CRV hypes seed strategy, peers say it’s no big deal

Charles River Ventures generated positive press last week with a small loan program for startups, but some say it isn’t novel and questioned how successful CRV can be without focusing solely on seed investing.

Named CRV QuickStart, the program provides startups with up to $250,000 in the form of convertible notes. This is non-dilutive funding, although CRV can get rewarded if the company successfully raises a Series A round. In those situations, CRV retains the right to contribute up to 50% of the round. In addition, CRV can receive a discount of up to 25% when the convertible loan is rolled into the Series A.

Waltham, Mass.-based CRV plans to do 50 deals over the next three years, which works out to about two deals per full-time partner. “Over the past year, roughly one-third of the projects we have committed to have been seed projects,” said General Partner Bill Tai in a prepared statement. “It’s a sign of a fundamental change in the nature of company formation today, particularly in the Internet segment.”

VCs acknowledge the validity of CRV’s basic premise, but they also point out that plenty of other firms have similar programs. Highland Capital Partners, for example, devotes its entire first floor to startups with which it has the right of first funding refusal.

Stuart Davidson, a managing director at Labrador Ventures, a Silicon Valley firm that has focused solely on seed deals since 1989, described the CRV program as “an EIR program with a little bit of walking around money to have a captive source of deals.” Adds Davidson: “You can dabble in [seed investing] and it might work on a one-off basis, but the likelihood of success is enhanced by having a consistent focus on the area.”

Says another venture capitalist whose brand-name firm is active with seed stage companies: “My question to CRV isn’t why they’re doing it, but why they’re talking about it so loudly. They’re going to get flooded with low-quality business plans.”

“It’s probably the right thing to do with a small piece of the fund, says Peter Rip, who recently joined Crosslink Capital as a general partner. “The wrong thing would be to start an incubator. It’s a different place on the risk dial.”

In fact, CRV once had an incubator called CRVelocity, but it started phasing out the program in 2002, when it let go of four partners, one of whom was hired to run CRVelocity in 2000. CRVelocity is now defunct.

The idea of extending a loan very early instead of doing an equity round isn’t exactly groundbreaking. Sanjay Subhedar, a general partner at Storm Ventures, which makes seed and early stage investments, says Storm has been offering entrepreneurs loans for two years. The strategy has allowed the firm to avoid conflicts over valuations until a formal first round is done, as well as conflicts with other VCs that may want to participate in the first round, Subhedar says.

As for CRV’s plan to make 50 loans through QuickStart in the next three years, Subhedar says, “It is very much a scattershot approach.” He adds: “It could work, but only with consumer Internet deals” because they don’t require much work on the part of a venture capitalist until they reach critical mass. “You’re not going to do this with a semiconductor project.”

Some venture debt firms are touting the success of their recent deals. For example, TriplePoint Capital made equipment loans early on to YouTube and Facebook, says Sajal Srivastava, chief operating officer of the venture lender. He wouldn’t say how much TriplePoint made when YouTube was acquired by Google for $1.65 billion in stock last month. (Facebook is also rumored to be an acquisition target.)

Other investors question the choice of debt as a vehicle for financing early startups, particularly Internet plays. Anurag Chandra, a managing director of Lighthouse Capital Partners, says his firm has turned down several notable next-generation Internet companies seeking venture debt financing because the risk was too high for the reward.

Seed investing is in the midst of a renaissance. As PE Week reported in its Oct. 30 issue, venture capitalists poured $540 million into seed rounds in Q3, up more than 80% from Q3 2005, according to the MoneyTree Survey by PricewaterhouseCoopers, Thomson Financial (publisher of PE Week) and the National Venture Capital Association. That’s on top of a surge in seed investments from angels. U.S. angel investments totaled $12.7 billion in the first half of this year, up 15% from the same period in 2005, according to the Center for Venture Research at the University of New Hampshire.

Lawrence Aragon and Alexander Haislip contributed to this story.