Finally, actual data: Series A crunch will kill 1,000 companies, $1B in angel money

By Sarah Lacy , written on December 19, 2012

From The News Desk

CB Insights has a fascinating report that puts actual data around the Series A crunch debate.

And as will be no surprise to regular PandoDaily readers, it's real. It's an actual mathematical phenomenon resulting from a glut of seed-funded companies and a stable (or possibly declining, we argue) number of firms doing Series A deals. As I've written before, I'm not sure why people are trying to deny it. But here is the first stab at actual data I've seen to back up what everyone in the ecosystem is about to watch or live in 2013.

After examining 4,056 seed investments made into US-based tech companies since early 2009, the firm found that more than 1,000 existing startups will be orphaned. This squares exactly with the numbers we first published back in November, gleaned from about 20 sources in the angel, VC, incubator, and legal world.

But CB Insights went further to put a dollar figure on it: More than $1 billion in aggregate seed money will be gone along with those once-promising ideas.

While those numbers sound dramatic, the report's take aways are similar to ours: This isn't some apocalyptic doomsday warning, and may well be the tamest shakeout the Valley has had, given this level of imbalance of supply and demand. That's because it's happening so early in these companies' lives. This is more proof of what I've argued for years: There is no bubble. The bulk of the froth in the Web 2.0 world was mostly just in the private hands of insiders, not the public markets or broader economy.

Employees from these 1,000 companies will get reabsorbed into the system as big companies, and growing startups are still starving for talent. We probably won't even hear about the vast majority of the casualties.

As for that $1 billion? Yeah, no one wants to lose it, but better to lose it now if a company isn't working than wait for down rounds , cram downs, or a failure down the line. It'll be a harsh reminder of the inherent risks in seed investing and many people may get out of the game as a result. But again, that's all healthy. The reason this is happening is that arguably we have a bit too much money in the system.

Others may look to keep a toe in the game via a new program like the AngelList/SecondMarket partnership, which allows you to angel invest in a mere $1,000 chunk instead of the more standard $25,000 or more.

There were a few other tidbits that may be helpful for entrepreneurs trying to weather this crunch:

  • CB Insights found that it takes more than 13 months to raise money, on average. They expect that will increase now that the balance of power is shifting to investors, many of whom will take more time to do due diligence if they can get it. So plan now if you are running low on cash anytime before 2014.
  • Here's one that's sure to rankle people: For all the talk that VCs at the seed level can only hurt your ability to raise a Series A, the research showed that seed deals that had VC participation actually had a higher rate of getting follow-on funding, historically. The concern is that VCs will always invest in way more angel deals than Series As, and if a VC doesn't re-up, it's a deadly negative signal to other investors. The historical data could have more to do with a correlation that better connected entrepreneurs are the ones who tend to get VCs in their angel rounds to begin with, making raising a follow on round easier. But it certainly bucks what people in the Valley have been saying.
  • Not a shock, but the Internet sector is the most wildly over-seeded. Computer hardware and services had far higher rates of follow-on funding success.
  • Also not a shock that this trend is seen most predominantly in California and New York. After my first article a few commenters said, "So what? The rest of the country has been dealing with this for years!" No, you haven't. The mismatch between a glut of seed funding and a limited number of firms doing Series A deals is a different phenomenon than living in a market with few VCs or seed funds to begin with. Not better or worse, just different.
  • Ironically, entrepreneurs in markets with some critical mass but not too much critical mass may be comparatively spared. Massachusetts is a "distant third" in seed activity but has the highest rate of follow on financings. The researchers expect New York to see the highest rate of orphaned startups. This squares with what Thrillist and Lerer Ventures' Ben Lerer said in our PandoMonthly: After the seed stage, New York entrepreneurs still have to get on a plane and go fundraise in the Valley. That puts them at a disadvantage. Of course, being in markets outside New York or Silicon Valley or LA has other disadvantages. So don't pack a U-Haul based on these stats alone.
[Image credit: thethreesisters on Flickr]