The round on the cover

I was talking about recent seed rounds with a friend the other day, discussing how they seemed to be inflating in size, with many creeping up to $10M of initial capital in. I’ll save any judgment, but this is an increasing departure from traditional seed round sizes. My sense is that most founders don’t target these higher amounts from the jump — they still set out to raise $2M - $3M seeds, but there’s now a wider variance in outcomes of where those rounds land. Internally, we call this “the round on the cover,” which can end up differing from the final amount that appears in TechCrunch, often bubbling up far beyond the initial proposal. 

If you talk to people about it, they’ll just tell you the dynamic is crazy — emblematic of frothy market conditions. Some might say it’s just another reshuffling of round names, in the way that pre-seed was the new seed, and seed was the new Series A a few years ago. I thought I’d peel back at the incentives on both sides of these transactions — founders and investors — to land at an understanding of what’s going on. 

I don’t know how many founders plan on their round sizes expanding way beyond their starting threshold, but for founders of a certain pedigree operating in defined categories, a lower number on the cover can work to their advantage. It reduces the allocation available for investors, thereby increasing fomo in an already capital-pervasive environment. In some instances, the founders will close up a round, but (sometimes uncapped) notes or SAFEs get stacked on top. This is a tricky dynamic and a separate discussion altogether. 

In some cases, traditional seed funds catalyze larger raises; but in many instances, a larger fund or capital base will lead these bigger seeds. Larger venture firms started doing seeds as they felt pressure from crossover funds and late-stage activity to move earlier in the fundraising lifecycle. The bind lies in the fact that many conventional Series A or B shops actually have even larger funds to deploy with distributions from the past decade coming back, but their investors are now allocating more time to places where they had less money at work — maybe $1M - $3M investments out of $500M+ vehicles. Furthermore, ownership thresholds at the early seeds are coming down, and if the company shows any sign of promise, there’s no guarantee that the big fund that leads the seed can also lead the A (to build more ownership in the company over time). There also might be a newer implicit assumption about how risk curves work for startups, asserting that steps between the seed and the A don’t change the risk profile of the company on a consequential level. I recommend Kanyi’s piece on this if it’s a topic of interest. He has the crispest articulation I’ve seen. 

This all leads me to pose the (perhaps unfairly simplistic) question: would you rather invest $2M into a startup for 10% ownership or invest $10M to guarantee 20% ownership, putting more dollars at work out of a fund with limited to no additional risk? There are a lot of assumptions baked into this prompt, but it demonstrates the rough calculus from the investor perspective and the incentive to offer a larger amount to the founder.

Again, I’ll spare the judgement on whether this is right or wrong — it’s ultimately a market, a scaffolding for incentives. It feels a little bit like I’m giving away a trade secret, but I continue to reflect on what I see in the current market and the moves that happen with a subset of seed raises.