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The Series A Funding Crunch: The Good, the Bad, and the Ugly

Photo Credit : Andrew Mager

Especially since the emergence of Silicon Valley, the concept of becoming an entrepreneur and founding a startup has become an increasingly appealing career aspiration. Everyone seems to be looking for that next big idea that can change the game and allow them to retire by age thirty. While many are looking to be the first to come up with that great idea, there are others that are looking to profit off of these ideas by getting in early to invest. When entrepreneurs are prepared to take their ideas and turn them into startups, they often times look to venture capitalists (VCs) for funding.

Since the late 1990’s, the VC industry has undergone a massive boom period. Especially in Northern California, seemingly any entrepreneur with a half-decent idea could find seed funding to take their idea to the next level. While smart VCs know that it takes more variables than just a good idea to create a successful company, even the experts find it hard to predict that start-ups such as Instagram are billion dollar ideas.

AndrewMager_JDsmall

 

(Left) John Doerr, an early Netscape and Google investor, is considered
Silivon Valley’s most prolific VC.

The venture capital industry has faced what many believe is just an inevitable downsizing. Venture capitalists historically have reaped extraordinary returns, and the opportunity to fund and work with entrepreneurs like Zuckerberg and Dorsey is certainly exciting. Many, in turn, have flocked to the occupation and have saturated the market. Firms have not been able to survive in this environment, leading to the recent downsizing of the industry. In 2000, 1,022 venture capital firms in the US enjoyed 48% returns, but these numbers have recently fallen to 462 firms that earn a meager 6% annual yield.

After a new company’s initial seed funding, often from friends and family as well as angel investors, entrepreneurs look primarily to VC firms for their next round of funding, which is known as the Series A round of funding. The vast majority of companies that were successful enough to make it past their seed funding stage used to be able to attract Series A funding from VCs. These days, seeking the next round of funding is much more competitive, leading to crushed dreams for many hopeful entrepreneurs. As of December 2012, CB Insights estimates that about 40% of recently seed-funded startups will fail to attract Series A funding and will end up being orphaned.

This isn’t all bad though. Many inexperienced or incompetent entrepreneurs are able to get seed funding from friends and family. These early investor are often not experts when it comes to new venture funding, but victims of entrepreneurship’s trendiness, and they often don’t vet the business proposals the way a VC would. As a result, many of these ideas that are taken to VCs shouldn’t have been considered in the first place.

While there seemingly is no harm in being more conservative, as failed startups help nobody, many industry experts expect that even many good ideas won’t be getting funding in this new age of venture capital. This new venture capital is prioritizing capital efficiency more than in the past. While many software and social media startups that don’t need massive injections of capital to begin will still find success when pursuing VC funding, more capital-intensive startups in biotech and health care may have a tougher time getting funded in the future. This could have great impacts on such sectors, as 80% of biotech revenue in 2010 was venture funded. Even though I’m sure everyone would love a new app that lets other people know what their friends like, this may be at the cost of funding innovation in biotechnology and healthcare, areas that are more important in the long run than photo sharing. It makes sense that VCs don’t want to make as big of bets with their funds that some of these more capital-intensive startups require, but this is at odds with what may be best for society. While the new era of conservative venture capital may be more effective to keep the VC industry strong, it begs the question: will VCs opt to overlook the capital-intensive biotechnology company researching cancer solutions to protect their bottom line?

About Jeff Goodman

A Carmel, CA native, Jeff is NBR's Finance Editor. He likes squash (the vegetable not the sport) and Sporcle, a website devoted "to mentally stimulating diversions."

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