To keep pace globally, we must be willing to allocate significant resources to the effort of creating new businesses.
This is a story about Jack and Jill, but no one is fetching water. Jack has a software startup and Jill is a boss-lady venture capitalist. (This is not taught in your child’s kindergarten… no, not even at Montessori.) Okay, now for some context…
What Is a Seed Fund?
Within the startup community, a “seed fund” is a venture capital fund that has a specific investment thesis, which is that the fund manager seeks to make frequent investments of smaller amounts of money into (very) early-stage startup businesses.
Venture investing is risky, and early-stage venture investing is even riskier. The strategies and plans of startup businesses are built on assumptions and unknowns, and in the early-stage days, the work of the founders (and the company as a whole) is to learn about these assumptions. Is the problem worth solving? Does the idea for a solution match what the potential customer needs? Can the business model perform at scale… or before the company runs out of cash? These are the questions.
So, making seed-stage investments can be thought of as a numbers game. Since the survival rate of growth-oriented startup businesses is somewhere between 10 and 40 percent (depending on which data set or dubious blog is to be believed), then the investment strategy is to make a lot of small investments in a differentiated set of startups. There will be failures. But those failures do not define the success of the fund. The companies that get traction in the market, experience growth and become profitable will cover the losses and be quality holdings or better downstream investment opportunities.
Making seed-stage investments is also an economic development strategy, but the topic is ripe for the chicken-and-egg argument. Entrepreneurs think there is no risk capital available to them; investors think there are no good deals and no experienced entrepreneurs. The communities that continue to go around and around on that argument create a self-fulfilling prophecy.
Our hypothesis is that our seed fund model solves for this. This hypothesis is founded on what we have heard during our learning diligence. Seed fund managers from across the country use phrases like created a tailwind and accelerated critical mass when referring to the effect their early-stage investment strategies have had on the local startup ecosystem.
Jack and Jill
Startups typically raise funds in “rounds,” in which a handful of investors participate. That’s because when a company progresses meaningfully, its value theoretically goes up. Therefore, the company and its investors (new and existing) must agree on what that value is—a process called valuation—before a price for the company’s stock is set for each round.
In most cases, the company that is raising money will work with one investor to set the terms of the investment. After the terms—price of stock, changes in governance, etc.—are set, the lead investor often brings other investors in on the deal.
Example: Jack’s Software Co. is raising a $2 million round and is working with Jill’s Ventures, LLC to set the terms of the deal.
A common scenario is that Jill’s Ventures, as the lead investor, will agree to put in roughly half the amount Jack is asking for, then make a few calls to other investors who Jill thinks would follow her into the deal. They must buy in at the same terms to which Jill and Jack have already agreed. The credibility of Jill’s firm among her peers becomes incredibly important; they trust that she has evaluated Jack’s Software Co. competently.
Similarly, it is critical for Jack’s team to do their homework before agreeing to go into business with Jill’s Ventures. Even if Jill puts in $1 million, the round still has $1 million to be raised before it closes. If Jill is a reputable investor, she will bring some peer groups in on the deal, hoping that those firms will offer to bring her in on the good investments they get in on. Because: portfolio diversity.
Anyway, negotiating terms should not be an adversarial exercise. After terms are set, Jill will become a champion for Jack’s company and help him close the current round, as well as participate in future fundraising rounds as her firm is able.
The example of Jill’s Ventures, LLC illustrates what it would mean to have a lead investor in Greater Peoria. While our market may not be overflowing with good seed-stage deals, there are investable ideas that Jill could fund while exercising professional discernment. If Peoria Jill were to invest in everything that came along, she would lose credibility among follow-on investors, and may actually undermine the company she is trying to help grow!
How This Differs from Past and Present Investing
Some readers may be thinking that we have tried this before in Greater Peoria, or that there are already active investors here. Well, they are correct. However, I would humbly ask that they consider the following differences, which represent a readiness level far greater than in years past.
First, our current startup investing community (with few exceptions) and the VC firms from our past have tended to be follow-on investors, meaning that some entity from outside the area would have to be the lead investor. The disadvantages of this can be inferred, but mostly it is incredibly inefficient. And if there’s one thing a startup cannot afford to be, it’s inefficient. In addition, depending on outside entities to lead every deal does little to develop the sophistication of our startup ecosystem.
Second, past VC attempts resulted in a couple million dollars being put into four or five companies. Seed funds are designed to play a numbers game. Because they are designed to make a lot of small bets, more entrepreneurs get a chance to have a go at a business opportunity. That is why so many economic development entities are employing it as a strategy. An important point here is that, as a steward of her and others’ risk capital, Peoria Jill will still be discerning, but the investment strategy should allow her the freedom to take risks and be the first money in on founders with potential!
Third, our entrepreneur support ecosystem is coming together. There are a handful of experienced founders, several of whom have raised money and built growing companies. The programmatic offerings continue to evolve to meet the needs of our young companies. Through the venture activities of OSF HealthCare and Caterpillar Inc., there are now experienced venture professionals who call Greater Peoria home.
Fourth and finally, seed fund managers have access to more national resources than ever, including the experience of their peers.
Here’s the Pitch…
If we want our regional economy to keep pace in a global economy, we need to be intentional and willing to allocate significant resources to the effort of creating new businesses.
With a small group of advisors, I have been researching models and making phone call after phone call to seed fund managers all over the U.S. to learn what has been working in their regions. We plan to start small to prove there are deals to be made, then level up. Any investors (individuals, families or organizations) who are interested in more details—or are ready to participate in an opportunity with upside and a strong community development element—should reach out to me at firstname.lastname@example.org. iBi
Randon Gettys is director of Startup GP, a program of the Greater Peoria Economic Development Council.