If top startups are "Thunder Lizards," top VCs are radioactive cockroaches

By Sarah Lacy , written on January 7, 2013

From The News Desk

More money going to fewer people. That's generally going to be the theme, when it comes to all things fundraising in the startup world in 2013.

Last year, I compared the Series A crunch to a game of musical chairs where thousands of companies are vying for a few hundred seats. The numbers may be less extreme when it comes to C and D rounds, potential exits, and venture capitalists themselves raising funds, but across the board, the phenomenon is similar.

Mike Maples likes to refer to the handful of great startups that launch every year as "Thunder Lizards." The VC firms who can survive cycle after cycle are more like radioactive cockroaches, that seem to only get bigger and more dominant with each downturn.

The key is that money doesn't just dry up when there's caution in the venture world the way it might in more liquid capital markets. Startups can make money last for 6 to 18 months and farther up the food chain, 10-year funds are already committed and in the hands of VCs. They gotta spend it somewhere. And even further up the food chain, the limited partners who invest in VCs have allocations of capital they have to put to work in the category.

So the only option when concern sets in is to spend and invest slower, and for investors and LPs to concentrate their bets, putting more money they have to work in the deals, firms, and companies that they think will do well.

In many cases, it's a Darwinian game of musical chairs. Many lose. But if you get the chair, it's a huge, cozy recliner with a beer fridge in the side. Witness, Michael Carney's story this morning that stealthy security company Shape has raised a $20 million series B less than a year after its $6 million series A. Every time there's an announcement like that some journalist somewhere will write the lead: "What crunch?" Back in the early 2000s, I'd get at least one press release a day starting "At a time no one is raising money..."

Not only is it unoriginal, the sentiment has no understanding of how the startup world contracts. The money still has to go somewhere, and when limited partners or VCs see something they think could be a win, they're happy to give it more in a downtime, not less. And the company -- eying the same uncertainty -- is frequently likely to take it.

It serves to make what's already a polarized, home-run based business even more of a market of the extreme haves and the penniless. This is why so many investors say great companies shouldn't be worried by a funding crunch. There's still plenty of cash that needs to be invested. We can generally all agree on what a "great" company looks like. The problem is which of the merely "good" companies -- or venture firms, for that matter -- keep getting more runway. That's where the pain comes in.

Several studies are coming out showing that this phenomenon was already starting to play out at the end of 2012. We've already reported that exits slowed dramatically, towards the end of the year. Meanwhile, Dow Jones has numbers out today showing that fewer private equity firms (including venture capitalists) raised funds in 2012 -- dragged down by a slow second half of the year. But the firms that did raise funds raised enough that the asset class had an overall 20 percent increase in new dollars. The researchers noted that the numbers are deceiving because the surge was mostly driven by seven large funds reentering the market.

And separately, the NVCA reports today that venture funds, in particular, raised 10 percent more in 2012, but the number of firms able to raise new funds declined slightly to 3 percent.

A few other interesting details from the two recent reports:

  • Dow Jones reports how much Europe continues to struggle. On the venture side, the median fund size increased 11 percent, showing a mini-version of what we're seeing in the US with fewer firms getting more. But overall the money is spread thin. Index Ventures raised the largest European VC fund of the year, at $435 million. (They could have raised far more.) Elsewhere some sixty European venture capital funds raised $4 billion in aggregate. Compare that to the US where NEA's most recent fund was more than half that. Haves and have nots are a global game as well. The stats show why European startups continue to move to the US -- no matter how you spin it, there's just an order of magnitude more money here.
  • That NEA fund was a whopper at $2.6 billion. NEA is unlike almost any other firm on Sand Hill Road. It is the largest radio active cockroach of them all, steadfastly refusing to ever pare down its fund size no matter what the cycle is. With multiple offices and a large staff, it may not be one of the top five firms, but it has long been the only firm that seems to have made mega-scale work cycle-after-cycle. I wrote an in-depth story about this in 2001 or so, when the firm raised another surprisingly multi-billion fund. I could probably reprint the same story today.
  • Dow Jones reports that the median US fund size was up to $150 million from $134 million a year ago. Think about it. That doesn't describe any venture fund we normally write about, save micro-VC funds. This puts into perspective how varied the industry is. We've reported before that out of some 750 "active" VC firms, just 97 funds have invested $1 million per quarter over at least four quarters. When you consider how relatively small the funds under management of the bulk of the industry is, it puts those numbers into even greater perspective. There's a reason most startup blogs tend to write about the same few dozen firms over and over again. Most simply don't come close to having the same impact on company formation.
  • Onto the NVCA's numbers: The fourth quarter dramatically slowed momentum, as the amount raised decreased by some 35 percent and the number of funds getting commitments decreased by 25 percent, compared to the third quarter.
  • Similar to Dow Jones' overall figures, the NVCA reports that five firms raised 55 percent of the cash in the fourth quarter.
  • NVCA president Mark Heesen noted that a small number of well-heeled mega funds that invest across industries and stages and geographies are having success. Meanwhile, many funds focused on a particular stage or region are able to raise small amounts. Those in the middle who try to do more but don't have the brand recognition are the ones suffering most.
  • The NVCA notes that many in the industry are happy that the venture industry has stayed below $25 billion in new capital per year since 2009. Many others think it should contract further to make the overall returns higher. Many of the top firms and investors believe there are only a dozen or so great new companies created every year and more money doesn't change that.