The VC Seed Bogeyman

22nd November, 2012 No Comments Blog , Fundraising , Venture Capital

There is a popular discussion, which occasionally becomes a debate, about the risks inherent in taking seed financing from a venture capital firm (as opposed to taking it exclusively from angel investors).  The most commonly-cited “risk” is that of signaling:  if the VC firm does not invest in the company’s subsequent (Series A) financing, no one else will.  Prospective new investors will assume that the seed VC, who theoretically has better information by virtue of its investor status, feels the company is no longer viable and therefore must be correct.

I believe signaling is a risk and that it is worth taking.  There are three possibilities, broadly speaking, as to the performance of a company after taking seed financing.  The first is that the company performs well.  In this case, having institutional backing is nearly always a good thing; a VC firm can speed the Series A fundraising process, making a quick decision to provide additional financing and/or warm introductions to potential co-investors.  The next possibility is that the company performs poorly and has little prospect of recovering.  In this case, the VC firm may not invest in the next financing, but then, arguably, the management team should probably move on.  The final possibility, which is very common, is that the company’s performance is mixed.  In this case, attracting outside investment will be very difficult, and angel investors may not have capital to provide additional financing, but a VC firm that still believes in the company may continue to support the company.

It is true that an angel-backed company that does not perform well may be able to attract new investment by sugar coating the reality in a way that it could not with an institutional investor.  But then, there is no guarantee that this approach will attract new investment, and I suspect that most entrepreneurs would prefer to have a faster path to growth capital if they perform well than a better chance of raising a smokescreen if they do not.

There are some real risks of taking a seed investment from an institutional venture firm which I’ll cover in my next post.

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