of the Seed
January 24, 2005
Early-stage investors and entrepreneurs are emerging
from their post-boom hibernation with a different approach to starting
Vincent Occhipinti sits at the head of a large table in Palo Alto,
California, surrounded by many of his fellow early-stage venture
investors. As chairman of the Early Stage Venture Capital Alliance,
he begins each meeting by asking the assembled members to stand
up and announce the number of deals they’ve done since the
Over the past few years, Mr. Occhipinti has come to dread this
tradition. He’s often heard “zero” or, in the
best case, “one” or “two.” At this most
recent meeting, however, he is floored by the responses. “Four
deals!” calls out one. “Six deals!” says another.
“Eight!” chimes in someone else.
“The experience was overwhelming,” says Mr. Occhipinti,
co-founder of Woodside Fund in Redwood Shores, California, which
did eight Series A deals of its own in 2004.
After three years of post-boom doldrums, seed- and early-stage
venture capital are finally on the rebound. There is some disagreement
on which deals qualify as “early-stage” investments.
While some VCs consider all money raised before the IPO to be early
stage, the generally accepted definition is an investment in the
seed round (usually under $1 million) or Series A round (usually
in the low millions).
The key is getting into the game while valuations—and staff
size—are low. An improved exit environment and more manageable
fund sizes are driving VCs to take bigger risks, entrepreneurs to
jump back into the garage, and experienced managers to crawl out
of the corporate woodwork to join startup teams.
“All of the movements are in the right direction,”
says Edward Roberts, a professor at the Massachusetts Institute
of Technology’s Sloan School of Management, and an angel investor.
“You can see it in the mood of our guys at meetings. You can
see it in the willingness of people to talk seriously about making
investments today. People are feeling that the marketplace is turning
The new spate of early-stage deals, however, contrasts sharply
with those done during the 1990s. VCs are much more reluctant to
fund bright-eyed entrepreneurs just entering the garage, or invest
in brilliant ideas sketched out on a napkin. Companies receiving
early-stage funding today must be more developed and refined than
In 2000, seed- and early-stage funding represented 54 percent of
venture deals, but by 2003 that number had plummeted to less than
30 percent, according to VC research firm VentureOne. Third-quarter
2004 statistics showed a slight up-tick, to almost 32 percent, but
even that figure doesn’t tell the whole story, because many
of today’s early-stage deals don’t show up in research
Companies used to make a public relations splash immediately after
their first funding, but entrepreneurs and VCs are now more cautious
about unveiling themselves early on. For example, Mohr Davidow Ventures
in Menlo Park, California, early backers of Agile Software and MIPS
Technologies, has only publicly disclosed two of its last seven
seed investments, according to partner Nancy Schoendorf.
Early Stage, Starting to Rise
In venture capital, greater risk always meant higher returns—that
is, until the year 2000, when later-stage investors started driving
down valuations so far that earlier investors were washed out. Less
than two years after pumping $25 million into online financial services
firm Juniper Financial, Benchmark Capital’s share of that
company was diluted by 75 percent in 2002, after late-stage funding
rounds led by the Canadian Imperial Bank of Commerce.
By 2003, many early-stage investors had become so brutalized, they
were terrified to do another deal. “So many of the classic
VC funds doing Series A financings were saying ‘We’ll
sit this one out,’” says Steve Weiss of Grey Heron,
a firm based in San Francisco that consults for venture startups.
“Why invest early if they were going to get squished in Series
As the market for IPOs and acquisitions gains steam and enterprises
exhibit a renewed willingness to spend money, young companies are
once again able to score new customers. That means early-stage investments
are finally starting to show some upside potential, which, in turn,
means startups are actually able to increase their valuations from
round to round—just like the textbooks say.
“Two or three years ago we were looking only at B, C, and
D rounds, but almost all the deals we’ve done in the last
year and a half have been series A,” says Bart Schachter,
managing partner at Blueprint Ventures in South San Francisco, California,
whose early-stage investments focus on IT infrastructure companies.
Now that VCs are increasingly willing to jump back into the early-stage
game, entrepreneurs are taking notice. VCs are finally returning
their calls and holding meetings, encouraging them to pursue new
ventures. Some entrepreneurs are even scoring multiple term sheets—something
unheard of since the gluttony of the bubble days.
“We ended up having to turn people down, or give them smaller
allocations,” says Stewart Butterfield, CEO of Ludicorp, which
just raised an angel seed round for Flickr, its photo-sharing and
social networking service based in Vancouver, British Columbia.
With more venture money at their disposal, early-stage startups
are also able to round out their executive teams with experienced
managers, many of whom have been hibernating in large public companies
since watching their earlier stock options evaporate. Now that the
market has turned the corner, they’re putting their faith
back into the Silicon Valley startup system.
“CEOs, strategic marketers, and other people who had an option
to wait it out did,” says Stuart Davidson, managing partner
at Labrador Ventures, a Palo Alto, California-based early-stage
venture firm that did twice as many deals in 2004 as it did in 2003.
“A lot of those people sitting out are now looking to get
The Google effect hasn’t hurt either. While massive exits
are the exception rather than the rule, the Google IPO showed that
the Silicon Valley dream is still alive. You can build a wildly
successful public company and become fabulously wealthy in just
a few short years.
There were 16 venture-backed technology IPOs in 2004 (including
five during the fourth quarter) that raised $2.1 billion, compared
to 10 IPOs in 2003 that raised $726 million, according to VentureOne.
“The IPO windows are opening more frequently, so investors
are moving from fear to greed,” says Harry Weller, a partner
in New Enterprise Associates’ Reston, Virginia office. “People
are now willing to take bigger risks because they see bigger exits.”
The New Deal
While risk-taking has returned, today’s early-stage deals
look quite different from comparable fundings in 1999.
The startups, for one, are more mature. Many entrepreneurs who
made big money during the boom have spent the last few years toiling
away in the garage on their own nickel, or bootstrapping off of
government and university grants that didn’t dry up when venture
funding did. These teams often have solid customers, strong revenues,
and a well-developed product and business plan before they ever
sit down with a VC.
“We are seeing more and more of these fully baked Series
A deals,” says Blueprint’s Mr. Schachter. “That’s
something we never saw in the past, when people may not have even
left their prior jobs before meeting with us.”
By funding well-developed companies at the early stage, savvy VCs
are able to minimize their risk. In effect, as Mr. Schachter and
others are saying, Series A is the new Series B. In the bad old
days, many startups received tens of millions in early-stage funding,
rented the most expensive office space, and launched a marketing
blitz before finalizing their business plans.
Now, when hyping their portfolio companies, VCs often emphasize
capital efficiency as much as market potential. The current goal
is to build a complete company from start to exit for less than
$20 million. This can mean leveraging everything from low-budget
office space and cheaper engineering talent to investing at lower
Some firms are taking unorthodox paths toward creating capital
efficiency. Blueprint Ventures, for its part, has focused on identifying
promising technologies within corporations and spinning them out
into startups. These deals often take advantage of millions of dollars
already spent by corporate R&D departments.
For instance, Blueprint recently led a $6-million Series A investment
in a video surveillance company called Vidient. Its Tokyo-based
corporate parent NEC had already pumped $10 to $20 million into
developing the core software, which was originally intended for
broadcast market applications such as automatically pulling highlights
from a sports event.
But investors were much more intrigued by the security applications
of the software. Several airports and large corporations are already
testing its ability to quickly identify suspicious activities in
high-risk areas. It’s still an early-stage deal, however,
requiring the same heavy lifting of assembling a management team
and identifying the appropriate market for the technology, says
Other firms, such as Ignition Partners in Bellevue, Washington,
are conserving cash by employing a new twist on existing entrepreneur-in-residence
(EIR) programs. Instead of giving an entrepreneur an empty office
and a blank slate to come up with the next great idea, Ignition,
an early-stage VC firm founded five years ago by Microsoft and McCaw
executives, sometimes uses its EIR program to incubate prequels
to seed deals. Deals that, in the past, the firm may have funded
outright are now shunted over to the EIR program, where they can
be fleshed out before capital is fully committed.
“Seed deals used to be ‘let’s figure out a business
plan,’” says Ignition partner John Roberts. “Now
we look at a seed deal and say: ‘Slow down, be an entrepreneur-in-residence
for a quarter. Bang out a bunch of customer meetings. Understand
the market better before you take on the cost structure of more
Finding the Right Guy
The success rate of early-stage venture capital will also benefit
from the simple fact that those who do it best are returning to
the sector. At the end of the 1990s, the VCs that grew up as early-stage
firms suddenly began raising mammoth billion-dollar funds that required
putting vast amounts of capital to work. Because early-stage ventures
involve smaller deals and at least as much time, they didn’t
fit into that system.
In 2004, firms like Kleiner Perkins Caufield & Byers, Charles
River Ventures, and Battery Ventures moved away from these bloated
funds and raised more modest amounts. As a result, these talented
funds can go back to being hands-on and managing a smaller portfolio,
using the methods that made them successful in the first place.
With more early-stage capital searching for placement, the balance
of power also shifts ever so slightly in the entrepreneur’s
favor. Instead of scratching and clawing for a single term sheet
at the early stage, the top startups are sometimes showered with
Startup consultant Grey Heron’s Steve Weiss is working with
one seed-financed software company going after its first institutional
round. Barely a month after their first investor meeting, VCs served
them with one term sheet, and they received three more over the
next two weeks—all during the holiday season.
For the first time in several years, VCs may have to compete for
early-stage deals. So venture firms are becoming ever more creative
in how they woo and service their startups. Woodside Fund, for example,
brings as many as three partners together on a single deal. This
allows the firm to be incredibly hands-on in all stages of the mentoring
process, especially when it comes to recruiting executives.
For one portfolio company, they interviewed 22 candidates for the
CEO position. “For every meaningful executive job at one of
our startups, we can spend up to four hours with each qualified
candidate,” says Woodside’s Mr. Occhipinti. “That
takes a lot of time, but it gives us an advantage over many other
Naresh Batra, CEO of Woodside portfolio company Intelleflex, experienced
that selection process firsthand. The San Jose-based RFID company
recently raised an $11-million Series A round. “When I met
with them, I was limping and sweating by the time I got out of the
building. I was mentally and physically drained. But they spent
the same kind of time and effort interviewing candidates to help
me build my management team,” says Mr. Baresh.
Other firms avoid heavy competition by looking outside of traditional
tech hot spots like Silicon Valley and Boston’s Route 128.
Many VCs dabbled with this concept in the late 1990s, but few have
gone so far as Draper Fisher Jurvetson managing director Tim Draper,
who spent the last 15 years establishing an affiliate network of
firms from Portland to Beijing. DFJ now has the connections to search
for the next big thing in a place like Pittsburgh.
At the most fundamental level, an increase in early-stage investment
means innovation is once again flourishing in the technology industry.
The more Vincent Occhipinti hears a VC yelling out “Eight
deals!” the greater the likelihood that one of those young
companies just may change the world.