Make Series A’s Great Again

Over the past few weeks, I’ve caught up with and hung out with some of the larger investors on Sand Hill and beyond. At the same time, I am helping lots of seeded companies begin to think about and/or prepare for their Series A. As every seed investor and firm touts their “value add” as being a bridge from seed-to-Series A, the realities of that pitch are now being tested — the bridge is longer than one imagined. Many of the large VCs I’ve talked to have remarked that not only has their own investment pace slowed down (and not just in 2016, but even back into 2015), that this is true within their funds at large. Yes, Series As are happening, but the shape of them has been contorted — smaller (or healthier) check sizes, more ownership for the VCs (and more risk), and fewer and fewer deals coming by with fundamental momentum.

I don’t mean to write this in a negative light, as I think it’s healthy. It’s just where we are now. I know that everyone will say they’re still active and willing to invest, and that is true, but based on what I’m hearing from founders on the street and what the deal pace is for larger checks, the market seems to be waiting. I’ve been thinking about why we are here and how it happened. My list so far:

1/ Valuation compression from over-valued Series Bs: Many good companies raised at valuations that were too big. They’re now coming back to market and new investors don’t want to be the bad cops and suggest recapping the company. That realization of overfunding at B has trickled into the Series A consciousness and slowed the pace down.

2/ At the same time valuations at Series A have come down (with less momentum), many of the larger funds on Sand Hill have gotten much bigger in the last year. As the funds hold more money under management, but the check sizes they can justify for smaller As are smaller, some funds have decided to wait, to elongate their investment period, and make sure to deploy capital at the optimal point on the risk-reward curve.

3/ The excesses of capital in the seed market and plethora of companies makes it easier for new companies to be started, but also harder for talent pools to form around an early company. Talent is incredibly fragmented. Everybody wants to be an owner. A hot team of 5-10 core builders who could’ve formed a strong unit 5-7 years ago could today spawn three (3) new startups inside, each of them fighting to recruit the same talent from a dwindling pool.

4/ At the same time, many seed investors, most of whom are newer, younger, and less experienced in fund management (including yours truly) spent most of 2014-15 seeding companies with other peoples’ money earlier in the company lifecycle, at the point where traditionally friends and family or even founders would be putting in most of the cash. Now, many of these companies need extensions or bridges or prime rounds or second seeds, or whatever you want to call them.

5/ The end markets seemed to be tightening up, too. Yes, yes, I know, something will breakout and we will all be surprised, but if you think about what share of the consumer wallet is left to grab or if you consider how every enterprise application or infrastructure product takes on a SaaS model, every single SaaS startup is fighting with each other to get a share of budget using the same business model. (SaaS overload is so real that I just funded a startup whose mission is to help CFOs at large enterprise companies identify and manage their various SaaS subscriptions.) This may be why folks have gravitated to the frontier stocks, investing in new emergent technologies and spaces.

Again, to repeat, this isn’t a negative post — I think it’s all moving in a positive direction. It’s taking a while for the tide to go out, and new things will emerge that will surprise us. But for fund managers who have seeded companies, the reality of the gap between seed and Series A is beginning to look like a canyon, and it will take more time, money, and grit to get to the other side — some of those teams will score their Series A, but that checkpoint isn’t the end all, be all — some will also begin to partner earlier with larger companies in their industries and/or even be acquired. It will be interesting to see which teams and investors hold the right map to traverse the course.