Crystal Ball – Near Term Outlook For VC

I’m on a panel this afternoon about the “near term (6 to 12 months) outlook for venture capital” particularly focused in NY (but also more broadly).  So I decided to get my thoughts together on the subject and I figured writing a blog post would help me do it.  Here’s what’s obvious:

Lot’s more Angel investors:

  • Seed stage deals are growing quickest of all VC segments at 19% of total deals in Q1:12 up from 13% a year ago.
  • In New York Seed deals are fueling venture growth.  The 2 year CAGR of Seed deals is is 151% compared to 5% for all other stages of venture investing.
  • The Jumpstart Our Business Startups (JOBS) Act is minting even more Angel investors.

Lots more Startups:

  • Startup costs are lower on a relative basis than they ever have been thanks to cloud services.
  • Unemployment conditions are encouraging otherwise ‘tentative’ entrepreneurs to take the plunge and start a company.
  • At RTP Ventures have been seeing unprecedented deal flow.

A near-term increase is stupidity:

  • I now know of 3 online bra-fitting companies (it’s not the product it’s the number for a relatively small market). Lot’s of other ‘me-too’ companies.
  • Ohio now thinks its a VC hotbed.
  • San Quentin prison is hosting an accelerator.
  • etc.

Opinion #1 – There is an increase in non-smart money funding a growing number of non-innovative companies.  And it may be starting to get out of hand.

Opinion #2 – There are not nearly as many Series A and Series B investments being made at present as Seed allowing growth stage investors to be more particular.

VCs are becoming bigger and more stage agnostic:

  • In the last 15 years funds under management has increased 11x while number of funds has increased 2.6x.
  • Sequoia, Accel, Battery, Menlo, NEA, CRV, Benchmark on average tripled their fund sizes in that time period.
  • Andreessen Horowitz raised 4% of all venture capital in 2010 and 2011.
  • Of the 38 VCs which raised funds in Q2, 5 firms (NEA, IVP, Lightspeed, Kleiner, Mithril) made up 80% of the total money raised.

Opinion #3 – there are fewer and fewer ‘king-makers’ deciding on the future success of startups.

Pathways to venture exit are fewer:

  • There are 132 companies in the IPO pipeline valued at over $24 billion.
  • Greater than 90% of VC liquidity has been M&A since 2001.
  • The VCs of Kayak (NASD: KAYK) – Oak Investment, General Catalyst, Sequoia and Accel were so concerned that the company would have a soft IPO that they participated in a 1.2 million share private placement concurrent with the public offering to bolster investor confidence.
  • Worldwide M&A activity fell by 21.5% between the first half of 2011 and the first half of 2012.

Opinion #4 – a glut of companies legitimately ready to exit is forming and they have no place to go.

Summary opinion – When I look at all of these forces acting on the environment for venture capital it appears as if there is a traffic jam forming.  There are a whole bunch of companies coming onto the onramp funded by lots of seed stage investor.  The lanes are relatively narrow because there are not as many investors doing Series A and even fewer doing Series B. In addition the investment/funding decision are concentrated in the fewer more powerful hands. And finally there are not as many companies getting off on the offramp as there should be.

That means there will be some choices that will need to be made  There will be a small percentage of deserving companies that will not get funded.  There will be a larger percentage of non-deserving companies that will not get funded.  I looks to me like the start of this trend will be the late fall and into the spring.

I didn’t really touch on the economy as a driver.  I’d say the bias on the economy is negative, but there is always greater fear and loathing about growth in the summertime.  The Fed is currently engaged in a campaign to talk the economy up – by suggesting that they will act with stimulus if things don’t improve (this can be a self-fulfilling prophecy).  Anyway, there are a lot of moving parts and if the economy slows down, undoubtedly the impact on fundings and startups will be greater.

The follow on effects might be:

  • Lower valuations on new rounds or even recaps/cram downs
  • A greater percent of seed stage companies failing
  • Discouraged Seed Stage investors (which is actually a good thing)
  • Less stupidity (see above)

So if it were me that was raising I would consider the following:

  • Raise sooner rather than later
  • Be reasonable about valuation
  • Run lean in terms of cash burn
  • Expect to take longer to get a raise done
  • Raise a little bit more if possible (without giving up the farm)

So there you have it – a look into my crystal ball.  I’ll be curious how much turns out to be right and how much turns out to be bullshit.  Here’s hoping I’m mostly wrong.