Seed is the New A, A is the New B

The 2019 V21 Analysis

Last year Wing unveiled its inaugural study of the changing nature of early stage financing. This is based on our “V21” analysis, which includes only technology companies financed by one of a select group of the industry’s top venture firms. The response was overwhelming, so we decided to renew the study with a new year’s worth of data. The curated V21 data set now captures the details of 6,205 financings at 2,982 companies invested in by one of 21 elite venture firms across 9 years.

This year’s analysis reveals an acceleration of the trends that we measured last year. The Seed phase is rapidly expanding to encompass a broad segment of company development. Meanwhile, Series A investors are applying ever-stricter and ever-more mature investment criteria, looking for factors traditionally reserved for the Series B. Now more than ever, “Seed is the new A, and A is the new B”.

Here is a summary of the key findings:

Seed Financings

  • Companies are consuming more Seed capital than ever before. In 2018, the average company had raised a total of $5.6M prior to raising a Series A, up from $5.2M in 2017 and 4.3x more than the $1.3M of 2010.
  • The size of Seed financings has grown considerably. The average seed financing in the V21 sample was $3.9M in 2018, up from $2.9M in 2017 and 3.9x more than the $1.0M of 2010.

Series A Financings

  • Pre-revenue Series A’s are nearly extinct. A stunning 82% of companies completing their Series A in 2018 were generating revenue, up 5.5x from 15% in 2010. This figure was 56% a mere 2 years earlier in 2016.
  • The size of Series A is spiking. In 2018, the average Series A was $15.7M, up from 11.8M in 2017 and 3.1x bigger than the $5.1M of 2010.

Seed vs. A vs. B

  • The size of financings has escalated an entire “alphabet rung”. Average total financing prior to Series A reached $5.6M in 2018, actually exceeding the average Series A of 2010 ($5.1M). Similarly, the average Series A in 2018 ($15.7M) was larger than 2010’s average Series B ($14.8M).
  • Seed and Series A valuations are diverging. Seed pre-money valuations declined in 2018, while those for Series A rose sharply, resulting in a growing valuation gap between Seed and Series A.

On dimension after dimension, Seed financing has assumed the role once played by the Series A, which now looks very much like a “traditional” Series B.

The Data: Updating the V21

For this year’s study, we updated the V21 analysis and made some modest improvements intended to enhance fidelity. First, we added a new year’s worth of data, which according to our methodology also impacts some of the prior years as the longitudinal financing histories of newly included companies are added to the sample. We also revisited the set of 21 venture firms in the dataset, bouncing one that was no longer relevant and adding another in its place. For consistency’s sake, we reran the entire analysis all the way back to 2010.

For readers unfamiliar with the V21, here is a quick recap of the motivation and methodology. Others may want to skip ahead to the next section, “The Findings”.

Motivation for the V21 Analysis

The future success of an early stage venture is not yet known. To focus on the highest quality companies, you need a proxy for company quality that is observable in the present. The one we chose in creating the V21 is the quality of the investor.

There is a lot of research support for this choice of proxy. Analyses from academics, limited partners and even venture capitalists show that fund returns and top-performing companies are disproportionately concentrated in the portfolios of the very best venture firms. Of course it is true that even the best firms make bad investments, and mediocre firms sometimes make good investments. But it is also true that the highest quality firms vastly outperform the rest, with strong persistence effects. By focusing on the investment activity of the top firms only, we are able to create a sample that better represents the companies that matter.

Methodology

The V21 starts with the identification of a group of 21 leading venture firms with a focus on the US technology sector. This is a subjective selection, performed by the partners of Wing, based on our deep experience in the industry. The firms in the sample are all best described as “Series A” or “multi-stage” firms. The group does not include Seed funds, although many of the firms in the sample make Seed investments as part of a broader strategy. This should not be interpreted as a negative statement about the importance of Seed funds, but rather the recognition that the portfolios of the leading major venture firms contain the highest fidelity signal. The best portfolio companies of the Seed funds are usually also captured in this sample, but with less accompanying noise. While we do not reveal the names of the 21 firms, it is fair to say that if we did, there would likely be no disagreement concerning 10 of them, broad consensus on 5, and lively debate concerning the remaining 6.

Having selected our 21 firms, we next identified every company in which one of them has made a new Seed, Series A or Series B investment from 2010 to 2018. These “V21 companies” form the backbone of the data set. It is worth noting that a follow-on investment from a V21 firm is not enough to include that company in the set – the investment must be the first time that firm has invested in that company.

Finally, we collected information on all Seed, Series A and Series B financings for the V21 companies – their longitudinal financing histories. All in, the V21 data set captures the details of 6,205 financings at 2,982 companies invested in by one of 21 venture firms across 9 years.

The focus of the V21 analysis is technology venture investing in the US. We specifically exclude companies in obviously divergent sectors and geographies. Some exclusions: no later stage investments, no growth equity; no life sciences; no China, no India. V21 companies in more closely aligned geographies and sectors, like Europe, Israel and Health Care IT, were left in the sample, but since the V21 firms are all US-based and technology focused, this is a relatively small proportion of the overall data set.

The Findings

1. Size of Financings

The growth in the size of early stage financings accelerated last year. The average Seed financing in 2018 was $3.9M, up 34.4% on the year; the average Series A was $15.7M, up 33.1%. Meanwhile, the average Series B held relatively steady at $30.7M in 2018. It is possible that we will see this figure increase in the next couple years as the newer cohort of cash-consuming companies reaches that stage.

The “cross-class” comparisons are also instructive. The average 2018 Series A has now surpassed the 2010 Series B; and the average discrete Seed has reached 76.5% of the 2010 Series A (a comparison that does not include the additional effect of multiple pre-A financings per company).


2. Sequential Number of Rounds

“Sequential Number of Round” in the V21 analysis indicates the chronological sequence of a financing. Is it the first? Then it is “round number 1”, and so on. The average “round number” for Seeds appears to have leveled off at approximately 2, having started the decade much closer to 1. The number for Series A and B continues to drift higher, with the A cresting 3 and the B hitting 4 for the first time. Most of the companies in our sample seem to be doing 2 distinct financings prior to raising their Series A.

3. Cumulative Capital Raised “Prior-to”

Cumulative capital raised “Prior-to” is the total capital a company has raised prior to a particular financing. Over the course of the decade, the starkest increase in “prior-to” capital is associated with the Series A. V21 companies raising Series A’s in 2010 had raised an average of $1.3M beforehand. By 2018 this number was $5.6M, a 4.3x increase.

Capital raised prior to the Seed and Series B declined modestly in 2018, though both figures saw sharp increases in 2017 and are up enormously since 2010.

4. Valuations

Valuation trends are starting to diverge between the Seeds and the Series A’s / B’s. Average Seed pre-money valuations declined in 2018 by 13.3%, while Series A and B valuations increased by 18.0% and 6.2%, respectively (both having troughed in 2016).

Valuation statistics are often sparse and inaccurately reported, so the above figures should be considered a “sample of a sample” with some unknown error factor as well. The fidelity is higher for the Series A and B financings, where 75% to 90% of them include a valuation figure depending on the year. Seed valuation data is sketchier, with 35% to 60% including a valuation.

5. Years Since Founding

It used to be that the Series A occurred at time of inception. Series A VC’s backed a couple founders and an idea. By 2010 the average new Series A company was about 2 years old and by 2018 slightly over 3 years old. This “aging” effect is seen at the Seed and Series B stages as well. “Years Since Founding” continued to increase in all stages in 2018, though at a slower rate than in 2017 and most prior years.

6. Revenue Generation

With companies taking more time before raising their Series A, it should not be surprising to see a rise in the proportion of funded companies that are revenue-generating. However, what is surprising is the sheer magnitude, even at the early stages. 82% of new Series A companies are now generating revenue, as are 54% of those completing Seeds. These represent massive increases since 2010, when both figures were 15% or less.

Taken together, the trends in both Years Since Founding and Revenue Generation indicate that today’s V21 Series A companies are now far more mature than prior cohorts.

Welcome to the Metrics Generation

The V21 analysis shows that the role of Seed capital has expanded enormously, fully occupying the territory once held by the Series A. Series A investors have moved their goalposts, migrating to yardage traditionally served by the Series B.

At first I was puzzled by this. The venture capital industry had been built through courageous de novo investing. Its most valuable franchises stood on the shoulders of ground-zero bets and craftsman-like company building. Such work delivered the greatest returns and was the domain of its most legendary practitioners. Would they really give it all up to become “Series B” (recently rechristened as Series A) investors?

The answer appears to be yes, and one of the reasons appears to be scale. There is simply no other way for a venture firm to ramp up its Assets Under Management and per-GP economics, even if this means a trade-off in quality of returns. I discussed this “aircraft carrier effect” in more detail in the second half of last year’s study.

Another reason is a fundamental change in investment methodology. There is now an entire generation of venture capitalists who have been trained to make investment decisions based on financial and usage metrics. These stats and ratios are intended to illuminate value drivers like go-to-market efficiency, flywheels, stickiness, expansion factors and the like. This is especially true for application companies, which constitute the majority of new ventures these days. I recently spoke to a brand-name “early-stage” venture capitalist who told me that his firm not only wanted to see meaningful revenue before leading a Series A, it wanted to see over a year’s worth of it so they could evaluate renewals and upsells. Such “spreadsheet investors” don’t have much to go on when looking at pre-adoption ventures and prefer to evaluate companies mature enough to display a complete menu of metrics. The gulf in financeability between pre-adoption and post-adoption companies is wider than ever before.

Founders should not care about the scalability of the venture business – they have their own businesses to focus on. However, they do need to think ahead about how downstream investors will evaluate them in the future. With the Series A goalposts receding, the expanded seed phase is where company foundations are built. Decisions about seed financing – when to raise it, how much to raise, and who to raise it from – now have a profound impact on long term success.

We expect to see a new breed of venture firm emerge that is built for this work. These investors will engage deeply during formative stages while also bringing the long view and the experience required to build a company that matters. They will look quite different from prior seed firms, taking a more concentrated approach and bringing more financial and operational strength to each investment. They will also look different from the V21, willing to take pre-adoption risk and capable of making decisions in the absence of obvious metrics. As the venture markets continue to scale and diverge, this new breed of venture firm may ultimately become the founders’ most trusted and difference-making partners.