Back in 2016 we published a post, How to Avoid the Series A Crunch, studying the state of venture capital and the boom in seed investing that was taking place. Fast forward to 2020 and not much has changed. The Series A crunch is still a reality and is a burden many founders will face for the foreseeable future. However, there are a few added dynamics that are continuing to shape the landscape since our original post in 2016.
If you follow along with venture deals at home, you’ve probably noticed that the size of an early stage deal is exploding. Founders, often with a proven history, are raising seed rounds in excess of $3m, even $10m in some cases, before a product is built or customer check is cashed.
As Elizabeth Yin, Founder of Hustle Fund, puts it, “I’m seeing massive party rounds — like $3m-$5m seed rounds. Sometimes higher! No product / no traction. My friend – fantastic founder – raised $8m recently. $30m+ post-money, no product. If you have this background, raising is EASY… For non-pedigreed founders, if you are running a SaaS company & have some rev traction, also pretty easy to raise. VCs have gone gaga over SaaS in the last 2 months.”
With that being said, Elizabeth goes on to explain that raising venture capital is still incredibly hard as we only hear about the “hot” deals in the media. She explains,“the reality is that SF mostly has poop on the ground. Sometimes you will find a Benjamin.” So why does this matter?
More Seed Investors
More venture capital is being invested in fewer companies than ever before (AKA rounds are larger than ever before). This is partially due to the fact that VC funds are also larger than ever before. In order for a mega fund to create outsized returns for their LPs, they need to hit home runs… a lot of them.
While funds can scrape for late stage deals and possibly find some success, the best way to generate massive returns is by getting on the cap table early. As Fred Wilson, Founder of Union Square Ventures, writes, “The competition to invest in Seed and Series A rounds is not really about the right to make that initial investment. It is about the right to execute a long buy. And the firms that do that, company after company, fund after fund, are typically the best performing firms in the venture capital business over the long run.”
Now we have later stage, mega funds entering the seed stage fray creating more competition to get on cap tables for seed stage deals. So what does that mean?
Early Stage Investor Competition
Now that the later stage, mega funds have entered the seed stage market competition is through the roof. Danny Crichton of TechCrunch writes, “Firms are doing what they can. They are staffing up, trying to hire more raw talent in the hopes of finding that last undiscovered company. They scour their own portfolios and probe their founders, trying to find a tip to a deal that their competitor may have missed. They host dinner after dinner (sometimes multiple in one night — as I sometimes witness when I get an invitation to all of them, as if I can be in more than one place at the same time), again, hoping to find some bit of magic.”
According to Josh Kopelman of First Round Capital, “the time from first email/contact to term sheet has shrunk from 90 days in 2004 to just 9 today.”
And we all know that increased demand means…
Higher Valuations + Profitability = Crunch
With the increased demand at the seed stage comes increased valuations. Before they know it, founders are strapped into a rocket ship and are expected to clear higher valuations for their next round (AKA Series A). With the recent fallout of a few mega investments investors are also on edge when it comes to company profitability.
The added focus of profitability AND the need to clear a higher (possibly/likely inflated) seed valuation will lead to fierce competition downstream when it comes time to raise a Series A or Series B. (There are now more alternatives to venture capital for earlier stage companies for those not ready to take the venture capital journey.)
To the original question, “How do I avoid the Series A crunch?” maybe better asked if there is a Series A crunch or if it is simply reality?