One of the big inflection points (out of many) in any startup’s trajectory is of course series A funding. In speaking to a friend of late who is looking to get into the wacky world of startups, I’ve discovered there’s a perception gap regarding the role of VCs. The perception is that they seed-fund great ideas which someday become the next Google and so on. Some do, but in general this is about as grounded in reality as Santa Claus or the tooth fairy..
It’s worth looking at the heavy lifting in funding, and Don Dodge has done a lovely job of summarizing the data:
“The Center for Venture Research at UNH today released their annual Angel Capital report for 2007. Angels invested $26 Billion in 57,120 companies, up slightly from last year. The report says there are 258,200 active angel investors in the USA. By comparison, Venture Capitalists invested to $29.4B in 3,813 companies in 2007.”
So let’s see, deal ratio is near 20 to 1 with about 50-50 on total cash. So Angel Investors are the ones doing the biggest risk taking (as most people in silli valley know intuititvely). Said another way, VCs are outsourcing early stage investing to Angels. This is of course beyond the tactical scope of the barcamp style conference in Palo Alto on April 26th, 2008 called StartupLegalandFinancecamp (or “StartupCamp” for short). Still, any meaningful discussion of getting funded in 2008 will have a backdrop of credit crunch and real estate bubble burst. As individual investors, angels are invested in land and other credit- fueled investments (heck, everything in our economy seems to be credit-fueled). Many of them may have gotten pummeled on those investments – any angel who was invested in Bear Sterns may recoil at funding anything with those fresh wounds.
There’s another side to this. Sramana Mitra obviously feels this may reign in bloated valuations and gut check-writing. I’m inclined to agree (economics 101 here: misallocation of resources = FAIL). The concern of course is an over-correction. I figure most of what’s going on is a mixed blessing of sorts. According to Valley-watcher Tom Foremski, Jeff Nolan (a former venture capitalist now at Newsgator) says money moved away from VC funds and into hedge funds, but that’s reversing with the large institutional investors will be rebalancing their portfolios and pouring more money will come into VC funds. This might lead to the odd effect of increasing series-A funding while decreasing the amount of seed money spread around. Ever drive down a street with stoplights where the timing is of greens and reds is off, forcing you to stop at every intersection?
A few things seem certain. I’ll bet a significant amount of startup capital is going overseas, since the Euro, Yen, and Reminbi provide capital preservation over the free-falling Dollar. I’ll also bet that we’ll see a number of hot ventures jump out of this recession, just like the last. Recessions seem to do that.
The basics never change too. Investors will keep looking for a sustainable revenue model and a smart exit strategy, and entrepreneurs need to partner with investors for more than just their money. As Paul Kedrosky writes, “Today I had lunch with a smart, seasoned entrepreneur who told me about a 4-inch deal binder he had been forced to create for angel diligence. As I said to him: Run. Hide. Any angel who wants that much security in an early-stage deal is to be avoided like a banker.” Exactly Paul.
Update: Jeff Nolan of Newsgator has an editorial up on incrementalism he’s seeing in the funding market where he discusses how startups’ seed capital now is far below the minimal economically feasible VC threshold.