Reflections On The Startup Funding Climate As We Slip Into Summertime
Disclaimers: This isn’t a doom and gloom speech. There’s tons of opportunity out there. And, this is mainly focused on consumer markets. Also, this post is a little long in the tooth. Please forgive me. I haven’t had time to write with all the little kids running around my house, but I’m devoted to changing that this summer. More soon.
It is fashionable to hold a contrarian position. If everyone believes in X, believing that things will unfold in a different direction than X — if chosen wisely — can be the key to public acclaim, riches, and legacy. Of course, there are many who subscribe to a contrarian script and are wrong — only a very select few end up being right.
In terms of startups and investing in them, it is fashionable to say, even in times of uncertainty or financial restraint, that “great companies can be built at anytime.” It is a contrarian position, in opposition to combinatory external forces — in today’s case, geopolitical risk abroad and at home, financial risk in the form of monetary policy and liquidity crunches, pricing risk as seen in the dislocation between public and private markets for technology stocks.
So, we must ask of the contrarians, are they right today? Is this, indeed, a good time to start a new technology startup? Of course it is. Time doesn’t matter. There will always be new technologies to bring to market, new teams forming that can drive value and change the world. In this narrative, many often cite companies like Airbnb, Uber, Whatsapp, and other companies started around the financial crisis of 2008 as examples that, in fact, it’s possible to start great companies during dire times.
What’s missing from that storied contrarian stump speech, however, is the fact that, at some point early in the lives of these companies — they found a growth vector. They may have spent some money acquiring customers, but they didn’t rely on paid acquisition entirely. Since 2011, when these three companies began to take off and caught the eye of some of the best venture firms in the Valley, the timing coincided with (1) a rush of cheap capital flooding into the technology startup sector and (2) a restructuring of the global economy toward technology and networks.
The result was that, in an effort to chase the growth curves of the companies cited above, investors started investing even earlier in the life of a company, sometimes just in the people themselves. Traditional venture capital firms grew in size and morphed their DNA to go beyond active board management, building batteries of portfolio services in the same vein that a private equity shop would bring with it to a portfolio company. There’s nothing wrong this shift, and many companies and LPs believe it was the right way to get the inside track on an investment (a competitive arms race) and the right way to help manage an investment beyond the limited scale of a single general partner in a fund model.
One issue, however, is that era of larger institutions making multi-millionaire investments before looking at data (including growth curves) is coming to a halt. We thought, back in January and February of 2016, that the time had arrived, but not just quite yet. At seed, companies are still being funded left and right, and even some Series As occur, but most of them are closed on the back of some type of demonstrable growth vector. It’s pretty clear for the past few months that while there’s enough to seed most people who want it, the next round requires bringing some meat to the table. Most don’t have it. They’re just chasing growth. It’s a noble pursuit, but the lifelines to support these experiments has shortened.
Put another way, there’s a slight decrease in the number of experiments being funded (it’s still huge on an absolute basis), and the amount of time allotted to those experiments will shorten. As a result, I believe the following will be ripple effects:
1/ Fewer Seeds: We’re going to have fewer quality seed deals, relative to before. Most investors downstream won’t notice this because they will only see the quality that bubbles up. People those who play in the very early stages already have been living it.
2/ Slower Rounds: As a result, the rounds will take longer to unfold. The only triggers that make a round move ultra-fast are when one of the very few credible leads makes a move and those who syndicate fawn over them, and/or when the founder knows how to play the fundraising game. The rest are much slower.
3/ Extending Runway: As most teams will spend more time fundraising and have read enough about market conditions on blogs like this (sorry), I suspect founders will be more careful about burn rate, especially as it relates to vendor burn, office rent, and most critically, headcount.
4/ Financing Extensions: These are harder to get done. They actually require real relationships with the earlier investors. I’ve participated in a few of these recently, and I’ve let many just go. The ones that work are involving investors and demonstrating progress in an authentic way. These also take a long time to get done because some people get hung up on price.
5/ Point Break: After a startup gets through 1-3 (or 1-4), it’s judgment time. Is there a Series A with a lead investor who joins the Board? Is it time to look for a strategic acquirer? Or is it time to call it a day?
And, this is where things in the future will get much clearer. One could argue it already has. There are still Series As happening, but definitely not as much. Nowhere near levels from 4-5 years ago. More founders are open to the idea of landing the company for acquisition, but even though we read about the good stories in the press, most won’t find soft landings like this. I spent all of the first quarter this year meeting with corp dev departments and M&A teams at all the big consumer and enterprise companies. They have mandates to buy companies, but probably not at the rate you’re thinking of.
To underscore, this is not doom and gloom. This is all very healthy for the ecosystem. I am still investing and excited by new stuff. But about 18 months ago, I started investing in entirely new stuff — I am excited to write more about those companies this summer as I catch up on my writing and on life. I started to invest in more frontier technologies applied to industrial and commercial settings — sensor networks, software for 3D printing machines, commercial drones, and technologies that could play a part in helping people deal with climate change, rare diseases, or even large regulated industries like insurance.
As we slip into summer and investors slow down a bit (yes, despite what they say — they do!), I suspect the fall — like every fall — will be a frenzy fundraising pitches, and that after a summer break, the investors downstream will be looking for simple evidence: Is there demonstrable momentum? Or, is this is a hot team in a big market? Or, is this on the frontier of what could happen in the next decade? If you’re a founder or early investor in a company preparing for Fall 2016, it would be wise to ask these questions and, depending on the answers, to plan accordingly.