The ‘other’ seed signaling problem

April 25, 2012, 9:24 PM UTC
Fortune

There’s been plenty of chatter over the past few years about the potential pitfalls for entrepreneurs taking seed money from VCs. This includes a recent and very thorough overview of the issues by Elad Gil which I’d highly recommend reading (including the so called “party round” where everyone takes a piece but no one takes the lead).

I’ve noticed something recently that’s a bit of the flip side of the same problem that everyone is talking about, but that I haven’t seen mentioned yet: An increasing number of Series A pitches where a company has at least one venture investor in its seed, the business is very clearly doing well and where the entrepreneur is simply not pursuing their existing institutional investors for money

(note: please give me a little credit here for knowing the difference between an entrepreneur not pursuing money from their existing investors and their being told by their investors that they’re not interested; I’m talking about cases where it’s either pretty clear that the business is seeing excellent traction or where we’ve actually been able to confirm that they’re trying to go around their existing investors).

You could call this the VC seed signaling problem.

A venture capitalist throws some money around into a bunch of different seed rounds assuming they’re buying optionality for their Series A. But by essentially ignoring these seed companies, some investors are showing them that perhaps they’re not the value-added investor that they claimed to be.

I’ve heard a variation of this theme a number of times in the past few months. Entrepreneurs completely disappointed with the lack of attention they’ve received from their seed investors and, as a result, choosing to either try to keep them out of their Series A rounds or minimize their participation. Most have received pro-rata rights as part of their seed investment, so sometimes this becomes a negotiation – again, clearly evidence that these entrepreneurs are indeed telling the truth on this subject as their seed investors try to negotiate for more participation in the Series A.

I find this pretty amusing. At Foundry we view seed investing the same way we view all of our investing – we believe that we’re in this business to add value to the entrepreneurs and companies we back regardless of the capital we have invested (great post from Brad here explaining this in more detail). Clearly that view is not held across our industry.

Seth Levine (@sether) is a managing director with Colorado-based venture capital firm Foundry Group