I recently came across this tweet which accurately describes the current funding environment: large, multi-stage funds are spending more time investing earlier. This is mainly due to two reasons. The first is that there’s a dearth of fundraising activity at the later stages. Companies are either flush with cash or trying as hard as they can to avoid a raise in light of the depressed market conditions. The second reason is that multi-stage investors are simply less risk-on and more comfortable deploying smaller amounts of capital. It’s worth noting that multi-stage funds investing at seed is not a new phenomenon but something thats exacerbated by the current market.
It’s true that more money at the earliest stages is great for founders. What’s also true is that with different types of investors competing for allocation in early-stage funding rounds, founders need to decide which investors they want to work with. Choosing early investors is one of the most important decisions founders are faced with.
At Cherry Crypto we invest at the earliest stages of company formation and strongly believe that founders should pick investors that focus on their stage. Put simply, when you are an early-stage company, pick investors that focus on early-stage investing, and when you are a growth-stage company, pick growth investors.
With the rise of multi-stage funds over the past couple years, early-stage founders are left with a choice to go for an early-stage focused fund or for a multi-stage fund out of the gate.
The reasons to go with multi-stage funds are well cited. The first and perhaps most obvious is that given their resources, multi-stage funds can lead, or heavily follow on in company’s subsequent funding rounds. The prospect of avoiding a comprehensive fundraising process that involves creating a data room and pitching to external investors and instead reaching into the deep pockets of existing investors is compelling to some founders. In addition to the financial weight, some notable multi-stage funds have a strong brands that founders want to leverage. For some multi-stage funds that brand is a function of past success, for others it’s the result of a lot of resources put into marketing. Multi-stage funds often times also have large platform teams with employees across functions such as marketing, communications, finance, go to market etc. that are offered to startups as additional support.
So what’s the case for early-stage focused funds? First there are some pragmatic reasons.
Seed investments are a lot more meaningful for early-stage funds because they constitute a greater percentage of total fund size. Let’s assume a company is raising a $2m seed round and has an offer to lead the round for a $1.5m investment from two funds: a $100m fund and a $3B fund. For $100m fund that investment would represent 1.5% of their total fund size, and for the $1B fund 0.05%. Which fund do you think has a stronger financial incentive to make the investment work?
Don’t waste a bullet too early. Save an investment from a multi-stage fund for a round that is core to their strategy and where they compete against other large funds. Early-stage funds typically only have one opportunity to invest into a company. Multi-stage funds always have the opportunity to come into later rounds.
Ultimately, though, I think that the most powerful reason to go for an early-stage fund is emotional in nature.
Early-stage investing is a boutique business that is focused on something that is not scalable - building trusting and long lasting relationships with founders. Early-stage funds are limited in their headcount but that is their strength. The investment process isn’t divided across different teams for different functions - sourcing, due diligence, portfolio support. At early-stage funds, investors tend to be full-stack - they run a process end to end in its entirety. At the earliest stages, when the path forward is uncertain and the going gets tough, complete trust needs to exist between a founder and their investor. I think that trust is best nurtured when the investor is focused, has full context at all times and is fully vested in your long term success. An investor that doesn’t view your success as optionality, but as existential to their portfolio and firm.
A couple years back I was trying to convince a founder to choose us as their investor over a multi-stage fund. One of the reasons I gave back then to go with us was that if a multi-stage fund wouldn’t lead a subsequent Series A it would be bad signalling for future investors and make it much more difficult to fundraise. The founder responded to me by saying: “Patrick, I’m a startup founder. I’m already taking so much risk that this small additional risk doesn’t change anything.” I liked that attitude and looking back it was the wrong approach to communicate the benefits of an early-stage fund (even though I still think that signalling risk is worth paying attention to!). The right way to look at it is that in my opinion choosing an early-stage fund doesn’t protect your downside as a founder, but it maximises your upside.