The problem isn’t too little smart money, it’s too many dumb deals
By Ronald Weissman
The meme of the month is “The Series A Crunch.” According to Crunch Theory, many worthy seed-funded startups lack follow-on capital because VCs now have smaller funds or have moved later stage. CB Insights estimates $1 billion in seed financing will be “incinerated” and at least 1,000 companies will be orphaned. Other data suggest that the number of orphans could be much larger.
Those who say the problem lies with VCs (CB Insights isn’t one of them) must argue that the number of Series A deals has fallen sharply. This is not true and the problem lies elsewhere. Whatever the cause, there is, certainly, a capital crunch for seed-funded startups and it is likely to get worse, as the backlog of seed-stage companies needing Series A funding continues to grow.
Angel investors are panicked that it is hard to move from seed to institutional funding. As Adeo Ressi (founder of The Funded.com), urged well-heeled angels in late 2011, “don’t launch a company, launch a fund” or startups will die. The pain is growing; a search for “Series A Crunch,” now returns more than four million hits.
So, are VCs funding significantly fewer Series A deals? According to CB Insights’ venture and angel investing data, not at all. VC Series A deals in the U.S. have actually increased over the past two years, (until Q4 2012, when both angel and VC funding decreased). The average quarterly number of Series A deals for the past two years has been higher than the overall average (145) number of deals per quarter for the past four years and the trend line is positive. (See Chart 1: Weissman Crunch Series A)
So, where’s the VC-caused crunch?
Take a look at Chart 2: Seed Vs. Series A Funding. The problem is clear when one compares the number of VC Series A (green) to the number of angel-funded seed deals (red). Series A financings have been stable, but there has been a dramatic increase, since late 2010, in the number of seed-funded startups.
Pitchbook noted that the ratio of seed to Series A was 1.9:1 in 2008 but is 3.3:1 today. And analysts may be understating the problem. CB Insights estimates that 4,000 new U.S. companies were funded by angels, from 2010 to 2012. The University of New Hampshire’s Center for Venture Research (CVR) estimates that nearly 58,000 startups received initial angel funding between 2010 and June 30, 2012. According to CVR, angels invested $20.1 billion in 61,900 deals in 2010 (31 per cent were startups); $22.5 billion in 66,200 deals in 2011 (42 per cent were startups); and $9.2 billion in 27,200 deals in the first half of 2012, (40 per cent were startups).
If CVR is even half right, there are far more companies at risk of becoming orphans than CB Insights estimates. CVR’s data, for example, suggests that the 11,000 software startups founded and funded during the past two-and-a-half years is, by itself, more than double CB Insights’ total of all seed-stage deals in all sectors.
Angels everywhere
In the last full year studied by CVR (2011), 66,000 startups were funded by 318,500 individual angels. Where did all of these angels come from?
It seems like everyone is an angel. Major groups like Sand Hill Angels, Golden Seeds, Tech Coast Angels, Launchpad, The Angels’ Forum, Investors’ Circle, New York Angels, the Band of Angels and 300 other institutional angel groups account for approximately 12,000 to 15,000 of these investors.
Beyond institutional angels, there’s been an explosion of new models: seed stage funds, so-called “super angels,” and initiatives like Startups Across America to launch incubators and accelerators in every major metro. And almost every university has its incubator, too. Angels have gone online via Gust, Angelsoft and Angel List, websites that enable speed dating between investors and entrepreneurs. The recent US Jobs Act will broaden the base and lower the qualifications for angel investing even further. Today, virtually anyone, the proverbial “dentist with dollars,” can be an angel. I fear that the New Jersey boiler room hucksters are salivating at the chance to sell Florida retirees the latest “hot” Internet property.
As an active angel (the Band of Angels and the Berkeley Angel Network) I am strongly in favour of a healthy U.S. angel capital sector. Smart angel financing, together with the mentoring that experienced angels provide, is a tremendous force for social, political and economic good. I’d much rather see creative, private sector approaches to the problems that aging Western societies face than government “investments” and mandates.
But viewed in the aggregate, it seems like a year 2000-style investment bubble all over again, with angels this time, instead of VCs. We’ve new angel groups, incubators and seed funds appearing weekly. Xconomy identified 20 startup incubators in 2009, 64 in 2011 and 121 in 2012. Each of these nurtures dozens and in some cases hundreds of startups annually.
Why the surge in angel investing?
1. Lean startups. Capital requirements for software and Internet businesses are at record lows thanks to open source, cheap hardware, and offshore and outsourced engineering and customer support. A little capital–$50,000 to $200,000 – can go a long way. This has tempted a new generation of lean entrepreneurs to seek funding from a new generation of investors, many too new to remember the last bubble in 2000, or the PC-fueled storage bubble of the 1980s.
2. More exits = more newly minted angels. Since 2009, we’ve seen a sharp recovery in exit valuations, which soared in 2010 and 2011. Facebook, LinkedIn and many other public and private exits have created a new group of angels.
3. High public valuations attract investors and are a self-fulfilling prophecy. Angel and VC investing trends react to public markets. Pre-money valuations of deals in so called “hot” sectors, like social gaming and social commerce, reached stratospheric levels for a while after celebrated IPOs. High valuations are, to some, a sign that good times are back and investor confidence has increased. During the Internet Bubble, just like during the Dutch Tulip Mania, high valuations gave investors the psychological confidence to keep investing in public and private companies. For someone like me, high valuations are signs of trouble.
4. The rise of Ego Capital. The sexy career path for some successful entrepreneurs is to become angel investors or seed fund managers. Having had one startup success, many newbies seek to apply their success formula to a new crop of startups. We’re seeing new seed and even “dorm funds” managed by recent college grads who have no experience in venture or fiduciary fund management. It’s so cool to run a fund that even bloggers are doing it. And a new class of angels, “super” angels, are writing bigger cheques. One super angel, Ron Conway, famously warned in 2010 that angel investing shouldn’t focus on the personality of the investor; it is, he argued, about helping entrepreneurs succeed. Sadly, we’re now at the stage where angel investors are becoming brands. This is bad for angels and for the companies we fund.
Rather than look for unique deals, the Ego Capitalists all too often look in the mirror to invest in a familiar, narrow range of deals from their entrepreneurial past or in herd deals – mostly catalyzed by the last over-hyped social commerce or digital media exit. The Ego Capitalists need to ask, “how many social coupon or video sharing sites does the world really need?”
So, what’s wrong with this state of affairs?
We’re drowning in me-too companies. The number of self-funded or angel funded me-too deals screams that the supply of people and capital has far outpaced the supply of good ideas. Adding “social” to a few gaming, e-commerce or media sites is interesting. Doing it hundreds of times is self-defeating.
Let’s look at a few tech sectors where Crunchbase’s partial but helpful directory of startups hints at the depth of the me-too problem:
- 450 businesses with tags indicating a focus on coupons
- 257 “daily deal” deals
- 408 sites tagged as focused on dating
- 80 video sharing sites
- 146 photo sharing sites
- 330 job recruiting boards
- 151 places to go shopping socially
- 142 online sites to help charities raise funds
- 64 places to go to find bars
- 75 companies managing or monitoring social media
- 60 gifting sites
- 108 sites to find an online tutor
Investors advise a first time founder to start a company based on “what you already know.” So Crunchbase suggests that today’s software entrepreneur knows how to find a bargain, search for a date in bars and online, share photos and videos of his date online, give dates gifts and, when he’s run out of dates, or, more likely, run out of cash, he knows where to go online to look for a job.
Even staid categories have a serious oversupply of companies. A year ago, the Gartner Group listed more than 60 mobile device management firms. How many does corporate America need? A handful is likely to do well; the rest will die or become zombies. Most tech sectors are winner-take-all, where only the top two or three firms IPO, M&A profitably, or partner with market makers. In a 50-company market, you’ve a six per cent chance of being in first, second or third place.
We’ve been starting and funding far too many Me-Toos that compete for limited market share. With many firms exactly like all the others, dozens of startups compete for the same customer. Cisco, Blue Cross, Pfizer and even your college roommate can’t buy from all of them. And Google, IBM, Salesforce and Facebook can’t partner with every startup, either.
At a recent pitching event, I was unenthusiastic about a CEO’s undifferentiated advertising deal. He asked (and you can’t make this stuff up), “Would you like the deal more if we added a shopping cart to our ad network?”
We’ve started thousands of copycat, paint-by-numbers companies. As a result, many seed-stage startups who are competing for small slivers of market share will never gain enough traction to raise follow-on capital – and many don’t deserve to. Overfunded sectors are bad for everyone.
Following the 2000 dot-com implosion, one third of all angels disappeared, as did most incubators and accelerators and many corporate VCs. Startups suffered down rounds, a capital crunch and plenty of low-value IP asset sales. Many investors and incubators lacked the capital to defend their positions in the inevitable pay-to-play rounds that followed the crash and took crushing valuation hits, and eventually disappeared.
Sound familiar? The Ego Capital bubble is starting to burst. And this is one mania that we angels and our entrepreneur friends can’t blame on Wall Street or the institutional venture community. Want to know whom to blame? Just look in the mirror.
Image: Financial News Net
Ron Weissman is a Silicon Valley-based venture capitalist and angel investor with Performance Works and Band of Angels. He has been a board director of more than 25 companies and advised more than 50 CEOs and management teams in areas relating to corporate growth, market strategy, business development, HR and finance. He blogs about entrepreneurship and VC investing at www.perworks.com/weissman
Technorati Tags: series A crunch, bubble, venture capital, VC, angel, investor, ego capital, super angel, CB Insights, Center for Venture Research, CVR, me too, valuation, incubator, accelerator, dot-com crash, low value, asset sale, Adeo Ressi, Xconomy, Ron Conway, CrunchBase, Band of Angels, Berkeley Angel Network, Weissman, Performance Works
By Jesse Rodgers
First-time entrepreneurs: There are big ideas, and then there are doable ideas
This is the second article in a continuing series chronicling the growth path of ..duo, a startup based out of Kelowna B.C. that creates simple keywords that use your name, brand, slogan or any other word combination as a shortcut to content on the web.
Daylin Mantyka, cofounder of ..duo, is reconsidering her entrepreneurial path and the future of her startup following counsel from a mentor who said her idea might be too “big.”
To advise a first-time startup founder to avoid shooting for the stars is like telling a child Santa Clause doesn’t exist. It’s the kind of stuff that crushes dreams. But there might be some merit in talking first-time startup founders down from the clouds and encouraging them to focus on smaller ideas that can be more easily realized.
When we last checked in with Daylin, she had just pitched her concept at Accelerate Okanagan’s Jump:Start:Challenge.
It was Daylin’s first pitch ever, and while she thought she communicated her idea perfectly, she wasn’t selected as one of the top five startup founders to go on in the competition.
Following this experience, she decided to seek the counsel of a local mentor to determine her next steps. She began meeting with this mentor on a regular basis to discuss entrepreneurship in general and the various directions one could take as a new entrepreneur.
“He provided a lot of valuable information about the various paths of entrepreneurship, which really got us thinking about what we wanted and what our goals were,” said Daylin. “We decided, through his counsel, that ..duo might be too big of an idea for us at this stage, and that it might be better to come back to it after we gain more experience.”
Learning from experience, while mitigating risk
It’s no secret that entrepreneurship is risky. But there are smaller projects that less experienced entrepreneurs can tackle where failure comes with a less crippling price tag.
Daylin understands that the experience entrepreneurs can gain from failure can be extremely valuable, especially if they plan on pursuing future opportunities. But it’s perhaps more valuable for an entrepreneur to go through all the steps required to start and exit a new business. Daylin felt that her chance of successfully going through this process was more realistic if she went after a more well-defined opportunity.
“There’s nothing wrong with big ideas. It’s just a matter of selecting the idea that’s right for you at that particular point in your career,” said Daylin. “..duo was a risky opportunity for us. At this point in my entrepreneurial adventure, I thought it would be a good idea to tackle something more manageable, learn from this experience, and then go after bigger opportunities.”
Early errors
Daylin said she already made some critical mistakes in the early days of developing ..duo.
“I hate to admit it, but we developed a product first and then tried to find our market second. In the startup world, that’s seen as a startup sin,” said Daylin.
In her defence, however, she explained that because they were “nobodys” with no business or technical experience, she felt she had to build a product to prove that they were resourceful, capable of planning, passionate and able to take an idea and make something of it.
Developing the right team was another challenge.
“We decided to hire out our technical talent. This worked for us in the short-term,” said Daylin. Though this developer did a great job, Daylin said it would have been far more efficient to hire a developer from within her community.
“While I still believe this is the best approach, I also understand that some communities are not ready or right to seek talent when you need it. Sometimes, more creative strategies may need to be employed if you want to advance your project,” said Daylin.
A technical cofounder can be critical for raising funds. Without a committed cofounder that could be easily accessed, Daylin said they couldn’t push their ideas forward fast enough.
“We quickly realized a lot of our shortcomings,” said Daylin. “Not only did we need a technical cofounder on our team to be attractive to investors, we needed that person to be right beside us to tell us immediately that something on the development side was quick and easy or nearly impossible.”
In a previous startup story, we explained that cofounder Katie Hrycak experienced a similar obstacle during the development of her startup, Commentair. The moral of the story was that startups should not outsource their core competency.
“Teams are what win and they’re what differentiate you,” said Daylin.
And while having the right skills for the job is imperative, she also said it’s important to choose people who share the same overall goals, and to whom you feel connected on a personal level.
“Entrepreneurship is hard and you can’t do it all on your own,” said Daylin.
What’s next?
Daylin and her team are in the process of finding a new developer and building the business model and prototype for their new venture. She won’t say what her new idea is, but she will reveal it to us when the time is right.
In our next installment, we’ll catch up with Daylin and talk about how her new venture is moving forward.
Technorati Tags: Daylin Mantyka, ..duo, dotdotduo, startup, entrepreneur, entrepreneurship, new venture, small business, startup lessons, startup advice, technical cofounder, Accelerate Okanagan, Jump:Start:Challenge, mentorship, Katie Hrycak, Commentair, accelerator, incubator
Posted by: Alexandra Reid on January 4, 2013
Tags: ..duo, Accelerate Okanagan, accelerator, Commentair, Daylin Mantyka, dotdotduo, entrepreneur, entrepreneurship, incubator, Jump:Start:Challenge, Katie Hrycak, mentorship, new venture, small business, startup advice, startup lessons, Startups, technical cofounder
Posted in: A Startup Story — 2 Comments