One of the concepts we emphasize at Equidam is the inversion of qualitative and quantitative factors in startup valuation, as you go from Seed1 to pre-IPO funding.
The archetypal Seed startup (perhaps just an idea) has nothing to measure. Investors must use their imagination, peer into the future, project a scenario. On the other hand, a startup raising the last round of private capital before an IPO will be weighed and measured almost entirely on financial metrics.
Even as early as Series A you have access to some useful data. Can they actually build the thing? Do customers really want it? Does anyone want to work there? All sources of rich signal to help you make an objective decision about the company.
Seed is different. Success comes down to the quality and consistency of your subjective, independent judgement. In many ways it is a unique discipline within the strategy of venture.
What happens if you try to find a path in the data?
You find…
- Great founders can look like anyone
- Great startups can be based anywhere
- Almost all of the dogma is wrong
- Consensus is a value-destroying trap2
- Confidence is a value-destroying trap
- There are no easy answers
Essentially, it’s a hunt for outliers with no shortcuts and two specific qualifiers for any investment strategy:
- Any attempt to pattern-match to past success is going to dramatically limit your pool of opportunity, with no clear upside.
- Any constraints built into your investment strategy (sector, region, industry) are essentially a sacrifice of volatility (potential alpha).
Thus, the ideal Seed investor is likely to be a generalist, with no preconceptions about what great founders look like, where they come from, or what they might be building.
Rather than the hubris of a (supposed) rockstar stock-picker, Seed investors will find confidence through constructing solid processes, systematically rewarding good decisions and mitigating bad ones.
They wont necessarily benefit from operational experience, but they will benefit from being able to recognise a good business. Indeed, some basic financial principles, often overlooked by today’s managers, can help uncover the potential in novel opportunities.
Finally, and perhaps most importantly, they’ll have a firm grip on the biases which manifest in all forms of investing. Particularly the curse of overconfidence which erodes the positive influence of success.
In summary, considering all of the above, we should expect Seed investors to present with an idiosyncratic worldview, some robust fundamental skills and an appetite for risk.
Sadly, reality is the opposite: Seed investors are often risk-averse herd animals with little real competence. They have Rick Rubin-esque affectations, pontificating on ‘taste’ and ‘craft’, while copying each other’s homework and hiding deep insecurity.
Why? Predictably, it’s the incentives.
In the last 15 years we’ve seen the emergence of a Startup Industrial Complex, where a treadmill of capital, services and brand-strength was offered to participating firms and startups. If you wanted quick, reliable markups and easy downstream financing for your portfolio then you hopped on board.
This movement destroyed the institutional contrarianism of Seed investing. Billions of dollars were piled into safe SaaS money-printers when capital was cheap. When the market for safe investments was saturated, investors responded by dumping huge sums of capital into silly ideas (remember NFTs?).
That’s “risk”, right?
This worked during ZIRP, because everything was going up and to the right. Public markets were so cracked-out on COVID and cheap capital that they grabbed anything at IPO. But it was never going to last.
Seed VCs (and their LPs) need to recognise that role is, and always has been, to find breakout companies before they are obvious. Not to compete for deals. Not to seek validation from colleagues. To find those outliers. To be uncomfortably idiosyncratic. That’s it. That’s everything.
Critically, while it may lag by a decade or so, everything else is downstream from Seed.
The entire venture capital strategy depends on Seed investors doing their job properly. The entire premise of venture-backed innovation, and the promise of venture-scale returns, are entirely dependent on the health of Seed.
(image source: “Venice; the Grand Canal from the Palazzo Foscari to the Carità ”, by Canaletto)
- Pre-seed isn’t real [↩]
- There is a variety of perspectives you can use to confirm this. [↩]