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Why seed valuations haven’t fallen (yet)
At Eniac, we’ve been studying recent changes in the seed market — and what we’ve found surprised us, especially when it comes to valuations.
To understand the market, we pulled deal data on recent quarters from PitchBook, as well as conducting our own Seed Sentiment Survey. Some of the changes are obvious: The market has slowed, with seed capital deployment falling 39% in Q1 2023 compared to two quarters earlier. In addition, the number of deals tracked by PitchBook at every stage has fallen by more than 45% year over year (the biggest drops are at Series C and D).
What’s surprising, however, is that seed valuations don’t appear to have reset, especially when you compare them to later stages — in Q1, seed valuations only fell 4% year over year, compared to 42% for Series A and 51% for Series C.
We received similar comments in our Seed Sentiment Survey, with one respondent writing, “Despite broad repricing across the sector, pricing in the seed market still hasn’t adjusted.” Another noted that while they’re seeing more “realistic” pricing at the A and B rounds, “pre-revenue seeds can still be expensive.”
Why is this? We believe there are a number of factors at play, ranging from the activity of multi-stage funds to hype around AI. But we also believe that all of these factors should diminish over time.
The first factor relates to pricing changes trickling down through the VC ecosystem. The current data already hints at this: The later the stage, the bigger the decline in valuations. Of course, the price reset really starts in the public markets, which then affects later stage private deals. Over time, as C rounds get priced down, this pushes B valuations down as well, and then A — if a typical B valuation goes from $200 million to $100 million, then it stops making sense to value a company at $90 million in the A. So it takes time for pricing trends to reach seed rounds, but they will trickle down eventually.
Second, multi-stage funds who deployed capital too quickly in the bull run now need to respond to the macro environment by reducing the amount of capital they invest. Yet they need to remain active, so they’re shifting their attention from later stage deals to smaller seeds. These funds tend to be less price sensitive than seed firms (one Seed Sentiment respondent wrote, “The larger funds continue to be problematic with their willingness to pay higher prices at the seed”). As the macro environment changes, we expect their focus will eventually return to later stage investments.
Third, many seed funds were raised during the bull run of the past few years — frankly, too many. Some of these new funds will succeed, but others will be unable to return capital to their LPs and will struggle (or are already struggling) to raise new funds. So we expect to see less competition in the seed market over time.
Finally, there’s Generative AI — because it’s so novel, the most exciting opportunities are found with new companies raising seed rounds. But as those companies mature, the opportunities to invest in AI will move into the later stages — again, relieving some of the upward pressure on seed valuations.
Altogether, we believe this will lead seed valuations to correct over the next 12 or 18 months.
And irrespective of valuation trends, we see the next few years as a unique opportunity for seed investment in general, and for Eniac in particular. AI is likely to fuel a new wave of technological disruption, the longer hold times for seed mean that our new investments will be maturing and exiting in a different macro environment, and the reduced supply of capital in the market will mean there’s less competition for the best deals.
It’s a commonplace that the best companies are founded during downturns, from long-time giants like GE and IBM to newer icons like Airbnb and Uber. For the reasons outlined above, we believe that’s going to be more true than ever. And because we were more disciplined than our peers during the recent bull run, we’re well-positioned to bet on the next wave of winners.
