There was a time when each style of investor would argue passionately about why their model was correct. They would cite incentives, fund math, or other reasons why a particular model was clearly the right choice for founders. The reality is that each model has its own distinct strengths and weaknesses, and certain founders will naturally gravitate towards one or the other.
The good news is that I believe the pie is big enough for all four to co-exist. Different models will fall in and out of favor at different times among LPs, but all four can be successful—and all four can also have a pretty serious failure mode.
Here are the four approaches to early stage venture, and my thoughts on what’s attractive and unattractive about each.
1. Classic Institutional Seed
These are firms that focus on a stage but are fairly broad in the kinds of companies they target. They lead the majority of their investments and are relatively engaged with the companies they partner with. Seed is pretty much all they do, and these firms strive to stay focused and disciplined around ownership, portfolio construction, etc.
Strengths:
- Generally strong fund math. If you catch a unicorn, the fund does pretty well. If you catch a decacorn, you do really great.
- High founder alignment. Seed is all you do, so you’re fully invested in the outcome of each company.
- Good potential to catch outliers and to be contrarian. You’re in the market early and broadly enough to find the unexpected winners.
Weaknesses:
- More susceptibility to fallow periods. Small portfolios and a narrow range of entry points mean you can get caught flat-footed when the market shifts. This is happening right now, where the consensus view is that only 10 AI companies matter. Multi-stage funds at least had the chance to enter one of these mega-compounders later. Very few institutional seed funds were in these companies.
- Squishy “right to win.” You have to win by reputation, founder rapport, and strategic support. It’s harder to distinguish the value of these vs. some of the other models—although some might argue that these soft elements are actually the most important.
2. Specialist Seed Funds
Funds that have similar investment models to classic institutional seed, but with a narrow focus around a particular sector, geography, or type of company.
Strengths:
- Generally strong fund math, similar to classic seed.
- Potential for a strong “right to win” if one builds a specialized network or support services tuned to the particular focus.
- Fits the LP zeitgeist right now. LPs like the idea of augmenting their megafund exposure with specialists that can theoretically generate “alpha.” Even if some sectors fall in and out of favor, LPs can select in and out based on what’s working.
Weaknesses:
- Narrow scope means you have to bet right. A narrow focus will mean that your area will fall in and out of favor. The most successful funds are elegant about either shifting to new focus areas adroitly or expanding the definition of their focus without losing their soul.
- What LPs want is not necessarily what’s best for the investor. The best generalists often outperform specialists over multiple vintages. This is probably controversial, but I think it’s true, with some exceptions.
- The outlier companies are rarely in the verticals that are hot. This is why specialists often miss the best companies in their focus areas. Also, the best founders sometimes don’t feel the need for a specialist partner since they already have many of the advantages that the specialist purports to offer.
3. Multi-Stage Megafunds
Large funds ($750M+) that primarily write Series A or B checks but stretch down to seed. There is a distinction between the Series A/B funds and the mega platforms, but I’m going to combine them for now.
Strengths:
- Can pay the highest prices relative to the other four players, since the seed is just an option to deploy larger amounts of capital into the companies that are working.
- Often the biggest brand, network, and resources. Attractive to founders that find value in association with a power player in the market.
- Very hard to beat in consensus areas where one needs to pay high prices to win.
Weaknesses:
- Misalignment with founders. I can’t tell you how many times I talk to a multi-stage fund about a company they seeded in the past, and they say something like “well, it was just a seed”—like it was a discarded tissue. Some founders won’t care about this, but some will want a more aligned, committed partner who will stick with them through thick and thin.
- Questionable fund math. You need a decacorn to do okay. Unicorns don’t move the needle. This further amplifies the founder misalignment.
- Good at consensus, weak at non-consensus. The incentives of megafund investors lend themselves to being very strong at investing in consensus founders and in consensus categories. But stuff off the beaten path has a harder time getting through a filter that is more tuned towards piling on to consensus winners.
4. Accelerators
Organizations that invest in a large number of companies on somewhat standardized terms, often in a batch model.
Strengths:
- The best offer of an alternate, less dilutive funding path than traditional seed. The bargain is: “Take a little money at a low valuation from us, and you’ll immediately 5-10x your valuation by the time you want to raise more money later.” This allows some founders to skip a step and potentially get on the radar of the more price-insensitive firms.
- Network effects mean a built-in customer base for companies building in certain sectors. For startups selling to other startups, this is a nearly unbeatable value proposition.
- Breadth of portfolio increases the likelihood of catching interesting companies and the potential to cover a wide range of businesses.
Weaknesses:
- Huge adverse selection problem if you are not one of the very elite accelerators.
- Returns are diffused over many companies. You either need a pretty high hit rate or to enter at a low enough price to make the model work. Again, you need to be elite to have a chance.
Other Models
These four cover most of the approaches. The other models are generally variants of the first four, but a couple are worth touching on.
Broad portfolio seed funds. These are dedicated seed funds that have a broader portfolio and less tight ownership relative to fund size. You get a blend between institutional seed and accelerator dynamics. The value prop ends up being network effect given the scale of the portfolio, and the bet is that you can capture enough hits to make up for smaller investments in each company.
Retrenched Series A funds. These are funds that used to do Series A’s but are now mostly doing seeds, either due to fundraising difficulties or the realization that they can’t win Series A’s against the true megafunds. This is a tweener between classic seed and the megafunds. These players should be able to beat dedicated seed funds for the big, marquee seeds due to larger fund sizes. But it’s a real mental shift to go from being a Series A investor to investing in seed, so it’s unclear how well this segment of the market will do from a picking standpoint.
So What?
As I said earlier, my general belief is that we are past the point where there was one right option for founders at seed. These four approaches will continue to coexist and will win or lose share based on the strengths and weaknesses I described.
For founders, I think it’s important to know what kind of bargain you’re making with yourself when you select a particular type of investor for your seed round. I feel like I could sell against any of these four pretty effectively if I were being intellectually honest, so it really comes down to founder judgment and your own assessment of what you need, what you want, and what kinds of risks you are more or less comfortable taking.
For LPs, I hope this is an interesting framework. I’m personally not convinced that any category is destined to outperform the other at all times, but one may resonate more based on the rest of your portfolio. You could probably create a similar strengths-and-weaknesses analysis for each model from an LP perspective that would add additional nuance. The current zeitgeist seems to be that LPs like megafunds paired with specialists—it’s intellectually coherent, but I’m not sure this strategy has really driven outperformance in the past.
For my brethren at seed-focused funds, I offer a word of encouragement. Your model does not have to be the best or clearly have an advantage over the other three. The opportunity set in front of us is so vast that it’s not about winning every opportunity but winning the right opportunities for you and your model.
As I’ve said in other posts, the failure mode is constantly trying to chase your own tail and not knowing what game you’re trying to play. And whatever game you’re playing, you have to be elite. There isn’t really an easy win in any of the four strategies, so you may as well do what’s native to you and do the best job you can. Also: don’t let LPs be the tail that wags the dog here. As good as their feedback may be, what’s right for an LP in the context of their portfolio or incentives is rarely exactly right for the manager. And the historical wisdom that may drive their preferences is inherently backward-looking, while it’s our job to try to make bold bets about the future.
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