When founders raise a pre-seed or seed round, there are several defining decisions. One of these is selecting investors. In this article, we cover the key tenets for assembling an early-stage round that prime your company to breakout.
There are two main philosophies for investment rounds pre-Series A. The first is that a single fund should invest to own a large stake of the business of roughly 12% to 20% of a company’s equity. The idea is that a clean round with a single lead investor enables a founder to build a deep personal connection with a prospective board member who will act as a solo point of contact to the fund. Smaller investors might ‘follow-on’, but limited allocation in the round means that fund participation as a follower is often de minimis.
In the second, a lead investor owns less equity and is followed into a round by multiple groups with small allocations. The idea is that together, these investors represent a greater collection of resources, connections and expertise to propel founders. In this scenario, a lead investor might own closer to 8% equity, with a co-lead matching up to that amount, or potentially following with as little as 1% or 2% in some cases.
At Seedcamp, we believe that the second approach to early-stage venture is the best way to create an unfair advantage. There are many reasons for this, but in short, more parties around the table simply means that a founding team has access to more resources. Each venture fund, angel or angel syndicate has a portfolio of companies which are potential customers, talent hubs and pools of knowledge. You want more compounding reach, not less, which is why we encourage founders to think of ‘building a village’ around themselves.
On Day 0 or Day 1, a lot of things are in-flight and your customers probably haven’t heard of you yet. Founders embark on a winding road to product market fit and the areas where support is useful may emerge and evolve over time. You are likely to kiss a lot of frogs. One way to think about selecting a group of investors is that you want to increase the ‘surface area for serendipity’. Founders clearly don’t need the help of funds a lot of the time, but if you can access a larger collection of top class resources at the critical moments of a company’s journey, you are simply more likely to find the thing that impacts your trajectory. At Seedcamp, large segments of our platform are designed to allow founders direct access to this network – more quality candidates and more eager customers is a good thing!
Building a village also enables a fuller spectrum of support. All top tier funds will help you find customers from their rolodex. However, no matter your sector, no venture fund can help you get to everyone. So, while we think being a generalist fund sharpens our decision-making and company-building network, if you choose Seedcamp to lead a round into your fintech business, we might want to bring in two micro funds that have deep ties to every bank, acquirer and issuer, in addition to the five hands-on angels who have built and exited adjacent businesses. We are proud to have invested in Revolut, Pleo and Wise, but our rolodex is always a work in progress; a great syndicate helps founders get closer to optimal coverage. As the newest crop of emerging managers develops in Europe, the opportunity to combine deep company building expertise with sector-specific wisdom has never been better.
An oft-cited concern with this approach to investing is governance. If a lead investor owns less equity, who will lead the board, or how will the pre-board investor group collaborate? Structured investor meetings are great fora to formalize reporting, embed good practices and ultimately align strategy and direction. However, at the very early stages, while these considerations are important, they are not always the most important. In most cases, we are the first money into a business and we prefer to emphasize nimbleness and speed. Strategy and planning are key founder tasks, but it’s difficult to chalk up future geographies and features before you have sold a product to a customer persona that can’t live without it. HR and FP&A are crucial but won’t be existential problems before you have significant numbers of employees and revenue. Rather than waiting weeks to strategise formally as an investor group, we encourage founders to do what feels natural and flexible — a short recurring call or even an adhoc call at the right time to the right member of the cap table can be much more productive for solving problems in real time.
The other worry with this approach is the admin burden. Securing a larger number of signatures feels like it may consume time, and collaborating efficiently in the future feels tricky. Founders should never feel like investors are creating work for them and great funds and angels won’t do this. To avoid this risk, it’s important for one fund to take the lead, or for two funds to serve as co-leads, allowing founders to negotiate terms that other investors can then follow. Party rounds, where many funds receive approximately similar low ownership, are almost never a good idea. Luckily, software that manages contracts, cap tables and KPIs is also pretty good at eliminating labour on all sides of the table.
Of course, as a company moves forward in its journey to Series A and beyond, this logic wanes. The critical junctures change and while great founders remain ‘in the weeds’, they have to zoom out, delegate and some amount of personal perspiration becomes team inspiration. Venture resources still matter – e.g. for hiring that elusive SVP of sales – but being right about the decisions that matter each quarter matter at least as much, and a stage specialist board with fewer voices becomes the priority.
Ultimately, investing with conviction means sculpting a round that primes a company to breakout. While a fund may aim to secure as much equity as the founding team is willing to dilute, if that team is poised to redefine their category, having a broader group of investors from the start can serve as a powerful force multiplier.