Start-ups have been through a dreadfully dry funding period over the last 9 months or so as VC's, angels and other investors have retrenched following the financial market collapse. It does seem as if there is a thaw starting to happen now, driven by an improvement in exit prospects (IPO or M&A) and a returning confidence now that we appear to have avoided a second great depression. And frankly there are some very interesting ideas out there like UsTrendy, a start-up with which I'm working, that in a slowly normalizing market deserve funding to drive to the next level. So what's happening out there now?
We know valuations are down - maybe half of what they would have been a year or more ago, even for start-ups that have made good business progress over that timeframe. While no-one likes a down round, if you raised money a year ago just be happy that you sold less of the company then than you would now to raise the same amount - and that hopefully the cash kept you in business during this downturn.
However now we're also seeing the amounts raised go down as well. In fact your traditional Series A round is now looking more like a seed funding - perhaps a $0.5m to $2.0m raise versus the more traditional $2m to $6m. Despite valuations being down this is also translating into selling less of the company in the fundraising - maybe 20% to 40% versus 30% to 50%. The reality of many start-ups today is that they can do a lot with less money anyway. People are cheaper, and with the tools, technologies and techniques available today (eg: building cloud-based apps as opposed to complex software applications from scratch) developing the business is faster and a lot less expensive that it used to be.
What we see now is a class of micro-VC's emerging and filling the space occupied previously by angel investors, along with larger VC's getting in earlier with smaller amounts. In the micro-VC class are funds like Come Lague's $20m Nueva Ventures, Fruition Ventures, Capybara Ventures and all the way up to the new Andreessen-Horowitz fund which with $300m is not micro in size but many of the deals, in which they plan to invest from $50,000 and up, are definitely at the seed/early stage. New firms like Javelin Venture Partners, with two partners and a $75m fund are also emerging. Meanwhile established firms like Matrix Partners just closed a new fund in part focused on new seed/early stage investments (this is a marked shift from their typically bigger, later-stage investments) and Draper Fisher with a $7m (miniscule for them) seed stage fund focused on Plug and Play TechCenter startups.
The reality for VC's is that their limited partners put money in their hands to invest and get better-than-average returns (around 20% per annum as noted in my recent post) for higher-than-average risk. VC's don't accomplish that by sitting on their hands. If anything, logic says the dynamics of great ideas, cheaper costs of execution and lower valuations should be encouraging more investment right now. And I think this trend of micro-VC with micro-investments in micro-startups is going to be the key funding growth area for the future in terms of number of deals being done. That said, there is also a good argument to say don't raise any true VC money if you can get where you need to go with friends and family, angels and a little seed money.
Which brings up the next question - as an entrepreneur, what kind of terms do you want/expect to get for this species of money these days? See my next blog shortly!
Good stuff Philip. I'm interested in your thoughts on anti-dilution clauses in early stage deals in this age of scarce capital. My sense is that angels have been burned one too many times by VCs who come into later rounds and devalue the angel equity to near zero, so the few angels who are active may be much tougher on anti-dilution terms.
Posted by: Kent Ragen | September 02, 2009 at 04:58 PM