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An Analysis on Seed Funding in 2010 (Part 2 of 2)

Written By: Gary 19 August 2010 Other Posts By: Gary

This is a guest post by Gary Whitehill who was kind enough to allow Founders Block to repost his article, originally published on August 11th, 2010. In case you missed Part 1.

Seed Fund Opinions Numero Uno – The Nay Sayers

In a recent blog post, Paul Kredowsky voiced his disapproval of the seed funding phenomenon. However, his post is less about the entrepreneur, than the seed funding companies themselves.

His argument boils down to the fact that he believes many of the seed investors out there are running on very tight budgets themselves. They’re investing small amounts in lots of new ventures, in hopes that one or two of those ventures will become “homeruns.” That of course is not a good idea.

His point of view has validity. The challenge with seed funding investors spreading their own resources too thin is that if something goes erroneous in one of their portfolio investments, and capital must be deployed unexpectedly, the investor’s hands become tied. The funder also won’t have the necessary capital to allocate toward companies that actually do succeed, and who seek a follow-on second round of funding. This dynamic will force entrepreneurs to then search out their funding from traditional venture capital firms – which is the most expensive money they could take.

Seed Fund Opinions Numero Dos – The Fans

In response to Paul Kredowsky’s post, warning of a seed funding bubble burst, Chris Dixon made a post of his own, which tempered enthusiasm with caution.

As Chris points out in his post, we’ve come a long way from the dotcom bubble of the nineties. Both entrepreneurs and seed fund investors are savvier, and more skilled in business than their forerunners.

Chris rightly points out that as long as:

  • Seed fund investors are exercising a little caution choosing their investment vehicles
  • Entrepreneurs have both business acumen and a good idea

….. then the seed funding model can work, and is a valuable asset to a market where company founders struggled for years to obtain funding.

Of course, Chris’s post also mentions a huge wild card that traditional banks, VC’s and seed funds must watch out for – the economy in general. Then again, business is all about risk.

Time Will Tell

Of course, not everyone has a definitive negative or positive outlook on the seed funding phenomenon. Both Fred Wilson and John Boyd chimed in on the discussion and agree that the seed funding model is necessary, but that it will need a lot of tweaking to become a long-term viable option for start-ups.

A few years ago, entrepreneurs who sought to secure small amounts of funding to launch their start-up would have struggled to find any options that matched their needs. With the proliferation of seed funds, that’s no longer the case.

In the end, there are only two real questions:

  • Have the seed funders have backed the right horses?
  • Will the funders be able to deploy capital when the next round of funding is needed?

I certainly hope so on both fronts.

What It All Means For You – The Idea & Early-Stage Entrepreneur

Of course, you may be wondering how this all relates to you. Well, if you’ve been hoping to build a start-up but have been stumped about where to turn to find the seed capital you need, now just might be the right time for you.

If you have a great idea and your funding options are limited or nonexistent, then seed funding might just be the alternative to bootstrapping that you’ve been looking for.

However, BE AWARE – as the industry matures, there will be may be interesting consequences:

Skyrocketing valuations – What is your Justification?

There are two reasons I believe valuations could skyrocket literally overnight:

  • The year 2008 sets a perfect prescient for this point – as was the case with the private equity buyout craze – seeing that more professional seed funds are entering the market, supply and demand (number of potential companies and their valuations) will begin to shift.

As a result, bidding wars will begin and valuations will skyrocket. This will inevitably drive out certain investors – whether individuals, seed funds, or VC’s playing the seed game and most likely bring the horse right back to the water – true venture capital funding terms ($2M-5M).

  • Funders and entrepreneurs actually become too savvy at the process – because of too many entrants.

I know I am going to get some push back here because many folks will refute that there are a ton of great companies out there to fund (lots of supply). Let me be clear: I do agree with that statement. However, my point is if the seed funding game gets too big, meaning too many angels and VC’s magically think they can run a seed fund, then there’s going to be a lot more white noise in the marketplace. This becomes a forcing function for why funders and entrepreneurs will get more savvy in the process and why valuations will go up – because those who don’t know what they’re doing will make noise, create fragmentation and the result are valuations rocketing upward.

A simple solution to the above though would to build another simple platform such as TheFunded. Instead, lets call it “TheSeeding.com” (domain is open at the time I wrote this) so that everyone has an open source way of knowing who’s full of b*llshit and who is not.

On the flip side, I also believe there are a few variables that may keep the valuation war from happening regardless:

  • Investors won’t tolerate ridiculous valuations because they know the IPO market is stagnant. High or overly optimistic valuations are not a good thing today.
  • Another shift in technology that exponentially decreases the barrier to entry once again

My advice is to do your homework before searching for seed funding, and make sure that you have a backup plan for your second round of funding – just in case things go pear shaped.

As a successful, under-30 serial entrepreneur, Gary’s game-changing endeavors have been featured on television and in magazines and newspapers across the nation. Gary is a member of the AOL Small Business Board of Directors and the founder of New York Entrepreneur Week (NYEW), The Relentless Foundation and Whitehill International, each of which reflect his entrepreneurial drive and relentless energy

For more innovative entrepreneurial strategies visit Gary’s website and follow him on twitter.

Related posts:

  1. An Analysis on Seed Funding in 2010 (Part 1 of 2)
  2. A Peek Inside the NYC Venture Capital Ecosystem
  3. Steve Blank: The Rise of the Lean VC – Consumer Internet Gets Its Own Investors
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