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A lack of help from investors in the early stages keeps entrepreneurs from reaching their full potential.
4 min read
Opinions expressed by Entrepreneur contributors are their own.
Seed stage is the time of highest risk and greatest challenges for a startup, and yet that's the time when founders receive the least amount of help from investors. There is no shortage of money out there, but what is desperately missing is an investor approach for seed stage entrepreneurs that preserves the craftsmanship of company building from experienced operators and investors while preparing founders for the rocket fuel rounds the megafund VCs are now focused on.
Related: Avoid the Seed-Funding Surge Trap With These 8 Tips
Most of the Tier 1 venture firms have evolved to a megafund model, raising enormous sums of capital every couple of years. With funds that large, it has become impossible for the experienced investment partners to spend meaningful time with seed stage portfolio companies. There's also a tendency for these bigger firms to jam more money into their early companies, thereby diluting founders excessively. Entrepreneurs should be wary of both.
Contrast that with seed-focused funds and accelerators that do specialize in early stage entrepreneurs. Most have taken on a volume strategy, spraying money into high numbers of companies hoping to catch the next Snap or Facebook. The strategy is to cover every square on the board so that they don't miss out, but the high volume approach limits them to providing capital but not enough support.
This is especially tragic for early stage founders. The seed stage is unique. Entrepreneurs need to quickly make correct strategy decisions regarding the initial use case, market segmentation, product direction, pricing, messaging and go-to-market model. They have to perform nearly flawlessly in hiring, customer acquisition, sales and business operations. Doing all of this at a high level of skill is often the difference between wild success and brutal failure. It's not easy, even for experienced operators.
Related: 5 Essentials for Maximizing Results From Seed Capital
The right foundation needs to be built before taking on the bigger money and expectations of a Series A round, at which point investors will expect demonstrations of consistent growth. Taking on too much money at the earliest stages but not being ready for it can be disastrous for a young company.
Founders should be turning to their investors for help navigating challenges but today's venture ecosystem has evolved such that entrepreneurs aren't getting the service they need. Systemic changes to the VC industry definitely point to a need for a different approach. Among them:
1. The number of angel investors, incubators, and micro VCs -- many of whom lack the investment or operational track record of building franchise companies -- has increased exponentially.
2. Seed investing has ballooned over the past decade. In 2007, there were a total of 655 seed and angel investing rounds totaling $1.25 billion in the U.S., according to Pitchbook. Last year, there were almost 4,000 seed and angel investing rounds with $7.8 billion invested.
Related: 12 Tips for Finding Seed Funding, Starting With a Close Look at Your Pocket
3. Tier 1 firms claim to be committed and expert at investing in all stages, from the earliest seed stage all the way through to late-stage growth rounds. It defies the very thing all VC's preach to founders -- focus. Specialization is what enables optimal support.
4. The percentage of seed investments that converted to Series A rounds used to exceed 50 percent, but in recent years that number has dropped below 20 percent, according to an analysis of Pitchbook's data of seed funded companies and Series A follow-ons from 2006 to 2016. The volume approach has driven up the supply of funded companies while the lack of quality guidance has decreased, which has contributed to a drop-off in the ability of these companies to advance to the next round.
5. Doing venture capital at a large fund means the job has shifted from working closely with entrepreneurs to help them turn ideas into companies to chasing down entrepreneurs and selling them money for scale.
Every industry needs innovation, especially venture capital, and it's time that some new approaches to VC be developed and implemented quickly.
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