The Three Things Seed Investors Need To Know About Brexit

Will Brexit impact early investing?

It will. But will it slow it down? No way.

As a matter of fact, it should do just the opposite.

It should make central banks and the Fed more willing to keep interest rates low. And that should translate into more money pouring into seed-stage companies than ever before.

Seed capital in the U.S. has increased from $200 million per year to $2 billion per year in the last 10 years. Here’s a great chart from Tomasz Tunguz of Redpoint Ventures that clearly shows the seed-stage boom…

Yet the surge in seed investments isn’t quite as steep as Tunguz says…

For one thing, 10 times more seed money doesn’t mean 10 times more startups are raising in seed rounds. During this period, seed rounds have gotten two to three times larger. Rather than 10 times more companies raising seed money, it’s closer to three to five times.

And then there’s the ever-evolving nomenclature of fundraising.

A decade ago, a startup went from seed to Series A. Now it may be going from pre-seed to seed to extended seed to Series A. The seed rounds of today are the Series A rounds of yesteryear.

So there’s probably more than a little inflation built into these numbers.

Yet there’s no question that the seed boom is real.

The Dawn of a New Era

Last week, my partner Adam interviewed Mike Norman – a co-founder of Wefunder. It’s the most active portal doing seed equity crowdinvesting right now. A month into the ECF era, Wefunder already has $2 million committed to startups raising money from the crowd, Mike says.

Granted, even if we annualize the $2 million, $24 million is a drop in the bucket compared to the $2 billion of venture capital going to seed-stage companies on a yearly basis.

But remember, Wefunder is but one of roughly a dozen portals we’ve identified in the ECF space. We’re just scratching the surface… witnessing the dawn of a new and exciting era for investors.

For example, it’s far too early to predict how much of the roughly $100 billion that goes into mutual funds every year will migrate into early-stage startups.

So let’s be conservative. Let’s say that just a quarter of mutual fund investors end up putting some of their savings into startups. And let’s say that they redirect a mere 10% of their mutual fund investments into startups.

That’s a $2.5 billion increase.

Of course, that won’t happen overnight. It’ll take a few years. A half decade? An entire decade? Hard to say.

Mike says, “We are seeing a lot of folks come in and make these first-time investments, which is really exciting. I think that is a big testament to the interest out there.”

There’s a lot of pent-up demand out there for this kind of investing. Let’s just say that – on the basis of the math above – at some point in the next decade, we should see seed investing double yet again, from $2 billion to more than $4 billion.

What does this mean for early-stage investors? Here are three big questions that need addressing…

1. Too much money chasing too few startups? Even before Brexit, this was a big question. Now it takes on even more urgency.Will valuations rise from too much available capital? Will the quality of startups getting funding decrease? Or will there be some combination of the two?

Valuations have come down recently as VC investors have grown more careful. If anything, Brexit will reinforce this sense of caution in the short term. But it won’t offset the stimulus that equity crowdfunding will be giving to early investing.

The longer term? Much harder to predict. But I think all kinds of different but deserving startups will emerge to absorb this new capital – from innovative consumer companies to startups launching exciting entertainment and civic projects.

Supply and demand has a way of balancing out in unencumbered free markets. With the lifting of restrictive regulations, we’ll see that happen in the startup space.

2. Will there be another Series A crunch? It wouldn’t be the first time. We just saw this: a rising tide of seed companies overwhelming capital availability at the Series A stage – which is also growing, just not fast enough.

Brexit on top of the new ECF rules will give seed investing a big boost. The new rules have also opened up Series A funding to everyday investors. But these raises are much bigger and more costly than seed fundraising. It will probably help contain a Series A squeeze, but in all likelihood, it will not prevent one from taking place.

3. Will cashing out your investment get harder? Or, asked another way, will the number of IPOs increase at the same pace as the growing number of seed-funded companies? If not, then seed investors will have to rely on bigger companies buying out their startups.

Fortunately, that’s a pretty good bet, more so now that Brexit is expected to keep the cost of capital low. Add to the equation that public companies are sitting on a record $1.9 trillion in cash. And that startups are much better at developing new technology than many legacy companies.

I fully expect a surge of buyout activity in the years ahead.

In short, more available money will allow more great ideas, technology and founders to be funded. Corporations with large cash reserves should benefit from the choice of a growing number of small tech companies becoming available to them at the right price.

The one concern that could well prove true is a reprise of the Series A crunch.

Seed investors will have to keep this in mind. Investing in companies with exceptional long-term promise is not enough. They must also develop the kind of traction in the next 12 to 18 months that can translate into a successful Series A funding.

The good news? I’m seeing several startups – addressing massive markets – whose progress at the seed stage has led to strong early metrics. Their short-term execution matches their long-term potential.

These are the startups that make the top of the watchlist Adam and I are developing for our new ECF service that will be making fully vetted recommendations to our members.

We’ll be launching it in the next couple of weeks, so stay tuned!