In today's venture world, self-discipline is a virtue and denial is a red flag

By Sarah Lacy , written on December 3, 2012

From The News Desk

There has been a pretty large response to our post about the Series A crunch last week. I don't know what's more surprising: That so few people argue with the premise or that there are actually one or two who try to downplay or outright dismiss it in the face of pretty overwhelming evidence.

For years we've written about the expansion of seed funding, the dramatically lower capital to start something and the shrinking number of active venture firms. The scale of the crunch may be a surprise, and it's relevant now because it starting to hit now. But the fact that it's happening really shouldn't be a surprise to anyone who has been paying attention.

It's interesting to see the parties that try to downplay it-- or outright deny that it'll happen. Some are angels who have had challenges going from individual angel to micro-VCs. Obviously, headlines about wild over-investment at the seed level, hurts the environment for them to raise money. And lucky for them, I guess, that most of the companies that go under will be so small we will have never heard of them. When you are trying to deny a shakeout is happening, it helps when it's quiet.

Some people have cited the NVCA's numbers as evidence that there's either no "crunch" or that there's no newness to it. I don't totally get the arguments, but it's either naive or incredibly manipulative. The NVCA-- while amazing at many things-- has never been good at measuring seed and angel activity. Nor have any of the venture reporting agencies. They collect data by relying on VCs submitting information to them. The vast majority of angels and seed investors are simply off their radar.

When seed investing dramatically contracted back in the wake of the 2000 bust, I used to call these research agencies trying to get numbers on what was clearly going on in the Valley, and they'd explain this in telling me why they just didn't have it. That's just not what they do. No one should expect the data to show up there.

In the link above, the author even admits the seed data is bad, but argues it must somehow be a barometer of seed activity nonetheless. Wait, what? The reason the data is bad, isn't because the NVCA doesn't do a good job. It is because seed funds don't tend to report their data to research groups. Newer ones -- the very ones who are driving an increase in seed investing-- would be even less likely to. This isn't a statistical sample. It's just not very good data. There's a difference.

That's why you have to talk to the people who see a vast majority of the activity: People like Paul Graham, Ron Conway, Jeff Clavier, Naval Ravikant and the handful of law firms that process most of these deals. Those people know what is happening, because they see it everyday. Not in the form of data an lobbying group collected, but in the form of actual human beings building companies.

And all the ones I've spoken too are in agreement this is a thing, whether they characterize it as good or bad for the industry. Some call it a "crunch;" some call it just a new more experimental way of doing business in the Valley. But I haven't heard anyone with credibility argue that seed investments haven't dramatically risen in recent years, and that the people doing A rounds haven't stayed the same or even contracted-- no matter what flawed data may say. As Graham said in our article last week, what was an obelisk has become a pyramid.

Pretending this isn't the new funding reality doesn't really help the ecosystem. The companies going under may not be household names, but that doesn't mean that each failure isn't hard. There's no reason the startup community shouldn't accept and own this trend and help these teams plug back into the ecosystem for new jobs and help them learn from what went wrong. For the companies on the bubble now is the time to figure out options. Should you focus on revenues? Give up if its just not working? Pivot? Those conversations only open up if we're all honest about what's going on and what very young startups are facing right now.

Speaking of Graham, it's interesting that Y Combinator has taken the role of contracting its activity just as it's at the peak of its power in the industry. Two weeks ago, we wrote about YC taking over the venture follow-on fund for its grads and decreasing the amount that would be invested. On Sunday, it announced it'll be shrinking the size of its upcoming classes, at least until it figures out a better way to scale.

This reminds me of what Sequoia Capital did in the wake of the 2000 crash. That era was most known for a massive ballooning of the amount under management for each firm. $100 million funds became $1 billion funds. Many of the top firms in the industry took it upon themselves to "right size" things. Sequoia was noted as one of the first and most powerful firms to peg its post-bubble fund back in the $300 million range.

Sequoia was arguably the top venture firm in the world then. The firm that could continue to raise $1 billion funds even if no one else could. By willingly decreasing the amount they felt they could conceivably invest well, they sent a powerful message: Why do you think you can profitably invest more money in this climate than Sequoia can? And that was what LPs continued to ask during the next cycle of fundraising. Simply by leading by example, they actively drove a lot of contraction in an industry where LPs were still clamoring to get in. (Interesting to note this was a temporary move. Adding in other geographies and stages, Sequoia has crept back up to mega-fund status since. YC, too, says it wants to figure scale out.)

It'll be interesting to see what the ripple effect of YC's moves have on other incubators and spray-and-pray seed funds. Discipline is always most powerful when it's self imposed by those at the top. Those who impose it quickly-- whether investors or entrepreneurs-- will come out of this on top. Those who deny it's happening won't.

For a stellar discussion of the Series A crunch, check out the comment thread from our original story. And in case you missed it, here's a link to our follow up about how if you make it through the A and B, raising C and D rounds gets a lot easier. Some reporters have said all rounds are harder to come by at each stage, but according to data and logic, that's not true. With so many companies getting shaken out of the system at A and B rounds, there's less competition for the C and D rounds.

As this very quiet shakeout rolls on, let us hear from you if you're an entrepreneur trying to raise a Series A. Whether it goes well or bad, I'm sure you will learn a lot from the experience that could help the rest of the community. You can email me directly at sarah at