225. Seed Crust: This is the Seed Crust

VC Minute
If all Seed & Pre-Seed funds shift just 5% of their allocation from first checks to follow-on checks, there will be $3 billion fewer available for first checks.

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Let’s keep swimming upstream and talk about how this impacts the LP side of the business. LPs, limited partners, those are the folks that give the venture funds money. Fund distributions dried up. Distributions in 2023 were down 64% compared to the long-term trend line from 2010 to 2020.

Think about it this way, investors in venture funds that are used to getting back, say a dollar, are now getting back 33 cents and being told, “the other 67 cents is coming your way eventually.” Imagine if you were expecting to get a dollar and you got 33 cents instead? What are you going to say to that person? What you’re going to say is, “if you’re slowing down on your distributions, I’m slowing down on my distributions.” And so LPs then have slowed down.

And you can see this with the years between closings for venture funds. During the 2021 madness, we’re hearing of some funds that were raising and deploying capital in 12 months. And to any Gen Xers out there, such as myself, you will remember the dot-com boom. That pace of investing in 2021 is awfully a lot like the 1999 era.

What happens when the LPs slow down? Then the GPs, the investors, have to slow down. Aumni estimates that the fund velocity has been cut by more than half. This is the average number of investments that a venture capital fund participates in per quarter. At the peak, it was 4.6 investments per quarter, and it’s down to 2.1.

Add all of this up. You have more Seed funds than ever before. Series A is spoiled for choice. Series A raises the bar. Startups spend more time in the Seed phase. Startups come back to investors for inside rounds. VCs shift allocation from new checks to follow-on checks. There’s less capital available for new checks. Some venture funds are shutting down. There’s less capital available overall.

Meanwhile, cash-on-cash returns dry up. LPs slowed down their pace. So VCs slow down their pace. So startup funding slows down again, resulting in startups spending more time in the Seed phase, coming back to their investors. Investors are allocating even more money for follow-ons, making even less money available for new checks. And on, and on, the cycle goes. This is the seed crust.

About AVL Growth Partners
AVL Growth Partners, founded in 2009, is the leading fractional Finance and Accounting firm supporting organizations in pivoting from growth to scale. AVL brings an experienced team of CFOs, Controllers, and Accountants to your organization, delivering transparent, strategic actions for short and long-term success. Transform your financial approach affordably with AVL, supporting companies coast to coast – get to know AVL Growth Partners at avlgrowth.com. (Sponsored)

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