When I entered the VC business 10 years ago, I tried to keep thinking about venture capital as a business, where the key focus area was on meeting the needs of our target customers — entrepreneurs and limited partner investors.

In the case of entrepreneurs, those needs have changed radically in these last 10 years.  The surge in seed investing over the last few years has been well-reported and analyzed.  With advances in cloud computing, open source infrastructure, development tools and general “Lean Start-Up” techniques, entrepreneurs need less capital than ever before.  And when entrepreneurs’ needs change (i.e., requiring less capital), smart investors adjust to meet those new needs.  Hence, the rise of angels, super-angels, incubators, accelerators, micro-VCs and VC-led seed programs.

But as the “Great Seed Experiment” (as my partner, Michael Greeley, calls it) matures, a new trend is emerging.  Entrepreneurs are beginning to learn the difference between what I’ll call Passive Seeds and Activist Seeds.  And entrepreneurs are learning that the difference between the two, although somewhat subtle, matters greatly.

Passive Seeds are when a VC invests a small amount of money (for a $200-500M mid-sized fund, typically $250k or less, for a large $1B fund, perhaps $500k or less), to achieve a very small amount of ownership (typically less than 5%) to simply create an option to participate as a more meaningful investor in the future.  Passive seed programs get most of the press attention because of their sheer volume.

When you ask venture capitalists about their seed programs, many will brag about how many seed investments they have made (20-40 per year is not uncommon) and how wonderful it is that so few of them “graduate” to become series A investments (perhaps 10-20%) because it shows how discriminating they are.  Other characteristics of passive seeds is that one or two of the partners can make the decision to invest, rather than requiring the entire partnership to approve, and the due diligence is very light.  Additionally, in a passive seed round, VCs don’t mind if 3-5 firms participate, as opposed to more tyically 1-2, and each VC partner can juggle a dozen passive seeds at any given time.  Sometimes there are more VC investors than employees in a passive seed!

But entrepreneurs are starting to wise up.  The conventional wisdom has emerged that Passive Seeds from VC investors are bad for start-ups and entrepreneurs.  VCs who make passive seeds are not typically engaged enough in the business to add meaningful value.  Further, they send a bad signal to the funding market when they don’t invest in the Series A, thus creating inappropriate leverage on the entrepreneur at the time of the Series A decision.

Seed investor/venture capitalist/entrepreneur Chris Dixon has written extensively about this issue, and I couldn’t agree with him more when he declares, based on his discussions with experienced founders, “there is no room for debate” on the issue.

Activist Seeds VC investors are a different story (which Chris acknowledges, although uses different language).  From the VCs perspective, an activist seed is when the firm commits the full time, resources, and energy into the investment that they would do with a Series A.  From the entrepreneur’s perspective, they truly wants to raise less capital because of all the positive Lean Start-Up trends noted below, but wants the active involvement of a value-added VC firm.

An activist seed from a VC is typically more like $250K-$1 million and the ownership is closer to 8-10%.  The full partnership approves an activist seed and the due diligence, although abbreviated, is thoughtful and serious.  The firm gets to know the business and the entrepreneur better and thus makes a deeper commitment in making the investment.

The conversion rate of an activist seed into a larger Series A is more like 50-75% and each VC partner dedicates as much time to an activist seed as they do a larger Series A.  In short, an activist seed is nearly identical to a Series A, just smaller, slightly more streamlined, and informal – all appropriate for the stage of the business and the requirements ahead.

So next time you are discussing a seed round with a VC firm, figure out if their firm’s philosophy is activist or passive.  At Flybridge, we firmly believe in activist seeds (two nice examples recently in the news are Crashlytics and ZestCash).  Different firms have different approaches.  Make sure you find out which is which, and make sure it’s a fit for your needs.  Here are a few questions you can ask yourself to distinguish between the two:

  • Was the entire partnership engaged in the investment decision process?  Did I meet with and pitch to the entire firm?  This results in a greater sense of commitment and shared ownership.
  • Did the VC open up her network and make a few value-added introductions to prospective talent, customers and business development partners?  Again, this is an indication that the VC is willing to add value along the way and be more active than passive.
  • Was the due diligence process rigorous? Do they seem to really understand my business and the subtelties around what it takes to win?  Did they ask tough questions, check my personal references to get to know me better, put me in front of prospective customers?

Absent these elements, you are at risk of taking money from a VC that views you as “an option” rather than “an investment” – not a place a hard-charging entrepreneur who needs as many friends on their side as possible wants to be!

Jeff Bussgang is a general partner at Flybridge Capital Partners. He is the author of Mastering the VC Game, is an insider’s guide for entrepreneurs on financing and company-building. Follow him at his blog Seeing Both Sides where this post first appeared.

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5 Responses for “Activist Seeds – The Latest, Subtle Trend in Seed Investing”

  1. DeterminedMD says:

    What does this have to do with health care issues?

    Sounds like Jack in the Bean Stalk to me!

  2. john says:

    I get your suspicion of health IT companies, @Determined.

    As a doc, you’ve seen a lot of snakeoil and a lot of snakeoil vendors. (pharma reps, technology companies coming ) I get it. I really do. But a lot of our readers are trying to develop ideas in the healthcare that really could do some good. This post is about helping them figure out how to work with the system as it is presently constituted.

    If you disagree with a post, cool. That’s the point. The idea is to move the conversation forward. Challenge the argument. Refute the logic. Say something intelligent.

    You also have another option. If a post is too micro for you, you can always skip it.

  3. DeterminedMD says:

    No, it is just selling profit motive attitude in a profession that is ruined by such mentality. THCB can run whatever posts it deems presentable.

    This does NOT meet my definition.

  4. John Ballard says:

    I agree with MD.

    Healthcare is already exploited as a commodity. And adding venture capital to the mix is pouring propellant into the fire.

    Moreover, the toxic mixture of so-called “not-for-profit” outfits working hand in glove with profit-making practices, specialties, device makers and drug companies (not to mention a host of non-medical hangers-on) has made the medical-industrial complex one of the most pernicious expenses faced by Americans. It’s money-laundering at it’s worst.

    And the only way to avoid it is to remain healthy and die suddenly without needing medical attention.

    So here is my litany…

    If Medicare and other medical expenses are to be lowered the answer lies not with rationing or tweaking the insurance industry, but with the reduction of the numerous non-medical expenses sucking the system for other purposes. Here are a few more expenses, all of which have but one revenue stream — medical
    bills.
    § TV ads — some of the most expensive air time for some of the most costly productions in the ad industry.
    § Mammoth executive bonuses and golden parachutes for both health care administrators and insurance companies
    § Facilities with manicured landscaping, marble floors, lived plants, flat-screen TVs in every room, and concierge food service
    § Elaborate accounting arrangements by which large so-called “not
    for profit” health care systems, often augmented by equally large,
    embedded insurance companies (BCBS comes to mind) launder bills mostly for the benefit of very profitable clinics, specialty practices and
    device manufacturers.
    § ”Free scooters” advertised for Medicare beneficiaries. Sometimes comes with a free recipe book or lighted magnifier “just for making the
    call!”
    § Catered meals and other treats for hungry office staffs, compliments of your favorite drug or other supplies sales representative.
    § And speaking of sales, don’t forget the sales bonuses for high
    performers. The only people in America with no limit to how much they
    might earn are not in medicine or other specialties, but in sales.
    (Investment bankers are in the running, of course, but they are in fact
    limited by how much capital and/or credit they have. Enterprising sales
    people have only transportation, cosmetics and a few other expenses.
    § Don’t let’s leave out some red meat for the tort reform crowd —
    legal and accounting services, and a grey area often called “defensive
    medicine.”

    With the exception of a dedicated group of community volunteers who provide a few ancillary goods and services, every dime of all that has but two sources:
    1.) Medical bills
    2.) Government grants for teaching hospitals and research by NIH. (taxes)

    What am I missing?
    *
    *
    *
    *
    *
    *
    * Yes, of course. I almost forgot — MEDICAL CARE!
    ~~~~~~~~~~~~~~~~~
    Don’t you love watching those ED ads where the whole landscape goes tumescent?
    That’s a really great special effect, huh?
    Makes you all horny just watching.
    Production expenses for those advertisements, special effects, prime-time broadcast air time and profits for the agency that were paid to put them all together…. all that money has only one source, medical bills. The money has to come from someplace and that is the only revenue stream feeding the whole medical-industrial complex, either OOP expenses or premiums.

  5. My Site says:

    It is possible to undoubtedly visit your abilities from the works of art you’re writing. The earth wants far more passionate freelance writers that you that aren’t scared post that they consider. At all times focus on your own coronary heart.

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