Why are seed deals still so expensive?
The global venture capital market has contracted steadily over the past year, but seed valuations have not, avoiding the massive cuts to round size and median valuations that later startup investment stages have suffered. And according to Accel’s Philippe Botteri, it appears there’s a simple answer as to why seed deals are holding up so well: rapid growth.
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The seed market is a bit weird right now. On one hand, PitchBook reports that at a total of $3.2 billion in the third quarter, pre-seed and seed deals in the U.S. have “fallen to pre-pandemic levels.” So yes, while we’re seeing seed deals decline in number and value in key markets, the data looks very different when you slice it on a per-deal basis.
CB Insights reported that the median early-stage deal was worth $2.2 million through the third quarter. That’s tied with 2021’s record for the global market. In the U.S., PitchBook data indicates that median valuations at the seed stage are ticking higher yet again this year, coming in at $12 million through the third quarter, up from last year’s record of $11.1 million.
Other datasets also point to expensive seed deals. Carta data indicates that the median pre-money valuation for seed deals on its platform peaked at $15 million in mid-2022, rising from around $9 million in 2020. That figure dipped to $13 million in Q1 2023 but recovered to $14.4 million by the third quarter.
If the venture market is contracting and overall seed investment volume is declining, the fact that seed deals are seemingly priced at or around all-time highs seems to conflict with what we’re seeing elsewhere in startup land. Late-stage deals, for example, are becoming rarer and smaller and cheaper today.
Solving the seed paradox
To understand why seed-stage valuations are holding on to their peak-era valuations better than other stages, we have to talk about more mature companies.
Chatting through data reported by Accel in its Euroscape 2023 report, which covers European and Israeli private-market startup investment, it’s clear that the trend of tech companies swapping growth for profitability is widespread. For example, here’s a chart of growth and free cash-flow results from the fastest growing quartile of companies in Accel’s public Euroscape index:
Growth data is forward, while the cash-flow data is trailing. Image Credits: Accel
It’s notable that the result of swapping growth for profitability (free cash flow) has not led to more public cloud companies qualifying for the Rule of 40. In fact, we’re seeing the opposite happen:
Via Accel, shared with permission. Growth data is MRQ (YoY), cash flow data is trailing. Image Credits: Accel
So while public tech companies have managed to exchange growth for profitability, the trade-off hasn’t been an equal one. As a result, many tech firms may be simply less attractive than they once were — a company that meets the Rule of 40 is, on average, more enticing than one that doesn’t.
How does this relate to the seed stage? TechCrunch+ asked Botteri how the data above applies to startups. First, he outlined why late-stage private companies act like public companies:
You have to separate the two different kinds of startups, because public companies are at scale with hundreds of millions [of dollars] in revenue. When we talk about private companies, you’re talking about companies that can be zero in revenue, or a million, and companies that can be $200 million in revenue. The [private] companies that are [at] $100 million or $200 million in revenues, their behavior tends to be similar to what we see in the public market, right? Because they’re a bigger company.
On the other hand, younger startups do not have a massive revenue base to grow against, which means that they can put up very impressive growth rates and are less interested in preserving cash:
If you’re an early-stage company in a pretty interesting space and people are buying, you’re going to invest a lot in growth. We have companies that have amazing growth rates on the early-stage side. There is no reason for this company to say, “Oh, now I want to be profitable,” because that would be a wasted opportunity.
Fair enough, but are early-stage startups still responding to the low-burn, slow-growth mantra?
I think the growth rate for early-stage companies is still very good. I don’t think anything has changed there. We have companies in the portfolio that are growing from $1 million to $10 million, this year . . . We’re seeing some very, very high growth rates.
So is really quick growth the reason why early-stage dealmaking is holding up in places like Europe better than we expected? “I think that’s a fair assessment,” Botteri said.
Now we’re getting somewhere. Applying the above insights to the seed stage, it seems that as long as rapid revenue growth is possible in the earliest stages of startup life, valuations are going to be strong. So, in a sense, sticky seed valuations are evidence that very young startups are often growing well and strong, not that the venture model is failing to correct itself to a new market reality.
We do have one caveat: We mentioned above that seed deals are generating less total investment than before. How do we square the fact that seed deals are expensive and becoming rarer? Simply put, the bar for startups to raise seed capital at all is going up. The deals being closed are pricey but also somewhat rarified.
This is the inverse of the problem that many unicorns face today, given that they are priced like outliers but are performing in line with market norms. Seed-stage companies, per what Accel can see, are priced like venture-ready startups and are posting great results.
That’s great news for the true outlier tech startups, but it’s a pretty sobering bit of info for startups that don’t spike their growth apex early.