I have been giving more thought to this issue of signaling and VC seed notes. As I have pointed out before there is a lot of chatter about it in the blogosphere. My initial thinking in an earlier post was that this is really much ado about nothing.

I was going to leave it at that, but one of my partners passed along a rumor to the effect that one of the top tier VC funds in Boston was pursuing (or considering pursuing) the following strategy. They, apparently, propose to do a whole bunch of seed notes with the intention of following up with an A round on only a small fraction of the seeded companies. I don’t believe this is likely to be good for entreprenuers

 This is, I think, a departure from what I have seen in the past. What I have seen is that these seed notes were hard to get and were typically done (1) with the full intention of providing an A round if the business plan proved out and (2) they typically (but not exclusively) went to serial entrepreneurs with strong records. I will now repeat what I wrote before. I have never had a situation in which one of my clients got a seed funding of this type from a top tier VC and then did not get funded. I have heard of this happening, but in each instance that I am aware of, it seems to me that there was a mutual agreement between the VC and the entrepreneur that the business should not be pursued.

The proposed strategy, as I understand it, would replace this model of exploration of a business idea and mutual agreement to proceed or not with more of a roulette game approach: The VC makes a bunch of bets that amount to giving the VC exclusives on a bunch of companies and hopes that a small number pay off big.

This strategy will leave a lot of entrepreneurs believing in their plans but holding seed notes and having been rejected for Series A financing from the VC who seeded the venture. Presumably, the VC supplying the seed money (but who did not provide the Series A) would want to have the note repaid in the event the business goes forward (let alone gets other financing).

In this scenario, the there seems to me to be a clear signal that the entrepreneur did not make the cut. She will have to hurdles to overcome: (1) she will have to explain why her seed source is not investing in the A round and (2) will have to use some of the proceeds of any future financing to pay off the seed note.

The upside, of course, is that it might be easier for entrepreneurs to get that initial seed money, albeit knowing that the odds of getting the A round are against them.

I am not entirely sure what to think of such a strategy, but my instinct is that this is not good for the ecosystem.