The Series A Shortfall Isn’t News

Anyone who is alarmed to learn that most of today’s seed-funded startups will not survive hasn’t been paying very close attention.

In an article yesterday entitled “The Series A Crunch Is Hitting Now. Have We Even Noticed?”, PandoDaily founder Sarah Lacy exclaimed, “We know this: As many as a thousand companies who’ve received seed rounds won’t be around in a year — maybe six months.” Her story was the talk of social media, with a stellar hundreds of tweets and “likes” as of last night.

But is Lacy’s story and attendant advice really news? Given the glut of angels and a shrinking number of active venture firms, it should hardly be surprising.

According to the University of New Hampshire’s Center for Venture Research, the number of active angel investors topped 300,000 last year, up 20 percent from 2010. The ranks of the matchmaking service AngelList also swelled, with 2,500 investors joining the community last year alone, most of them in the last six months. (When AngelList got its start in the spring of 2010, it listed 80 accredited investors.) A study from UNH shows that angels put a fresh $9.2 billion to work in the first half of this year, a 3.1 percent increase over the same period in 2011.

Meanwhile, the number of firms that are actually investing is dwindling, despite the best efforts of partners to save face. The NVCA pegs the official number of “active” traditional firms at 500, but according to NVCA President Mark Heesen, this number is misleading, because at least 200 of the firms only do a deal or two a year.

As for Lacy’s advice to startups, again, I question what’s newsworthy. Lacy says the “tip that everyone agrees on is to avoid the so-called party rounds” that have sometimes included dozens of investors, observing that investors with small stakes may not take as much of an interest in what’s going wrong at the company.

But more than a year and a half ago, investors were already publicly pointing out that while the rounds were enabling entrepreneurs to retain control, the cost of ensuring that no one meddled in their affairs could cost them dearly.

As Naval Ravikant, cofounder of AngelList, told me back in April 2011, “The problem with having [so many] investors is that when it comes time to raise another round, get bridge financing, or sell the company, no single investor is incented to take the lead and help you make it happen.” (Ravikant was referring to Milk, a perfect case in point. The company raised $1.5 million from 24 investors and was out of business less than a year later.)

Lacy also observes that “seed-stage entrepreneurs who have pushed for the maximum valuation possible haven’t done themselves any favors.”

But nearly two years ago, serial entrepreneur Tony Conrad told me that he consciously looks to raise very small amounts of financing in order to make his companies look more palatable to potential acquirers. (His first company, Sphere, raised $3.9 million, and his second,, raised $425,000. Both companies were purchased by AOL for a reported $25 million, respectively, not including earnouts.)

Lacy is clearly a talented reporter, but the fact that many seed-funded companies will run out of money isn’t a new phenomenon, nor should it come as a surprise that it’s happening in larger numbers now. The writing has been on the wall all along.

Photo: Image courtesy of Shutterstock.

1 Comment

  • This is a real and growing problem. Start-ups are the seed corn of innovation and job growth in America. Good venture capitalists bring more than money to a start-up – they bring expertise, human capital and support networks that can materially enhance the potential of success for an entrepreneur and their start-ups – basically a “support system”. As these experienced investors dry-up, so do those support networks. And in the Venture community – the capital is congregating in later-stage focused larger pools of capital. It’s about Risk/Reward and a lack of patience on the part of investors.
    Angel investors have become an increasingly important element of the capital mix but as Sarah points out, there are tradeoffs – the “herding cats” phenomena, lack of consistent engagement and strategic leverage, on-going access to growth capital. As with Venture Capitalists, there are some great Angel investors and some that are not so great. The “Net Net” is that there is no such thing as too many experienced and committed investor supporting early-stage companies. Today, we have a shortage, one that is likely to grow worse if some of the tax changes discussed in the media come to fruition.
    Early-stage investing requires a compelling relationship between risk and reward. If you increase the risk (which is already high), the rewards must increasing on a commensurate level. If you reduce the rewards, the risk had better do down. Today, we are looking at an environment where risks are increasing (regulation, access to trained talent, payroll expenses) while rewards are potentially reduced in a material way (higher capital gains, healthcare surcharges on investment gains). The net impact of this dynamic will be a reduction in the appetite for higher risk (early-stage) investments. This dilemma will confront Angel and professional Venture investors alike.
    Potentially most troubling are some of the discussions that all investment returns should perhaps be taxed at current income levels. In such an environment, why would anyone take the high and protracted risks associated with early stage investing if their gains, if any, will be taxed the same as current income after years of risk. With discussed changes to the Federal tax code for current income combined with new tax rates on high earners in California (higher risk investors), the effective combined tax rate for current income is in the neighborhood of 55%. If you apply this tax rate, or anything close to it, against long term capital gains from investments in start-ups, the capital well is going to run dry, very quickly. This is not politics, its economics.

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