How We Think About Seed Investments

by on January 31, 2013

Yesterday Allocadia announced their $1 million seed round that we were excited to participate in. As a question we often get asked, I thought that it provided a good opportunity to share iNovia’s approach to seed deals.

These days it seems like every fund, no matter the size, is writing checks to participate in seed rounds hoping not to miss out on the next big thing. As an entrepreneur it is important to understand the intentions a fund has in making these seed investments. There are 2 main things to be aware of:

  • The Signaling Issue. One of the toughest things to combat when raising capital is explaining to potential investors why a current investor with plenty of money (ie. a large fund) is not participating.
  • The Party Round. When venture capital funds are writing small checks in a seed round it generally means that there is no one really leading. In other words, when things get tough and the money is running low you may find that everyone has left ‘the party’ and no one wants to pick up the tab.

It is important to note that there are dedicated seed funds. Some of these investors will participate in follow-on rounds while others take the position of never participating in future rounds as to completely remove the signaling issue. The important thing is to clearly understand the policy, and more importantly, the behavior of the fund before you accept their investment.

Larger VC funds will take one of the following 3 approaches to seed investments:

  • Don’t participate in seed rounds. These funds focus solely on the Series A or later rounds and have substantial investments in every portfolio company.
  • Take a shotgun approach to seed rounds. A number of larger funds ($200M+) will write anywhere from 10-50 small checks ($50K – $250K) with no intent of following on with additional investment. They then have an inside track, essentially buying an option, in identifying the out-performers and will step up on a small number of them in a Series A. The main attraction to an entrepreneur in taking these investments is the brand recognition a large reputable fund brings. However, some entrepreneurs have started taking the position of keeping these funds out of future rounds.
  • Treat seed investments no different than larger investments. Some funds are comfortable getting involved in a company at a range of stages and treat them all the same. This includes allocating future capital for follow-on investment, publicly referencing the company and putting time, effort and resources in to supporting the company.

iNovia takes the position that we feel creates the most alignment with entrepreneurs – treat it no differently than any other investment. This is aligned with the approach of funds such as True Ventures, Foundry Group and Greycroft. We view any investment as the beginning of a partnership with the entrepreneur and that includes allocating additional capital for the company. We are comfortable with a seed investment as small as $250K, but generally they are $500K-$750K.

This doesn’t mean that every seed investment will result in additional capital from us. Sometimes a product-market fit is not found or the business model is not validated and it is time to pack it in. However, even in this case there is sometimes a mutual decision to go after another opportunity. A great example of this in our portfolio is Chango. The business we initially seed funded did not materialize – it happens, seed investments are risky. However, we made an additional investment to support Chris Sukornyk and his team to go after a different opportunity that has evolved in to a thriving company.

It is never too early to reach out to us as you are building your company. There are many factors that determine the stage a fund commits to a company, but one thing is true in all cases – it starts with building a relationship.