above, where we recapped a company that all of the other investors had abandoned. It turned into one of our biggest winners (both because it was very successful and because we ended up owning a large percentage of the business after all of the other investors bailed).

    As you say: "If you do your own work, come to your own conclusions, make your own decisions – and have partners who are similar in their thinking and trusting in each other – then it doesn't make a damn bit of difference who is in the deal."