Venture Capitalists Will Overpay For Seed Rounds But For Reasons You Likely Haven’t Considered
Do you know the parable of the Blind Men and the Elephant? The lessons of one’s subjective truth stuff espoused as an wool one based on their own experiences carries vastitude zoology. So when I tell you what I’m seeing in venture financing these days if you disagree with me, it might just be that we’re touching variegated parts of the elephant.
Like parenting a toddler coming off a sugar high, the last 18 months of startup worriedness has been marked largely by tears, shrieks, and occasional throwing of toys. And while I’m quite optimistic well-nigh the coming years, we’re not yet through the pain for many existing companies navigating the transition from a hypergrowth market to one which rewards a variegated style of operating. Haystack’s Semil Shah wrote up his POV on what this has all meant for the seed market and one point in particular unprotected my eye. Semil asserts,
Seed-stage valuations have often been left-unchanged, and I could oppose plane they’ve gone up since the whence of 2022. Looking when now, it makes sense – VC firms have lots of dry powder, and while they may have slowed lanugo relative to 2021, they’re still making investments. Early-stage is perhaps a increasingly lulu stage to deploy smaller dollars these days – a friend remarked everyone wants to gamble, but no one wants to sit at the whale tables just yet.
I think he and I are touching the same region, but variegated parts, of the elephant, so here’s where we differ (and all of this is “AI Startups excepted” obviously).
A. Valuations for the Top Decile of Seed Startups Have Fallen Less YoY While the Second Decile Have Been Hit Harder. I’m defining Top 10% and Second 10% as “degree to which their founders, markets, and milestones pattern-match for the stereotype seed investor.” This is obviously imperfect and to truly segment quality would take 10 years. But think of this as equivalent to stereotype salary of Top 10 picks in the NBA typhoon vs picks 11-20. I’m saying that 11-20 were hit harder by the downturn where as surpassing they were often evaluated similarly by the venture polity and rewarded commensurately. Whereas at peak of the boom, picks 1-20 were often raising the same (or substantially similar) rounds.
Why are the Top 10% less impacted? Well, the obvious reason is they squint like largest risk/reward opportunities, but I think it’s moreover considering often the largest trademark name firms are doing the Top 10% deals. They have stable wanted bases, superintendency less well-nigh the variegated between a few hundred thousand dollars in entry price, and so on. So to protract my NBA example, let’s say you basically only had Big Market Teams making the top typhoon picks – salaries would be higher right considering they could pay increasingly (no player salary cap in venture ).
Reminder: I’m not saying the Top 10% of seed startups are, startup for startup, largest than the Next 10% – that gets figured out later.
B. It’s Changing Venture Portfolio Models Towards Concentration, Not Just Dry Powder/Gambling. Gotta own unbearable of your winners. Nothing is increasingly true in venture but this math got a bit perverted during ZIRP. When $20B outcomes occur everyone on the cap table eats well. When it’s $2B, you largest have gotten your ownership. It’s just math. Funds, expressly new ones, who believed otherwise are now preaching greater ‘concentration’ and at seed, this creates a floor on valuations. Why? Considering you start to superintendency increasingly well-nigh understructure points than the forfeit to get those understructure points. In order to get your 5%, 10%, 15% target you’re willing to increase round size and valuation a bit to make the math work for the founders and any other investors they want to include.
Curious what part of the seed market elephant you’ve been touching and where you agree/disagree