The landscape of early-stage investment is always changing. I’ve lived through a confirmed bubble, a possible bubble (now), a severe post-bubble crash, a macro-economic crash, and a few periods of something else in between. It would be difficult to say what is normal for the venture market, but today it is clearly different. You hear a lot about barbell portfolios today, and I’m worried we may be “barbelling” the pool of capital targeting high-tech growth companies.
There is an unprecedented amount of state support for early-stage entrepreneurship. These initiatives include state-sponsored fund-of-funds programs, support for accelerators and a growing number of regional/local seed funds. Lots of opportunities are being seeded, lots of ideas incubating, and in some areas, through great increases in funding by high-net-worth investors.
While the coastal icons of super-angeldom are well-known, this kind of investing is occurring broadly across the country from smaller players and groups. In our portfolio, we have more than 80 individual investors acting alone or in small, informal groups. Separately, we work with a growing number of organized angel groups. The confluence of institutional seed investors, co-investing accredited individuals and organized angel groups is expanding traditional seed pools to what I would call seed+ potential. And seed+ is necessary because seed-stage investing traditionally has been the best way to lose money outside of starting a restaurant or buying a boat.
We practice seed+ investing in our portfolio as a way to mitigate risk and stay engaged beyond the first investment tranche, to and through validation and first revenue. We maintain internal and syndicate reserves to hold position in the first institutional venture round. And as a company reaches revenue, we always build a back-up plan to reach profitability independent of a venture timetable. That trajectory ensures that our ripening fruit doesn’t fall to the ground. Running out of capital because of a rosy scenario that is dependent on an unpredictable venture round is a fast path to a portfolio filled with pain.
While the scenarios play out differently depending on the company and industry, we try to focus on what makes the company investable from a venture standpoint. Since that can change unexpectedly — think 2008/2009 — sustainability is paramount in the pre-venture stage.
A seed+ strategy improves the chances of finding the very best venture investors for a company that is maturing. AssureRx Health, in which we invested in 2008, navigated three difficult years before securing an investment from Claremont Creek and Sequoia. During that time, syndicate members funded the company through and around a difficult economy, management upgrades, and a few less than favorable term sheet offers. Another portfolio company, NanoDetection Technology, has generated licensing revenue for its diagnostic platform during the seed stage, perhaps enough to avoid a dilutive pre-revenue A-Round. The licensing revenue gives the company greatly increased operating flexibility, allowing management to pursue its go-to-market plans with confidence and pursue other opportunities that might otherwise be deferred.
These cases illustrate that seed+ thinking does not mean not thinking big. Thinking big as a company matures is rational as long as the market is telling you it’s still big. In other cases, however, a company that felt big at formation often evolves into a more modest outcome (1x-3x return). Pretending otherwise is a waste of capital as well as precious time and energy. Finding exits for these companies is equally important, as they reload the ecosystem with money to reinvest in new opportunities and the later-stage rounds of the winners.
Venture funding is a critical milestone for our most promising portfolio companies. We know the competition for the funding will remain highly competitive. The pool of venture capital simply cannot expand as quickly as today’s growing supply of viable opportunities. Seed+ investing is our strategy for managing a broad portfolio of opportunities in an age of higher investment expectations in the venture capital market.
Mike Venerable is managing director of Cincinnati-based seed-stage investor CincyTech. Since 2007, CincyTech has invested in more than 30 seed-stage companies across two funds. Those companies have since raised more than $100 million in follow-on venture financing.