Shrinking

Shrinking

Last week's editorial was titled Gone. This week's is titled Shrinking. By some measures, that is an improvement. But last week's object of study was dying business models, DVDs, Magazines, and Buzzfeed. This week's focus is Venture Capital. And it certainly has not gone and is not going.

But it is shrinking.

Crunchbase News carries an overview of Seed, Series A, B, and C round shrinkage, both my number of rounds and the average and median raises at those rounds. But the more poignant is a second sister piece on Fintech. In that piece, Gené Teare summarizes where we are in the correction that began in private markets last year. The emphasis is mine.

Now let's look at companies that have raised funding - anywhere from seed to Series C - by year but have yet to raise funding in subsequent years. These are the companies in danger of running out of runway if they don't get additional capital.

Around 900 seed fintechs globally that raised at least $1 million in funding have not raised funding since 2021, an analysis of Crunchbase data shows. Another 1,400 seed-stage companies raised at least $1 million in a single seed funding in 2022 and have not raised again in 2023.

Of the Series A through Series C funded companies that raised funding in 2021, about 1,000 - around 65% - have not raised since 2021. A further 1,100 companies from Series A to Series C raised funding in 2022, but not again.

For companies funded at seed through Series C in 2019 and 2020, by contrast, roughly a third did not raise funding in subsequent years. Those companies have had more years in which to raise follow-on funding, but were also funded in a climate where median fundings and the absolute number of companies funded were lower.

Connect this to the points concluded in her first article and a picture emerges:

While it is clear we are not going back to funding levels from a decade ago, the question is whether round sizes will shrink back to pre-pandemic levels.

For now, the only stage we analyze here that's dropped below 2020 levels is Series C funding. But even Series C is still above the 2019 median and average round size.

What we can say is that the reset is only two to three quarters in and likely has not yet hit bottom. Each distinct funding stage is reacting to the cuts in the stage after it. If late-stage funding continues to contract due to the closure of the IPO markets, then startups at earlier stages face an uncertain future.

This correlates to Redpoint Ventures' analysis from a couple of weeks ago.

On this chart, your eyes naturally go to the downward curves in 2000, 2008, and 2022. But the real story is the flat bars that follow for several years. The normal recovery after a deep correction is over ten years.

Now, there are many important drivers in 2023 that did not exist in prior cycles. Over 4 billion internet users, the emergence of AI and its value creation potential, CRISPR and other BioTech innovations driving human health, quantum computing, new sustainable materials due to chemical and biological science progress, and possibly new cheap energy. All of these will provide ample sources of growth and value. Venture Capital will recover, possibly quickly.

We cannot even rule out that rational investing behavior will lead to a new bubble, especially in AI. But the power to attract capital at scale will belong to companies doing their Series A in 2023 and after.

Those who raised seed and Series A in 2020 and 2021 will, as Gené says, need to consider big valuation changes to qualify for 2023 B, C, and D rounds. That is a lot of companies. It will lead to more failures than has been normal. Or, to put it another way, the slowdown on Series B for 2020, 21, and 22 Series A companies is not just a slowdown. Without action, it is a signal that they may never do a Series B. That would imply there are two ecosystems now in startupland. One that raised a Series A before 2023 and one that has raised since. The second will be part of the new normal.

Like all projections, this one will be wrong in many cases, so if you are one of those founders, don't panic. Simply ask what needs to be done and do it.

Many things that were true in 2022 and before are no longer true. Here is a partial list:

There will be over 100 unicorns every year

The time between funding rounds will often be less than 12 months for good companies

You need an 18 month runway

Assumptions about valuations at each round and amount of dilution

Assumptions about IPO timing

Multiples of ARR needed to achieve a valuation

Growth investors will fight to get into the best B,C, and D rounds

Opportunity funds are a good idea

Funds will raise every 2-3 years

There are many more of these former truths that are no longer true. Knowing them is key to navigating the next phase. In that phase, capital is sparse, the quality bar is high, and past investors may not follow on. The quality of execution will be more important than ever, as well as the scale of the target market.

It is likely that the class of 2023 seed and Series A rounds will produce some of the biggest companies yet. Knowing which they are and engaging with them will produce very well-performing funds. More in this week's video on Saturday.