Seed vs. Growth Investing: A Reality Check

These days, you can’t walk into Silicon Valley hot spots like the Rosewood or read tech and venture blogs without hearing the deafening buzz about the most recent hot, seed investment. And with very visible 100x+ seed stage returns in companies like Zynga happening before our very eyes, every angel and VC firm is piling into the seed round of the Next Big Thing. Seed stage venture and super-angel firms are being formed left and right. Incubators are proliferating like never before.

Just last week, Fenwick and West’s recent seed stage survey captured what we all sense to be true: Seed stage valuations are growing rapidly, as are the number of seed stage investments being made — particularly in the consumer Internet and software space.

But no one is asking the fundamental question: Are the returns from seed stage investing worth the risk? And from a risk-adjusted returns perspective, is it better to be a seed or late stage venture investor?

To answer that question, I looked at the NVCA Benchmarking Database powered by Cambridge Associates — the same data source that Bruce Booth and I used last summer to uncover the little known fact that healthcare venture returns had outperformed IT venture returns over the decade of the 2000s.

At first glance, the returns numbers for realized seed stage investments from 1980 to Sept. 30, 2011, look quite good: nearly a 37% average gross IRR and 47% IRR for IT and Software (which includes Internet companies).

But look a little deeper and you’ll see that seed stage returns for the past decade — from 2002 through 2011 — look downright abysmal, with a paltry 5% gross IRR. As you can see, there has been a massive and unmitigated drop-off in realized IRR at the seed stage for software and IT companies since the 1990s.

When split out by sector, it’s clear that IT and software seed stage returns are bringing down the returns average for all of venture capital’s seed stage investing over the past decade quite dramatically. Healthcare seed investments realized a 14.1% gross IRR vs. a meager 4.8% from IT and software seed deals. Netting out for management fees, IT and software seed stage investments aren’t carrying their weight and clearly would have had a negative net IRR over the past 10 years.

The same data set shows that 71% of exited seed stage investments over the past decade have returned less than 1x. And just 4% of the returns of seed exits have yielded greater than 5x to their investors.

There is surely a lot to criticize in this data and approach — for one thing, it looks solely at the returns generated by the universe of over 1,300 venture firms in the Cambridge Associates data set. It also likely excludes some of the more prolific and successful angel investors. Further, it looks at a pooled average, and we all know that top-decile is really all that matters in venture returns. And, of course, it is a look in the rear-view mirror, excluding realizations from the recent crop of Internet winners. Past rarely predicts the future in investing, as we all know. But since these data are the best measure we have of performance in our asset class, it’s really hard to ignore these numbers.

In contrast to seed returns, the returns from late stage venture investing have been 4x better than seed stage returns since 2002 — that’s a dramatic difference in returns.

What seed investors surely must be counting on is that we are headed back to the go-go days of the ’90s — and that’s a pretty huge bet to be making today given that the exit dynamic of this era is thus far quite different than the ’90s. Today, the top end of returns are being accumulated by just a handful of companies and investors vs. the broad dispersion of returns and sky-rocketing IPOs in the last boom of the ’90s.

I’d argue that the seed stage returns data aren’t good enough to justify the amount of exuberance and valuation growth that we are seeing in the seed market, particularly in IT, Internet and software.

I’m all for new company creation — it is the lifeblood of our economy. And I’ve made a couple of seed investments in the past. But a decade of abysmal seed stage returns should tell the venture industry that it takes a ’90s-like boom to create the exit conditions that justify taking seed investment risk.

Betting on booms and bubbles may be inherent to IT VC — but it shouldn’t be, and can’t be a great strategy for limited partners — especially those with mandatory obligations to pensioners and university endowments.

Investors take massive risks with seed capital. Knowing that 70% of seed stage companies eventually have a negative outcome and less than 1 in 20 have a happy ending should cause lots of head scratching amongst those ramping up their seed investment allocation these days.

If the returns for the past decade have been four times better for later stage investments and the risk taken in later stages is significantly less, then what is the justification for the current seed boom?

Bijan Salehizadeh is a Managing Director at NaviMed Capital, a growth-stage healthcare firm based in Washington DC. He blogs at

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