Join us online at COVERGENCE OCT 22-23
The University Tech/Startup Gap Fund and Accelerator Summit
- 20 in-depth gap fund/accelerator program reviews
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- Corporate and Investor partnering panels
- Networking web-site and associated materials
Without a doubt, you’ve heard reports that the VC industry is booming. And it truly is; bigger deals, bigger exits, and bigger funds are making a splash in Venture Capital.
After all, who could forget the culmination of SoftBank’s $100 billion “megafund,” Spotify’s historic direct listing, or the roof-shattering $14 billion Series C round raised by Ant Financial last year? If you were to go by the headlines alone, you might assume that now is the perfect time to pursue seed funding for your fledgling startup.
However, as fundraising goals soar higher and records continue to be broken, the VC landscape is beginning to look a lot different than it did a decade ago. In the last three years, seed investment has sharply declined, evidenced by nearly every metric. And as someone who loves combing over fresh pitch decks and executive summaries, this comes as rather disappointing news.
The apparent culprit is a shift in the IPO window and an inflow of capital into late-stage VC. Rather than going public, companies are raising more money and spending longer periods of time in private equity. In other words, going public is no longer necessary to raise billions of dollars. This benefits both parties, as investors experience less risk on their investments and late-stage companies give up less equity in exchange for capital.
Unfortunately, this newfound focus on late-stage ventures has drawn traditional VCs away from the early end of the spectrum. Recent reports show that seed stage funding is on the decline in both count and amount. And the gap between seed and Series A funding also appears to be widening, making it more difficult for seed-stage startups to make the jump.
However, is seed stage funding truly dying, as some analysts may suggest? Or could natural shifts in the industry, incomplete information, and anomalies in the data, such as “megafunds” and supergiant rounds be skewing the data?
The Emergence of Seed Stage VC
To better understand the supposed decline of Seed Stage VC, it’s necessary to first understand its ascent. In 2006, the seed sector of Venture Capital saw incredible growth due to the decreasing cost of beginning a startup. Thanks to the advent of open source software and cloud computing, the average cost of starting a business went from $5 million in 1999 to just $500k in 2005.
Upon first glance, it may seem that valuations of startups decreased by 10x in six years. When placed in context, however, one can see that the decline in seed fund size was not caused by a devaluation in seed stage startups but rather a decrease in startup costs. This created both an increase in ROI for VCs and made it easier for founders to secure seed funding. From 2006 up until 2014, funds under $1 million increased in amount by over 600%.
In 2014, however, the uptick in seed funds stopped. According to research from CrunchBase, rounds below $1 million have been declining rapidly since 2014. And if you were to compare seed funding counts and amounts from 2018 with 2015, you would see a 41% and 35% decline, respectively.
Since this information tends to get updated much later after the round is raised, one can assume that much data from 2018 has yet to be included. When taking missing data into account, the team at Crunchbase estimated a 30% and 23% decline, respectively. This paints a slightly happier picture of the future for seed stagers, but not by much.
Why the Supposed Decline?
One important trend to note is that investors, as a whole, are making fewer investments while investing larger quantities than ever. Rather than invest small amounts in multiple ventures using a “spray and pray” method, investors are putting more capital into fewer deals in exchange for more equity. They’re also making follow-on investments and continuing to bet on startups that have shown proven results.
According to research from CB Insights, only 46% of seed stage startups make it to the second round, with a measly 1% reaching a valuation of +$1 billion. However, after each follow-on round of funding, the chances of reaching Unicorn status get higher and higher. For example, startups that secure the 4th round of funding have a 10% chance of surpassing $1 billion. Those that secure the 5th round have a 26% chance.
With more money in their pockets, investors can now afford to invest in late-stage companies, which are much more secure than those in the early stage or growth stage. After all, it makes sense to put all your money on the winning horse than a few bucks on all of them.
What does this mean for those seeking seed stage funding? Getting seed funding from a traditional VC is harder than ever. However, if you manage to secure Series A funding, you’re highly likely to continue onto following rounds, such as Series B and C.
A Split in the VC Industry
Just like rounds under $1 million, rounds of $1 million to $5 million began to experience a plateau in 2015. Since then, counts and amounts have slightly declined, but remain relatively stable. From 2015 to 2017, the total amount invested hovered around $7.5 billion.
Rounds between $5 million and $10 million, however, have nearly doubled in count over the last 11 years. Rounds from $10 million to $25 million have also continued to grow in count and amount by 73% and 78%, respectively.
At this point, you may have observed a pattern: seed-stage and early-stage funding is shrinking while growth-stage and late-stage funding is exploding. Securing amounts under $5 million is becoming a real challenge, as traditional VCs have moved further upstream, leaving a serious gap in the sectors of seed stage and Series A funding.
To fill this vacuum, so-called “Nano VCs” and “Micro VCs” have entered the market. Despite a concentration of capital in the later stages of the VC life cycle, new entrants in Venture Capital are starting to pick up the slack. According to CrunchBase News, both Nano and Micro VCs are on the rise, seeing 11.3x and 7.8x growth in the last 10 years, respectively.
Conclusion: VC Is Going Through a Transitionary Period
My conclusion is that a temporary shift in the traditional VC market created a gap between seed-stage and growth-stage VC. However, this chasm was short-lived, as Micro and Nano VCs have entered the market to fill this role. And as I mentioned earlier, data from seed-stage and early-stage VC rounds tends to take time to come in.
The perceived decline of seed-stage investment is most likely due to a lag in the data. In other words, reports that claim seed-stage investment is declining are operating on incomplete information. As missing data from 2018 starts to pour in, we will most likely see an increase in the count of seed-stage funds.
Despite all the hype surrounding post-$1 billion figures, it’s more important than ever that we examine the true heart of the VC industry: Early-stage and growth-stage funding. We need to remind ourselves that bigger isn’t always better—at least in the long term.
What truly makes VC innovative—and disruptive—is the constant entrance and exit of new players. By neglecting seed-stage and growth-stage companies, VC will fail to distinguish itself from any other form of private equity.