The last decade has seen a growing number of top tier venture funds increase their fund size to many $B’s of AUM and expand their investing activities to all stages. (Seed-Series X) We refer to these firms as Mega Funds. With so much capital to deploy, many of these funds are forced to allocate the majority of their bandwidth to big, later-stage deals, while using seed investments as option tickets for later rounds.
This phenomenon has an increasing number of founders asking whether or not they should accept seed-stage capital from well known Mega Funds. There are obvious advantages to working with a Mega Funds but also some potential misalignment. Below you’ll find some thoughts to consider in your selection process.
Taking seed capital from a Mega Fund is an effective way to validate your idea in the market’s eyes. People generally think of Mega Funds as “smart money” and their seal of approval will, without a doubt, increase a start-ups status. More importantly, though, recruiting talent will become far easier, as many talented employees use “strength of syndicate” as a highly weighted factor in their decision making process.
The most cited reason seed-stage founders tell us they want to work with Mega Funds though is the ability for the fund to lead many of the company’s future financing rounds. This, in theory, will make fundraising far easier and free up the founders time for other company building efforts. While this can be true, in practice it’s more complex and nuanced. In the same way that receiving investment from a well known Mega Fund can validate your startup, it can also have the inverse effect if the Mega Fund decides not to lead or participate well above pro rata in your next financing round. We commonly refer to this as signaling risk. When it comes time to raise your next round of capital and investors see that a Mega Fund on your cap table is not stepping forward, the new investors will suspect there is something awry. The Mega Fund has a smart team, they’ve been privy to all relevant information about your company, and they have TONS of cash. If they don’t want to do the deal, why should anyone else? The departure of the Partner who led the deal, a change in investing focus, and a competitive portfolio company are all valid reasons why a Mega Fund may not step forward and lead, but nonetheless, this situation makes fundraising significantly more challenging for your start-up.
Before taking investment, we recommend that founders have a clear conversation with the Mega Fund about exactly what it will take for the firm to lead or participate well above pro-rata in the next round. Based on what is said, it’s up to you to determine how confident you are in your company’s ability to hit that plan. If the odds of hitting the plan are fair, it makes tremendous sense to bring the Mega Fund onto the cap table. If there is significant uncertainty in your ability to hit the plan, tread carefully, and consider working with seed-only funds. Since seed only funds invest solely at the seed stage, there is never an expectation from the market that they will lead the next round. (no signaling risk)
Reference checks with other founders are the best way to predict how much attention you will receive from new investors. If reference checks are not an option, looking at the size of the investment offer as a % of fund size can be a useful heuristic. If a $2B fund offers to lead your seed deal with a $2M investment, they will have 0.1% of their capital tied up in your company. Compare this to a $75M seed fund that commits the same size check; they will have 2.67% of their capital in your business. (a 26X difference) While both investors are likely well intentioned, the team from the $75M fund is far more aligned to dig in and try to make a difference. It’s important to note that some Mega Funds combat this with dedicated “seed only” teams who focus all of their time on the seed portfolio.
Understanding who your company’s point of contact will be at a Mega Fund is an important variable to factor into your decision as well. Mega Funds often have hyperconnected and experienced investing partners that can add tremendous value when engaged, but it’s not uncommon to see more Jr. members of the investing team representing seed investments for the firm. Jr. team members can be rising stars with extra bandwidth and enthusiasm, but likely carry less influence on the investment committee to approve follow on investments. Primarily working with a more Jr. investing team member is not necessarily a bad thing but a good topic to have a clear discussion about before entering into a partnership.
If you do plan on taking a seed-stage investment from a Mega Fund, make sure you understand whether you will have access to their full suite of platform resources. It’s not uncommon to see different levels of engagement between seed investments and larger later-stage opportunities.
Accepting seed capital from a Mega Fund is more often than not the right thing to do! Just make sure to talk through all of the dynamics explained above and keep alignment top of mind as you make your selection.