One of the most important decisions for a founder of an early stage company is deciding who should be on the cap table. We’ve written about doing your due diligence on investors and funds to make sure you find the right partners for the journey.
Lately, we have seen more founders grappling with the question of whether to include a Series A investor in their seed round. Many Series A investors have bigger platforms and can provide a myriad of valuable services to an early-stage company but there may be risks.
For a seed fund like us, our primary focus is to get a company from “seed” to “A.” However, A funds may have different priorities – and the strategies and motivations for investing in seed companies can vary across A funds. For example, some A funds (like our friends at Union Square Ventures) look at a seed investment much like a Series A investment. In the event that they invest earlier, they maintain the same thesis and approach. Other A funds look to invest in seed rounds as a way to get a seat at the table, in order to have more options for a later round.
In addition to being a lower priority, there’s also the potential for signalling risk, i.e. when you take on a Series A investor at seed but they don’t lead your next round.
When looking at a Series A investor, there are ways to assess how your company might rank in the priority order, and identify the possibility of signalling risk. Here are a few considerations:
- Percent ownership of investor from seed investment:
Series A investors typically target 20-25% ownership for their fund economics to work. If they don’t have this percentage at seed and are not leading / upping their position with another investment at Series A, then this could be seen as a negative signal.
- Percentage of seed investments that lead to Series A investments:
Many Series A investors allocate a certain amount of capital to their “seed” programs (i.e. “discovery fund”, “greenhouse fund”, etc.) in order to have a seat at the table for the next round. It’s worthwhile to ask how many of their seed deals have translated into Series A that they’ve actually led, and why or why not. You can also go one step deeper and ask what percentage of seed investments have been able to raise Series A from other funds if the fund in question passes on leading the A.
- Percentage of seed investments vs. percentage of Series A investments:
To gauge the importance of a seed deal relative to a Series A deal, ask how many seed investments are made each year compared to Series A. This will give you a sense of priority in terms of time and resources. For example, a high ratio (e.g. 1:3) can be a good sign of the importance of seed relative to A at the firm. In contrast, when an A fund invests in many seed companies, this may indicate a “spray and pray” approach and the fund may dedicate less resources toward your development.
That’s why it’s critical to understand a the fund’s underlying philosophy on seed: is it true ownership or just a seat at the table?
And while these metrics will give you an objective measure of signalling risk, I would also suggest that you speak to founders in the fund’s portfolio who are in/were in a similar situation to you. It’s always important to have both subjective and objective information when making a critical decision like this.
Series A investors can bring a lot of value to an early-stage company and they might be the right partner for you, even with the chance of signalling risk. Just be sure to understand the risks and ask the right questions when considering a Series A investor to lead your seed round.