A Seed Strategy for LPs

I was speaking with a great entrepreneur recently about our seed strategy. We lead the majority of our seed investments with a goal of establishing a working relationship in which we can demonstrate our value and earn the opportunity to lead the Series A. To do so we spend as much time on these investments as we would with a larger round.

This strategy is shared by others, including many of the hiqh quality seed stage venture funds that have entered the market over the past few years. As the entrepreneur and I discussed, today’s best founders include many of these seed funds in their list of preferred partners.

Entrepreneurial interest in seed funds seems to outweigh that of LPs to invest in them.  While progressive LPs are making bets in these funds, many avoid them in large part due to the inability to efficiently invest across the class.

However, LPs can apply VC seed strategy to fund investing. While VCs cannot efficiently bet entire funds on seed opportunities, we can allot a portion of our capital to this riskier asset class with a goal of getting in very early to the biggest winners. LPs don’t have pricing issues, but they are at risk of getting completely shut out if they do not commit to emerging managers that drive significant returns in their first fund.

So they can take one of the larger checks typically given to a larger fund and allot it to a handful of smaller, emerging seed funds in the anticipation of aligning themselves with a big winner or two. These funds would likely raise a larger pool of capital the next time around and enable early backers to get a bigger allotment in a top performing fund.

How to Conduct References on Your Investors

When we are ready to make an investment proposal, we request a list of references. We also speak with off list contacts and ask permission to do so if those discussions could compromise the business. 

Any responsible investor about to enter a long term relationship with a team will follow that protocol. They need to learn as much about that team as possible within a relatively short time frame.

Entrepreneurs who are entering the relationship should conduct the same diligence from their end. However, it is far less common for them to do so. Below are some steps I’d recommend to make sure you’re signing up with the right investor. If they are unwilling to reciprocate references, you have to question whether they’re the right partner. 

1) When to Ask: Investors should not request references until they are very serious about making an investment, and entrepreneurs should similarly wait until discussions are at or nearing term sheet phase to do the same. Neither side should expect their contacts to conduct multiple reference calls with parties that are not serious about moving forward. 

2) Who to Ask For: Look at an investor’s portfolio and send a list of companies you would like to speak that are tangential to your business. Be sure that the fund representatives leading the investment are involved with those companies. You should reference the lead investor as well as the overall fund. Ask for references that have been successful exits and failures. Everyone shows their true colors when times are tough.

3) Go Off List: Investors like to speak with references that are not provided directly by the management team, making them truly neutral. Entrepreneurs should do the same when possible. These personal references can be conducted earlier in the process to make sure it’s worth continuing the discussions.

4) Make the References Worthwhile: Target references that can be helpful to your business as a partner or customer. If you’re working with a fund based on their portfolio, be sure that you can leverage it.