Originally posted on the SpringTime Ventures blog.
A few weeks ago, I was on the phone with a SpringTime portfolio company and shared my thoughts about the fundraising environment in the coming year. This is far from a well-researched, evidenced-based analysis and more of “breadcrumbs in the forest.” I have an opinion on where the breadcrumbs lead, so I’ll share that perspective and let you decide.
Seed Funds Are Making New Investments
The growth of new Seed funds has been extraordinary. SpringTime is proud to be part of a new wave of first-time fund managers (the experience of our partner Rick and CFO John notwithstanding). I would expect nearly all the funds that raised capital in the last two to three years still have enough left to deploy in the coming months. Many small funds (outside of the Bay Area) deploy capital over four to five years, and even if that’s shortened to three years, the growth of funds in the last two years plus the number of investments still being made says to me that there is money available in the Seed market.
This could lead to more new companies getting funded or the current portfolio companies receiving follow-on funding. Either way, there may be fewer failures than we’re all anticipating, which means more companies competing for late-stage Seed funding.
The media’s consensus seems to be that venture funds are done making new investments to allocate capital to their existing portfolio, ensuring their current companies make it through the tough times ahead. Since it’s on the internet, it must be true, right? The media also rarely distinguishes between Seed and “Seriesed” (A, B, etc) and that is key difference. How a $100MM fund operates is very different from the so-called Micro VC’s of $50MM and definitely not for sub-$25MM funds.
A very informal poll of the Colorado venture funds (including many micro-funds) via a group Slack channel showed that those with capital are still making new investments. What I’m seeing is a lot of Seed money on the sidelines, waiting to get in the game. This is the only good news I have to share—a least from a fundraising perspective.
Series A Raised the Bar
We recently saw multiple investment opportunities where Series A investors left a company at the altar—term sheets either rescinded or never delivered. We’re hearing this is happening broadly. In these cases, the funds in question had done an evaluation and decided to raise the bar for where they would invest, specifically related to revenue.
If this holds steady for the next two years, that means your Series A round is that much farther away. And once again, more companies competing for late-stage Seed funding.
Fewer Early Exits
An interesting trend in recent years has been an early exit to a private equity (PE) firm. We saw this happen with fitness-related startups in Colorado in particular. PE firms have been playing the roll-up game for decades, and in recent years smaller firms started dipping down into the startup market. These roll-up plays were scooping up startups for valuations well under $100MM, often under $50MM. For all intents and purposes, these exits replaced Series A rounds, sometimes coming quickly on the heels of late-stage Seed rounds. Expect these exits to dry up as PE firms shore up their current investments, looking to turn profits on their portfolios at any cost.
This means another post-Seed opportunity is farther away.
Series A Super-Crunch
I feel like every other year we hear about the “Series A Crunch” meaning there’s not enough Series A capital to fill the appetites of all the startups looking for it. I would argue this is normal, to be expected, and even healthy. If there is too much capital in the market then it gets spent wildly and deployed poorly.
With more Seed funds than ever before in the last three years, and Seed funding still available, there are more Seed-stage startups than ever before. Series A investors have raised the bar for what they will invest in, and sub-$50MM exits to PE roll-ups are all but off the table. With the goalposts farther away, the available seed money will dry up in the next two years. What’s worse, it may be harder to raise new venture funds, meaning less funding in the Seed phase in 2022 and beyond (but that’s our problem to worry about, not yours).
As much as I think the phrase is overused, I think we’re coming into a Series A crunch like has never been seen before. Post-Seed financing is going to be extremely competitive, harder to achieve, and leave many companies dead or stagnating. This is the Series A Super-Crunch.
Ready For Your Seed 4 Round?
What do you do to survive the next two years?
Get ready to raise Seed 2, Seed 3, Seed 4, whatever it takes to keep the lights on and the business growing. To do this, you must keep your investors close. If you’re not sending quarterly updates (monthly or bi-monthly if you can manage it) to all investors, start this right now. You’ll need those investors in the next two years.
Follow up with your current investors to know and understand their follow-on strategy and allocation. Some questions to consider: Do they have a portion of the fund reserved for current portfolio companies? Did they raise or lower that percentage? How much is left in their reserves? What are their criteria for investing in follow-ons?
Seed Is a Community
The thing that I love about Seed phase investing (note: “phase” not “stage” is intentional) is that it’s a community activity, as opposed to Seriesed stage investing which can be competitive between firms. At the Seed phase, no one firm has enough capital to take a whole round, so we all put our chips in together. The downside is that this can lead to group-think or herd mentality (if you’ve never heard my psychology of fundraising talk, get on my calendar and I’ll share with you). The upside is that we, Seed funds, are accustomed to working together. As you’re talking with your current investors, ask for referrals to funds that are not on your cap table.
The (arguably misunderstood) maxim, “a startup should always be fundraising,” is especially true in this environment. I think people take that too literally as though the CEO should always have a term sheet in hand. A better way to think of that is is to keep investor networking as part of your regular activities. It’s not an all-out-effort, but just a regular soft-circling via updates and check-ins. Just a little bit of time spent building new relationships now will pay dividends later.
This last item may not be a fit for everyone. Because we invested in your business we want to live in a world where your solution exists, serves its customers, and employs good people, I’m sharing some information about alternative capital. The rise of revenue-based financing in recent years is incredible. I believe this capital structure has great potential for businesses that are not a fit for venture capital. It has also historically been a bridge between venture rounds. It may be worth considering if this is a fit for your business in the coming months. Here is a list from TechCrunch with some of these firms. And I recently heard a podcast featuring Clearbanc that made some compelling points for their model. And Lighter Capital is also worth checking out as their model is specifically built to work between venture rounds.
The Things You’re Already Sort Of Doing
You’ve made some cuts. You’ve adjusted projections. You’ve froze hiring or prepared to balance it against matching growth. You’re doing the things. It may not be enough. I heard a great podcast the other day from a founder who had startups in both previous downturns and is a CEO of a fund-turned-startup right now. Dave Balter, CEO of Flipside Crypto is interviewed here. The big lesson I took away: when it comes time to cut, prepare to cut deep.
Breathe Through Your Ears
I’ll leave you with this one last bit of wisdom I heard somewhere along the way. A young distance runner asked her coach, “should we breathe through our mouth or our nose?” The coach responded, “breathe through your mouth, through your nose, breathe through your ears for all I care, just get oxygen into your system.”
Cash is the oxygen of business. Breathe through your ears for all we care, just get it into your system,