Series A Crunch, Seed Blues



If you’re an entrepreneur, what are you supposed to make of all this hoopla about the Series A crunch ?  The line of argumentation is nothing new, so is there something real to worry about or is it business as usual ?

Bubble ? Bubble And Squeak ?  Bubble Bath !

We’ve had talk of a bubble for a good two years, what with attacks on valuation uplifts or cries for “funding innovation that matters”.  Behavior that appears on the surface absurd to some (funding a hundred companies a year, seeing a valuation go from $10 to $100M in a matter of months) leads to endless debates that really have no answers (users first !  no, revenues first !).  

It does not take a genius to run the math on number of seed level companies versus absorption capacity of the venture market at Series A.  I could also give you the vivid examples of a promising startup (in Silicon Valley) that cannot even get a meeting with their current investors, let alone new ones !  

series A crunch
Source: Dan Primack post / CB Insights

But historical data is a poor predictor of the future in fast moving markets, and hence the debate does not die down that easily.  

On the one hand I give you Angellist, crowdfuding and deep market disruption, on the other I give you traditional VC approaches and guys (no ladies involved, typically) who seriously think a 90% success rate on seed investments is a likely strategy.  Who’s right ?

The bottom-line is that there is no correct answer that is systemic, only (different) strategies that work that can execute on them.  That’s why we’ve got a gloriously diverse market.

Calling The Top

So when Sara Lacy (@saracuda) calls the top (“the quietest nuclear winter in history“), half the pundits retweet it and the other half cries “but we told you so a year ago”.  The thing is, she’s true to her by-line (“the site of record of Silicon Valley”): she’s clearly talked to enough credible people to catch the change in sentiment, and she’s probably calling the top just about right.

A shift in sentiment

The narrative of the Series A crunch is at least two-years old, but that does not matter.  The only thing that matters is whether she captured the change in SENTIMENT accurately.  If she did, then it’s likely meaningful change is afoot.

Market sentiment is a phrase borrowed from public markets.  Where the market is feeling good about itself and the macro-themes it is pursuing, it tends to be healthy and display decent trading volumes (both short and long since positive and negative narratives co-exist).  

In periods of uncertainty however, liquidity dries up.  Uncertainty kills decision making.  That’s why the pronouncements of the media matter: they reflect the market’s confidence in itself.

No more suspension of disbelief – it’s Crunch Time

I think the shift in sentiment is real, and as a result, the crunch is real.   Here are the building blocks: 

  1. The bar on Series A goes up: when the pendulum swings back, the power shifts back to the follow on investors who feels less pressure to invest fast and demand more progress before committing.  Fast, expensive rounds take competition amongst investors and a sense of scarcity to come together.
  2. Angels and Seed Investors slow down: when you cannot be confident that the capital markets will support companies, you slow down.  It’s mechanical and rational, particularly when investing your own money.
  3. Runways need extending.  Either entrepreneurs need to be more capital efficient or seed round sizes need to go up … making them harder to close, as “rolling closes” may not be an option anymore.
  4. Many VCs cut back on seeds: I have heard this a number of times now.  Firms that tried out “seed programs” conclude that either they don’t work for them or they struggle with the lack of scalability inherent in pursuing these strategies in a classic “high touch” model.

Whether the numbers actually invested end up fully reflecting the above narrative may matter less short-term than the shift in sentiment.  Markets need to believe, and the startup funding market is no exception.  Without suspension of disbelief, there is only cold, hard metrics, and these take more time to build.

Indeed, investing in startups is always an act of faith (or love, sometimes) enabled by at least some suspension of disbelief and tempered by experience and discipline.

At Atlas Venture, we’re a seed led firm.  Seed is the heart and soul of what we do and probably 90% of our projects start as seed investments.  With the massive market dislocation of the past few years, we’ve experimented too.  We’ve been trying to find a sustainable pace (probably around 10-12 seed projects a year, down from an assumption that we could take on around 15-20 a year) and adapting in real time to the market around us.  We’re not expecting any of this to change our behavior much at all.

In any event, the oft glossed-over reality that many seed stage companies will not make it all the way is about to hit home, for everyone.  I think we always knew or expected it, and consider that patience, consistency and transparency are the key to treating our entrepreneurs with the respect that they deserve.  We don’t infantilize them, either; contrary to much of the media narrative, they’re not dumb and they know what they’re doing !

For the best teams and the best projects, none of this matters of course.  For most startups out there, whether you chose the right investment partner suddenly matters a lot.  For many, it will be time to embrace the euphemistic “fail fast” philosophy.

Dusk4
 
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  • Edward Zimmerman

    Fred: I like the post and agree with a good chunk of what you say. You indicated at the bottom that this won’t matter for the best teams. I respectfully disagree. the best teams will still have to work harder and will feel the market’s gravitational pull on (a) valuation, (b) terms, and (c) speed to close. There will also be a desire to lengthen the planning cycle for funding, which will take some focus off the rest of the business (at leas a bit). Moreover, start-ups have benefitted by outpacing the rest of the economy in terms of the ability to attract talent (we have more demand for employees than elsewhere in the economy, generally speaking). If the mood terms gloomy, that too could change, which also impacts even the best teams, especially if they’re working early in the life of the company.

  • Ed Boyle

    well put… including the point about the best of teams. Venture market is a bit like real estate…there are macro forces at play but it is often a ‘local’ game, and certain sectors cool off more than others. As long as GPs are being paid to put money to work, the very best of teams in thr very best of sectors will continue to get the funding they need at reasonable terms. of course ‘reasonable’ is open to great debate!

  • http://www.facebook.com/ben.tompkins.750 Ben Tompkins

    Interesting article Fred and I agree with the sentiments. As a seed-led fund as well, Eden’s rough guide of attrition from the seed to the A round is 50%. Even then, I am sometimes not sure this is tough enough. One of the big questions that we debate is how much do we need to anticipate putting into our best companies to get them ‘all the way’. Any thoughts on this?

  • http://www.twitter.com/stevenkane Steven Kane

    Great post. But when you write “For the best teams and the best projects, none of this matters of course, ” you are assuming that that is clear at the time of series a fundraise. which of course it often isnt?

  • Jose G. Gonzalez

    What is
    SERIES A CRUNCH ??

  • http://csertoglu.typepad.com csertoglu

    Good post and perspective on the usual VC ebb and flow, @fdestin. 2012-2013 vintage funds will do well.

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