Mark Suster, a partner at GRP Partners, has an outstanding post up this morning titled VC Seed Funding is Dead, Long Live VC Seed Funding. Mark started blogging recently and has quickly turned into my second favorite VC blogger (after Fred Wilson) – if you don’t subscribe to his feed, you should.

Mark just did his first seed deal, a $500k investment in a company called Ad.ly, and his post is a long essay on how he’s thinking about seed investing these days.  He makes the appropriate warning (and differentiation) between VC investors who view seed investments as “options” on future rounds (e.g. they toss a little money in and then generally ignore the company until the next financing) and “active seed investors” (like First Round Capital, SoftTechVC, True Ventures, Union Square Ventures, and O’Reilly AlphaTech) who view the seed investment as their first round of several as they help get a company up and running.

I’ve been making seed investments since 1994.  I don’t know the actual number that I’ve done, but as a VC (starting in 1996) it’s probably more than 25.  In our most recent fund (Foundry Group) that we raised in 2007, we’ve made six seed investments (AdMeld, Gnip, Lijit, Next Big Sound, Standing Cloud, and Trada ) out of 17 investments in the fund to date and have one more that we expect to close this week.  Interestingly, we did only two of these by ourselves; the other four included co-investors such as First Round Capital, Spark, SoftTechVC, Boulder Ventures, and Alsop Louie.

In my world, there is no real difference between a seed investment and a “Series A investment.”  Ironically, when I started doing this, seed investments were the Series A investment; at some point in the last decade a bunch of VCs started saying “we only do Series A investments” so the seed investment became “less than the Series A” investment, although it never got relabeled so you see a lot of Series A (seed) and Series A-2 (the next round after the seed) investment rounds these days.  Regardless, in my world, a seed investment is the first round – when I make a seed investment I’m committed.

VC’s keep reinventing seed programs.  In 1994 when I was first making angel investments with my own money that I got from selling my first company I encountered several VC firms that had “seed programs.”  These firms had an accelerated way to invest $250k in an entrepreneur to help him get up and running quickly.  These investments were always convertible debt that converted into the Series A round at a discount.  The entrepreneur quickly got $250k, the VC got a seat (usually a controlling seat) at the table for the next round, and off they went.  I participated in a few of these – some that worked (e.g. a new VC came in and led the next round) and a few that didn’t (no new VC showed up, the entrepreneurs and the seed VC watched tensions escalate, and eventually there was an unhappy ending.)

Over time, I soured on the “convertible note seed funding” approach.  I’ve written about this in the past, but at the minimum I think it misaligns the entrepreneurs and the early stage VC.  More importantly, in my experience, it’s a signaling device – the seed VC isn’t as committed in a convertible note round as they are when they price a seed round and do it as a typical VC preferred financing, albeit with lighter terms.

One key thing for an entrepreneur to test with a potential seed round VC is whether or not the VC will invest in the next round by themselves.  The specific question is “Do I need an outside lead for the next round, or will you do it yourself?” While either case is fine, this sets the ground rules clearly for financings going forward.  In our case, we are perfectly happy to do the first few rounds of financing ourselves.  Some other great seed investors, especially those with smaller funds need a new investor to lead the next round.  Then there are traditional early stage VCs who have specialized seed programs where the rules of engagement are that there needs to be a new investor to lead the next round.  Knowing where you stand and what the ground rules are before you consummate the seed round is important.

With the emergence of pre-seed programs like TechStars I’ve had more visibility into VC seed investing activity from other VCs.  In Boulder, we just finished year three of TechStars and while plenty of the TechStars companies have their first round of financing include angel investors, I think six of the ten companies this year have (or will) close VC-led seed rounds.  I haven’t decided if there is actually more seed activity in 2009, or if VCs are focused on hunting for seed deals in more qualified places.  Regardless, being a great VC seed investor isn’t a no brainer and I encourage entrepreneurs to make sure they know how their VC investor is going to behave when it comes time to raise the next round.

It’s Tuesday, so that means – well, I’m not sure what that means.  But I do know that if you want to watch me on video, following are three choices.

First up is Episode 10 of TechStars: The Founders – Crunch Time.  Special guest appearances from me, Paul Berberian, the Zenie Bottle, and the printer from Office Space.

The Founders | TechStars Boulder | Episode 10 "Crunch Time" from Andrew on Vimeo.

Next, a panel from the Twiistup 6 event in Los Angeles last Thursday starring me, Dave McClure (Founders Fund), and Andy Sack (Founders Co-Op).  Note Dave obsessively checking TweetDeck throughout the event to make sure everyone is catching and retweeting his creative use of the word “fuck” (NB – I think I used it first around minute 6.)

Finally, I did an interview this morning on RallyCafe at the Rally Software offices. 

Yesterday, I wrote about the new VC Blogger Network powered by Lijit.  A handful of VCs emailed me asking to be added to the network (which has been done).  There’s no time limit so if you are a VC and want to join, just email me.

In the mean time, I neglected to mention a super cool site called Venture Maven.  Greg Galant and several others put this together – it’s a great aggregation of VCs who tweet – both individually and by firm (quick – name all the firms that have 100% of the partners tweeting).  If you are a VCtweeter and are not on the list, wander over now and add yourself.

And, as the bonus round, go check out Twittorati, a list of the Technorati Top 100 and their tweets. 

A year ago, if you had asked me a year ago if I would write a post with the word tweet in it so many times, I would have twittered at you.

The meme of “Free” is one again making the rounds.  I expect it reignited when Chris Anderson’s new book Free: The Future of a Radical Price (available on Amazon for $17.81) quickly followed by Malcolm Gladwell’s semi-scathing review in the New Yorker titled “Priced to Sell.  Is Free the future?”  (I kind of feel like Gladwell wimped out on the review, even though I like Anderson’s point of view better than Gladwell’s.)  This then created a predictable tussle in the blogosphere, the kind of which I find tedious and dull, so I avoided the rest of it.

Over the weekend I saw two more blog posts on this meme.  The first – by Fred Wilson titled Freemium and Freeconomics – is clear and well written (and free).  It’s then followed by an excellent comment thread.  The second – by Marc Cuban titled When you succeed with Free, you are going to die by Free (also free) is a muddy as Fred’s is clear (and the comments are much less interesting).  Nevertheless, both are relevant and insightful.

Whenever I see this meme rise its head, I think of a line I use whenever I consider an investment or an acquisition of another company.  “Would You Want It If It Were Free?”  I learned this from Len Fassler, one of my early mentors who acquired my first company (fortunately he decided it was worth more than free).  Before I make an investment, or support an acquisition, I sit quietly and ask myself “would I want this if it were free?”  By this, I don’t mean as a customer, but rather “would I invest in this at a $0m pre-money valuation” or “would I want 100% ownership of this company if it cost me $0.”

Over the past 15 years, I’ve found my answer to this question to be “no” more times than I can remember.  It often surprises me when I realize this, as up to that point in the conversation, investigation, or negotiation I’d been focusing on “the deal” rather than “whether or not I perceived any value in the company being discussed.”  When I reflect on some cases that I remember, I realize how my internal rationalization machine had kicked into high gear as I got excited about “a transaction”.  By taking the transaction out of my thought process, I could focus on the essence of value (or lack thereof).

Of course I’ve been wrong (both directions) plenty of times.  But I can think of a bunch of situations where asking myself this question saved my ass or that of the company I was involved with that was considering an acquisition.

I realize this is a different version of free than the one Anderson, Gladwell, Wilson, and Cuban are discussing.  But, if you step back and think hard about it from a customer perspective, it magically becomes relevant.  Certainly lots of people “would try it if it were free”, but do they actually want it?

I say “no” all the time.  I could start keeping track of the number of times I do it a day, but I’d guess it’s a minimum of 10 and occasionally over 50 times a day.  When I type that, my first reaction is “no way, there’s no possible way I say no more than 50 times a day”, but when I think a little more, it definitely happens sometimes.

One of my goals is to be accessible to anyone that reaches out to me.  Another goal is to minimize the amount of time I spend on things that I either (a) don’t have an investment in, (b) won’t have an investment in, or (c) don’t have an interest in.  Basically, I want to “optimize my accessibility”.  This ebbs and flows – when I’m in balance I’m very happy; when I’m out of balance I’m still very happy, but notice that I’m out of balance.

One of the keys to this is to “say no in less than 60 seconds.”  Given that my email address is easily discernable, I get a lot of random inbound “we are looking for money” and “do you want to have coffee” emails.  These are easy to say no to, but I also get a lot of not-random “we are looking for money” (e.g. sent from someone I know) and “do you want to have coffee” (e.g. sent from someone I know or recommended by someone I know) emails.  And it escalates in relevance from there (and morphs into all forms, including breakfast, lunch, dinner, meeting, run, …)

Somewhere between 1% and 10% of these fit my a/b/c criteria above.  I can figure this out from the first interaction at least 50% of the time and my first email response is (hopefully a polite) version of “no” that usually consumes a total of less than 30 seconds from beginning to end.  Another 25% of the time I need a little more information and request it via mail.  This has the side effect of eliminating another chunk of interactions since the person on the receiving end never bothers to respond.  For those that do respond, I can usually figure out from the response whether or not I want to spend more time or not; if not, I’m still probably under 60 seconds for saying “no”.

The rest usually end up in more email interactions, a phone call, or a meeting. I try to limit all first meetings to 30 minutes so I don’t waste either of our time if it’s not going to go anywhere, although I’m not always successful at this (the wasting time part).

Now, lest you think this is “overstructured”, remember my goal: minimize the amount of time I spend on things I don’t care about which allows me to maximize the amount of time I spend on things I care about, while still being very accessible.  While I don’t always get this right, I’ve gotten a lot better at it over the past 20 years.

It blows my mind how many people think they can treat entrepreneurs and other investors poorly and think that it won’t come around to negatively impact them some time in the future.

I had two interactions last week with companies around a particular VC investor.  I’ve worked with them in the past and had a crummy experience.  I have a “fuck me once” rule where I’ll always give someone a second chance, but I’m wary and – if I have a second bad experience – I’m done.

When this VC came up in the first conversation, I couched my feedback with the appropriate disclaimers (e.g. “it might have just been me.”)  Interestingly, several other people around the table expressed much stronger negative feelings about this particular investor.  I noted that.

When this VC came up in a discussion later in the week, I stated my feedback and echoed the feedback I had heard from earlier in the week (keeping the names of the people involved appropriately confidential.)  Interestingly, the negative feedback was reinforced by another person in the meeting.

Now, I’m sure some people out there think I’m a dunderheaded lummox who occasionally takes leave of his senses, makes a mistake, or let’s someone down.  But – when I do – I try really hard to own up to it and apologize for it.  In both of these cases the VC in question behaved poorly and trashed at least five direct relationships.  There were at least a dozen key people involved in the various discussions that this VC will interact with again in the future.  My guess is that a dozen people have little to no interest in engaging with this VC.

Remember – the smell of shit can linger for a long time especially if you don’t clean it up.

I’m psyched that my friends at Spark Capital have launched Start@Spark, their new seed program.  In their post Why are we doing this? they explain:

“So, this must be a terrible time to fund a start-up company. Correct? Au contraire. This may be the best time in the last 8 years to start a company. While capital is scarce, the tectonic plates continue to shift creating major rifts. The walls are coming down and the barriers to entering new markets are falling along-side.

We don’t expect the economic woes to evaporate soon; however, we are long term investors. We are looking forward to what will happen in 4 years rather than in the next 4 months. We see a clear opportunity to partner with talented entrepreneurs who possessing the vision and commitment that transcend current market conditions. We have prided ourselves on being aggressive and funding disruptive, early stage companies.”

The program provides seed stage investments in early stage Boston and New York based companies that fit Spark’s areas of interest.  They have a simple application process and – if they decide to fund you – provide a straightforward deal (convertible loan of up to $250,000 that converts into equity in the next round at a 20% discount; Spark has the right to invest up to 50% of the next round.) 

This is not new behavior for Spark – our co-investment with them in AdMeld was a seed stage investment (although we structured it as an equity financing.)  They are excellent early stage VC investors and it’s neat to see them formalize this type of program in Boston and New York.

Spark has also been super helpful in bringing TechStars to Boston.  The TechCrunch article Spark Capital Launches Seed Funding Program Start@Spark mentions this affiliation but concludes “… undoubtedly they’ll be competing for the same investment sooner rather than later.”  This is an incorrect conclusion.  While TechStars is looking for great pre-seed companies to help get to a stage where they are ready to raise a seed or first round financing, if Spark wanted to invest in one of them prior to them entering TechStars, we’d be all for it (and if that caused the company to decide not to participate in TechStars, that would be fine.)  And – optimally – one or more of the companies coming out of TechStars will be interesting to Spark – either for a full first round investment or a seed investment.

The notion that these efforts are fundamentally competitive perplexes me.  I think it’s awesome that the Boston region is getting more seed stage focus and energy for software, Internet, and media companies.  In my world view, the more options for entrepreneurs, the better.

I’m really enjoying writing my print column for Entrepreneur Magazine.  It’s a different kind of writing than my blogging and exercises different mental muscles.

This month’s article A VC’s Biggest Flaw: Arrogance is out (both on the newsstands and the web).  Amy told me this is her favorite one so far as it includes a number of people she’s met: Mr. Know-It-All and several of his cousins. 

I hope you enjoy reading the articles as much as I enjoy writing them.

I caught the tail end of SXSWi (showed up yesterday and gave a speech sponsored by the Canadian Consulate) and am hanging around today for some night time music entertainment as the music part of SXSW. It’s pretty cool to watch Austin shift from “nerds” (the SXSWi gang) to “hipsters” (the SXSW music gang); while the music scene is not my thing (I’m a nerd), it’s highly entertaining to observe this species in action.

On Monday night I co-hosted a meeting at the Governor’s Mansion in Denver with a group of about 20 significant Colorado entrepreneurs (and a few academics, government people, the Governor and State CIO, one other VC, and two CxO’s of a large Denver-based “ICT” company).  The discussion was around ICT in Colorado and our local entrepreneurial ecosystem.  I’ve long believed that the entrepreneurs are the motive force behind all entrepreneurial ecosystems – not the VCs, the other service providers, the government, or anyone else.  It might be a tautology (e.g. “entrepreneurs drive the entrepreneurial ecosystem”) but I regularly hear people – including very smart and experienced ones – assert other things such as overstating the importance of the presence of VCs to the entrepreneurial ecosystem.

My experience with TechStars has given me a set of great insights into the notions of entrepreneurial communities and how they develop, evolve, and sustain themselves.  I’m heading over to Capital Factory this afternoon to talk to the guys there about what they are doing (a similar type of seed stage mentoring program that is running their first year in Austin this summer).  When wandering around SXSW yesterday, I saw floods of techies and entrepreneurs – nary a VC in sight.

When I think about who I spend most of my time with, it’s entrepreneurs.  When I think about who really drives innovation, it’s entrepreneurs.  When I think about the core of any entrepreneurial community (or ecosystem, or whatever you want to call it), it’s entrepreneurs.  When I think about the history (and future) of innovation in the US, it’s all about entrepreneurs.

Last fall I read Spencer Ante’s fantastic book Creative Capital: Georges Doriot and the Birth of Venture Capital.  It’s been bouncing around in my mind as I ponder my view of the role of the VC in the entrepreneurial ecosystem, especially as all the noise has started circulating again about the inevitable change / re-invention of the VC industry. 

VC’s play a role in all of this, but it’s one that I regularly feel is dramatically overstated, misrepresented (including by many VCs) and misunderstood.  We provide different resources and value than lawyers, accountants, investment bankers, and PR and marketing firms, but we are still simply one of the inputs into the entrepreneur ecosystem.

I’m sure I’ll have more to say about this as I continue to think out loud on my blog about the dynamics of “entrepreneurial communities.”  As always, feel free to challenge me about anything as I play around with these ideas in public.