Early-Stage Investors Apply The Brakes

In June, Fred Wilson of Union Square Ventures penned a widely read post using data from the law firm Cooley that showed, in Wilson’s words, that seed and Series A deals were “more or less healthy” while Series B deals were “getting overheated” and Series C and later deals had “gone crazy.”

Something appears to be changing, suggests new data from the market research company Pitchbook. Seed and Series A deals aren’t just healthy. They’re slowing down. A lot.

Based on the numbers, investors poured $1.95 billion into early-stage startups across 115 deals in the second quarter. As of Friday, we’ve seen $300 million invested across 66 deals in the third quarter, and there isn’t much time left. The quarter ends Wednesday.

There could be numerous factors leading investors to taper off their deal-making. The Federal Reserve will probably raise interest rates before year end, which could spur newer startup investors to look for more certain returns in fixed income or dividend-paying stocks and turn them off to riskier private-market investing.

China’s rocky market — which unexpectedly if briefly dragged U.S. markets down, too, in late August — could be playing a role, too.

As venture capitalist Brian O’Malley told us in the immediate aftermath of that frightening nosedive, the current market has grown “scary. We have a lot of investments in companies that are going to need to raise money, and I think there are starting to be enough signals from the global markets that, at some point, it has to impact the private side.”

It’s also the case that when market volatility hits, the “two groups that scatter to the hills the quickest are the late-stage investors and the angels,” as noted VC Greg Gretsch of Jackson Square Ventures when we talked with him most recently. “It might be interesting to see if there’s a market decline in the level of angel interest over a period of time,” he’d added.

At TechCrunch Disrupt last week, early-stage investors said they were, in fact, writing fewer checks, though they cited different reasons.

“[T]his year, we’ve been slower to invest partially because in our analysis, there are years where there are lots of new ideas and big swings that are going for new industries,” said Aileen Lee, cofounder of Cowboy Ventures. “I feel like last year and maybe the year before were better years for big new ideas. This year, we haven’t seen as many.”

Meanwhile, Dana Settle, cofounder of Greycroft Partners, told the audience she’s grown wary of inflated valuations.

Though seed stage deals “aren’t crazy when you look at Series and Series B valuations,” Settle said, there are plenty of reasons for pause. As she explained it: “When you look back to 2012 through today, the pre-money valuations have essentially doubled. And that’s just not healthy for the overall ecosystem… [When] you sit back and you look at [current] average Series A valuations at $20 million and Series B valuations at $40 million, then you look at average exits going back for 30 years, with 90-plus-percent being at around $100 million to $125 million, the math gets tough when you add in the risk.”

There could also be also be a trickle-down reaction at play, according to Semil Shah, founder of Haystack, an active-seed stage micro fund that, like most firms, is in constant communication with existing and potential investors. “A lot of [the institutional and individual investors who fund venture funds] have held off making commitments because they’re affected by capital markets,” and when investors’ investors start getting nervous, fewer checks tend to get written out to startups.

Of course, another possibility may simply be timing. Summer means vacation, and deal-making often slips in the third quarter. Interestingly, though, that hasn’t really been the case in recent years, as you can see in the chart below by Pitchbook.

Check it out for yourself, and let us know what you think.

PitchBook Analysis of VC Deals

Here is a link to the spreadsheet.

[Disclosure: Shah is on the advisory board of StrictlyVC, a startup founded by this editor.]