series-a-crunch_bestversion

It seems we’re going to have to go over this Series A crunch thing one more time. Not for the entrepreneurs living it, but for the reporters and research groups who keep trying to rebut the concept — only showing they don’t quite get what the concept is.

There was a report by The Big Data Group written up on The Next Web today that says there isn’t a Series A crunch — rather there is a Series B crunch. The evidence: There were more Series A rounds done in 2012, and they were done faster, but there were fewer Series B rounds done, and they were done slower.

This is a common misconception, and I’ve seen a few blogs make it: The Series A crunch has nothing at all to do with how many absolute rounds get done, or whether there are more Series A rounds done this year versus last year. It doesn’t refer to a decrease or a tightening in the number of firms that will do Series A deals, although some have speculated that could exacerbate the problem.

In fact, it has little to do with anything changing about Series As at all.

Rather, it has to do with the huge increase in seed rounds relative to prior years. The basic math of the venture world tells us that even if there was an increase in Series A rounds, there are simply not enough firms out there doing them that everyone who got a seed round would get funded. (Nor should many of them.)

Think musical chairs. As companies move through the deal pipeline and mature, seats are always taken away in between rounds. Contrast how many companies get seed funding with how many survive to reach an IPO. This is the nature of the industry — in good times and bad times.

Normally, it’s a controlled winnowing — just like in musical chairs. Only one chair is taken away at a time. But imagine a hundred kids came into play a game that was designed for about 10. That is effectively what is different this time around. The number of chairs (the Series A round) hasn’t changed. But since so many more kids are trying to play the game and don’t get one, it has a more dramatic ripple effect.

Indeed, as I’ve said before, I wouldn’t be surprised to see a larger absolute number of Series A  deals done in 2013 than 2012, because there are so many seed deals pitching and many of them are likely on to something. But even an uptick in the number of Series A deals would still be consistent with a larger Series A crunch felling hundreds or even a thousand or more companies. There simply isn’t the capacity in the system. This is something no one who works in the venture industry is debating, because it’s basic math: There are way more seed funds, and the same number (or slight shrinking) of venture funds.

As for the comments about a Series B crunch, these deals will also be hard to come by, as we’ve reported before. But since fewer companies make it to the Series A stage, there is not nearly as much of a winnowing down between rounds. Put another way: If fewer companies can get a Series A deal, there are fewer to “get crunched” when it comes to raising a Series B.

That said, you will always see a smaller number of Series B deals in any rational venture cycle — particularly one where cold water has just been thrown on the exit climate due to some lousy IPOs. By Series B, investors want to see more proof points of the business to keep a company alive. Proving out a real business is hard. So there’s nothing remotely remarkable about that.

So in short, this data tells us nothing whatsoever about the Series A crunch, because it says nothing about the jump from seed to A. Contrast it to this study which tracked the actual discrepancy between companies funded at the seed level and the capacity in the market for Series A deals.

Besides, even if these were relevant data points, using 2012 data would be way too early to tell anything as it’s a phenomenon that investors only expected to really start seeing this year. This may be what you expect from a firm whose other brilliant findings were what the most popular first letter of a startup was and the correlation between the number of letters in a company’s name and whether they’ll go public. That’s a half-step above numerology in terms of insights to help entrepreneurs.

The report is a good reminder of why most entrepreneurs spend more time focused on their own business than what the macro-climate is doing anyway. Hit your milestones, develop deep relationships with deep pocketed investors, and start raising your Series A well before you need it. The great companies will be fine; the less than great ones will at least fail early enough the carnage will be modest, and their teams can get reabsorbed by other growing companies that are all still desperate for talent.

As for bloggers and research firms who still can’t quite get the concept, we’ve also explained it in song: