Victor Basta hit a nerve with his article on TechCrunch last week describing the “implosion” of venture capital over the past 36 months. Using PitchBook data, he found that the total number of VC rounds committed to startups has declined from 19,000 in 2014 to 10,000 estimated for this year, even while dollars invested has remained mostly static.
Silicon Valley is no longer making it rain so much as it is making it trickle, and that makes it much harder for startup founders who are just trying to get going building their companies. My conclusion is that we have a massive “first check problem” that goes beyond the vagaries of the investment market.
First though, let’s go through some alternative explanations. Basta posits that the end of the app and SaaS booms are largely to blame, along with a drop-off in investment in fintech.
Union Square Ventures investor Fred Wilson added his own two cents over the weekend, writing that, “When I talk to my friends who do a lot of angel investing, I hear that they are being more selective, licking some wounds, and waiting for liquidity on their better investments.” Similarly, “When I talk to my friends who started seed funds in the past decade, I hear them thinking about moving up market into larger funds and Series A rounds.” Wilson’s conclusion is that “For investors, it means seed rounds are going to be the place to be.”
There is some truth that investors are moving upstream. I analyzed a list of top angels and early-stage investors from 2012 to see how some of the highest-flying players in the Valley have changed their careers over the past five years.
The most common pattern is simply that highly successful angels now have their own institutional funds or have joined well-established VC firms in the Valley. Kevin Hartz joined Founders Fund last year, Keith Rabois joined Khosla, Shervin Pishevar founded Sherpa Capital in 2013, Joe Lonsdale put together the ill-fated Formation8 in 2011 before launching 8VC in 2015. And, of course, Marc Andreessen and Ben Horowitz converted a very successful angel investing career into one of the top mega funds of the Valley.
And a huge number of that list of top investors also expanded the size of their funds. Take Garry Tan, for example. He founded Initialized Capital in 2011 with a $7 million first fund, but last year closed on a $115 million vehicle for the firm’s third fund. That’s the story at a lot of places, from accelerators like Y Combinator or 500 Startups, to former super angels like Jeff Clavier, whose newly rechristened Uncork Capital (formerly SoftTech VC) increased its fund size from $12 million 10 years ago to $100 million last year.
Indeed, going through that list from five years ago, I had expected to find a bunch of people who had backed away from investing. There are definitely a few who are investing less today according to Crunchbase, but the reality is that success has begot success, and the most influential investors have largely remained so. So the cause for the implosion isn’t that a bunch of top investors suddenly decided to go home.
Instead, I see the challenge being purely the friction in the earliest round of a startup, what might be called the “first check problem.” Wilson is right when he says that seed investors are being more selective. As angels investing their own capital have professionalized by raising institutional dollars, they have added more and more steps to their due diligence process.
Founders I have spoken to who have recently fundraised — some of whom are on their second or third company — have told me that the level of diligence at the seed stage seems to have increased significantly over the past few years. Outside the blockchain space, where there is that “Wild West” throw-money-at-everything vibe, the days when you could load up on capital by just having a deck and a bold presentation seem to be closing.
That’s probably good on a risk-adjusted financial basis, but is devastating for a startup ecosystem. Indeed, there is a huge gap in the market for first check investors, the investor who believes in you the founder before any other data or proof is available. Being the first check in a company used to be a deep badge of honor for angel investors, but I have heard that boast less and less over the past five years. Everyone wants more data and evidence, everyone wants to reopen the last round rather than to lead the next one. So founders wait, and hustle, and try to construct a round as best they can. That friction shows up directly in the numbers.
There is still plenty of capital for great companies. Indeed, if you can build an extraordinary company, it has never been easier to go from single-digit millions to single-digit billions in valuation in a shorter period of time. But almost all startups start out ordinary before they become extraordinary, and without those first checks, they will never be able to make it.