What's happening at the seed stage? Featuring Jenny Fielding, Kirby Winfield, and Nate Williams

0:00Welcome back to another episode of Venture Unlocked, the podcast that takes you behind the scenes of the business of venture capital. This week, we're doing another special roundtable discussion with a focus on the seed stage market. Joining us are Jenny Fielding of Everywhere Ventures, Kirby Winfield of Asset, and Nate Williams of Union Labs. During our conversation, we spent most of our time discussing how the market reset affects seed stage decision making, fund sizing, and reserve strategies. We also touched on what they are seeing and hearing from LPs that invest in seed funds. Whether you're a founder, GP, or LP, I think you'll find it to be a nice comprehensive discussion that provides a ton of valuable insights into early stage VC.

0:39Let's get into the episode now. If you're a venture investor, then I'm sure you already know about Sidecar, the go-to platform for emerging VCs to manage their SPVs and funds. Sidecar is on a mission to make private markets more accessible, transparent, and liquid by standardizing how investment vehicles are created and executed. Their powerful and robust software allows VCs to launch SPVs and funds instantaneously, track funding in real time, and offer hassle-free opportunities for early liquidity. Whether you're syndicating your first or 50th deal, Sidecar acts as your silent operating partner, handling all back office functions in a single place.

1:17Sidecar always has your back so that you'd never have to worry about chasing subscription documents, lost wires, or late K-1s. Sidecar's responsive and proactive customer support team is there to assist you, helping you build trust with your investors, and tackling the challenges of building your firm. To learn more, visit sidecar.io forward slash venture unlocked. Samir Kaji is the CEO and co-founder of Allocate. Allocate and Venture Unlocked are independent of each other. Any statements or references made by Samir or his guests regarding third parties, investments, or securities are solely their views and opinions and are not intended as investment advice or an endorsement of such parties or securities by Samir, his guests, or Allocate.

2:00Allocate or its clients may maintain relationships with or investment positions in guests, third parties, or securities mentioned in this podcast. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. I'm joined by three great seed stage managers that really have the ear to the ground of what's happening in the seed environment. And today really is going to be a really open RIF discussion about seed, what we're seeing, both from the founder perspective as well as the GP perspective. And then we'll end with what LPs are doing. So I want to start off with maybe a statement of what we've seen over the last decade.

2:39So over the 2010s, we saw a lot of emerging managers come into the market. The seed stage part of the industry really explode in terms of the number of deals, the number of funders. And of course, over the last couple of years, we've seen a dramatic change in the environment, both in terms of follow-on financing, the bar that entrepreneurs need to meet to get that follow-on financing, and the number of players that play in seed. So I want to start off with, maybe I'll start with Jenny to start, is what are you seeing on the ground and how have things shifted for you in 2023 versus pre, let's call it 2022 when the world changed?

3:17We're obviously affected by the tech downturn, even at the earliest stages. So while we're still seeing incredible amount of innovation and great companies, I'd say, you know, the bar to get funding at all stages is being impacted. In addition to there being less capital coming in, another trend that we're seeing is what we call this flight to quality, where there's a certain demographic of founder who's able to attract more capital, higher valuations, kind of maybe typical 2020-2021 setup. And that's really providing almost a bifurcation between these two groups of founders. So the first-time founder, maybe the founder that's not in San Francisco, the founder that's not building AI, really struggling.

4:03And it's taking a much longer time for them to close their rounds. And oftentimes, they kind of have to cobble it together. So I'd say, you know, the first trend that we're seeing is there's less capital and we're feeling that, you know, our founders are really feeling that. A round that may have taken a few weeks to get together are now sometimes taking months, literally, to get a million dollars together. When you look at that and say, you know, there's a first-time founder and actually some of the best companies historically were actually started by people that were first-time founders, not just repeat founders, is that because the rounds are taking longer and the funding for those companies is probably less, lower valuations.

4:43Yet you're also against the backdrop of a million dollar round may not get company far enough to get the next round of capital. What does that actually mean for that first time founder? And how are you prosecuting on looking at opportunities that are not those bifurcated second time founders successful? Yeah. So, I mean, we have a rubric of what we're looking for in founders. At the pre-seed, there's really not, there's no metrics. And so we're looking for, you know, the founder characteristics. And so if we can pressure test things like resilience, do we think that they're a fast founder? You know, some of the other data points that we're looking are, we're completely happy to be that first round of capital.

5:22We're happy to lead, set the terms and hopefully, you know, syndicate with other folks. And then what it's meant for us is that we actually have to do more work because we'll develop conviction early. And then we have to kind of call all our friends who are, you know, many on this call and say, hey, you know, we have a lot of conviction in this company, you know, you should take a look. So I think one of the things that we're seeing is that the investors have to step up and really help these first time founders get their rounds together. Now, luckily, there's a lot of capital out there. And it's very collaborative at the early stage, there's really no sharp elbows.

5:55That's a great thing, because the investors can make a real impact on the round. So I'd say that's one of the trends that we're seeing and one of the ways that we can lean in. Yeah, I mean, I think to Jenny's point, at pre-seed two years ago, we were generally expecting a mark within six months. The capital requirements were actually much lower at pre-seed. It was easier to fire quickly and maybe you didn't have to syndicate as much. And that phenomenon is largely gone now. So we have seen even pre-seed round sizes go up Like Jenny, we're looking for friends, often seed friends, to come in, if we're a$500K check, for them to come in with$1.5K, so we know we can get that pre-seed into a seed, which is generally taking a lot longer now.

6:42If I can offer a takeaway, Samir, just real world, is if I think of our mentality at Union two years ago versus today, just in terms of the heuristic by which we look at a founder, two years ago, we were less focused on were they amazing fundraisers because the market was sort of taking care of itself. I would tell you point blank, 100 % real, like I will not invest in someone right now who cannot convince me that they can raise follow on capital because it's too hard. So the basis of union, I've been on venture a lot before, was that we thought in an entrepreneur's journey in the first 12, 24, 36 months, there are two to three crux events every year.

7:26They're either product, team or go to market. And that's where we lean in besides capital to do it. Now I'm adding kind of a third leg to that stool, which is fundraising. And so one of the benefits that Jenny and Kirby, myself have here that we can avail our founders to is we are in market literally every day, every week, every month fundraising with our teams. We're seeing the micro changes from month month and quarter and quarter in terms of valuations and what series A appetite is. And I think this market you asked us to classify it, I would say this is a very turbulent market right now. Like the only constant right now is change.

8:08If we talk about this now in February, I guarantee if we record this in April, it'd be hella different. We have increased the frequency of the AMAs that we host for our founders in our portfolio. And we've also increased the percentage of those that are Series A VCs from the Valley. We're up here in Seattle, primarily. Our founders are kind of known for maybe cooking their steak, but not selling a sizzle. And as things tighten up, we're really, really cognizant. And I'm a former founder who raised venture semi-successfully twice, but also missed Series A twice. And so from painful personal experience, I wish I had more exposure to those investors.

8:50and I was constantly tracking what they were thinking and what they were looking for, where that bar might be, although they will never really tell you where the bar is. And I know we all know it's, you just see it, but there are some numbers that you ought to be hitting. And so we try to expose folks to that, like Native's vet. Let's actually go a little layer deeper, if you don't mind. So Kirby, you mentioned something earlier that, particularly in 2021, I think that most people would consider 2021 to be the peak of the peakiest in terms of activity, and pretty much all asset categories, but certainly venture, is that you had companies that were raising six months after receipt.

9:28So go from seed to series A, often with a step up in valuation that was sometimes 5x plus. Without a lot of tangible progress of the company, there's maybe a nicer narrative, but there wasn't too much. Now it's more that kind of 12, 18, 24 months. And what people are looking for is more than a narrative, but real tangible progress from that C to the series A. So maybe talk a little bit about how you're underwriting that time period because the goalposts do constantly move and goalposts might be different two years from now than what they are today. And then how do you help that? What are you telling founders to do during that timeframe to ensure a higher probability of getting that series A around?

10:08Yeah, we're trying to untrain some of the habits that folks got during that kind of ZERP period, one of which was raise a pre-seed, find a founding engineer and another co-founder and build an alpha and raise a seed or raise a seed, build an alpha, raise an A. Now things have changed. You're not going to get credit for just making product progress or hiring the team or just changing the story a little bit. You need commercial traction. I mean, in almost every case, although we invest in AI and sometimes that's an outlier, but you need commercial traction. At the same time, I've seen people overcorrect.

10:42And try to start selling before they have an ICP or a product that matches a problem or even have really figured out what the problem is that they're trying to solve. And so we always say, look, after I write my check, the last thing I want you to do is grow. Don't grow right now. Even if you have some revenue, please don't grow. take a minute and really dig into your customers and really understand okay optimize for metrics that will get you to non-churning good revenue when you need to go because what what we're solving for here is the amplitude of the of the revenue growth into the egg not the raw number of the revenue i think we see way too many people go out way too fast and all their network because good founders have a network, they can dial a friend, and they can get to a million in ARR.

11:36But is that real revenue? Is that good revenue? Is that revenue going to churn? And did you do that in the first six months after your seed? And now it's plateaued? Because that's a very different million dollars than one that you ramp into in the six months prior to raising your A. And so we're really trying to work with founders to help them shape the revenue to support a growth story that actually matches with what investors are looking for. Yeah. And Jenny, maybe I was going to just point to you a little bit on this particular topic. You know, a lot of the folks that you're funding are likely people that have never actually been through a true economic reset up until this last one, right?

12:14So last one was 14 years ago, 15 years ago, almost. You know, sort of the DNA that was built, whether it's Silicon Valley or just tech in general, was you grow at all costs, you grow really fast. And eventually, you figure out things like economics, insurance, and you have a product. How do you change that? And maybe, you know, you have a few thoughts on what Kirby mentioned, but also, how do you change that behavioral DNA where it's not just about the valuation, how much you raise, you know, and from who it's about building a durable business? Yeah, I started my first company in 2008. So you can do the math of what time that was.

12:50There was no venture capital in New York. There was hardly any capital, right? So it was just a different time. I bootstrapped my business while I had a full-time job at J.P. Morgan, right? And when we had revenue, I quit my job. You don't see that too often. So there's been a whole, as you say, deprogramizing of this generation of founders who kind of right out the bat expect that they can raise capital. That's only a relatively new phenomenon. Many of us had to get to profitability or we had to control our own destiny in the early years as well. So I think there's been a little bit of a swing, maybe too much in that direction.

13:26We want folks to take venture capital when they can use it as rocket fuel. But bootstrapping for the first 18 months is not a bad thing. To Kirby's point, I just wanted to throw in that one of the things that we're trying to coach founders with is the reality is we're seeing sometimes up to five rounds before the Series A, right? So we have the angel, you know, friends and family, we've got the pre-seed, then we have the seed, we have the top-up, we have the post-seed, and then maybe we have the A. So if you go out with that friends and family at a$15 million valuation, where does that leave you, right?

14:03How are you going to have step-ups or get to, you know, grow into that if you're starting so high? So one of the things that we're trying to tell founders is it could take you a number of rounds. We're realistic that it could take four to five rounds to get to an A. And so how do you kind of pressure test your business to figure out, you know, what are those levers that I can get some metrics where I know I'm going to be able to raise because you just can't start with an unreasonable evaluation. So I think that what's happening now with this reset is actually quite healthy. And we can go back to pre-seeds being priced in the, you know, say five to eight size instead of, you know, this kind of 10 to 15, which we started to see, which is really just unhealthy.

14:44This is a finance show. And I know sometimes it's, you know, third rail to talk about seed managers debating finance. But I think something in this current conversation, the seed market that gets missed is the interdependence between the private markets and the public markets. So basically, the product that Jenny and Kirby and I have with our funds is effectively a private market investment product that cascades its way eventually to public markets. And so, Samir, you're a student of finance. You understand this lack of liquidity in the public markets, the IPO window not being open, the lack of DPI.

15:20That type of heuristic discussion with an entrepreneur almost never happens at sea. But now a conversation just to pick on what Jenny was saying to build off that is I have to talk to a founder about the attitude of a series A investor who may not have a crossover fund at series B next to that. So when they're thinking about one of our investments, they're not only thinking about entry price from union, they're thinking about who is the Series B investor or a Series C investor if it's capital intensive to get this out. And so I think that mathematics is extremely, it's not exogenous. It is very important to how these companies are underwritten.

15:59to Jenny's point, what I would say, we're talking to our founders about appropriate stages of capital, appropriate prices when you look at historical data, and also how much miscritic mitigation per dollar, risk mitigation per dollar. If you raise a million and a half dollars in a pre-seed, what metrics actually get accomplished with that million and a half that make the business more likely to be sustainable? And then Jim, one last thing, I want to give a shout out to Charles Hudson at Precursor, I thought he wrote an unbelievable article about changes in the Series A graduation rate. That is reading that anyone in our cohort needs to do.

16:41We're living in a newer world, and this phenomenon, I'm not going to name the seed manager, but they had a 90 % graduation rate. That's probably not likely to happen in the next 36 months. I'm glad you brought up the topic of graduation rates because historically, if you go back to 2014, 15, and I wrote an article, which is way dated now, but in 2015, we look at graduation rates and for even top funds, it was kind of 30 to 50%. It was not what we saw really at the tail end of the ZERP period where many firms were at 70, 80, 90%. And it was because companies could easily raise the next round of capital because of the abundance of supply.

17:23So if you carve back and say, we're going to go back to historical NARS, maybe it's 50 % of the companies then reach that next tipping point of getting that Series A. Obviously, that requires much more risk mitigation at the seed level in terms of company selection, the time you take to really understand those businesses and the capital raise at the pre-seed or seed level to give the companies enough time to grow into the metrics they need to get to, to be able to even have a chance of getting series A financing in today's market. Yeah, maybe the point on that is to understand our ability to affect graduation rate is helping them to focus on two to three North Star metrics that they can knock out in 12 to 24 months.

18:06Looking at issues with go to market propagation or product development, that could be like sort of bad throwing motion that we can help correct. And then Samir, it's always going to be a sliding scale what the graduation rate is. I think a different way that we try to look at a union is to do a four stack rank every quarter, looking at our investments of what are investments that we feel most passionate about that are likely to return the fund and be able to have sort of forced ranking. Because if you assume that fall on capital dollars are finite, you have to make tough decisions. And if you don't run the scenarios ahead of time, when you're forced to making a decision, do you write a second check or third check, you're basically in deep water.

18:51And so one of the things that I would be public, say about our strategy is like union is a two check investor. We invest and try to lead pre-seed rounds, million dollar check, 10 % ownership. And we try to be supportive on a second check to keep our prorata. Third check, there's not a lot of data that supports a third check generates much alpha. And I'd rather have that check freed up to go make a new investment. Part of this as an emerging manager and also as an asset allocator is having a prepared mind of at what price does it make sense to do my pro rata at what, you know, I have a company that's doing quite well right now.

19:28Should I consider taking a secondary to generate some DPI to my investors? So I'll be honest in the circles that I run in, some of these harder conversations, telling the founder to shut it down, seeking an acqua hire, maybe burning slower. Like, hey, you don't have to graduate Harvard Law School in three months. You can actually do it in the three years. That might be okay. These conversations were not being had 24 months ago, period, full stop. We had a funny conversation with our LPs where we started it saying, so just want you to know our average entry valuation has gone up. And everyone on the Zoom turned on their cameras and leaned in and was like, what are you talking about?

20:09This was in 2023. And we said, because our average round, the average round has actually doubled as well, right? So this is another thing that we coach our founders on now is that having 12 months to Kirby's point where we just expect an upround is not realistic. So if you're going to have your financial model built for 24 months, you're going to need more cash. And so obviously, we're going to pay up. So I think that, you know, some of the data that people are quoting on Carta, there's there's some nuance there because although round sizes are going up, that's really factoring into some of the valuations that we're seeing.

20:45So when everyone's saying seed is holding steady, it's like, well, instead of the average round being 2 million, it's 3 million. So I don't know if seed is holding that steady. The one that a lot of people cite is the graph that they had that showed seed series A, series B, series C, I think of series D and beyond. And what they showed is two axes, first axes, the number of deals. And the second one was the valuation. And the last one I looked at was the Q3 report. And it was taking Q3 2023 versus Q1, I believe 2021. And they were just, you know, juxtaposing the two. And what it showed is seed valuations went up, whereas series B, C and D valuations actually decreased pretty dramatically.

21:26And the takeaway from a lot of people just reading the LinkedIn posts and the comments on that was, well, seed is now overcrowded. There's too many people doing it because you have the emerging managers that are doing the small pure play seed funds. You got the big funds. What I'm hearing is that some of this is really a function of one, higher quality entrepreneurs, because a lot of the tourists are leaving. It's not just fun to raise a startup company. It's really, really hard. And it's much harder now from a degree of magnitude standpoint. Second is round sizes are getting bigger to mitigate against what is now a higher follow-on bar for the Series A or even post-seed, if you want to call it that.

22:10Is that a fair statement? And are there other nuances that people should consider when looking at that type of data? The data probably over-represents investments from larger funds. The larger rounds, the longer time. If you are a pedigreed second-time founder raising$3 million out of the gate from foundation, then yes. But for a lot of us who are playing at the pre-seed and writing a$500K check, those aren't the founders that we're always working with. Sometimes we are. when we're working with founders who are raising smaller rounds still, maybe who aren't able to raise from blue-chip VCs out of the gate.

22:51I want to go back to Nate saying they're a two-check investor. We were also a two-check investor in the first fund in 2019 to 21, but the second check was always chasing into the next round with the same risk profile at a higher valuation, actually a strategy that we of course corrected but now that second check in a lot of cases is us having great information about a founder that we've learned to believe in that the market does not have that information that founder has not gotten the commercial traction to raise that more money and we can sit there and say well look we believe in you let us continue to participate and maybe do that at an advantageous valuation.

23:37We're seeing in our fund too now, ownership up to 20 % sometimes on that strategy, which is out of hand for a pre-seed fund, at least in our market, investing in AI. In some cases, it can be a good thing. You mentioned reserves, which is something that I really like to talk about. Nate, you mentioned being a T-Check investor. Going back a few years ago, these rounds from C to series A were six months and the step was really large. And if you actually look back, many of those funds would have actually been better to do almost the entire fund in the initial check versus doing, you know, the follow on, which writes five X higher.

24:15And in many cases, you know, the fallen decisions were objectively probably a little bit lazy for a lot of different managers. It's like they raise, we want to, we're going to do our pro rata and it really didn't matter. Today, it seems like a reserve strategy is much different because as you, and I'd put it in maybe two potential scenarios. One is you invest in a company, you give them 24 months of cash. They then raise that series A, making tangible progress with a valuation step up that's probably much more reasonable with historic norms, where it makes sense to double down on the best companies.

24:50The second is the company does well, but yet hasn't quite hit the or crossed the chasm to be able to raise that Series A. And they need a little bit of extra fuel so that extra reserves gives you an advantage for people that don't have reserves because you can show the company that we will be there in two years if you're still trending, but yet might be just a step away from that Series A. How are you all thinking about the reserve strategy given that backdrop? And again, I'm assuming that that's fairly consistent with what you're saying. The fun one was 50-50 reserves. And fun two is 75-25. And we kind of talk about the 25 being more for bridge and defense.

25:31Whereas the 50-50, you know, that 50 % was really for opportunistically back in the winters. And, you know, I like to think we weren't lazy, but we were certainly playing the game that was on the field from 19 to 21. You know, we did follow into a lot of A's, a lot of which are doing great. But I think the big learning for me as an emerging manager going from fund one to fund two was that, especially at pre-seed, look, my advantage is having that first check in and getting the lowest valuation the company should ever have. If I believe that's the case, and I believe I have the right deal flow and the right picking, then why am I reserving half my fund to chase into later stage stuff?

26:08So I think the big shift for me has gone to looking at reserves much more as sort of defense and opportunistic bridge in deals that aren't getting to A versus following into A. I was just going to say we have the opposite because we're a one-check fund. And the reason we did that was because when we raised, we were getting in at$7 million precedes, and then the next round was pricing at$25. And so it just didn't make sense as a teeny fund to double down. So we want to buy up ownership early. Now, an LP was asking, so what would you do differently in your next fund. I said, well, it kind of depends on the environment.