Three Future States of the Early-Stage VC Ecosystem

Sharing a slide from our annual meeting that sums up one of the things I've been thinking about for the majority of this year.

Every year, I pick a few slides from the Precursor Annual General Meeting to share with a broader audience. This year, the team and I presented one slide that generated a lively discussion with those in attendance. If you’re a regular reader of Venture Reflections, you’ll recognize many of the themes on this slide. I’ve spent much of this year thinking about where the early-stage (as in pre-Series A) venture market is heading and what it means for our firm and the larger ecosystem. I presented one slide during our meeting that offered three potential states where the early-stage VC market could land in the near term. Here’s the slide I presented without any edits or changes to what we shared with those who attended - I promise you it was much easier to read when presented on a large screen!

I’ve spent so much time thinking about these scenarios because they predict pretty different futures for our ecosystem and call for pretty different strategies based on which scenario, or combination of scenarios, plays out over the next 5-7 years. Depending on where you sit in the ecosystem, some of these outcomes are more comfortable than others; I’ve been examining each without any hope or fear of which one is most likely but with an eye toward what the world looks like in each case.

Scenario 1: Return to the Status Quo

There is a world where we see a reversion to the venture capital dynamics that dominated the past two decades. Seed-only and multi-stage firms would find their familiar rhythms, with Series A graduation rates stabilizing between 30-50%, down from the inflated ZIRP-era rates. Both types of firms would continue to thrive with $1B+ exits, maintaining their distinct but complementary roles in the ecosystem. We would have distinct lanes and focus areas, with pre-seed and seed-stage firms doing most of the zero-to-one work and larger, multi-stage firms coming in at the Series A and working with companies from early product-market fit through growth. This would be a comforting return to the previous era as a firm investing primarily at the pre-seed stage. This is highly unlikely in a world where most multi-stage firms have dedicated seed funds and investing programs and are unlikely to cede the seed market (no pun intended) to dedicated, seed-only firms. Multi-stage firms are now a permanent fixture in the seed investing category. Returning to the historical status quo would be nice and self-serving if true; it’s unlikely to happen going forward.

Scenario 2: The Bifurcated Seed Market - Same Industry, Different Business Models

As I’ve mentioned to colleagues, small and large venture funds might be in the same industry but not the same business in the future. With their larger fund sizes, multi-stage firms need massive $5-10B+ exits to generate meaningful returns. In contrast, seed-only firms can generate meaningful returns with more modest $1B+ exits. This divergence would create a dynamic where seed-only firms focus on investing in companies where $1 billion outcomes would be considered a success. In comparison, multi-stage firms focus exclusively on companies where they see a path toward outcomes in excess of $5 billion. In this scenario, I expect multi-stage firms to dominate the market for proven, repeat founders, as those funds can offer larger inception rounds at higher valuations than seed specialist firms can. On the flip side, I would expect most seed specialist firms to dominate the market for first-time or less-proven founders, with smaller seed rounds at more modest valuations. This would create a new dynamic where seed firms might find themselves with portfolios of good companies with strong prospects but not obvious candidates for $5B outcomes. In this scenario, seed firms would have to get good at advising those companies on managing growth in a world where a Series A round from a large firm is an unlikely next step. In short, there would be a business model for small venture firms and a home-run model for big, multi-stage funds with less overlap between the two models than we have seen in the past.

Scenario 3: Big Fund Hegemony

There is a third scenario that wasn’t really on my radar screen a few years ago but is now a possibility worth considering. Now that multi-stage funds are a permanent fixture in seed-stage investing, there is a world in which they come to dominate the category. Their access to capital, strong brands, and active networks would allow them to pay higher prices and write larger checks for competitive seed rounds. I’ve noticed that entrepreneurs are less concerned with signaling risk associated with taking seed checks from multi-stage firms than a decade ago, which should give multi-stage firms more opportunity to compete at seed.

The core question in this scenario is what portion of the returns in seed investing will come from the proven, repeat founders who the multi-stage funds are likely to attract. If you believe 75% or more of the future returns in seed will come from this population, there is a strong argument that the multi-stage funds will dominate seed. The remaining alpha available to seed specialist firms is too small to support the number of seed-focused firms in the market today. I have spoken with institutional LPs who do believe multi-stage funds will capture enough of the alpha in seed to obviate the need to focus on dedicated seed-only managers. I would not describe this as a consensus opinion, but it is one that I’ve heard enough times to know that it is a view held by some who allocate capital to private equity and venture. I do not think that 75% of the best opportunities in seed will come from that pool of founders, but I also believe proven, repeat founders will make a meaningful contribution to overall seed returns.

I have spoken to many smaller, sub $200 million fund managers with strong opinions about how good multi-stage funds will be at seed investing. While we can argue about how successful these larger firms will be, there is no argument about whether they will be run; LPs have already voted with their dollars, and this will happen.

This is not an exhaustive list of how this ecosystem could develop. And not all of these states of the world are mutually exclusive. But they strike me as the three states I see most likely in the near term. Venture capital is a weird business in many ways. One of the central ways in which it is weird is that 10+ year fund lives are both a feature and a bug. A lot changes between when a fund is raised and when it’s returned and I think the next 5-7 years will be a new era for seed investing.