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Startup Fundraising Trends: Ask the VCs

Posted by Early Growth

October 23, 2014    |     7-minute read (1350 words)

In case you missed our recent webinar on startup fundraising, we featured panelists Lucas Nelson, Principal, Gotham VC; Marlon Nichols, Director, Intel Capital; Alan Wink, Director of Capital Markets for EisnerAmper LLP; and Sirk Roh, COO for Early Growth Financial Services. Not only was the conversation lively, there was even a bit of a West Coast versus East Coast smackdown. Keep reading for great insight and funding advice, view the Current VC Trends and Insights deck on SlideShare, or stay tuned to see the upcoming YouTube video on our YouTube channel.

The funding landscape:

  • 2013’s fourth quarter saw $13B invested in 1,000 deals. This was the largest quarterly investment total since 2001’s first half. The trend continued in 2014: with activity during the six months through June the strongest since the comparable period of 2001.
  • Median pre-money valuations have increased by 43% so far in 2014 compared to 2013. But the number of investments is 37% lower.
  • More money chasing fewer deals means competition works to entrepreneurs’ advantage.

Where are investors placing the most bets?

  • Software, biotech, media, and entertainment are seeing the most flow, followed by IT, and energy.
  • 52% of capital was invested in seed and early-stage deals: with first-time financings accounting for 13% of all dollars invested.
  • In New York City a large number of institutional VC firms invest in seed/early-stage rounds AND in later rounds.

Drilling down on funding:

  • In terms of the geographical distribution of investment, Silicon Valley continues to attract the lion’s share of funds, taking in more than 50% of all money invested through the first six months of this year.
  • And Silicon Valley sees larger deals sizes versus New York: investment sizes for each average $5M and $11.3M respectively.

Why choose VCs over angels or crowdfunding?

  • Each funding option has plusses and minuses. To some extent, it is a question of timing and what stage of development you are in. Very early-stage startups looking for seed funding will have a hard time getting interest from traditional and corporate VCs.
  • Also, it's about more than money: professional investors have rolodexes and valuable professional experience of how to scale a company. They can also provide startups with access to the wider ecosystem.

What’s the right amount of capital to raise?

  • Marlon was preaching to the choir when he pointed to milestone funding as the best approach to determining funding needs. Specifically, he recommended entrepreneurs think in terms of an 18 month runway: asking themselves what are the next major milestones they need to hit in order for their startup to be successful.
  • And VCs expect founders to dedicate "financial rigor” to their analysis. While the number is likely to be wrong, the point is to assess how knowledgeable an entrepreneur is about the market space he or she is in: as opposed to picking an arbitrary number based on which round they’re seeking.

What should proceeds from startup fundraising be used for/where should it take them? How does this vary by round?

  • Spending is usually allocated to a mix of product development and sales and marketing. At the seed stage, it mostly goes to product development and getting the beta product market ready. By the A round, once product market fit has been done, spending focuses mainly on building up sales and developing a marketing strategy.

How do VCs feel about entrepreneurs paying themselves? Is this a turn off?

  • Most investors want entrepreneurs to have enough skin in the game that their interests are aligned, but not to be so strapped that they will jump at the first (bad) exit opportunity.

Our VC panelists countered with questions of their own:

What are entrepreneurs giving up to get investor capital? In addition to the obvious cost, equity, entrepreneurs also give up some independence when a Board become involved. On the other hand, your Board is also there to provide guidance.

  1. What do entrepreneurs gain from VC investment?
  2. It’s not just money. VCs see themselves as partnering with entrepreneurs to offer them access to investor networks, introductions, and the opportunity to benefit from their reputation.

Most VCs see 75 unsolicited funding opportunities in a week. How do you stand out?

  • Do whatever you can to get an introduction. Warm introductions provide VCs with a level of comfort.
  • A big part of a CEO’s job is sales. It doesn’t speak well to your networking ability if you can’t identify a connection who can make an introduction.
  • If you have to send cold emails, do enough research to be able to explain why you’ve targeted a particular investor.
  • Successful serial entrepreneurs focusing on the same space get more credibility versus first-time entrepreneurs.

East Coast versus West Coast VCs comparison

Term sheet differences have disappeared because: East Coast startups are now getting more attention from West Coast VCs as VCs invest in multiple markets; while entrepreneurs communicate with each other and are more savvy about deal terms.

  • East Coast — more focused on disrupting existing business: Fintech, e-commerce, AdTech
  • West Coast — still has lead in computer science

So are valuations surprising? Are we in a bubble?

  • The answer from the panel seemed to be a qualified no.
  • For Lucas, while early-stage valuations and activity may be bubble-like, he doesn’t view them as having the same ramifications, namely recession, that the previous, more broad-based (technology exposure including public stocks ballooned to 50% of the market ) technology bubble did versus the 1% early-stage investing represents today.
  • For Marlon: Not sure I’m ready to call it a bubble. The previous bubble featured high valuations for pre-revenue companies. Today, valuations are high, but companies are generating revenue. Looking at the dynamics, today it’s much cheaper to start and develop companies prior to institutional funding. But compression of rounds is a big deal.
Traditionally, by the time they reached Series A rounds, startups had a working prototype, an identifiable revenue stream and starting to see evidence of customer traction, but weren't yet generating revenues.

Today they’re expected to have a prototype, demonstrate some customer success, and be ready to scale. In that context, higher valuations reflect that difference. Companies are also lingering longer in the private market before seeking funding, which also contributes to higher valuations.

Burn rates are similar for both periods though. This is because competition from a lot of “me too” players, folks trying to solve the same problem, is leading to lots of money being spent on marketing and sales.

What are your thoughts on the Series A Crunch?

  • Some companies are getting unsupportable valuations at seed and then can’t grow into them by the time they need to raise their next round.
  • There are only so many opportunities for winners and only so many $1B outcomes. But it’s so much cheaper to start up now that the top of funnel is much wider; while the bottom hasn’t changed. That means we’ll start seeing the crunch filter through to B rounds.
  • In some cases investors are setting entrepreneurs up for failure by setting valuations that are too high and lacking the discipline to walk away from unreasonable deals.
  • On the other hand, some of the newer investors are dropping out of seed investing providing professional investors with an opportunity to recalibrate the market.

Parting shot for would be entrepreneurs or founders looking for funding.Which areas are VCs especially interested to invest in?

  • Security, Bitcoin
Have questions or comments about startup fundraising options or strategies? Tell us in the comments comments section below or contact Early Growth Financial Services for a free 30-minute financial consultation.

Deborah Adeyanju is Content Strategist & Social Media Manager at Early Growth Financial Services, an outsourced financial services firm that provides small to mid-sized companies with day-to-day accounting, strategic finance, CFO, tax, and valuation services and support. Deborah is a Chartered Financial Analyst (CFA) charterholder with more than a decade of experience as an investment analyst and portfolio manager in New York, London, and Paris.

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