Every VC admits there's too much seed investing. Still, it surged in the first quarter

By Sarah Lacy , written on April 10, 2013

From The News Desk

As Mike Maples told us a few weeks ago, venture capital is an industry of exceptionalism. The problem with being an industry of exceptionalism filled with Type-A, overachievers? Everyone thinks they are the exception.

CB Insights has published its first quarter deep dive into venture deal-making. There are a lot of interesting findings. But one of the most telling is that seed deals were up over last year. This despite our and CB's own research showing the Series A Crunch -- brought about by too much seed investing -- is very, very real. The level of seed funding in the first quarter wasn't the highest it's been and was flat on a quarter-by-quarter basis. But it was up a strong 31% over the first quarter of 2012.

Basically: Everyone admits the glut of seed deals is a problem. But the behavior doesn't change, because of exactly what Maples argues: This is an industry of exceptionalism, and everyone thinks his or her portfolio is that exception.

There's also a more structural reason seed investing won't wane anytime soon: This isn't a liquid asset class. Funds are already committed to seed funds, and that money has to go somewhere. It's the same funny dynamic of the long-term venture industry that meant there wasn't an immediate racheting down in investing after the dot com crash, but instead a slow decade-plus shift towards fewer firms commanding more money.

Ultimately, the venture world's fundamental inability to overreact or make a knee jerk response to macro changes is healthy. After all, this is supposed to be an asset class that invests in contrarian ways in times and places when others do not.

The study backs up what Y Combinator's Paul Graham told us in our first piece on the Series A Crunch, that it wasn't a one-time phenomenon. It was simply the new reality to the startup ecosystem, particularly in Silicon Valley.

There has been a structural change that isn't going to be reversed anytime soon: Whether micro funds come and go or not, there are always new angels coming into the ecosystem as more mature companies exit. And since the cost of starting Web and mobile companies is so low, there will simply be way more companies started than the rest of the ecosystem -- talent, venture funds, even office space, potential acquirers -- can absorb. So the death rate between seed and Series A will just continue to be higher than it's been in past Valley waves. As Graham described it, it is a new reality where companies are more like experiments until they get that elusive Series A of validation.

While that may annoy people who complain there are too many "features" launched in the Valley and not enough companies, it's not necessarily a bad thing for the industry. More experimental apps are tried that can turn into big companies -- think someone like Instagram, which certainly seemed like a feature to most people in the early days. It's also a way for developers to essentially audition for jobs at larger companies who may acqui-hire them. And it can provide valuable first-timer experience for budding entrepreneurs who may build something more substantial the second time around.

But it's only healthy if entrepreneurs getting seed funding realize they aren't really a company yet and the odds for follow on investment are stacked against them, mathematically.

Go here to read more about the first quarter in venture capital. Here are some of the other highlights:

  • The number of deals was the highest since the dot com days, says CB Insights. 841 companies raised a combined $6.9 billion. We'll see how this squares with numbers out of the other major research groups. 
  • New York overtook Massachusettes in both the number of deals and amount raised-- something other studies have shown before, and more evidence that Massachusettes is losing its startup mojo. But take heart, Boston: Washington State fared even worse. CB Insights says the state usually ranks fifth for venture capital and fell a distant tenth in this quarter's regional rankings. Meanwhile a few substantial mid and late stage deals buoyed up two other states higher than usual: Georgia and Utah.
  • Mobile deals dipped a bit; Internet deals hit a multi-year high. Social was finally down as a percentage of those Internet deals. I guess after 1 billion users, a movie, and an IPO, we've all finally accepted that Facebook won social.
  • Investments in clean tech were down... again. This sector is officially hype-free and only for the most dedicated and mission driven firms.
  • So what's still hot? Enterprise and business software. In an earlier report, CB Insights noted there hadn't been many exits in the much invested in social enterprise space beyond Jive and Yammer. The firm wondered whether the enthusiasm behind the sector would wane as a result. No doubt: There was way too much investment in these apps, many of which didn't really solve problems for big companies. But beyond this, building a large enterprise company just takes time, and that's the case when you have a big sales force. This lofty vision of business software that sells itself may pan out, but companies using that playbook will take even longer to build. As far as I'm concerned, momentum-oriented entrepreneurs and investors getting frustrated and abandoning enterprise is a good thing.
[Image courtesy Thomas Rockstar]