[Updated] The Coming Super-Seed Crash

Unnoticed by almost no-one, the startup financing landscape has been transformed: a combination of ease of entry, lower capital requirements, failing incumbent venture capital (VC) firms, and general fervor has driven the emergence of a host of new “super-seed” firms. These small-ish outfits — usually running less than $20m — specialize in seeding a bazillion companies, following on in very few, and generally trying to be fast-moving and networked. 

Now, however, the super-seed crash is coming. We have silly numbers of companies being seeded — I had someone at a well-known, larger venture fund tell me yesterday in San Francisco that they were seeing dozens of Series A-seeking newly angel-funded companies a week. Valuations are escalating as super-seeding angels compete against one another, while fourth-quartile incumbent VCs jack prices to buy deals through dint of having more money to put to work. At the same time, more companies seeded means more full-cycle money required to break through the noise and competition, which while drive dilution of seed investors who can’t follow-on in subsequent larger rounds. And, importantly, don’t forget to add-in the consumer-centricity of so many of these funds, all chasing a financially anaerobic U.S. consumer who is shopped out and indebted to death. About the only piece missing is the kind of parabolic fund-raising blow-off that marks the end of most such frenzies, and that can’t be more than one social network IPO away. 
Of course, this doesn’t mean that the super-seed model is all wrong. They aren’t, and smarter seed funds are back in the landscape for good, even if they won’t all be funding the umpteenth mobile-social-network-game thingie. Nor does it mean that incumbent VCs will once again rule the world with mega funds. Many of them, like the dinosaurs, have turned out to be evolutionary dead-ends that couldn’t adapt with a changing financial landscape. It does means that the super-seed side of the market is soon and healthily going to drop from its current outsized prominence. 
[Update] My this-was-bugging-me-while-showering musing has apparently got all sorts of people getting wiggy, so let me add some color and perspective. We need to start with some assumptions:
  1. Incumbent VCs in IT running more than a few hundred million dollars, at most, are screwed. The industry is maturing, requiring less capital, and producing fewer IPO winners, and that means the fee game is over, and they can’t produce returns justifying their size.
  2. Super-seed funds are, in game theoretic terms, a dominant strategy in the current market, one characterized by low capex startups, consumer-centricity, and a general Next Big Thing sensibility.
  3. Declining average cost of company creation is driving declining average cost of venture firm creation. When companies need less money, their VCs need less money. When VCs need less money, more people get to declare themselves VCs (or at least super-angels).
  4. More angels means more companies getting funded, and an inflection point in competition for the “best” low-capex deals. 
  5. More companies being funded means more companies languishing, being triaged or looking for growth dollars, as there is simply not enough market space to create and differentiate hundreds of new centi-million-dollar companies in the crowded consumer interstitials being chased by these low-dollar startups.
  6. More funders of early-stage firms means higher valuations on those deals, which means more risk and lower returns for the people who do the deals (on average).
  7. Incumbent VCs make up shit about the inadequacies of super-angel funds. While their small size is a problem sometimes, as is, sometimes, their inability to follow on, their nimbleness, work ethic, and ability to pivot matter more. In other words, saying that super-angels are going to crash says nothing about the raging rigor-mortis-in-the-prime-of-life inadequacies of VC incumbents.
  8. Venture capital is hard, whether practiced by brain-dead VC incumbents, or by smart and nimble super-angels. Most VCs, and most angels, fail — it’s just that its takes 10 years to kill a VC fund, while angels, like drosophilidae, evolve and die faster, which is a good thing.
If you accept the preceding assumptions, and you see the rapid rise in the number of seed-centric firms across the country, but especially in the Valley, you see a classic (eventual) overshoot going on, in ecological terms. A host of well-adapted and fast-growing organisms, perfect for the current funding environment, are emerging in a hurry, driven by need, incumbent stupidity and low marginal cost of super-angel creation, with the result, sooner or later, almost certain to be a population crash. Arguing otherwise requires you to believe that this time is different — perhaps supply creates its own demand, or the consumer opportunity is far bigger than it looks, etc. — and that is a tough case to make. 
Now, I’m prepared to accept that super-angels who mutate past/beyond consumers will find things considerably easier going, and that there are great brands out there among angels doing consumer funding who will continue to do very well (and we all know their names, so I won’t list them), but as incumbent VCs justifiably vanish en masse, niche overshoot seems almost ecologically inevitable among super-seed funds.

Related posts:

  1. Is the VC Seed Pool Really Shrinking?
  2. MySpace Launches Seed Fund
  3. No-one Does a Second Seed Fund
  4. Venture Capital: No Second Seed Funds
  5. Seed Investing and Why VCs are Risk-Averse Greed-heads

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