From the way Greycroft Partners’s Alan Patricof tells it, the shelling is about to begin. Okay, he didn’t say a blood bath was coming, just that “this is a precarious time.” Still, it was enough to make people sit up straight during a session in which Patricof, Venrock’s David Pakman, AlphaPrime Ventures’s Alessandro Piol and Golden Seeds’s Daphne Kis zeroed in on what founders face, and why, at various stages of raising money.
It’s hard to disagree with First Round partner Josh Kopelman’s assessment, at times in colorful language, that the quadrupling of seed investment money is giving way to a Series A funding crunch. The easy money that’s funding companies is eclipsing the team / market / product focus for reasonably getting a startup off the ground. This means that startups not yet mature enough to attract meaningful series A funding need seed extensions to ramp up progress. “The challenge is that a bunch of seed investors don’t do extensions, so if the market for early-stage investment dollars contracts at all, there are thousands of companies at risk if they don’t make progress between seed and series A,” said Pakman.
The rise of angel syndicates is a relatively new phenomenon giving individual investors much greater access to angel investment opportunities that also means more seed money being pumped into the market. Angel syndicates are generally created and run by someone with a high profile in the technology world and can be broad or narrow in focus; the call for investment ranges from $1,000 to $10,000 per investor and generally appeals to mid-level workers at technology companies who otherwise wouldn’t have access to such deals (The Angel syndicate’s general partner puts in as little as $1,000, while keeping 15% of the upside). “That to me is scary,” Pakman conceded. “I would rather see those dollars go into ETFs.”
This explosion of seed money is compelling more people to launch startups and more founders to seek larger series A rounds. “We see about 60 to 75 new deals a week in New York; we see about 30 a week in Los Angeles,” says Patricof, who isn’t so sure it’s a Series A crunch so much as an inconsistency. “The industry—angels, VCs, incubators, accelerators—is funding so many startups, thousands of startups. I didn’t think there was enough money in the world to keep funding A rounds. Now, that said—and I said this three years ago, two years ago and last year—we go out to put into A rounds, and we’re losing deals left and right because people are pricing them not 10% higher, but two to three times the price. So clearly there’s money around to go into A rounds.”
“If the market for early-stage investment dollars contracts at all, there are thousands of companies at risk if they don’t make progress between seed and series A.” —Venrock’s David Pakman
The free-flowing seed and Series A money is funding a lot of Me-Too companies, which Piol suggested be corralled into a room and some done away with, a consolidation effort that Kis noted would also reduce infrastructure. “There’s a day of reckoning coming with Seed to Series A,” he said. “The fact is you need process. [Founders] get lost in building product and getting customers. Step back and put together a process. You have to have internal processes and regular board meetings. Figure out metrics and show investors and the board where you are with the business.”
The best predictor of startup success, based on Patricof’s experience, is that the founder can attract people he has worked with before to come into an early-stage company. And as companies grow, it is essential the CEO be the company’s chief recruiter. “There are very few CEOs who really internalize the skill set to recruit and retain truly extraordinary talent. It’s really super hard. It doesn’t come naturally. It’s something you have to learn how to do,” Pakman said. “If the CEO, particularly with Series A and B companies, doesn’t get religion about being the chief recruiter by going out and determining who’s extraordinary, it’s the difference that makes great companies.”
With the venture money flowing, Kis asked her fellow panelists the obvious question: Are we in a bubble? “Valuations are super rich, particularly at later stages. On a multiple basis, valuations in early stages are much higher than in 2008. On an absolute basis that doesn’t break the bank for many funds; it’s the difference between investing at a 6 or 8 pre, versus 20 or 25 pre,” said Pakman, who declined to use the term bubble. What he’s concerned about is the “super bad” CEO behavior that can put many things in jeopardy, such as raising money at the highest price possible when you know your business is far behind that price, setting the stage for very unhappy investors down the line, or “doing a B round, then selling $3 million worth of secondary shares and going out and buying a Ferrari. …I’d rather see curbing of this behavior than worry about where we are in the macro sense.”
But to Piol the numbers suggest something more telling. “Today, you have companies that actually have businesses, so it’s a much better situation than 15 years ago, but the valuations are out of whack. If you think about the IPOs last year, about 25% of them went public at a price that was below their last round. These things are mispriced. That also reflects itself in earlier rounds, so now we see companies raising series A rounds that are asking for astronomical numbers. So when you ask them to justify that, they come up with reasons that really mean all the stars need to be aligned to fulfill the promise.”
That promise is what Patricof calls the “Cascade of Miracles, in effect, that everything is going to go right. I see too many companies that assume 19 out 20 salesmen are going to work out, instead of 10; that there will be higher productivity; churn rates will be lower; everything’s going to go right, and they’re going to go public. No more than 2% of venture funded companies end up in an IPO.”
That said, those buying at very exorbitant prices have no choice but to go public. “There aren’t enough tech buyers to buy these companies that have reached one, two, five, 20, 40 billion dollars, so they have eliminated the possibility of selling to another company at a big markup,” observed Patricof. “In the next few years, a lot of these people are going to have to hold their inventory a lot longer than they think. If the public markets react—and they always do—I don’t think we’ll see a blood bath, but you will see people with long holding periods and low IIRs as a result. I believe we’re in a precarious time.”by