The Follow On Or Re-Seed Round

When does it make sense to follow on, and when do you quit?  That is one of the more nuanced things in seed investing.  It is one of the things that seed investors are going to be confronted with more and more.   With crowdfunding, and the changes in the funding cycle, I think we will see more internal follow on rounds.

A lot of funds are stepping back from even doing seed investing.  The math says they are wrong, but I think the major reason they are stepping back is seed valuations were too high.  A $3M pre-money is quite a bit different than a $6M pre-money when it comes to venture math.  As valuations at the upper tier get crushed, the knock on effects are filtering down to seed and changing risk appetites.  When valuations at seed drop, I think you will see a renewed appetite for seed from VCs.

I have passed on internal follow on rounds, and I have written checks.  There isn’t a hard and fast formula.  One thing I think seed investors should do is get together before they do that first round and discuss possibilities.  I’d make sure that there was enough money at the table to get the company to Series A.   The Series A metrics have to be  generally known before you write a check.   Just ask a VC and they can tick them off for you.

Once a company hits that $40M-$60M point in valuation, seed investors are better off using their capital to seed new companies.  Angel math tells you that every time you write a check, you look for a 30x return, not a 10x return like VCs.  Angels take a lot more risk so they need more return.  The problem is psychologically, people feel there is less risk putting money in an established company.  Of course, companies that hit that mark fail too!

The funding cycle has changed, and it’s more like this:

Bootstrap—>Friends and family—>Seed—>Re-seed—->Series A

Crowdfunding can enter at any point in the cycle.  F+F rounds are crowdfunded now.  Seed rounds are crowdfunded.  Interestingly what I am seeing is if a seed investor or angel group adds value, entrepreneurs want them in their deal.  Otherwise, the money is commodity money.

Since the costs to start a company have gone down tremendously, it’s easier for entrepreneurs to bootstrap longer, F+F rounds are smaller.  I am seeing companies raise too small a round at seed which has morphed into a double seed round before Series A.

I think this is why YCombinator came up with the SAFE system of early stage financing.  Everyone was doing a note, and in a re-seed often you would have to extend the terms of the note.  With a SAFE, you avoid that conversation and risk.

Series A rounds have grown in size since VC’s want to maximize their risk/reward.  They don’t want to do the exhaustive work it takes for seed.  But once product market fit is there and the company looks like it could be something they want to jump in with both feet.

Here are some of the things you should be thinking about on a re-seed:

  1. Has the business progressed?  Is it closer to finding product market fit?
  2. Has the team performed, or are they dysfunctional in some way?  Can you change the team, keep the business and give it another try?
  3. What are the clear metrics they have to hit to raise a series A?  How much extra runway are they going to need to get there?
  4. Has any part of the initial hypothesis changed since the original funding?  Has the market moved?  What have you learned about the market that you didn’t know and can the team execute on it?
  5. Are there any new funders you can bring into the deal now?
  6. Are the investors taking too much equity leaving no incentive for the entrepreneur to build a blow out business?

For me, I really take a hard look at team.  At seed, the team is everything.  If I am comfortable with the team, I look at the business.  Sometimes, businesses just don’t work.  I also look and see if I can have a material impact on the company.  Can I introduce them to a potential customer to help them grow their top line?  And lastly, I look at my own capital.  I don’t have a money tree I can shake so there are constraints.



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  • Seph

    Living this right now with my founder. Although we were calling it a “Super Seed” for awhile, it is just as you describe.

    We did not raise enough on the 1st seed and have to regroup before a Series A push. The 1st seed was enough to find the right fit, and the re-seed will allow us to really validate the model. The SAFE system was a significant influence on our structure for the re-seed.

    Honestly, the biggest reason for coming up short on the 1st seed is the incredible opacity of the early stage environment. There is no master formula that will tell you, “ok, in your case you need $x, can get it at $y valuation, will be able to run for z months, and must show traction here, here, and here for future investors”.

    (Thank you for sharing your experiences so freely.)

    We found that the best way to get actionable information was to plant our flag in the sand, move forward, and pay serious attention. It was the only way to get good feedback in a short time frame. Not optimal, but that’s the cost of tuition. Oftentimes it feels like the wild west out here, but so far, so good.

    • Great feedback. Good luck. It’s very difficult to try and figure out what your burn will actually be. I like to be aggressive with the burn number-meaning if the entrepreneur thinks it will be 30k, make it 50k and see where you are. Ideally, you raise enough for 12-18 months of runway, but you have to know what the metrics around your Series A are going to be so you can hit them—and start having conversations with potential VCs that are a fit during your seed process. Build relationships.

    • Nick Katz, FRICS

      Such a great response here. This is exactly how we felt with what we have called our pre-seed round and our recent seed – but being based in the UK, we couldn’t use notes because angels have to invest for ordinary shares and straight equity to be able to take advantage of a very advantageous tax scheme created by Gov in the UK called SEIS and EIS.

      That idea of closing a round to get going, plant a flag in the ground, and then get to know your metrics, burn and milestones before a larger seed makes sense – but it feels disadvantageous to founders and early members as you have to deal with multiple rounds of dilution (at least when going with equity (in the UK)).

      • Great point. I did not know UK law. They should amend the law to make it more founder and early stage investor friendly. One thing I cannot stress enough is investors need to make sure there is enough equity in the deal for the founders and team-investors should buy a Porsche, founders and island on successful exits.

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  • Seph

    To speak more to your point above regarding the SAFE structure. We also looked at the KISS structure from 500 Startups. The general consensus appears to be that SAFE favors the entrepreneur while KISS favors the investor. (Quora was a good resource here.) The KISS has a debt version and an equity version. The SAFE is equity only, by design.

    The basic KISS structure is more, um, structured. It includes a 2x liquidation multiple if there is a buyout before conversion (basic SAFE is 1x). There are clearly defined “Major Investor Rights” which are not addressed in a SAFE. There is an option to convert to Preferred at any time following Maturity. There is a clearly stated Most Favored Nation (MFN) clause. (Both KISS and SAFE assert pro rata rights.)

    I believe these are the reasons why KISS is said to favor investors more than SAFE. Done correctly, that structure could have made for good and more sophisticated terms. But I can only say that with the benefit of almost a year’s worth of hindsight and paid tuition.

    We elected for the SAFE structure because the language was more accessible and we could get our heads around it faster. At the time, all of our financing was from individual angels. Accredited investors and smart people, but nobody who does early stage or VC as their day job. My founder and his team were able to have these investor conversations more efficiently around the SAFE structure.

    The SAFE has fewer obvious moving parts – dial in the Discount and/or Cap, switch on/off the MFN clause, and everything else will be exactly the same as Preferred on a following (priced) round. We felt that MFN was not necessary because we would do that anyway, and it saved having to describe another moving part. Our goal was to focus on the Discount and Cap to fairly reflect the risk assumed by a new investor.

    One point on which we have been firm throughout is having no debt piece to the financing. We felt it a poor use of scarce capital to service debt when it could be put toward building the venture. Even an interest rate so low as to be purely symbolic can represent something material to a lean burning company – 2% of $500k is already $10k, which could account for up to a week (or more) of burn for a company that measures its reserves in months.

    We did make a couple of departures from the basic SAFE structure. First, we borrowed from the KISS to tack on a Maturity date with option to convert. Second, our counsel changed the name because he didn’t want people to think “SAFE” was some kind of judgement about the investment itself. An apt observation. So the “Simple Agreement for Future Equity” became “Simple Instrument for Future Equity” – SIFE.

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