The Ascent Of Early-Stage Venture Capital

Editor’s note: David Blumberg is the Managing Partner of Blumberg Capital. David has been investing in early-stage technology companies for more than 24 years. His current investment focus includes Digital Media, Social Media, Mobility, SaaS/Technology Enabled Services and Internet.

Early-stage funding by angels and venture capital firms is growing in size and impact on the technology industry.

Last year, U.S. venture capital firms raised 10 percent less than in 2012, but VC funds focused on early-stage investing raised $9.37 billion, a jump of 51 percent, according to DJX LP Source. In addition, 151 early-stage firms closed funds – more than in the last dozen years. Moreover, investment returns among early-stage venture capital funds are starting to outpace late- and expansion-stage funds, according to the most recent National Venture Capital Association’s (NVCA) performance benchmark, the Cambridge Associates LLC U.S Venture Capital Index.

And at the angel (seed) stage, the number of investments announced globally tripled in 2012 and 2013 versus 2007-2011, according to the 2014 Preqin Private Equity Report.

Why the Surge?

There are a number of structural reasons for the surge in early-stage funding:

• In the first years of this new Millennium, the cost of early-stage entrepreneurship dropped significantly. It is easier and more capital-efficient to start an information technology company, get product to market and reach large and expanding markets than ever before.

• There is a continuing trend in multiple sectors toward the dematerialization of product value – moving from physical to virtual goods and services – reducing transportation, storage and sales costs at all levels.

• Entrepreneurs have benefitted from sharp reductions in infrastructure costs through the adoption of cloud-based computing, applications, storage and services.

• Advances in computing hardware, machine learning and other algorithms to analyze newly available “big data” sets have enabled software to perform increasingly complex tasks at previously unimaginable scale.

• New platforms, standards and tools have made it easier to code, deploy, use and de-bug software.

• Product development and testing have become more continuous, automated and more open to customer input and feedback through technological innovation, A/B techniques, controlled beta tests and crowdsourcing.

• Products are moving to market faster, thanks to shorter product cycles and iterative development processes.

• Distribution to enterprise customers is faster, easier and less expensive because of the adoption of SaaS, freemium and self-service models.

• Distribution to consumers has been fundamentally transformed through the rapid adoption of mobile and social platforms, bringing inexpensive communication, searchable information and real-time consumer choice as well as voice to billions for the first time.

• Selling to enterprises has become easier, because many software products can be tested offline without interfering with production systems; these products can also be purchased at the individual seat or departmental levels – unlike the past, when they were sold to the corporate CIO.

• Purchasing of software and digital services has fragmented and proliferated from the former central control of corporate IT departments; this purchasing process now includes marketing, finance, sales and operations executives who often make independent decisions about digital platforms.

• Selling to global consumers has become feasible for startup entrepreneurs who can access much larger markets because of the dramatic expansion of the middle class in developing countries and their rapid adoption of mobile technology in particular.

• Today’s graduates and ambitious young people are blessed with more knowledge about the most important technological and sociological developments of our era, such as mobile, social and cloud.  At the same time, they are paradoxically cursed with relatively sluggish employment markets – hence the low opportunity cost of technology entrepreneurship and part of its relative career attractiveness.

The bottom line, then, is that starting companies, creating product and reaching customers is lighter, easier, faster and cheaper today. And these factors are expanding the number of entrepreneurs while increasing the need for early-stage funding.

The growing opportunities for venture capital firms focused on early-stage investments will continue in the current investing environment because of the deep and rich support system that they provide entrepreneurs.

Unlike a disparate group of angel investors – most of whom have very small ownership stakes, limited capacity for follow-on investment and fragmented attention – an early-stage venture firm’s team can offer entrepreneurs a focused and cohesive portfolio of resources from multiple skill-sets across varied domains.

The early-stage firm’s networks, methodology and viewpoint can also contribute to the entrepreneurial mentoring and nurturing. There is also continuity, because early-stage firms can help entrepreneurs with follow-on investing, providing preferred access to later-stage venture capital firms and introductions to potential strategic partners, customers and acquisition targets.

At our firm, for example, we offer entrepreneurs the opportunity to meet members of our CIO and CMO Councils, which consist of hundreds of marketing and technology executives from companies like WPP, Merck, Coca-Cola, Safeway, Hearst, IBM and ESPN. We also have a CEO Club for the leaders of our portfolio companies where they can meet regularly to discuss issues of common concern in a supportive, confidential setting.

Enriching Startups

To illustrate the entrepreneurial enrichment that an early-stage venture firm can provide, let’s look at Trulioo – one of our portfolio companies.

Trulioo improves transparency and protects consumers by authenticating real users and denying fraudsters in real time through the validation of social profile information. It has benefited from our introductions to strategic partners such as USTGlobal, and, through them, WalMart and Equifax, among others. This has led to a strategic partnership as well as an investment by USTG.

We’ve also helped Trulioo CEO Stephen Ufford negotiate the acquisition of a company that expands Trulioo’s scope globally to include new countries and important, proprietary data sets. Additionally, we’ve assisted with recruiting and negotiations with other, later-stage investors, who have made offers or invested in Trulioo. Finally, in a joint effort, Blumberg Capital and Trulioo recently organized a startup pitch contest in Vancouver, Canada, to offer value to the technology ecosystem on which both of us depend. The event garnered more than 70 entrants, six finalists and a grand-prize winner.

We’re not alone when it comes to mentoring and nurturing early-stage companies like Trulioo.

• True Ventures runs True University, which provides entrepreneurial education to the engineers, designers, salespeople and marketing managers who help the firm’s early-stage portfolio companies grow.

• First Round Capital has built a platform team to encourage a sharing community among its portfolio companies, hold industry events, promote mindshare and offer consulting services.

• Techstars channels seed funding from over 75 venture capital firms and angel investors and offers mentorship from hundreds of successful entrepreneurs.

• Y Combinator runs a highly competitive admission process for startups, invests seed capital, and then works with the founders to provide mentoring that leads to investor pitch sessions on Demo Day. Y Combinator also provides additional mentoring thereafter.

• The Founder Institute offers entrepreneurs a structured, four-month curriculum of weekly training courses and business-building assignments. The curriculum was built using Silicon Valley best practices, and each training course is led by members of the Founder Institute’s worldwide network, which consists of over 2,500 entrepreneur mentors.

The future will remain bright for early-stage companies and their venture funders. It’s a great time for early-stage IT entrepreneurship and investing, while many alternatives look weak by comparison.

The entire global services oriented economy (more than 50 percent of world GDP) – which consists of financial services, advertising, publishing, logistics, education, health care, travel and retail, for example – is also facing an onslaught of rapid technological change. In the face of such unprecedented change, the only way to survive and thrive is by embracing and adopting a steady stream of next-generation innovation in areas like mobile, social, e-commerce, cloud computing and big data.

At the same time, large enterprises generally have strong balance sheets, brands and distribution channels, but they are weak at innovation. As a result, they’re increasingly reaching out to the early-stage venture capital community, incubators, accelerators and startups to engage more actively. These big companies realize that they need to buy or partner, rather than trying to build advanced technology internally.

Adding up all these factors, there are many exciting opportunities for early-stage startup entrepreneurs and their early-stage VC funders to cooperate. And I believe that they will collaborate in coming decades, by launching a variety of exciting new technological innovations that will transform our lives, businesses, institutions – and the world over – in ways that are scarcely imaginable today. It’s a good time to be an IT entrepreneur, to work for a startup, to invest in startups, to partner with startups, or to buy from startups.

It’s strategic to be early, and early is beautiful.