Seed capital is invaluable for startups. But as the number of institutional Seed-stage firms, often referred to as Micro-VC’s, has ballooned, founders have many choices. According to First Republic, there are nearly 350 Micro-VC firms in the US bridging the gap between angel funding and Series A rounds.
The choices of seed capital present a complex decision for founders. They must pick investors that not only help them reach operational milestones, but who help them secure their next round.
Why Follow-on Rates Matter
Follow-on rate is strong evidence that an investor is not only adept at picking good companies and adding value, but also at guiding a company to downstream investors for the next round's financing.
Founders want to build big, iconic companies. To scale and capture a big market usually requires an escalating series of capital investments. The biggest hits almost always follow this path.
And follow-on rates matter today more than ever. We are experiencing an economic reset that creates choppy waters. Macro instabilities cause many investors to pull back on capital deployment (and valuations), and to require more traction before investing.
Micro vs. Traditional Fund Performance
We analyze follow-on rates from Seed-stage VC’s using data from CB Insights. Since larger seed-extension rounds often serve as Series A rounds, we consider a round to be follow-on whenever a subsequent financing is greater than $2.5 million, regardless of how the round is otherwise named. We net out companies acquired prior to additional funding.
The table below lists follow-on rates for institutional Seed-stage investors for vintage years 2010-2014—2015 is statistically irrelevant as most seed rounds offer 12-18 months of runway. Traditional venture funds here are employing a strategy of investing in Seed-stage companies (e.g., NEA, Crosslink Capital, Foundation Fund).
Several fascinating insights stand out to us.
- Micro and Traditional VC have nearly identical follow-on rates. Despite some founders’ sense that it’s best to raise seed from the larger funds, the evidence doesn’t bear it out. Institutional Micro-VCs are securing follow-on for their portfolio with at least the same rate.
- Having a mix of both leads to dramatically higher follow-on rates. The best option is clearly to have both, with follow-on likelihood more than doubling when a seed round involves both Micro and Traditional funds. Despite the signaling risk that many founders fear when a large VC participates in their seed round, it’s seems to be mitigated when a Micro-VC is also involved.
- There is a drop in 2012. Given the robust early-stage funding levels in 2013-2014, we were surprised to see follow-on rates drop in 2012. Much of this is explained by the evolution of the seed market, where we saw more seed extensions and bridges—more companies in 2012–14 received second (and third) seed rounds under $2.5 million, which weren’t counted. As such, we don’t think the lower follow-on rates necessarily reflect higher startup mortality rates.
The Best Micro-VC Funds by Follow-on Rate
The more important question for founders is this: Which Micro-VCs had the highest follow-on rates—in other words, which firms have provided the best odds of securing the next round? We should note that Switch Ventures started investing in 2014 and therefore is not included.
Top Micro-VC Investors with at Least 15 Seed-Stage Investments, 2010-2014
Just as important as overall follow-on rate is the quality of follow-on financing. Attracting follow-on financing from top venture funds undeniably increases the long-term probability of startup success. As a proxy for top traditional firms, we used the CB Insights' list of “Smart-Money” investors for our analyses.
Top Smart Money Follow-on Rates: subsequent round >$2.5MM, 2010-2014
Top Smart Money Follow-on Rates: subsequent round Labeled as “Series A", 2010-2014
Attracting follow-on capital is critical to scale. As an entrepreneur, it’s important to consider your seed stage syndicate’s ability to help you raise your next round.
A version of this post also appears on CB Insights. It was coauthored by Samir Kaji, Senior Managing Director at First Republic Bank, and Paul Arnold of Switch Ventures.