startups

David Gardner: Venture capital funds grow massive but that’s not good news for startups – WRAL Tech Wire


Editor’s note: Investor and entrepreneur David Gardner is the founder of Cofounders Capital in Cary and is a regular contributor to WRAL TechWire.

CARY – Several telling reports have been released over the last couple of years clearly showing that venture investments are booming in North Carolina and the entire nation.  Historically the most consistent asset class for best returns, venture funds continue to grow in popularity and size.

The average amount of seed-round money raised in 2010 prior to raising an A round was $1.3M.  That number has steadily increased each year since.  In 2018, that number had grown to $5.6M… a 4.3X increase!  Fund managers typically raise the largest fund they can because larger funds mean greater management fees and prestige.  This number is skewed by west coast ventures that often have to raise up to twice the capital of their east coast cousins due to the much higher cost of launching a venture there.  Still, it is safe to say that NC ventures have seen the same percentage increase in required funding albeit on smaller total raises.

Larger funds are good news for later stage ventures seeking large check sizes but there is a dirt lining to this silver cloud for startups.  As venture funds grow ever larger, they are forced to write larger checks in increasingly later stage ventures that can absorb and use that much capital.  A typical venture fund can manage around fifteen to twenty portfolio companies per fund.  If you have a $500M fund you can’t write $300K or even $1M checks.  That would be hundreds of portfolio companies!  In fact, once a fund approaches $100M, it is impossible to deploy any money into early stage startups.  To deploy that much capital, fund managers have to find deals that are much further along where they can make multi million dollar investments.

The paradox is that as venture funds grow ever larger, there is actually less and less capital available for startups, and this is just the first problem this causes for new ventures.  The second is that startups need to raise much more seed capital now than in previous years, because they have to get much further along before they can meet the ever-increasing investment criteria of the new engorged A round funds.

When I was an entrepreneur starting seven ventures in NC, the rules were simple for SaaS-based startups.  Seed funding only had to last long enough to get my minimum viable product to market and drive close to $1M in recurring revenue from happy customers, for me to be a very viable candidate for about any fund’s A round.  Today, A round investors are telling us that they need to see $2M to $5M in recurring revenue before they can consider our portfolio companies.

The moving A round goal post is also having a chilling effect on angel investing.  Most angel investors don’t have enough capital reserves to protect their startup investments through an ever-increasing trek to A round funding.  This means a greater chance of failure or dilution as their portfolio companies have to raise more bridge round capital.

The thing that keeps me awake at night is that if there is less money available for startups, and those startups now need up to four times more money to get to their next round, are we making it exponentially more difficult for entrepreneurs to succeed?  The entire venture industry is dependent on startups succeeding.  If everyone now just wants to harvest the big crops and no one wants to plant and nurture the seeds, then there will be a major reduction in viable later stage companies for the big funds to consider, which could have a catastrophic impact on innovation over time.





READ SOURCE

Leave a Reply