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Planting Seeds into Startups
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The State of Seed
Seed rounds are quite literally the seeds of the startup ecosystem.
Seed is the beginning of the startup funnel, so it makes sense this round would have the highest amount of deal volume.
But over the years, the number of seed rounds have greatly outpaced Series rounds at a very high rate.
This trend of increased seed rounds can largely be attributed to:
Easier than ever to startup (startup programs, AWS, access to capital)
Startup returns being reinvested
New/more funds wanting to get in the game
The explosive growth in the seed market has led to incredible variability in companies.
At HyperGuap, we’ve invested in seed companies ranging from $7M to $70M valuations. As you can imagine, the metrics have varied widely, with some companies having $0 in revenue and others at $3M+ ARR and profitable.
About 1 in 3 seed companies go on to raise Series A rounds.
Due to the volume increase in seed, over the next 24 months the amount of early stage companies unable to raise a Series A/B round may be the largest the startup market has ever seen.
What’s even starker, is that less than 5% of startups raise a Series C round and even fewer go to later stage rounds (D, E, F, or G).
The likelihood of a seed startup making it through successive financings is low.
So why invest in seed?
Well obviously, the risk/reward profile is the highest.
Startups are always risky no matter the stage, so it’s traditionally been viewed as a way to plant a lot of seeds and bet that 1/20 of your investments (5%) will go on to generate the returns for your fund — known as the Power Law.
The Power Law, is the idea that a small # of investments, will generate the majority of returns for a fund.
Given it’s hard to know which one or two investments will support the Power Law return, investors plant many seeds across early-stage companies hoping they picked right.
Thus, we’ve seen an explosion of seed investing with investors hoping that their seeds will become the next unicorn or decacorn.
But Series A/B/C rounds are becoming less common, making seed investing even riskier.
In addition, the tremendous amount of variability in company types, valuations, revenue, and traction makes seed investing even more difficult.
But there is something special about finding a startup before anyone else does and investing and believing.
Then to watch that company succeed, and generate exceptional returns for the risk, is like getting a front row seat to civilization advancing in real-time.
What to look for at seed to increase success
I believe startups that build real businesses (making more than they spend) and are solving a real problem in a novel way, are good investments.
To date, we’ve backed one profitable seed stage company and are looking at another profitable seed stage company.
Both tackling critical problems in extremely large markets with strong user growth.
We’ve backed other seed stage companies that aren’t generating revenue or aren’t profitable, but that’s typically because they involve more R&D.
In general, it’s easiest to have conviction in a seed stage company when it makes sense from day 1 because they are profitable and don’t need to raise a Series A/B/C round to make the company work. Follow on financings then become an opportunity to fuel growth and not a medicine to survive.
When capital was cheap with low interest rates, profitability didn’t matter. But in this new world where capital is expensive — a cashflow positive business is king.