High Resolution Seed Financing for Startups in 2022.
This is not your dad’s seed financing environment.
There’s a ridiculous amount of money flowing into seed-stage startups right now. According to Crunchbase, investors put $29 billion into seed-stage deals in 2021, an increase of 35% over the previous year. 2022 looks to be even bigger. It’s a completely different seed-stage startup fundraising environment than it was just a few years ago.
First, a little history:
It once was that Venture Capital funds focused on making large bets on startups that were far enough along that they had proven market demand and were now scaling-ready. This meant that startup founders often needed to go find some “rich uncle money” in order to get their startup to the point where it was ready for Venture Capital.
When you finally got to a Venture Capital round (typically called Series A financing) it was always structured as equity with a fixed price and a simultaneous close for all investors in that round. Your legal fees for a Series A financing would typically be $50K-$100K and the process would take several weeks (or months).
Over time, seed financing grew into a cottage industry of its own, filling the financing gap for startups that weren’t yet VC-ready. Seed investments were typically done as Convertible Notes, which is a way of your crazy rich uncle saying “Let’s just call it a loan for now and we’ll convert this to equity when you raise that VC round a year or two from now”. When there were multiple seed investors in the round, the expectation was that it would be structured as a set of Convertible Notes on exactly the same terms with exactly the same close date for all investors.
Then Paul Graham wrote an essay called High Resolution Fundraising in which he suggested that seed-stage fundraising should happen in a whole different way. There was no logical reason for it to be fixed-price, simultaneous close, like a typical VC round is. Eventually he and his firm developed a new investment instrument called a SAFE to replace convertible notes, and it has become the seed financing structure of choice in Silicon Valley today.
OK, enough history, let’s talk about 2022.
Seed financing is now a thriving industry of its own. Last year 17,000 startups raised a total of $29 billion in seed financing, driven by incredibly strong investor appetite. There are now thousands of active angel investors making seed investments in startups. Meanwhile, many VC firms, not wanting to miss out, have created their own seed-stage funds to work alongside their traditional venture funds. Seed financing, once the domain of a few crazy rich uncles, has now grown into a whole new asset class.
So what does this mean for startup founders today?
As a startup CEO, your most finite resource is time. Optimizing how you spend your time turns out to be a key success driver for startup success. You want to be focused on getting customers and building a product that delights customers — you do not want fundraising to become an endless time suck. So take advantage of the current environment to run a high resolution seed financing process:
- Use SAFE’s. They are designed to be lightweight investor agreements that can be executed quickly and efficiently by all parties.
- Do rolling closes. Don’t wait for all investors to be in before a seed round closes. As each investor wires their money, send them a signed SAFE.
- Create a sense of urgency by rewarding early investors. Tell the investors you are courting that “Investments received by the end of the month will get a SAFE with a valuation cap of X. Next month the valuation cap will be Y”.
- Choose a law firm that is on-board with your desire to run a high-resolution seed financing process. Some lawyers are locked into the old way of doing things (and getting the fees that come with an old-school equity financing).
- Social proof matters. Do you know 1–2 people who, if they invested, would provide tremendous social proof that would help your fundraising? Go to them first and offer them a great deal on a small investment — maybe $10K each with a very low valuation cap. Having them in on the deal will help immensely with the rest of your seed fundraising.
- Give yourself some flexibility on the size of the round. Investors like to know the exact size of the round, but you want to be a bit flexible based on how much investor demand you get. Mark Suster suggests a way to do this is to write a clause in the term sheet that sets a round size but says it may be increased by 50% for money received within 90 days, allowing you some flexibility while still putting bounds on it for the sake of investors.
We are definitely in a founder-friendly period in the startup funding world right now. Take advantage of the fact that 2022 is a great year to be shopping for seed financing and that there are investment instruments and protocols that allow founders to effectively run a high-resolution seed financing process. Optimize your efforts for 2022, and you’ll create a startup well-positioned for long term success.