Some new data debunks the myth that certain types of early funding rounds backfire.
For fast-growth startups — or at least those who aspire to grow quickly — there are lots of variations on the typical seed round. Both the “party round” (lots of small investors, with no one taking the lead) and the “piggy round” (one big investor) have been derided by venture capitalists and other industry observers. But some new data from CB Insights suggests that both of these fundraising strategies may actually be good for founders and their companies. The data may also bode well for other controversial changes to the financing process, such as crowdfunding.
Two or three years ago, the so-called “party round” was threatening to become the next big thing among early-stage companies. In a party round, a company raises money from 10 or even 20 investors, including angels, a smattering of celebrities (preferably actor Ashton Kutcher, who now invests through his venture firm, A-Grade Investments), and maybe a seed-stage firm.
In this situation, no individual investor has enough clout to set the terms of the deal. That can be great for entrepreneurs, who often get higher valuations for their companies in a party round than they might achieve with a traditional “investor” round.
There are also downsides to the party round–or at least there are supposed to be. VCs such as Chris Dixon, now of Andreessen Horowitz, and Y Combinator’s Sam Altman pointed out that, in a party round, no investor has that much skin in the game. So companies wouldn’t get that much help, or future funding, from any single investor. Each investor would rather wait for someone else to step up to the plate. In a tough acquisition or refinancing, the company was unlikely to be able to call on an investor who’d been there, done that. And by letting so many people into the earliest round, there was no one left aching to get into the later rounds–and no lead investor to re-up.
Viewed through that lens, companies that raise party rounds should have a harder time raising later rounds than companies that raise traditional rounds. But even if it’s a tougher slog to raise money, companies with party rounds seem to be doing better raising follow-financing than their peers. CB Insights finds that 53 percent of companies that raise party rounds go on to successfully raise subsequent rounds. That compares to an industry average of just 39 percent.
Then there are the opposite of party rounds, termed “piggy rounds” in a post by Hunter Walk of Homebrew Ventures. In a piggy round, one investor takes over 80 to 100 percent of a company’s seed round. That investor is often a later- or multi-stage fund rather than one that specializes in the earliest companies.
This too is predicted to be bad for entrepreneurs. The later- and multi-stage funds put pressure on entrepreneurs to build really big companies, really fast, before they’re likely to have any idea of what they’re doing, according to Walk. Chris Dixon also writes that if the one investor in a piggy round doesn’t want to reinvest in the next round, it looks terrible, and the company can find itself effectively stranded.
But so far, according to CB Insights, companies with piggy rounds are doing pretty darn well: Companies that have completed piggy rounds have managed to get follow-on financing 54 percent of the time, compared to 32 percent of companies that raise money from traditional seed-stage funders.
Similar to its party and piggy counterparts, crowdfunding has also been called out as overly risky for fast-growth companies. But based on the naysayers’ records so far, entrepreneurs that are attempting to crowdfund their companies should be sleeping pretty well — at least for now.