Friday, January 18, 2013

Seed and Later Investments for Startups are Booming

new-enterprise-associatesThe number of startups getting seed funding in 2012 jumped by 65% over the previous year to a total of 1749, according to a recent report by CB Insights. “Seed investments” are early stage financings (typically less than $1.5 million) made by either Angels or venture capitalists, or both. This is great evidence that the recession drag on funding new startups is behind us.

In another report more specifically on Venture Capital Activity for 2012, CB Insights noted relatively flat but still healthy funding levels, compared to the previous year (down in total dollars by 7.5%, but up in total deals by 7%). Thus the venture capital industry isn’t dead yet, despite all the rumors, and more startups are getting money, even at Series A and later levels.

Of course, there are still qualms, cautions, and risks highlighted by these reports that every entrepreneur needs to understand, to optimize their own chances of getting the funding they want:

  • A “Series A Crunch” could orphan 1000+ startups. The explosion in seed funding, without a corresponding explosion in investors willing to lead the next round (Series A), may mean that you can’t get a second round and will be “orphaned” or die. The pundits are now debating the impact and potential alternatives for startups. Stay alert.
  • Seeded companies will take longer to raise a next round. As soon as you get seed money, it’s time to start working on the next round. The current average is slightly more than 13 months to raise follow-on financing. As the leverage increasingly looks like it is shifting towards investors, the time required may go up, so plan ahead.
  • Only 40% of seeded companies get follow-on financing. This is nothing new. The death of startups and the loss of investment dollars is part of the process of separating the best companies and investors from the rest. To prepare yourself, make sure you have enough runway, be prepared to make drastic cuts, and have a Plan B for organic growth.
  • The Internet sector is tops for seed deals. Not surprisingly, the Internet sector is still the primary destination for seed investing. Interestingly, follow-on financing rates to the computer hardware and services sector is the highest of all tech sectors. Healthcare is not far behind.
  • California and NY dominate for number of seed deals. California is the clear #1 for seed investment activity followed by strong #2 New York. Massachusetts is a distant #3 but in terms of the rate of follow-on financing, Massachusetts has the highest rate. Texas is still struggling to hold the next position.

Make no mistake, even with these caveats, 2012 has been a banner year for startup funding, and the cost of entry has never been lower. Investment amounts and deals were near 10-year highs, and all indications are that this year will be just as good. Of course, it always helps to be in the right business sector, in the right part of the country, and know the best players:

  • Top business sectors for venture capital. The Internet sector continues to lead the pack (information technology and software), followed by Healthcare (medical devices and equipment), then Mobile (CRM) & Telecom (wireless). Green Tech is still in a slump, with renewables leading the way. Yet these comprise much fertile territory for entrepreneurs.
  • Top five states for venture capital. California (Silicon Valley), Massachusetts (Boston), NY, Washington, and Texas held as the top 5 states for venture capital in 2012, but overall, 38 states got in on the action. As is typical, funding and deals remain concentrated in venture’s big markets. Be there, even if you have to move.
  • Most active venture capital firm. New Enterprise Associates, in Silicon Valley, leads all VCs as most active in 2012, putting some of its $2.5 billion fund to work. By activity, the other four of the top five firms were Kleiner Perkins, Google Ventures, Andreessen Horowitz and First Round Capital. It helps if you know someone in one of these.

Of course, every entrepreneur needs to remember that even if you are in the right sector and the right location, there is no entitlement to venture funding, much less success. Most sources agree that less than 1 out of 100 who apply get the funding they want. Of those who get funded, only about 1 in 10 succeed. But who amongst us doesn’t love a challenge? Now is the time.

Marty Zwilling



1 comment:

  1. Martin,

    Of course everyone loves an upbeat story like this. However, the realist in me forces my to set this false positivity straight, so we stop fooling ourselves.

    The problem is that VC has in the past ramped up as well, yet the investment pace has been - and - is no indication that it produces returns in line with that pace.

    In fact, limited partners are still faced with an asset class that performs under the organic technology adoption rate, underperforms against corporate innovation (and thus proving market excuses wrong), has cost them $234B (yes, absolute losses) and grew at a meagerly 2.6% nebulous IRR. And all that in light of an 80% adoption greenfield.

    With the attrition of the asset class to fewer VCs garnering the support of institutional investors in contrast with more companies raising money, can really only mean one thing: the asset class is turning further subprime at a rapid pace.

    For entrepreneurs this is not good news, because it means they can more easily raise money based on downside, but very few will ever be married with an investor who can align on upside.

    And thus, the economic output subprime investing generates has proven to be negative and will continue to be, let alone makes false promises to the public as the greater fool (as investor and buyer). For the fragmentation of dollars and risk would have been better spent on the few killer propositions with the potential to create real social economic value.

    New distributions of the same subprime risk, including crowd-funding and the plethora of so-called accelerators and incubators will turn venture further subprime, not because their heart is not in the right place, but their assessment of risk is not.

    I am all for positivity, but that positivity cannot be based on the recurring false promises of the spinning wheels without traction. Let's all keep it real.