"Seed is the New A, A is the New B"

Peter Wagner | April 25, 2019
"Seed is the New A, A is the New B"

The 2019 V21 Analysis

Preamble

Since its original publication in May 2018, the Wing V21 analysis has become an important resource for entrepreneurs and investors trying to understand the changing nature of early stage technology financing. We have now performed this analysis for three years running, each year improving our methodology and data quality. The most recent analysis can be found here and includes the latest, most accurate data.

What follows below is the narrative of the second year’s post, which was published in April 2019. It makes important points about the drivers of the trends observed in the analysis – the forces behind the numbers. Please refer to the most recent analysis for the data that underpins this narrative.

Introduction

Last year Wing unveiled its inaugural study of the changing nature of early stage financing. This is based on our “V21” analysis, which includes only technology companies financed by one of a select group of the industry’s top venture firms. The response was overwhelming, so we decided to renew the study with a new year’s worth of data. The curated V21 data set now captures the details of 6,205 financings at 2,982 companies invested in by one of 21 elite venture firms across 9 years.

This year’s analysis reveals an acceleration of the trends that we measured last year. The Seed phase is rapidly expanding to encompass a broad segment of company development. Meanwhile, Series A investors are applying ever-stricter and ever-more mature investment criteria, looking for factors traditionally reserved for the Series B. Now more than ever, “Seed is the new A, and A is the new B”.

The Data: Updating the V21

For this year’s study, we updated the V21 analysis and made some modest improvements intended to enhance fidelity. First, we added a new year’s worth of data, which according to our methodology also impacts some of the prior years as the longitudinal financing histories of newly included companies are added to the sample. We also revisited the set of 21 venture firms in the dataset, bouncing one that was no longer relevant and adding another in its place. For consistency’s sake, we reran the entire analysis all the way back to 2010.

For readers unfamiliar with the V21, what follows is a quick recap of the motivation and methodology.

Motivation for the V21 Analysis

The future success of an early stage venture is not yet known. To focus on the highest quality companies, you need a proxy for company quality that is observable in the present. The one we chose in creating the V21 is the quality of the investor.

There is a lot of research support for this choice of proxy. Analyses from academics, limited partners and even venture capitalists show that fund returns and top-performing companies are disproportionately concentrated in the portfolios of the very best venture firms. Of course it is true that even the best firms make bad investments, and mediocre firms sometimes make good investments. But it is also true that the highest quality firms vastly outperform the rest, with strong persistence effects. By focusing on the investment activity of the top firms only, we are able to create a sample that better represents the companies that matter.

Methodology

The V21 starts with the identification of a group of 21 leading venture firms with a focus on the US technology sector. This is a subjective selection, performed by the partners of Wing, based on our deep experience in the industry. The firms in the sample are all best described as “Series A” or “multi-stage” firms. The group does not include Seed funds, although many of the firms in the sample make Seed investments as part of a broader strategy. This should not be interpreted as a negative statement about the importance of Seed funds, but rather the recognition that the portfolios of the leading major venture firms contain the highest fidelity signal. The best portfolio companies of the Seed funds are usually also captured in this sample, but with less accompanying noise. While we do not reveal the names of the 21 firms, it is fair to say that if we did, there would likely be no disagreement concerning 10 of them, broad consensus on 5, and lively debate concerning the remaining 6.

Having selected our 21 firms, we next identified every company in which one of them has made a new Seed, Series A or Series B investment from 2010 to 2018. These “V21 companies” form the backbone of the data set. It is worth noting that a follow-on investment from a V21 firm is not enough to include that company in the set – the investment must be the first time that firm has invested in that company.

Finally, we collected information on all Seed, Series A and Series B financings for the V21 companies – their longitudinal financing histories. All in, the V21 data set captures the details of 6,205 financings at 2,982 companies invested in by one of 21 venture firms across 9 years.

The focus of the V21 analysis is technology venture investing in the US. We specifically exclude companies in obviously divergent sectors and geographies. Some exclusions: no later stage investments, no growth equity; no life sciences; no China, no India. V21 companies in more closely aligned geographies and sectors, like Europe, Israel and Health Care IT, were left in the sample, but since the V21 firms are all US-based and technology focused, this is a relatively small proportion of the overall data set.

Welcome to the Metrics Generation

The V21 analysis shows that the role of Seed capital has expanded enormously, fully occupying the territory once held by the Series A. Series A investors have moved their goalposts, migrating to yardage traditionally served by the Series B.

At first I was puzzled by this. The venture capital industry had been built through courageous de novo investing. Its most valuable franchises stood on the shoulders of ground-zero bets and craftsman-like company building. Such work delivered the greatest returns and was the domain of its most legendary practitioners. Would they really give it all up to become “Series B” (recently rechristened as Series A) investors?

The answer appears to be yes, and one of the reasons appears to be scale. There is simply no other way for a venture firm to ramp up its Assets Under Management and per-GP economics, even if this means a trade-off in quality of returns. I discussed this “aircraft carrier effect” in more detail in the second half of last year’s study.

Another reason is a fundamental change in investment methodology. There is now an entire generation of venture capitalists who have been trained to make investment decisions based on financial and usage metrics. These stats and ratios are intended to illuminate value drivers like go-to-market efficiency, flywheels, stickiness, expansion factors and the like. This is especially true for application companies, which constitute the majority of new ventures these days. I recently spoke to a brand-name “early-stage” venture capitalist who told me that his firm not only wanted to see meaningful revenue before leading a Series A, it wanted to see over a year’s worth of it so they could evaluate renewals and upsells. Such “spreadsheet investors” don’t have much to go on when looking at pre-adoption ventures and prefer to evaluate companies mature enough to display a complete menu of metrics. The gulf in financeability between pre-adoption and post-adoption companies is wider than ever before.

Founders should not care about the scalability of the venture business – they have their own businesses to focus on. However, they do need to think ahead about how downstream investors will evaluate them in the future. With the Series A goalposts receding, the expanded seed phase is where company foundations are built. Decisions about seed financing – when to raise it, how much to raise, and who to raise it from – now have a profound impact on long term success.

We expect to see a new breed of venture firm emerge that is built for this work. These investors will engage deeply during formative stages while also bringing the long view and the experience required to build a company that matters. They will look quite different from prior seed firms, taking a more concentrated approach and bringing more financial and operational strength to each investment. They will also look different from the V21, willing to take pre-adoption risk and capable of making decisions in the absence of obvious metrics. As the venture markets continue to scale and diverge, this new breed of venture firm may ultimately become the founders’ most trusted and difference-making partners.

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