Sep 1, 2015 · 6 minutes

Last week, I published a long story about the growing “pre-seed” trend in venture capital – the brave new wave of investors willing to back an idea on a little more than a couple guys and a Power Point. Or as we used to call the exact same thing: Seed investing.

Absurdist labeling? Yes.
Weird Russian nesting dolls of potential signaling risk? Uh-huh.
And yet, actual need in the market? In my view, yes.

The whole trend has been driven by the institutional seed funds who did this kind of investing six years ago becoming successful enough that they could raise bigger funds, at the same time as worries mounted about the Series A crunch and companies needing bigger rounds. But, if you are going to invest a few million instead a few hundred thousand in a startup, you want to see more than a PowerPoint.

Lo and behold, these investors have really become Series A investors. Meantime, Series A VCs are really doing Series B or C deals and just calling them As. And late stage mega-growth rounds are really what IPOs used to be.

But here’s the real existential threat to the pre-seed wave, as Charles Hudson explained in my piece last week: Adverse selection. Put another way: Pre-seed essentially competes with so-called “friends and family” rounds. And there are enough ways for any remotely connected entrepreneur in Silicon Valley to get that early couple hundred thousand dollars. The concern Hudson flagged-- which potential LPs I spoke with shared-- was that pre-seed could be the new incubators and accelerators. A place where “those who can’t” go for funding.

After wrapping my story I spoke with Nick Chirls of Notation Capital, a leader of the pre-seed trend in New York. Chirls and his partner Alex Lines came from Betaworks. They left to start a fund for much the same reasons Hudson left SoftTech to start a new pre-seed fund: They weren’t able to back first time entrepreneurs with little more than an idea and those entrepreneurs had few other places to go. There was a lot of “let us know when you are raising a seed round of $1 million to $2 million, and we’ll consider participating” Chirls says.

Same story, different coast.

Here’s where things are different, according to Chirls: When a “seed fund” says no to an idea without traction there aren’t 20 angels hanging around that an entrepreneur can hit up for $50,000 chunks of capital to cobble together a pre-seed amount of cash. In the Valley, getting a dozen checks may be a hassle compared to one check from one seed or pre-seed fund. But at least there are thousands and thousands of angels willing to write them.

In New York, Chirls argues it’s a very different story. As funds like Thrive Capital, Lerer Hippeau Ventures, Betaworks, and First Round Capital have migrated up to writing bigger checks, there’s been almost nothing to fill the void, he says. [Disclosure: Lerer Hippeau Ventures and Josh Kopelman of First Round Capital are investors in Pando.]

“The situation is much more dire here than in the Valley,” he says. “So much about New York’s tech scene has changed so dramatically in the last seven or eight years, but it’s actually harder to raise a true seed round than it was a few years ago.”

Think about that for a minute: Almost everything about starting a tech company has gotten easier in New York, as the ecosystem has gotten bigger, except raising the first few hundred thousand to get going.

How can that be? According to Chirls, New York has missed a crucial step in the playbook of building a thriving venture ecosystem: Angels who have had success and recycle their cash back into startups. That means as seed funds who helped fund the last wave of companies enjoy their success and get bigger, there is no one to fill the void they left behind, because the entrepreneurs who succeeded aren’t becoming hobby-VCs like they do in the Valley.

“There’s a totally different mentality to recycling capital in New York than the Valley,” he says. “If you have an exit in the Valley, the next day you put your shingle up as an angel investor and start running a seed fund. But look at the founders who had success in New York now. Perry Chen (of Kickstarter) is opening a restaurant in Brooklyn. We work above a brewery which is owned by a very successful tech operator who wants nothing to do with tech. David Karp (of Tumblr) has made a few investments with his buddies but there’s no way he’s going to recycle a considerable amount back into the ecosystem.”

It’s a ripple effect of something that New York entrepreneurs always brag about: In New York, it isn’t all tech the way it is in San Francisco, it’s just one of many things the city does well. That makes people who work for startups much more well-rounded and gives people an escape from the startup grind, they argue.

It means you don’t have this conversation every time you leave the house:

“Oh hey dude, how’s it going?”

“Great! Great! We’re totally crushing it! How about you guys?”

“Totally crushing it too!”

But all that well-rounded-ness also means people have other ideas for what they’d like to do with their cash once they are successful. It’s not that they aren’t recycling their cash into the city, it just may be going to the arts or a hip new restaurant instead.

New York may be more the rule when it comes to this, and the Valley may be more of the exception. Consider how many millionaires came out of Amazon and Microsoft in Seattle, and while it’s emerged as a decent third tier ecosystem, it’s never even come close to the size of New York in startup activity and exits. And I remember years ago after Skype was bought by eBay, folks in London expected a flood of Skype angel money that mostly never came.

It turns out the Valley may be the weird one that expects successful entrepreneurs to de facto use that cash to back more entrepreneurs. One reason may that be the odds of winning are just higher here because there’s a greater density of… well, everything needed to build a successful tech company. But there’s also extreme social pressure to angel invest here. It’s the thing you do when you succeed. It’s our version of going to the opera. It’s how you achieve “You’ve made it” social standing here.

“There’s nothing wrong with that,” Chirls says of New York’s reticence to re-invest in tech. “It makes these cities more interesting places. But a lot of the new founders right now in this cycle look at a lot of these folks and expect help from that first generation of founders and it’s not coming. In the Valley, pre-seed is more of a meme than anything. It’s just a different word for something historically called seed investing. In New York it’s also that but there’s a real lack of capital at the early stages we didn’t have three to four years ago.”

There are others who see the hole in the market too. In addition to Notation Capital, Chirls lists Box Group as another seed fund and FourSquare founder Naveen Selvadurai as an active NYC angel. I’m guessing a few more will pop up. New York is a big enough market and the tech scene is legitimized enough there now, that capital will flow to an open opportunity.