Paul Martino
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Editor’s note: Paul Martino is a co-founder and GP of Bullpen Capital, an early-stage VC firm.
When we started Bullpen Capital in 2011, there were about 30 or so “microVC” or “micro-seed” funds — and we knew them all. Today, four years later, there are likely over 220 micro VC funds and growing. In fact, I joke with my partners that “we will likely get to 400 before we go back to 40.”
That line always elicits a nervous laughter, as it captures an essential truth: there were over 1,000 VC funds at the bubble peak in 2000, and now fewer than 100 are still active. Just as the “Series A crunch” provides a rude wake-up call to seed companies which can’t make the next step, the looming “micro VC crunch” will kneecap many of these smaller funds.
How did we get here? The rush to hunt unicorns is driving big money into the venture asset class, and much of it is ending up in these micro VC funds. These funds have helped seed many companies, often raising larger seed rounds; yet the number of Series A deals roughly remains the same. Most micro VC firms that participated or led these deals don’t have big enough checkbooks to support their companies, so the fate of those who can’t make it is predictably grim.
We have noted at least 85 new micro VC funds in 2014, many of which were super angels that went institutional. This trend should continue as long as the boom continues, so we expect another 100 or so in 2015 and maybe a final 100 in 2016. Difficult to know when this will end, but it surely will.
As a result, many of these micro VC funds which don’t have the multiple hits required to survive, will by contrast, die a slow death. Here, the “crunch” is actually a period where the micro VC fund becomes inactive as their dry powder evaporates. Just like a seeded company that doesn’t have the metrics to catch the eye of a firm like Sequoia, many of these smaller firms won’t have the metrics and events needed to catch the eye of larger LPs.
For instance, their model may not allow them to capture much ownership in a company they invest in; or, they may not have the capital to take their pro rata (assuming they obtain it in the first place); they may not have the connections to create special purpose vehicles (SPV) for follow-on investments; they may face structural competition from larger funds who elect to move earlier or startup accelerators that create auction formats to drive up prices.
You may have read the stats that the amount of money in the seed stage is potentially four times greater than it was five years ago. It creates a terrific climate for founders, but among investors, it is something discussed in private and one that often triggers concern. Like the founders they back, these micro VC firms require entrepreneurial energy to start, yet also will succumb to basic laws of supply and demand, as well.
At some point delivered results will matter and not logos on the wall. When that occurs, the consolidation will begin. And only those firms that have truly differentiated their partners and their offerings to the entrepreneur will survive.
As much as we are painting a grim picture of how this ends for most micro VC firms, we firmly believe that there will be one more leg of this “seed fund” bubble. For example, an enterprising LP can theoretically put hundreds of small micro VCs in business, develop relationships with them, and gain access to curated portfolios.
When the time comes to raise a larger round in a growth-stage company that’s somewhat de-risked, an LP can use a variety of vehicles to invest into the company for a lower fee and carry charge than the old, typical VC model. Here, “going over the top” to invest directly in growing companies is what many LPs crave.
We think this final wave of proliferation will happen because this same option-buying strategy is what was employed by the most successful of the micro VCs in the first place. So why not buy options on whole funds and double down on those winners if you’re a forward-looking LP?
For those micro VCs that can play this game, those funds will make great returns, raise bigger funds, and earn the right to own more of a company. And for those who don’t, just like a seeded company that hasn’t found product-market fit, they’ll be left to eke out their runway and hope that something catches in time.
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