It’s no secret that the early stage investment ecosystem is changing. More money than ever before is flowing into Seed deals, but companies are finding it increasingly difficult to raise follow-on Series A rounds. The disconnect has been labeled the “Series A Crunch.” But for Ryan Swagar and Brandon Zeuner, the founding and managing partners of the Scottsdale-based VC firm Venture51, the phenomenon might as well be dubbed “opportunity.”
Venture51 filed documents with the SEC earlier this month declaring its intention to raise a $25 million early stage fund. According to sources close to the situation, the firm completed its first close last Friday, with the amount raised to date being described only as “material.”
Swagar and Zeuner describe their thesis as making “traction gap” investments, or in other words providing Seed extensions or pre-Series A bridge financing to promising companies that need to extend their runway prior to raising a more substantial institutional round. The timing couldn’t be better, both with the state of the ecosystem and given that Y Combinator founder Paul Graham unknowingly gave a commercial for the strategy – invest less, on founder-friendly terms, with full transparency, and act quickly – in a recent speech and subsequent blog post. (AngelList founder Naval Ravikant delivered a similar message in his blog post Startup SLA.)
This would mark Venture51’s second fund, as the firm recently completed investing out of its “nearly $10 million” Fund I. The thesis remains the same, although the company plans to write slightly larger checks this time around.
In Fund I, Venture51 made 37 investments which averaged $250,000 in size and were distributed primarily among the Bay Area, New York, and Los Angeles. The firm’s portfolio includes Betable, Life360, Space Monkey, Etoro, and Getaround, among others, and 24 of its 37 portfolio companies have raised follow on funding to date.
In Fund II, Venture51 plans to increase its average check size to between $500,000 and $1 million, while syndicating the additional capital for rounds that it expects to average $1.5 to $3 million. The plan is to price most of its rounds, which is a departure from its previous strategy of investing mainly through unpriced convertable notes. This change is driven by what the founders describe as the “negative consequences” they’ve seen startups encounter as a result of raising multiple unpriced rounds. Swagar and Zeuner will only rarely take board seats. The goal is to deploy all $25 million – assuming they raise the full amount – over a two to three year period, Swagar says, citing the current market opportunity.
Venture51 will focus its investments on the “digital household,” mobile ecosystem infrastructure, new commerce and marketplaces, and the consumerization of enterprise. Both Swagar and Zeuner have operational backgrounds. Swagar previously managed North American investments for a private family office, while Zeuner’s background includes senior roles at Plan Plus Online (sold to Franklin Covey), Flypaper, and SalesLogix and ACT! CRM maker Interact Commerce (sold to Sage). The pair co-founded and continue to operate a rich-media ad-tech platform called Republic Project.
There’s no ignoring the opportunity that’s been created by the Series A Crunch. Many deserving companies will struggle to raise money over the next several years and firms like Venture51 will be well positioned to get in on otherwise unavailable investment opportunities. But – there’s always a but – this model has significant risks.
There would seem to be a negative selection bias in this strategy, meaning that companies that haven’t generated sufficient traction to raise a full Series A are inherently not the highest performing companies. While they may be “late bloomers,” and those who back them may eventually see a return, the venture game is about hitting home runs, not doubles. Venture51 is essentially planning on hitting multiple inside the park homeruns, an exceptionally rare event that early on resembles a double or triple, but which typically requires that a few lucky bounces go its way before the player touches home plate.
Despite living in Scottsdale, Swagar and Zeuner are well connected in the startup ecosystem and seem to have a good eye for opportunity, as demonstrated by their attractive Fund I portfolio. If they can duplicate this performance in Fund II, but write bigger checks and get into deals when competition and thus valuations are low, it should bode well for their ultimate returns. But it’s these “ifs” that are why we play the game.
[Image source: Ideamensch]