Seed funding continues to sprout, but the growth is slow, according to a recent report from Fenwick & West, a Silicon Valley law firm. And while companies face significant hurdles in raising their next fund, once they land a check, it’s usually fairly sizable.
The 2011 Internet/Digital Media and Software Industries Seed Financing Survey follows the firm’s first report in 2010, and gathers data from 56 transactions in 2011 and 52 deals in 2010.
From 2010 to 2011, seed transactions rose 3 percent, from 43 percent to 46 percent. Of the companies surveyed in 2010 that received seed funding, only 45 percent went on to land venture funding, and only 12 percent received additional rounds of seed funding.
“…The hurdle for seed funded companies to obtain their next round of financing appears to be significant (note that in our survey less than half of companies receiving seed funding in 2010 had received venture funding within 18 months),” the report noted. “This suggests that the increasing number of companies receiving seed funding are being carefully evaluated before they are being provided with more substantial next stage funding.”
The report named several “fundamental reasons for the growth of seed capital investing.” First, the Internet makes it possible to launch startups on shoestring budgets. Secondly, growth of mobile devices and Internet usage only adds to growing demand for startup products and services. Finally, such startups can pay investors back big time, with over 30 venture backed companies now carrying valuations of $1 billion.
While the stakes are high, many startups will still fail to get off the ground. At the same time, more entrepreneurs can retain equity ownership of the companies they create, with convertible note deals rising a median $1 million in convertible note deals 2011, up from $662,500 in 2010. The median valuation cap on convertible notes like rose from $4 million in 2010 to $7.5 million in 2011.
“In general, we consider the increased use of convertible notes, the increased cap on convertible notes and the increased valuation of preferred stock transactions to be entrepreneur friendly trends, and the increased use of convertible note discounts and increased note holder rights on an acquisition to be investor friendly trends, but generally less important than the entrepreneur friendly trends,” the report concluded.