September 25 2014
by Todd Hixon

Breaking The New Code Of Venture Financing

[This post first appeared at on July 7, 2014.]

There has long been a “code” for venture financing: one word and a series of letters (seed, A, B, C … ending with M&A and IPO) that denote different stages of financing. Entrepreneurs and investors all knew what those letters meant.

Now the code has changed. Understanding the new code is key to success for entrepreneurs and investors alike: the basis for setting expectations and putting forward proof points in a way that gets the deal done.

First, let’s look at the driving forces. On the demand-for-capital side, the cost of taking a “tech” (1) business from an idea to a live business with a minimum viable product (“MVP”) has imploded: Mark Suster estimates it has declined by 99% (2).

And, the tech ecosystem has expanded dramatically making numerous market opportunities huge: mobile internet, ubiquitous and cheap cloud, more subscribers, more connected devices, more hours per day, etc. This has fueled an explosion of business creation, as entrepreneurs see opportunities to build out new parts of the ecosystem.

But [always a but] taking a new business across the finish line is just about as hard as it always was. A very few businesses grow virally without need for major marketing investment: e.g., Facebook, WhatsApp. After they achieve significant early traction, most good start-up businesses require a very large spend to fuel growth and achieve scale: marketing, salesforce, product extension, infrastructure scale-up, and the like. Most of these resources have not gotten cheaper. So the initially-successful companies have a huge demand for growth capital.

Another but: the IPO market, which used to supply growth capital, has become much harder to access. IPOs were ~30% of venture exits in the 1990s; they have been ~10% in recent years.

Meanwhile, the supply of tech venture capital has contracted: from ~$50 billion per year committed to tech venture funds in the U.S. at the peak of the 1999-2000 bubble to ~$15 billion per year in recent years. And, the percentage of that capital raised into large VC funds (which put most of their money into later stage investments) has risen from 44% in 2005 to 59% in 2012 (3). So capital available for early stage tech investments has contracted even more.

At the seed level, new capital sources have emerged. Angel investment has grown to rival the dollar value of early-stage VC investment, and micro-VC funds (funds smaller than $75 million) have emerged as a new source of seed or very early stage capital.

So clearly the code is scrambled. What is the new code? Here’s my take:

Seed investment now spans two different categories. “Classic Seed” is what seed always was: a few $100k, often “friends, family, and fools” that enables a business to get organized, write a plan, recruit a couple of people, find a few customers, and produce a “wire frame” of its product. But, seed now extends to a new type of financing, which I call “Institutional Seed”: a $1 million – $2 million+ financing, sourced mainly from small venture funds and “super angels”, that enables a company to build a minimum viable product, fill the key leadership roles on its team, acquire the first customers, and start to execute its business plan. This is what a Series A used to be: Institutional Seed is the new Series A.

Series A rounds have gotten bigger: they now approach $10 million. They go to promising companies that have their business models working and a big opportunity in front of them. The purpose of the financing is to go from proof of concept to proof of momentum. Series A is the new Series B (what Series B used to be).

Series B rounds have gotten bigger too, often $30 million plus, led by big funds, invested in companies with momentum and a big opportunity: e.g., GrandRounds, a 3-year-old company, recently received a $40 million series B investment led by Greylock’s $1 billion fund. Series B is the new Series C.

For companies that are doing well and scaling, the later letter rounds are the new IPO, e.g., raised a $100 million round in December 2013. This is the financing equivalent of a good, old-fashioned IPO: go public and sell 20% of the company at a $500 million market cap = $100 million. Raising this amount privately has advantages: Box avoids the overhead and disclosure of a public company, the transaction is quicker and less expensive, and Box can continue to focus on growth, free of the quarterly earnings fixation of public markets. Today such growth financing is plentiful, coming from large growth-oriented venture funds, hedge funds, and sophisticated public market investors like Fidelity (4).

Fundamentally the venture business has divided into two parts: Seed, Institutional Seed, and Series A are about finding and refining gold (building valuable businesses), same as always. Series C and later are about “turning gold into platinum” in the words of Jerry Neumann (5): taking proven opportunities and scaling them to their full potential.

Here are a couple of ways to make use of this perspective:

For entrepreneurs, to raise money successfully from the right people, you need to understand what they look for and what they expect you to accomplish with the money you raise. In simple terms: the institutional seed investors are the new early stage VCs: the people who get you from an idea to a real business. Series B and C are very hard to raise, because they demand proof of momentum: you can’t sell a concept any more, there has to be red meat on the table. And, the capital raised for this type of venture fund has declined the most. Series D and later are an entirely different breed of cat: big checks, huge pools of capital, inevitably numbers- and terms-oriented.

For investors, there are many opportunities and wrinkles; here are a few I find important.

  1. Early-stage investing has moved downscale and is now centered on  small VC funds like First Round and True Ventures as well as super-angels. Over 30 years early-stage VC has delivered the highest return of all the VC sub-categories.
  2. Expansion stage venture investing (Series B & C) appears to be sharply underfunded, always a good thing for investors.
  3. Investing in the proven, scaling, high-potential businesses that the good early stage funds spawn can be a good business, too, if you have access to the best deals.

The brands, track records, and people of the most successful growth stage investors, like Sequoia, enable them to access the best companies: e.g., Sequoia was the only VC able to invest in WhatsApp. Recently good early stage funds, like Union Square and Foundry Ventures, have created “Opportunity Funds” that invest in the most successful companies coming out of their early-stage portfolios, taking advantage of another proprietary form of access: the legal right to participate that early investment creates. Our experience shows that Opportunity Funds can work out very well.



  1. “Tech” refers to venture funds focused on investment in companies based on information technology and digital media. It excludes funds focused on hardware, nano-technology, and bi0-medical technology.
  2. From Mark Suster’s blog post Why Venture Capital Is So Much More Compelling Now. This is a good read: a well-explained, well-documented analysis of the changes in Venture Capital.
  3. Prequin data, cited by Mark Suster in the above-referenced post.
  4. From Dan Primack, Term Sheet, July 1, 2014.
  5. From Jerry Neumann’s post, Betting On The Ponies: Non-Unicorn Investing. Another good read which cuts through the hype that surrounds venture investing and lays out the rational economics, like Moneyball for venture capital.



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