The Early-Stage Slowdown Explained: Nasdaq and FOMO

Earlier today, The Information reported a story suggesting that the “smart money is betting less on early-stage tech startups.”

Its evidence? Data provided by SignalFire, a venture firm and real-time information platform that says blue-chip VCs accounted for 5.3 percent of Series A funding in the first nine months of this year, down from 6.1 percent last year and 7.5 percent in 2013.

The downward trend isn’t entirely new, as investor Keith Rabois tweeted this morning.

For what it’s worth, we reported on the early-stage slowdown in late September. Still, the reasons for it haven’t been crystal clear.

We’ve speculated it could be anything from a seasonal slowdown to uncertainty in China to nervousness about the capital markets.

Now some investors suggest the impetus was, indeed, tied to a brief but somewhat terrifying plunge that Nasdaq took last summer, an event that made many rethink how much they were spending on startups — and the rate at which they were spitting out term sheets.

“I think deals are getting done; they’re just getting done a little more slowly,” says founder-turned-investor Jason Lemkin, who quietly left his role as managing director at Storm Ventures recently and is now investing on his own behalf.

Earlier in the year, a startup would receive “not just multiple term sheets in a week, but everyone was using preemptive offers, meaning they wanted to do the deal today and pay today’s price,” says Lemkin.

“Then Nasdaq peaked over the summer,” and investors began to realize they were funding “a lot of stuff that’s pretty good.” The problem, he adds: “VCs can’t fund pretty good. Pretty good leads to lots of carcasses. So things slowed down.”

VCs are still writing checks, Lemkin notes. But they want to see two to three times the revenue they did before providing the same terms as earlier this year.

“Before, a VC would give the company with $1 million [in ARR] $18 million in funding at a pre-money valuation of $60 million. Now, they want to see $2.5 million for the same terms. It’s multiple compression. VCs were learning forward 24 months; now, they’re maybe learning forward 12 months instead” because they’re feeling more risk averse at the moment.

Rabois, who invests on behalf of Khosla Ventures, appears to agree. Asked if if he’s been taking fewer meetings with startups, he says Khosla’s team is “looking to invest as aggressively as ever.”

But he also says that investors are “reverting to historical standards of diligence instead of jumping at the latest trendy company.” The end result, Rabois says: “Founders can longer rely on FOMO as a way of forcing a highly accelerated process.”

Sounds like there isn’t too much reason for good founders to be concerned. Venture is notoriously cyclical, and one could see sentiment changing as abruptly as it turned a few months ago.

In fact, Lemkin and Rabois agree that now is no time to more meaningfully slow things down, no matter what the public market is doing.

“In my opinion, it’s highly irrational to alter seed investments and most Series A decisions based upon the current environment,” says Rabois. “These companies will be valuable five to 10 years from now.”

“These are the best of times for certain companies, particularly [software-as-a-service] startups,” says Lemkin.

“People who have been around for a while [founding and investing in enterprise startups], our jaws drop when we see how well some of these companies are doing. The markets are bigger, so the bar is higher. But if you sit this out because the market was overheated earlier this year, you’re a fool.”