Brad Feld has another fine post on seed investing. His post, like so many others, focuses on the intent of the investor. In effect, he says there are good seed investors and crappy seed investors. He is undoubtedly right about that, but I am not sure it matters as far as optionality and signaling are concerned.

Any VC seed investor is likely to have a choice whether or not to fund an “A” round. It does not matter whether they made the investment with the intent of securing that choice or not. With respect to the value of the option, it does not matter that they were great investors and helped the entrepreneur massively along the way or that they were crappy investors and never returned a call.

The choice is the choice and, if the VC doesn’t make the next investment, the signal is the signal. 

(Now a great investor is a fine thing and worth every percentage of equity you give her. I am not taking anything away from the value add of a great investor.)

The difference between a seed investor and a VC is that the seed investor typically will not have the funds to participate in a meaningful way in the A round, let alone lead it. If, from the beginning there was no real possibility of participation in the A round, there was never an option and no signal can be implied.

But here is another way to look at the option/signaling debate (I admit not necessarily theoretically pure I the sense that the behavior would not exist in a world of pure economic actors). Entrepreneurs are afraid that if they bring in a VC for the seed round, they are placing downward pressure on their A round valuation. How can that be? If the A round price is too low, won’t someone bid higher? In a perfect world without friction and with perfect information, that might be true.

We don’t live in a perfect world with complete information. Once the VC has his nose in your tent, it will be hard (impossible?) not to deal with him when it comes time for the A round. The playing field will not be level for outside investors proposing to compete with the VC. The VC’s motive, of course, will be to keep the round price low since that implies a bigger percentage ownership and ultimately a bigger return.

Remember that those investment docs probably say that you can’t increase your authorized stock or create a senior preferred without your VC’s approval (true in most seed deals and absolutely true in all A and later rounds). This means your investor can block your next deal. You will not get far with an alternative investor unless you can get your seed investor on board. 

Whereas a VC seed player planning to lead (or at least participate in) the next round has a strong motive to get a lowish valuation for the reasons noted above, the angel seed player who can’t (or does not want to) participate in the next round has the exact opposite motive. She wants a high A round valuation since that preserve her investment and ultimate return.