Seed Funding Landscape Evolves Amid Downturn

U.S. seed-stage funding has shown resilience in the venture funding downturn since 2021, thanks in part to the increase in larger seed rounds. However, this growth conceals a lack of progression beyond seed funding, which could lead to a higher failure rate for seed-stage companies and wipe out many seed-stage funds.

According to Crunchbase data, since 2023, companies have been staying longer at seed and raising more seed rounds. This trend is reflected in the number of unique seed-stage companies from the year they raised their first seed round of $1 million or more, which are still predominantly stuck in the seed pool or have shuttered.

The graduation rate beyond seed has improved between 2% and 3% for each year since 2021. However, most companies have not progressed to Series A or had an exit. The percentage of companies that have graduated beyond seed is currently around 36% for the 2021 cohort and 20% for the 2022 class.

This trend has significant implications for seed investors, who will face a higher death rate and lower graduation rate at seed. According to Michael Cardamone, CEO of New York-based Forum Ventures, an active seed investor, “There’s going to be a higher death rate, much lower percentage of companies getting to [Series] A, which means a harder job for seed investors.”

The prolonged stay in the seed stage might lead to companies sacrificing growth to get to breakeven. This could further hinder their ability to show traction needed to get to a Series A.

Small and mid-sized funds are already having a harder time raising follow-on funds in this market. The repercussions of the lower graduation rate to Series A could take some time to play out, but it’s essential for seed investors to be aware of this trend.

Companies that raised their first seed round of $1 million or more are not progressing beyond seed at the same rates nor in the same timeframe they had previously. This suggests that something is amiss with the current venture funding ecosystem.

A market reset has brought some benefits to seed investors, as it reduces the number of not-great companies raising more money and allows them to focus on their winners. However, this also means that talent will be soaking up resources in struggling companies before moving on to a company that does have traction and funding.

Andy McLoughlin, managing partner at seed-stage investor Uncork Capital, notes that it’s good for firms to not have a bunch of not-great companies raise more money, as it allows them to invest more in their winners. Additionally, this trend helps the ecosystem as a whole by allowing talent to move from struggling companies to ones with traction and funding.

Talent will need to find a job elsewhere at a company that does have traction and funding, highlighting the importance of investing in successful startups.