Compared to a year ago, startup valuations have dipped across the board, no matter if you’re a startup raising a seed round or a Series E.
But there’s good news if you’re a growth-stage startup: Valuations for startups raising Series A, B and C rounds across the world ticked higher in Q1 2023 from Q4 2022, according to data from CB Insights.
That said, it’s not looking good for early- and late-stage deals: Valuations for angel, seed, Series D rounds and later-stage rounds are trending downward globally.
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In the United States, however, PitchBook data paints a different picture, one that confounds and fascinates at the same time: Seed-stage valuations have climbed higher, while Series A, B, C and later-stage deals are worth less now.
It appears startup trends in the U.S. are diverging from the rest of the world: What’s going up in the U.S. is going downward elsewhere, and vice versa.
This dissonance is interesting, but today we’re going to explore a question that’s even more intriguing. If we continue to see valuations rising for startups raising seed rounds while later-stage prices dip, how long will it be until the journey from seed to Series A becomes one that sees companies losing value?
The problem’s pretty obvious: If Series A investors are willing to pay less than they used to as seed rounds get costlier, startups may wind up stranded when they’re ready to raise a Series A, finding themselves unable to raise a round at a price that makes sense given their existing valuation. This could force them to raise extensions or bridge rounds, or even cause them to come up with horrid names for financings like “pre-pre-pre-Series A,” as they try to stay alive until a viable valuation materializes.
Of course, the best startups won’t trip on the climb from seed to Series A because they are exceptional. But what about the average seed-stage startup today? They might find their first lettered round much harder to land than their older peers did, not to mention that they’d have to pitch to a group of investors with different expectations.
Signs of what’s to come?
The median pre-money valuation for seed-stage companies rose 16.9% to $12.9 million in Q1 2023 from Q4 2022, and 28.6% from a year earlier, according to PitchBook.
In contrast, the median pre-money valuation for growth-stage companies declined 5.7% to $38.2 million in Q1 2023 from Q4 2022 and dipped even more compared to a year ago. The median valuation for late-stage startups was similarly down by 8.3% from Q4 2022.
You could argue that startup valuations are simply correcting across the board, becoming more equitable, since seed deals were underpriced and later-stage deals were overvalued. But that seems unlikely, given that seed round valuations keep rising, despite the sheer amount of carping over seed prices that we’ve had to endure since time immemorial.
We are not saying that growing seed-stage valuations will doom an entire generation of startups in the U.S. We’re simply noting that the seeds of a future Series A-ish crunch are likely being planted as we watch.
The math works out, but at what cost?
One reason for the rise in seed-stage valuations could be the fact that investors are stingier than ever before.
When the market was in overdrive and crossover funds were hyperactive, investors didn’t think twice before paying buckets of money for a share in a hot company. Now, everyone is looking for a bargain, which, in practice, involves trying to get into the future’s hottest companies as early as possible.
A16z’s rumored move to set up a formal fund of funds reflects the growing appeal of empty cap tables at promising startups. The investment firm is apparently looking to use the fund of funds to distribute capital to emerging fund managers, who would in turn invest in young startups and advance its own investments.
The math makes sense. The best time to get into a company at a good price is to invest early. If we are talking about a potential IPO candidate, granting it a high valuation at the seed stage won’t really matter in the long run. This likely explains why seed-stage valuations are climbing despite current market conditions.
The problem with that approach is, not every startup is a rocket ship. Many will fail, and even those who survive will have to get past key milestones to raise money. If investors are lax with seed valuations but want to frown and mutter when evaluating later rounds, aren’t they simply pushing startups towards a cliff?
It is impossible to talk about the seed stage in the U.S. without touching upon Y Combinator, especially since it changed its standard deal. Its decision to invest $500,000 in startups in its batch is likely contributing to the surge in seed-stage valuations. But the main factor here is its “most favored nation” clause, which likely impacts how seed-stage deals are priced in the market.
Obviously, Y Combinator is doing what works best for its core activity, which is placing early bets on rocket ships. But its decisions are extending the gap between the seed stage and what follows.
Of course, many investors are mindful of this growing disconnect and are trying to find solutions.
For instance, we heard in our latest psychedelics medicine investor survey that VCs are asking each other about a seed-stage team’s ability to raise their next round before they invest. “Our due diligence process now involves speaking to Series A and B investors to understand what they’d need to see for each potential investment to be investable,” Greg Kubin and Matias Serebrinsky, general partners at PsyMed Ventures, told TechCrunch+.
What else will the market come up with to avoid putting seed-stage startups up against the wall?