The Importance of Seed Investment for Ecosystem Growth

"Seed and Pre-Seed Pave the Way for Unicorns"

with Matt Harris

In a previous paper, we discussed the importance of angel and seed-stage investments to the development and growth of successful startup ecosystems.

We worked with Draper Associates, in partnership with Startup Genome, to expand on this thesis. In our current paper, we look at how to grow a vibrant startup ecosystem through the earliest stages of venture capital investment.

Startup Genome, the leading research and policy advisory organization committed to startups, has provided the research that makes this report possible. Their data shows that seed investment is the most important stage in the venture capital cycle and the most correlated to exits.

Setting the Right Foundation

Throughout the world, there is a desire to create high-paying jobs in the technology sector. While governments and nonprofits have good intentions, they often try to shortcut the process of creating resilient tech ecosystems.

The chart above excludes grants and shows that ecosystems do much better where more startups get private investors to support them. Capital alone cannot build a great, enduring business. Angels and VC partners bring capital, yes, but also industry experience, mentorship, and introductions to key customers, executives, and other investors.

“We see government money going into grants, funds of funds, and later-stage venture capital. But the results do not follow,” shared JF Gauthier, CEO of Startup Genome. A funding gap at Series A cannot be solved by governments through a simple injection of capital at Series A because it is not a pure capital problem. It is a funnel issue at the angel/seed stage. “You cannot triple the number of Series A deals without first tripling the number of angel and seed deals.”

The right ecosystem foundation is built by angel investors, angel groups, and institutional seed funds. As JF Gauthier put it: “If you have no angel groups, you have no exits.”

Funding from a true angel or institutional seed fund kicks off a positive cycle – starting with the right seed investors can open doors that help you hire the right engineer, compete for that next 6-figure deal, and meet the right firm to lead your Series A.

Ask any successful tech founder, many will say that their angels and seed fund managers were the most important capital providers for their startup. The person who says ‘yes’ first is by far the most important person when building your company. They help turn your idea into a reality.

Building a Global Mindset

“The best angel investors and seed funds have a global footprint and take their portfolio companies global from day one,” said JF Gauthier. One game-changing positive that institutional seed funds can bring to an ecosystem is their global mindset, deal flow, and reach.

We see a clear trend between startups that think global from the beginning and those that don’t. Startups that go global from day 1 grow revenue 2x as fast as startups that focus on their country.

Startups that have a global customer base (more than 50% of their customers are in foreign countries) grow revenue twice as fast as startups focused on their home country.

Having global ambitions also benefits the ecosystem. The data shows a positive relationship between the Global Connectedness of founders and the realized potential of the startup ecosystem. In this context, Global Connectedness refers to connections to the global fabric of knowledge, ideas, people, and organizations and is quantified by the number of quality relationships between founders in one ecosystem and founders in top ecosystems (most importantly, Silicon Valley, New York, London, and Singapore).

Global Connectedness shows a startup’s potential to scale. Well-connected founders and ecosystems can create completely new business models and products because they know what has worked in one part of the world or another. To realize the global potential of your new business model, one must – as Steve Blank asserts – immediately start developing global customers in order to learn, develop your product rapidly towards product-market fit, and sustain global leadership.‍

The benefit does not just accrue to startups. Ecosystems that are globally connected, where founders have relationships with other top ecosystems, grow larger, and help startups realize more of their potential.

How to Build Your Startup Ecosystem

Just as we have seen startup talent move from the SF Bay Area to areas with lower cost of living, we are seeing the same with VCs. This provides a once-in-a-lifetime opportunity for cities like Austin, Denver, Las Vegas, Atlanta, and Cincinnati.

“A startup ecosystem, like an orchard, has to start by planting seeds and fertilizing them. Government encouragement, light-touch regulations, and low taxes can help, but the ecosystem has to grow organically, and the startup capital is the most important,” shared Tim Draper, CEO of Draper Associates.

For a startup ecosystem to thrive, it has to be large enough to attract top talent. Startup Genome research has shown that ecosystems with 1,000 more startups than another will see the average value per startup grow by $1 million. This is a big jump, considering ecosystems like Phoenix and Montreal have an average value per startup between $4 and 6 million.

Moreover, the importance of seed investing cannot be overstated. “Cities with a higher percentage of seed funding have more startups that reach scale and successfully exit,” stated Arnobio Morelix, Senior Advisor at Startup Genome and author of the upcoming book Rebooted.

These venture capitalists are bringing their global networks with them, which is a huge asset to local startup founders. To capitalize on this opportunity, these cities should focus on creating an ecosystem that fosters not only entrepreneurs but also angel investors and institutional seed funds.

The key is to get local seed investors backing local deals, so when exits do happen, the money and talent stay in the ecosystem.