Early Stage vs. Later Stage Investing: Risks and Rewards

This has been a topic du jour. Seed stage investing is too risky, with valuations coming down the risk/reward is better in later stage companies, etc. Part of this is due to more seasoned companies – those that have done A and B rounds and are generating revenues – either seeking additional runway to achieve profitability or profitable companies seeking a “rainy day” cushion. But another impetus for this are VCs who have capital to deploy but want to do so in less risky enterprises. Clearly there is a big question mark around exits – few M&A exits are happening and the IPO market is closed indefinitely, raising concerns about funding seed stage companies with little track record and even fewer revenues.

So I am trying to separate out the risk/reward decision from the “I don’t want to take much more risk” decision. Given the sharp decline in seed stage valuations (at least that’s what I’m seeing), the risk/reward calculus for great companies looks pretty compelling. As long as they are funded with, say, two years of capital, and that this capital is designed to help them get to breakeven and hopefully beyond, AND the deal is done at an attractive valuation, how does this stack up with an A or B round supplement done flat to the last round? I’d say pretty well. While certainly the risks of the seed stage investments are higher, I’d argue that the potential returns more than compensate given the valuations currently available, even for great start-ups. But hey, this is only one man’s view.

One thing is for sure – there is a dearth of start-up capital out there. The pendulum has swung far in the other direction relative to 2006-2007, when start-ups were often getting crazy valuations based on a powerpoint and some good ideas. And it will continue swinging even farther away from rationality, IMHO. This is why I believe true venture investing will be one of the top performing assets classes over the next 36 months – Vintage 2009-2011 deals. Time will tell, but I’m putting my money where my mouth is.

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