When startups are choosing investors for their seed round, it is important to pick ones who will stick around for the long run. Otherwise, they may run into what Founder Collective co-founder Chris Dixon calls “signaling risk.” The risk of getting a high-profile investor in your seed round is that they might not follow on in later rounds, and that sends a signal to other investors that there might be something wrong with the company. Dixon discusses signaling risk in this episode of Founder Stories with Steve Anderson of Baseline Ventures.
In recent years, there’s been an uptick in seed stage investing to the point where “large VC’s [are] investing in seed companies,” notes Dixon. He is of the opinion that it’s risky for founders to take their cash because “if the big VC doesn’t follow on it makes it harder for the entrepreneur to raise the next round.”
Anderson agrees that picking the correct investment partner is paramount and referring directly to high-end VCs pouring into seed funding, he says it is basically illogical to think a fund managing hundreds of millions will give the same attention to small investments as large investments. This becomes an issue when “you have entrepreneurs who are looking for help … and then they didn’t get any.”
This is their opinion as seed stage investors – however the best VC’s would likely tell you: they like to invest early and stick with their companies all the way through.
Nevertheless, “the signaling issue is real” says Anderson, “my advice always is think about the motivations of the people that are coming in, how helpful will they be, how much help do you want, what are you looking for and then size your investment from them appropriately.”
The conversation continues in the video below and the two use a Wall Street Journal article titled Web Start-ups Hit A Cash Crunch, to discuss if the start-up sector is suffering a downturn. Dixon doesn’t agree that it is, saying “the market has been very, very strong for quality companies.” Anderson agrees with Dixon and says, “I think that article was really more of a forecast of a possible outcome in the future … but not a reality today.”
Anderson then adds “seed rounds are about product market fit and establishing something of value and in my opinion those will always get funding as long as you are doing those core things, if your thesis was wrong and you tried and it didn’t work out, well of course you are not going to get funding.”
The two end with Anderson offering what he considers to be a strong start-up bets in the future. He says, “the ecosystem that is evolving around Facebook is undeniably going to be one of the most powerful ecosystems going foward.”
Past episodes of Founder stories featuring Instagram, BirchBox and Eventbrite are here.
(Disclosure, Dixon is an investor in Baseline funds)