Many Boomtime Startups are Fizzling Out

Source: Sarah McBride, Bloomberg

As venture capital deals decline from their peak last year, more young companies are left without options. While many other VCs continue to make smaller investments, big firms are driving up the average investment size in young companies.

Declines in the venture capital market are hitting startups of all sizes, but the ones left particularly vulnerable are the thousands of young companies that raised seed funding during headier times just a year or two ago.

The seed frenzy peaked in the first quarter of 2015 when more than 1,500 startups raised their first rounds of capital, according to research firm PitchBook Data. Many of those companies are now running out of cash, and most won’t be able to get more.

Dying is a fact of life for most startups, but corporate graveyards are filling more quickly this year. The pain is likely to drag on for another 12 to 18 months as early-stage companies fizzle out earlier than usual or limp along without access to more capital, said Gus Tai, a general partner at Trinity Ventures. “The pressure is even more acute,” he said.

As many as half of fledgling startups today are looking to sell shares or take on convertible loans at the same price or terms as their previous rounds, said Jim Kim, a partner at Formation 8 who’s raising as much as $200 million for a new VC fund called Builders, according to a securities filing. He said such deals were rare a couple years ago when enthusiasm was higher and VCs were willing to pay a premium. “It is a completely different environment now,” Kim said.

Despite their recent pullback, American VCs aren’t strapped for cash. They’re on track to raise the most money since the 2000-era bubble. The top firms are raising larger funds, which is pushing many to make larger early-stage investments in the hopes of driving returns. Accel Partners, Andreessen Horowitz and Founders Fund have raised funds of more than $1 billion each this year.

While many other VCs, including Builders, continue to make smaller investments, the big firms are driving up the average investment size in young companies. The median valuation of early rounds involving professional investors has reached $15 million, more than any time in the last five years, said Wilson Sonsini Goodrich & Rosati, a law firm that advises startups.

However, the $55.5 billion of venture money spent in the first three quarters of the year fell short of the $61.2 billion invested in the same period last year, according to PitchBook. The overall startup market has rebounded in the last couple months but is still down 15 percent from its high last year, according to the Bloomberg U.S. Startups Barometer, an index that tracks VC funding and deals.

More than 11,000 angel and seed investments were made in 2014 and 2015, PitchBook said. Since then, the market has become depressed at all levels, but the imbalance in earlier stages, especially the one known as “Series A,” has created intense competition for survival among young companies. The number of companies able to raise their second or third rounds of funding fell 25 percent last quarter compared with the same period in 2014, PitchBook said.

Etai Beck raised a seed round in 2014 for his corporate software company Folloze. He later sold more shares under the same terms, bringing the total size of the round to $3.3 million. This year, as he looked for a second round of funding, he found that investors “are way stricter,” with higher expectations for revenue and customers. The company eventually found its way to $7.3 million in September.

“The new, higher bar is fine for companies that have very recently raised seed capital—they knew what to expect,” Tim Bliamptis and Judith Elsea, partners at Weathergage Capital, wrote in a blog post in August. “It’s not so fine for previously-seeded companies that had been operating under the old milestone expectations.”

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