By Matt Cohen
With the VC market as frothy as it is and investors chasing growth in earlier and earlier stage funding rounds, nascent startups are facing pressure to “grow up” faster and act more like later-stage companies.
The ballooning of seed rounds has led to seed companies acting like Series A companies all the way down the line to Series C companies acting like publicly traded ones. This wasn’t always the case, but the trend is here and won’t be going away any time soon.
Over the past few years, the amount of venture capital being deployed at early stages has continued to skip over traditional round dynamics one step at a time. Pre-seed rounds used to average $1 million-$2 million, and are now averaging $4 million-$5 million. Seed rounds used to average $4 million-$5 million, and are now averaging $8 million-$10 million while Series A rounds that used to average $8 million-$10 million are coming in at $25 million or more.
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This deluge of capital has forced startups to start acting like they would at later rounds because growth investors (and their expectations) have entered the early-stage arena.
The United States money supply, known as M2, has grown 39 percent since the Federal Reserve and the government intervened in the economy in March 2020. With such an increase in money support, it’s no shock to anyone that asset prices are highly inflated especially in riskier investment areas like early-stage VC.
But with more capital comes more risk and responsibility for those founders who accept those inflated investments that are hitched with expectations for higher returns.
This trend cuts both ways. The due diligence that funds place on founders is also moving in reverse as founders—who have traditionally not been able to be very selective in choosing their capital partners—are increasingly vetting funds in order to attract the right capital. Seed investing used to be (and according to some VCs, still is) about getting into the weeds and figuring out what works for each individual company, particularly during the formative period before they’ve fully settled on a product or service.
Recently, as late-stage funds have become more active in early-stage investing, attempts at simplifying this process by slapping on one-size-fits-all solutions that have worked for other companies are becoming more prevalent. That can be problematic for founders even if it goes hand in hand with increased availability of capital. At its worst, a vicious cycle can emerge if a founder tries to follow that kind of lead because they feel beholden to a huge investor, and that lead isn’t actually tailored to the kind of company they’re trying to build.
To avoid that situation, founders should keep early-stage investors who are intimately familiar with the mechanics of testing different startup business models within their inner circle of advisers, and on the flip-side they should maintain perspective on the extent to which later-stage investors who arrived to juice their seed round may be primarily capital providers whose advice may not become truly relevant until a later stage of growth.
In the broadest terms, founders may find that some of their investors are experts in the pre-product phase of building a company, while others are well-versed in how companies can grow once they’ve already figured out their product and found a viable business model. We used to be able to call the former early-stage investors and the latter late-stage or growth investors, but even with those lines blurring, founders should keep the distinctions in mind in order to keep their most relevant advisers close at hand even as they accept more capital than startups at their stage of development have in the past.
At the same time, the very best founders are those who are able to get ahead of the curve by laying strong groundwork of corporate governance, hiring and product development, so that when the inflated checks from growth VCs arrive they’re prepared to jump into gear.
How many of this current crop of early-stage startups fit this bill and will be able to leverage the current flood of capital in the market to grow faster than average remains to be seen, but one thing is certain—the ones that pull it off will be disciplined and leverage the expertise of the right investors at the right time.
Matt Cohen, founder and managing partner at Ripple Ventures, was founding investor of Turnstyle Solutions, which was acquired by Yelp in 2017. He is a frequent contributor to Crunchbase News, having written about why more VCs are becoming startup founders and other topics.
Illustration: Li-Anne Dias.
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