One of the most common criticisms of VC investors making seed investments is something that has become known as “the signaling problem.”  The explanation of this problem is that VCs create a “negative perception” about a company if they make a seed investment but then don’t follow through and make a next round investment.  Another way to say this is that a VC creates a “signaling situation” with their seed investment – if they don’t follow on in the next round they are “sending a signal” that something is wrong with the company (hence the label “signaling problem.”)

Last week I spoke with a partner at a large VC firm whose firm has been around for a long time.  They have a new seed program (as of a few years ago) after eschewing seed investments from 2002 to 2008.  The partner that I talked to told me that they are doing 30 seed investments out of their newest fund.

I was surprised on two levels – the first is that they have a very visible anti-seed reputation.  I pointed out that their market reputation was that they didn’t do seed investments nor did they do many Series A investments.  He said “we changed that a few years ago.”  I suggested that their web site didn’t talk about their seed program; he responded “yeah, we need to work on our web site.”

The second, more important thing, was that I couldn’t make the math work on their fund.  I asked them how many of the seed investments they expected to follow with regular first round investments.  He said “half of them”.  So – 15 of their investments in the fund would come from their seed program.  I asked how many other investments they’d have in the fund.  He said 30.  So they’ll end up with 45 active investments in the fund (high for their fund size) of which 33% came from seed investments.

I then asked how they were going to deal with the “signaling problem” for seed investments they didn’t follow on with.  Here he said something that made me pause: “We’ll sell them back to the founders, the company, or the angels at somewhere between $1 and our cost.”  I probed on this (as in “seriously, can you give me some examples?”)  Without naming names he explained three situations in the past two years where they’ve done this.  And, in each case, his firm had decided not to follow on, took themselves out of the cap table, and the three companies were able to raise additional financing (in one case from a different VC firm.)

I thought this was a pretty clever way to deal with this issue.  While it doesn’t eliminate the problem created by the signaling issue, it addresses part of it.  I don’t know if this firm will follow through on unwinding their positions in 15 of the 30 seed investments they make. I also don’t know how they’ll feel when one of the 15 they decided not to follow goes on to be massively successful and their seed piece, if they had kept it, would have returned a meaningful amount of money to them.  But if they do take this approach it seems like they should shout it from the rooftops as part of their VC / seed positioning statement.

I’m not a fan of this “spray and pray” seed investing strategy for VCs.  Instead, when we make a seed investment, we don’t treat it any differently than our non-seed investments.  Rather than repeat our approach here, take a look at the post How I Think About Seed Investing As A VC that I wrote a month ago.  That said, I found the approach of selling back the seed investment at $1 to be an interesting way to address part of the signaling problem.

Now that my Apple and Google experiments have been huge successes, I thought I’d try an Android phone one more time.  I like my iPhone 4, but it’s pretty weak with all the Google apps.  Specifically, I badly want better contact integration, clean email sync, and Google voice.  Plus, AT&T still blows in Boulder.

Any suggestions out there for the “best Android out there today.”  I was using a Sprint EVO for a while (and liked it a lot) until it was stolen by my assistant Kelly.  So, I open to any choice – suggest away.

TechStars is coming to New York City.  The first program runs from 1/10/11 to 4/8/11.  Applications are open now.  The NY mentor list is stunning and includes the following:

Phin Barnes (First Round Capital), Alex Blum (KickApps), Matt Blumberg (Return Path), Brad Burnham (USV), Jeff Clavier, Dennis Crowley (FourSquare), Chris Dixon (Founder Collective), Roger Ehrenberg, Darren Herman (The Media Kitchen), Jennifer Hyman (Rent The Runway), Alex Iskold (Adaptive Blue), David Karp (Tumblr), Zach Klein (Boxee, Vimeo), Evan Korth (NYU/HackNY), Mike Lazerow (Buddy Media), Ben Lerer (ThrillList), Sam Lessin (Drop.io), Joey Levin (MindSpark, IAC), Howard Lindzon (StockTwits), Eric Litman (Medialets), John Maloney (Tumblr), Dave McClure, Hilary Mason (Bit.ly/HackNY), Jeremie Miller (Telehash), Howard Morgan (First Round Capital), Charlie O’Donnell (First Round Capital), Eric Paley (Founder Collective), Raphael Poplock (ESPN), Alex Rainert (FourSquare), Avner Ronen (Boxee), Naveen Selvadurai (FourSquare), Justin Shaffer (HotPotato), Tim Shey (NextNewNetworks), Andy Smith (Daily Burn), Rex Sorgatz (Kinda Sorta Media), Jon Steinberg (BuzzFeed), Vinicius Vacanti (YipIt), Albert Wenger (USV), Fred Wilson (USV)

David Cohen, who is relocating to NY for January to March of next year, and David Tisch (I’m encouraging him to change his name to just Tisch to save me the brain damage of “which David”) will be running the program.  When we went about setting up the NY program, we evolved our funding model to be as inclusive of the local VC / angel community as we could.  We’ve created a long term funding model, which I expect David Cohen will write about at some point, that we implemented in TechStars Seattle and will be rolling out to Boulder and Boston this year.  As a result, the investors in TechStars NY include many local financial investors such as:

AOL Ventures, DFJ Gotham Ventures, FirstMark Capital, First Round Capital, Foundry Group, IA Ventures, Jove Ventures, Lerer Ventures, RRE Ventures, Social Leverage, Village Ventures, Zelkova Ventures, Peter Hershberg, Josh Stylman, David Tisch, Nate Westheimer, and Kal Vepuri.

When David first talked to me about his idea for TechStars in 2006, if you had asked me if we’d have Boulder, Boston, Seattle, and NY programs up and running by 2010 I would have chuckled (a real chuckle, not my evil laugh chuckle.)  The Seattle program is crushing it already and I’m excited to go spend time up there.  And I can’t wait to see the NY program start cranking.

We’ve got a few other interesting pieces of TechStars news coming over the next month – look out for them!  And, if you are an entrepreneur interested in the TechStars NY program, apply now so you can come to TechStars for a Day on 11/20/10.