The Glorious Post Seed Startup Financing Chaos



The other day I got a call from Scott Kirstner at the Boston Globe answering: “what happens to all these incubators entrepreneurs after Demo Day”.  

The short answer: chaos.  Full of opportunity, but chaos nonetheless.  Cue fractals on this blog.

TheCityScape
Welcome to your next round of fundraising

In the days of old, people with cred or tech would raise some seed funding, get a team together and do some product development, then promptly proceed to raise a $4-8 Series A from a couple of reputable venture firms for a measly 40% of their company (who cares about dilution when you're building a billion dollar business, right ?  right ?).

Then, of course, all hell broke lose.  Enter YC and the Do More with Less mentality.  Lean is In.  What can you prove on $500K ? Five years on, we have Techstars, Seedcamp and a plethora of incubators of variable quality. We have Angellist and it’s hyper transparency engine for seed investing and the "Great Unshackling of the Angel Investor". We have Micros VC's galore and corporate VC's back in the game. Suddenly we’re awash with Demo Days.

In the meantime of course, the top of the VC pyramid is shrinking. FLAG, based on its own research, indicates an estimate of only 100 active full lifecycle venture firms in the US (there are over 800 on the NVCA website). You don’t need to be a genius to build a theme called Series A Crunch (complete with cereal packet).

So here's what’s happening on the funding side:

  • Seed rounds are generally larger and companies are thriftier, so they “do more with less” ... with quite a bit more cash.
  • Seed rounds are followed by a bunch of hybrid rounds, usually called Seed Extensions 
  • ... combined with a number of alternative methods (a filler round on Angellist, a Kickstarter campaign, or getting a mix of money and investments from strategic investors struck by FOMO)

Read this first hand account form Danny Boyce (@dannyboyce) over at TechCocktail on the topic.

The old and convenient distinction between Seed and Series A has gone out the window, which is why I always violently agreed with Dave McClure that the so-called “Series A Crunch” (milk with that ?) is a lazy misnomer to describe what is happening, however elegant in its SEO-optimized brevity.   I never liked to use the past to describe the future – trends lie most of the time.

The current market overhang is partly cyclical, partly structural (we're breaking new ground with the likes of Angellist) and it's hard to determine which is which when markets are evolving this fast.  See this great data rich post on DataHero.

DataHero Total Amount of Angel deals
DataHero Total Amount of Angel deals

What’s of course more relevant is: what does it mean for startups ?

Incubator X Demo Day is a glorious celebration, which is as it should be. Everyone is high fiving the great pitches , basking in the glory of their two line coverage on Techcrunch and generally feeling like the world is their oyster.  As we all know, all a seed funding or a run inside Techstars can do is give you a shot at getting that MVP out in decent conditions. No more, no less.

The reality is as follows:

  • The competition for Series A money is ever more intense, and the bar gets raised all the time.  What was acceptable traction two years ago is dwarfed by traction today.  
  • Entrepreneurs are in a race with 1,000 other entrepreneurs to get far ahead of the pack  and demonstrate what they can do.
  • Getting Seed does not mean you are on a long-term venture capital track.  Have a plan B, C and D.  You may not see venture money ever again, so make that seed round count and look for funding alternatives early.

David Freedman (@dhfreedman) wrote an excellent article at Inc.com on the topic recently.  I only disagree with one statement:  "The Hurdles Forgetting Series A Funding Haven't Changed".   I think the hurdles has moved up and keeps moving up : better entrepreneurs, businesses the scale faster.  It's a brutal race.

People out there still talk of Bubble or Lottery, such as Greg Winterton over at PE Hub.  Sure, there's some of that in the pace that we're seeing, but I firmly believe this line of thinking misses the bigger picture.  

With super high capital efficiency, transparent markets, standardized investment terms, the rise of platforms, post seed chaos is the "new normal" in startup life.  Better get used to it.

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  • http://tedr.tumblr.com/ Ted Rheingold

    Not sure why I missed transparency being such a big factor in the new normal, but I will from this point on. No more shell games, no more ‘trust the slides’, no more blinded by the hype. This is so much healthier.

    • http://www.freddestin.com Fred Destin

      oh gosh yeah.. for everyone involved

  • Bob Mason

    Recently I’ve been thinking about the shift of product and engineering from waterfall to iterative, agile development and how that relates to the current changes in VC investing. I surmise that the trends we see in early stage financing are flowing a similar trend. We’re in the midst of the decline of “waterfall investing” and toward a more iterative, incremental on-demand “agile investing” environment.

    • http://www.freddestin.com Fred Destin

      yes for sure ! difficulty : most companies stumble at some point, even the good ones, so most of the time startups are in the greyzone when they need further funding. Suspension of disbelief usually required.

      • Daniel Maloney

        Another problem with that: time spent to be continuously fundraising. There’s got to be an efficient trade-off between founder time (especially) and agility of capital…

  • jeffgiesea

    I’m tripped out by that picture…. Excellent post.

    • http://www.freddestin.com Fred Destin

      it hangs over my bed in 100 inch x 100 inch

  • TerrenceYang

    What does “full lifecycle venture firm” mean?

    • http://www.freddestin.com Fred Destin

      ability to follow in every round from seed to exit

      • Daniel Maloney

        Does this decline represent a decline in the number of active VCs? Or a trend toward specialization, where individual funds target certain phases more?

        • http://www.freddestin.com Fred Destin

          Most definitely both as well as: polarization of market between multi-product multi-stage VCs (Index, Sequoia) and very specialized funds (IA Ventures, Atlas).

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  • http://www.chasminnovations.com Robert DiLoreto

    Very few B2B start-ups consider this approach in minimizing the chaos: Target the C-Suites of potential enterprise customers for “customer-funded” opportunities. These enterprises have key open innovation and strategic initiatives that may map well to the start-up’s technology/solution/value prop.

    I can point to numerous examples of leveraging corporate funds to validate and show value in the start-ups offering while gaining the important “voice of the customer”. These funds accelerate product development while validating customer development activities. In addition, you have a great chance of securing a longer term transaction/partnership with the Enterprise once the phase one pilot was deemed a success. (having references in the enterprise category adds credibility when raising your A round!)

    Identify if your start-up or advisors have experience with this approach. More here: Innovation Management Article: http://t.co/9qZwEh1z

  • http://www.ricfulop.com/ Ric Fulop

    Fred, amesome post! If I was 22 again starting a company today I don’t know if I would have made it. At least in the old days when you gave up enough of the company for a few $M you got enough money to attract a very strong management team and investors owned enough to be commited to help you. Now in this model the first time entrepreneurs are stuck with a lot less money which leads to weak management teams. This is in my opinion the biggest barrier to moving forward. Even in the startup world experience based judgement matters.

    • http://www.freddestin.com Fred Destin

      We are definitely working with teams that build management teams slowly. They may have only a couple of “senior” execs (usually the founders) early on and add heavy hitters slowly as the company grows. I am still of the view that it’s easier to get off the ground and that we are seeing less dilution early and less carnage from the weight of large rounds, which sometimes led people to years and years of toiling away trying desperately to return the large sums of capital they raised. I fully agree with you that more risk is attached to the new environment, but overall I like the fact that it gives founders much more control over their future.

      • http://www.ricfulop.com/ Ric Fulop

        Yes there are definitely pros and con’s to both approaches. I don’t like spreading peanut butter. I’d rather get the resources to have a fair shot at winning and building an experienced team to avoid rookie mistakes. The fact is cos like LinkedIn started with a $4M round…enough to build a strong team and execute sufficiently. I am all for lean startup but I think we are taking the concept too far :)

  • Evan Powell

    Fred, good stuff. Seems like there is broad agreement that the post seed chaos / crunch is here to stay.

    Along those lines – I’m not sure if folks get that, at least IMHO, it costs at least as much if not more than before to scale IF you are selling to the enterprise. Do you agree?

    SaaS companies for example decrease barriers to entry by customers through lower ASP and of course by running the software for you. However, the lower ASP generally means – less cash to the start-up. And running any business selling to enterprise is expensive AND the majority of SaaS business to Global 2000 have big direct sales teams which cost real money.

    So maybe the moral is – if you are building an enterprise focused company don’t let your seed funding take you in a direction away from what you really need – which is experience and staying power. Which leads you back to a solid VC.

    • http://www.freddestin.com Fred Destin

      SaaS definitely generates some nasty cash requirements but very high quality free cash flow once at scale.