

Here's the problem. A few years into the program, approximately 25 teams have gone through it. The sponsoring VC funded one team and passed on the other 24. None of those other 24 have gotten financing from anyone else. Why? Because once you go through the program and don't get funded by the sponsoring VC, you are perceived by the rest of the investor community as damaged goods.


Meanwhile, the unsuspecting entrepreneurs think: "I was at a prestigious VC this summer - this will look great on our bios and company deck." The truth is exactly the opposite: the better the VC, the stronger the negative signal when they pass.


The best programs don't have sponsors who are even capable of further funding the company. Y Combinator simply doesn't do follow ons, so there is no way they can positively or negatively signal by their follow on actions. (Although now that they have taken money from Sequoia people are worried that Sequoia passing could be seen as a negative signal. I just invested in a Y Combinator company and was reassured to see Sequoia co-investing). Other seed programs lie somewhere in between — they aren't officially run by big VCs but they do have big VCs associated with them so there is some signaling effect. (I would call this the "hidden sponsor" problem. I didn't realize the extent of it until I got emails responding to my earlier seed program posts from entrepreneurs who had been burned by it).


As has been widely noted, startups - especially internet-related ones - require far less capital today than they did a decade ago. The VC industry has responded by keeping their funds huge but trying to get options on startups via seed programs. Ultimately the VC industry will be forced to adapt by shrinking their funds, so they can invest in seed deals with the intention of actually making money on those investments, instead of just looking for options on companies in which they can invest "real money." In the meantime, however, a lot of young entrepreneurs are getting an unpleasant introduction to the rough-and-tumble world of venture capital.


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