Lessons from our last three funds and 97 investments.
Today we announce the first close and first investment of Seed Fund 4.
Thanks to the support of 80 investors- including several returning for the fourth fund : ) - we raised $15m in less than a month. We have also completed our first investment in Scott Barrington and Tom Batterbury, the founders of Harth. More about their amazing startup will be shared in time.
Our mission with Seed Fund IV is to invest in 30 of New Zealand’s most promising startups over the next three years. This fund builds upon the previous three funds which were among the earliest investors in Halter, Dawn Aerospace, OpenStar Technologies, Tradify, Sharesies, First AML, Mint Innovation, Ideally, Partly, Vessev, Basis, Zincovery, Ternary Kinetics, Tracksuit, and many other legends.
Seed Fund IV also builds upon the mistakes, losses, and heartbreaks of the earlier three funds. Our first Seed Fund investment was in December 2015, and we have completed 96 investments since. Seven companies have sold and delivered positive returns, and fourteen have unfortunately failed. The remainder continue to make progress (at varying paces).
We have regrettably missed and declined several great companies, competed successfully and unsuccessfully to secure access and allocations, had our hypotheses validated and invalidated, co-invested with dozens of investors from around the world, and invested in everything from regrowing human skin to HR software to foiling boats.
Here are a few lessons from the last 10 years, 97 investments, and too-many-to-count misses:
Due diligence on the product, market, competition, traction, etc, can come later. Why is that? Because at the seed stage, you are often investing when a product has not been built and when a market may not (and arguably should not) even exist.
Take Kami as an example. They started in 2012 as Notable PDF, a PDF editing tool. I was relatively dismissive at the time because it felt like a feature that could be added by Adobe. (And clearly I did not have the foresight of Sam Altman and Scott Nolan who chose to back the founders!) Fast forward several years and Hengjie Wang, Alliv Samson, Jordan Thoms and the team navigated the business into a $40m+ revenue, all-in-one platform that saves teachers time and improves educational outcomes. For the next due diligence, my focus is on the people.
For founders: At certain points on the journey, getting cash in the door can be more important than price optimisation. Of all 97 investments, only one company has progressed from Seed to Series A, Series B, and Series C. All others that have raised a Series of rounds have done so with the addition of bridge rounds, convertible notes, extensions, and more.
And then there are others that were not able to raise subsequent rounds in any form. In several cases, I wonder if that was a result of founders seeking unattainable valuations (for their stage) and having investors speak with their feet. As an investor, it can be easier to take the “It’s me, not you” approach than to deliver the bad news about valuation. Enough of these silent declines and founders can find themselves short on runway and low on credibility.
For investors: The risk is a great company speaks with their feet. In the case of LawVu, we meddled over valuation in their seed round. They ended up raising on their desired valuation and Seed Fund II missed out. Following this, Sam and the team have executed well and grown the business significantly. If we could go back in time, do you think we would have chosen a 10% better share price or a 10x uplift?
Our 9th investment in Seed Fund I was a software startup with three co-founders. They started the company with an even share of equity. One of the co-founders moved on a couple years later – and he was followed by a second co-founder. Without vesting in place, the final founder was left with a third of the founder equity and all of the burden.
A couple of years later, and despite the company performing well and having plenty of potential for future growth, they struggled to attract growth capital because of imbalanced cap table. (And frustratingly, the co-founders had enough equity to block most attempts to re-balance the cap table.) With limited options, the remaining founder elected to sell the company and deliver a modest return to early investors.
It sucks when a startup fails, especially for the founders and teams who have committed so much of their time, resources, and energy.
As an investor, the maximum you can lose is 1x your investment. Losses are a part of venture capital – and the good news is the performance of a small number of companies can make up for many losses. (As an example, Halter was one of thirty investments and represented 5% of Fund I’s investment. Its value has appreciated to 300% the entire fund.)
The problems for a fund do not come if a single company fails. They come if the fund misses the one company that could make up for the failures. In the case of Fund II (which is fine by the way!), we regrettably declined the opportunity to invest in Hnry's first round. James Fuller and Claire Fuller's leadership has resulted in Hnry growing significantly over the years. The appreciation of value in Hnry would have made up for much more than the nine losses in Seed Fund II.
Don’t invest in couples. Sharesies seems to be going fine! Only invest using preference shares. What about Crimson Education? Don’t invest in first-time founders. What about Ratu Mataira and @Al at OpenStar, James and Stefan and Dawn Aerospace, and Ben and Michael at Spalk? You must be an active director. Craig and Halter seemed well supported by Sir Peter Beck in our absence. Due diligence matters. What would it have told us about Notable PDF’s evolution to Kami? The list goes on.
These contradictions- and the above lessons- can cause investors to have a bit of an identity crisis. If we can’t pick winners and we can’t control outcomes, what can we do?
Lots. You can control the valuation and terms that you accept. (We did get it wrong with LawVu but have mostly gotten this part right.) You can control how much you invest relative to the round size and your fund size. You can control how you build a portfolio and how and if you take part in follow on rounds. You can control how you support portfolio companies through good times and bad.
Most importantly, you can control your value proposition to future founders. Success in this regard will enable you to invest in great founders– and 97 examples tell me the founders will take care of the rest.