The venture capital world is constantly changing, and its evolution can sometimes flip pieces of conventional wisdom on their heads. For example, a recent flurry of extension rounds from Silicon Valley’s hottest startups like Stripe and Robinhood seem to signal that the investment type has suddenly become cool.
Extensions evolving from unloved to hot is not the first time that a type of VC deal has gained, or lost luster. In past times, for example, raising consecutive rounds from the same lead investor was often perceived as a negative signal; why couldn’t the startup find a new, different lead investor? Today, in contrast, venture capitalists are using inside rounds to double-down on winning startups, a way of helping ensure returns for their own backers.
The recent phenomenon of extensions becoming vogue is a tale of the times, in which the best startups get to play offense, and startups that can’t show accelerating growth are left behind. Let’s explore what has changed.
A series of fortunate extensions
TechCrunch first wrote about the new extension-round trend after seeing what felt like a wave of the deals crop up. Some were large, like MariaDB’s huge $25 million add-on to its Series C, or Robinhood’s biblical $320 million addition to its Series F.
But most were smaller events like Sayari adding $2.5 million to its Series B, or CALA adding $3 million to its seed round. Even more recently, Eterneva raised another $3 million on top of its seed round, and also out this week was a million pounds more for Edinburgh-based Machine Labs’ seed round.
One reason for the growth of extension rounds in 2020 has been runway — making sure that a startup has enough. Upstarts often raise on an 18-month cadence. But because of COVID-19 and its constituent economic disruptions, many have reduced costs in a bid to bolster how long they have until their cash stores reach zero.
According to Redpoint Ventures’ Astasia Myers, “due to COVID-19, many companies re-evaluated their financial position and strived to achieve two years of cash runway” in response to market uncertainty. A result of this, Myers said, was “an uptick in bridge rounds [in] March through early May.” She added that the cadence of that round type could “slow to historical averages as businesses in [that] position have raised capital” or pursued a “different path.”
Rich Wong, a partner at Accel, said that startups historically bet on “filling up the gas tank” of capital every two years without compromising on valuation or dilution. But cash in the bank is much like insurance these days — there’s an increasing premium on it.
“Insurance gets more expensive when it looks like a hurricane is coming, so in an ideal world you have that buffer of extra safety from anytime in 2019,” he said.
Kiva Dickinson, co-founder and general partner at Selva Ventures, said that if a portfolio company needs money, most existing investors don’t want to initiate a down round, but often are not willing to increase valuation in the environment either.
“Extending the previous round has become the common compromise,” he said.
It is also true that extension rounds might make more sense in today’s virtual world than they did before.
While remote dealmaking is happening, some investors still struggle with sending a $2 million check to someone they have never invested in before. And, of course, some new financings are not directly related to pandemic woes but are just left over from pre-COVID days.
Perfect Day Foods, which raised a $160 million extension round on its first $140 million tranche, said that it received interest from its new investor after disclosing its initial Series C round in December.
From defense to offense
As COVID-19 rolled deeper into Q2, the startup market didn’t shake out as expected. VCs didn’t stop investing and startups didn’t stop growing. Some, that is.
More startups have seen their growth rates maintain, or even accelerate, in the COVID-19 era than many industry insiders and observers expected. This has loosely divided the startup landscape into COVID haves and COVID have-nots.
Startups were ready to accept the demand, meaning that instead of falling off a cliff many saw their growth accelerate. As hundreds of millions of workers began to toil from home, and millions of companies had to accelerate their previously ambulatory digital transformation into a jog, the demand for software, services and tooling went up.
This has changed the tone of more recent extension rounds from defensive to offensive.
Or as Precursor Ventures’ Charles Hudson put it in an exchange with TechCrunch this week, March and April were periods “about survival,” while the May and June time frame “has been more about strength.”
Other VCs agree. Homebrew’s Hunter Walk told TechCrunch “even strong companies are choosing to raise a ‘seed-2’ top-off from current investors,” and other capital sources.
Paying for growth
For startups that have caught a COVID-tailwind, how to best manage the boon isn’t always clear. Or affordable.
Jenny Lefcourt of Freestyle Capital, another seed-stage firm, told TechCrunch in an interview that rounds that she calls “toppers” are being raised by accelerated companies for a notable reason, namely that some early-stage startups are seeing areas of opportunity in which they they may want to invest, but are leery of risking lowering their runway time frame.
By raising a bit more cash — merely a top-off or extension, mind, not a full round — they can invest in those areas while keeping their net runway position static.
The result could be faster growth against a similar building period ahead of the startups’ next priced round. This could lead to a better valuation when they do go to raise again. The startup is therefore accepting a little more dilution now to help avoid greater dilution down the road.
2020 is not like 2008, according to Lefcourt. In 2008, she told TechCrunch, it felt like the market froze. In 2020, however, you are either starving or voracious, she explained. Either every investor wants into your round, or no one wants to know you. And many that already do don’t seem to mind putting a few more dollars to work.