A while back, Chris Dixon wrote this post about signaling effects in seed stage investing. I’ve come across a few entrepreneurs lately who have articulated this point of his:
“Don’t take seed money from big VCs – It doesn’t matter if the big VC invests under a different name or merely provides space and mentoring. If a big VC has any involvement with your company at the seed stage, their posture toward the next round has such strong signaling power that they can kill you and/or control the pricing of the round.”
While Chris makes a few good points in this article, I disagree with this one wholeheartedly.
At Highland, we do a ton of seed investing. In fact, the first floor in our office outside of Boston is an entrepreneur center where we host new companies. (We also have something similar in our Silicon Valley office.) These companies have included Quattro Wireless (acq. by Apple), Generation Health (acq. by CVS/Caremark), and Gemvara (still there), as well as many others. We’ve also seeded quite a few companies outside of our offices and have seen those companies go on to raise follow-on financings, some of which we’ve led, others of which we haven’t.
The trend I’ve seen with these deals is that signaling is a concern, but a paltry concern compared to everything else. Why? Because there are many good reasons to take a quality venture firm’s money in a seed round as well:
#1: We can help where many others do not.
We’re professional investors who make a living out of helping our startups. That help may come in the form of a customer intro, a referral for a new hire, advice on tactical issues, etc. Because we don’t usually take a board seat for seeds, the frequency of our interactions is a bit lower, but we try to make those interactions as substantive as possible. After all, the seed is a “get to know you” period, and we know we have to work hard during the seed to earn the right to invest in your Series A.
While there are a lot of excellent angel investors and “micro VCs” out there who work hard for their companies, you’d also be surprised how easy it is for others to write a check for $25,000 and wait it out in the wings.
#2: The perfect shouldn’t be the enemy of the good.
Let’s say the VC who participated in your seed chooses not to lead your Series A. This will raise a red flag for some firms. Some may pass on your company because of it. I say, “Eh.”
Why? I’ve still never seen a company get funded that didn’t fail one of these criteria:
- Perfect team
- Perfect market
- Perfect product
- Perfect deal
Venture capital is a fairly mature industry, and the market is pretty efficient. If #1-3 work out, #4 will almost certainly not. This is the reason companies like Quora can raise their first institutional round at extremely high valuations.
A non-participating insider is another form of a sub-optimal deal. However, if #1-3 are still true, that deal might get done. And, by the way, these criteria are incredibly subjective. One VC’s opinion doesn’t necessarily determine another’s, and the market is big enough that actively engaged VC’s may think differently about the same company.
Again, I’m not ignoring that signaling exists. I’m just saying it doesn’t matter as much as the blogosphere would like it to.
#3: Signaling is only bad in the downside scenario.
We’re all playing to win here, right? When you take money for a seed, your sole objective should be to give yourself the highest probability of success, to put yourself on the strongest footing for your Series A.
If you’re killing it, you’ll probably have multiple Series A term sheets, regardless of whether your seed VC participates. You should be less concerned with what happens if things don’t go so well because, in that situation, you’ll have bigger problems than a VC who doesn’t want to participate.
Like most things in life, you have to weigh the pro’s and the con’s of your decision. You may think signaling from a mainstream VC is a con, but don’t forget all the pro’s.
Your choice of a financial partner is extremely important, but my view is that you should choose the people who will help you the most and will be partners in building your business. Whatever bucket they put themselves in (angels, micro VCs, macro VCs) doesn’t matter as much.
Play to win, and pick the partner who will maximize the value of your equity.