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Seed Investing Report | Winter 2012

The Series A Crunch and Startup Orphans

With all the talk about the Series A Crunch, we wanted to offer a data-driven perspective into what is happening (and what will happen) in technology Seed investing.
This report analyzes 4056 seed investments made into US-based technology companies since Q1 2009. Seed investments are early stage financings (typically less than $1.5 million) made by either angel investors (those investing their own money) or venture capitalists (those investing others money) or some combination of the two. Below is a summary of findings:

The Series A Crunch is Just Math Despite the concerns about a crunch, the reality is that the level of Series A activity is holding steady. At the same time, the number of seed deals have exploded. As a result, the Series A Crunch is nothing more than excessive demand for a limited supply of Series A financings. The natural selection this forces will be a net positive (see below) but will mean that many startups will be orphaned and that some investors will lose their money. 1000+ Startups Will be Orphaned; $1 Billion+ Lost The process of natural selection that will happen with seed companies (and which wed argue should happen) will result in over 1000 recently funded seed companies becoming orphaned, i.e. unable to raise follow-on financing. This will result in over $1 billion of investment into these companies being incinerated, but again, this is nothing new. Seed investments are the riskiest bets an investor can make and the reality is most will not return money. Again, the death of startups and the loss of investment dollars is part of the process of separating the best companies and investors from the rest. The eventual death of many of these companies may also help the tight labor market for other startups who are looking for capable and driven talent. Seeded Cos Need 13+ Months to Raise Next Round Across quarterly investment vintages, we see that it takes seeded companies slightly more than 13 months to raise financing on average. The speed with which follow-on financing is raised has seemingly accelerated over time. As the leverage increasingly looks like it is shifting towards investors, it would seem that the amount of time it will take to raise follow-on financing will increase over time for recent and future vintages.

Almost 4 of 10 Seeded Cos Get Follow-On Financing On average, 39.4% of seeded companies go onto raise follow-on financing. Interestingly and contrary to what the punditry have often said, seed deals in which VCs participate have a historically higher rate of getting followon financing as compared to seed deals in which VCs are not participating. Internet Sector is Tops for Seed Deals Not surprisingly, the internet sector is the primary destination for seed investing. Interestingly, follow-on financing rates to the computer hardware & services sector is the highest of all tech sectors. Cali and NY Dominate for # of Seed Deals California is the clear #1 for seed investment activity followed by New York, which is a strong #2. Massachusetts is a distant #3 but in terms of the rate of follow-on financing, Mass has the highest rate. The New York seed boom which has buoyed the states investment activity #s for some time probably also means that NY will see the highest proportion of orphaned startups. This could also spell opportunity for those in the acqui-hire game or for companies looking to recruit talent away from these companies.

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Seed Investing Report | Winter 2012

The Series A Crunch is really just about supply & demand. Too many early stage companies chasing too few deals.
Seed financings steadily climbed through Q3 2012 but are down significantly in Q4. Over the same span, Series A rounds have held relatively steady. The reality is that the supply of Series A financings is in-line with historical levels while the demand for Series A is excessive. This supply-demand imbalance will lead to many orphaned startups.

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Seed Investing Report | Winter 2012

1000+ startups will be orphaned in the coming quarters. These companies will have raised over $1 billion collectively.
Based on historical follow-on financing rates for seeded companies between Q1 2009 through Q2 2011, we can forecast nearly 1000 to 1400 companies first financed from Q3 2011 to Q4 2012 will be unable to raise follow-on-financing.

Orphaned Startup Waterfall - Notes

Seeded Cos: Q3 2011 - Q4 2012. CB Insights tracked 2283 cos from Q3 2011 through Q4 2012 that have received some type of seed funding. This includes angel financing as well as Seed VC financing which are seed rounds in which VCs participate. Companies Receiving Follow On Funding. Of these 2283 cos that have received seed funding, 102 cos have already received some type of follow on funding (Series A, B, C, etc.). Given that on average it takes 13.4 months for seed-backed companies to raise follow-on financing, these are typically the companies that demonstrated the most traction, had the best management teams, etc. Companies Acquired. Of the remaining 2181 cos, 212 have been acquired or acqui-hired after receiving seed funding but before receiving follow on funding. Projected to Receive Follow On Funding. According to historical CB Insights data, the average follow on rate for mature vintages of seed companies (Q1 2009 through Q2 2011) is 39.4% (our base case). At this rate 778 of the remaining cos will receiving follow on funding. In addition to the average of 39.4%, we also looked at two scenarios the best vintage performance for follow-on financing (49.5%) and the worst (27%). At a 49.5% follow on rate, 975 companies could potentially receive follow on funding and at 27%, this number dips to 532. Companies Projected to be Orphaned. In our base case scenario, we see 1181 cos that will not receiving follow on funding considering the average follow on rate of 39.4%. At a 27% follow-on rate, this number jumps to 1437 and dips to 994 at 49.5%.

Not all orphaned startups will die.

Orphaned startups implies that they will not be able to receive additional financing. Some of these companies may be generating cash flow and be profitable allowing them to continue being in business. In other words, not all orphaned startups will die.
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Seed Investing Report | Winter 2012

Companies average 13.4 months from seed to follow-onfinancing. The time to raise follow-on financing was lessening. That trend will probably end.

Illustrated in the chart above is the average time in months for co who received seed funding to raise follow on funding, grouped by vintage quarter. Immature vintages are those in which seeded companies have not been in existence long enough to credibly judge follow-on financing activity and rates.

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Seed Investing Report | Winter 2012

Percent of seeded companies receiving follow on funding at 39.4%. No clear trend by vintage apparent.
Excluding immature vintages (Q3 2011 and later), the average follow-on financing rate for companies that raised seed funding has averaged 39.4%.

www.cbinsights.com

Seed Investing Report | Winter 2012

Seed deals in which VCs participate have grown steadily but remain fewer in quantity than non-VC Seed deals.
From the previous data set, weve isolated seed VC deals, or deals in which VCs participate from those which are non-institutional, i.e., they only involve angels. While there are slightly fewer seed VC deals than angel-driven seed deals, both types of seed deals display similar rising trends over time and weakness in Q4 2012 (QTD figures).

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Seed Investing Report | Winter 2012

Interestingly, and contrary to what pundits have said, companies receiving Seed funding from VCs have a higher rate of receiving follow-on financing than when no VCs participate.
Seed deals in which venture capital firms participate tend to have higher follow-on rates across almost all mature vintages. All the concern about signaling risk and the like from VC participation in Seed rounds appears to have been a bit overblown.

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Seed Investing Report | Winter 2012

Internet ranks #1 in seed funding; Hardware & Services rank #1 in follow-on funding.
Internet sector saw 2754 deals between Q1 2009 and Q4 2012. Hardware & Services enjoy the highest rate for follow on funding at 36% .

www.cbinsights.com

Seed Investing Report | Winter 2012

Cali dominates and New York is the clear #2. Mass beats all markets in rate of follow-on financing its seed companies garner.
New York which has had a very high percentage of its investments in seed deals and which doesnt put up big Series A and B numbers may find itself with more startup orphans than other geographies.

www.cbinsights.com