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 I first entered the venture capital business 10 years ago after being an entrepereneur, my partners warned me that “my bar” for new investments would get higher over time. In other words, the criteria to make a new investment – clearing “the bar” – would get more strict with time as I developed more experience and saw more things. I found this to be very true, and the notion that investors get wiser and more selective over time has become common wisdom in the industry.
But there’s something very new going on in the last few years – something very striking. Simply put, the collective bar of the investment community to fund young companies has recently gotten higher – much higher.
The entrepreneurs I speak to are feeling it every day. When they pitch their new idea to investors, they are told to build a prototype first. When they build the prototype, they go get customers. When they get customers, they are told to show engagement metrics. When they show engagement metrics, they are told to run some monetization experiments. When they run monetization experiments, they are challenged to prove scalability. Maybe I have Passover on the brain this week, but it’s like investors are putting entrepreneurs through a nightmarish version of Dayeinu, where no matter what they achieve, it’s never enough (speaking of Passover, if you haven’t seen this Jon Stewart clip of Passover vs. Easter, it’s a must. I’ll wait.).
Why is the new investment bar so high today? Isn’t there plenty of euphoria and “animal spirits” to go around with the IPO market returning, marquee acquisitions (e.g., Instagram at $1 billion) and the impending, earth-shattering Facebook IPO?