What We Are Seeing
The Wall Street Journal has a story out today that says "Web Startups Hit Cash Crunch." There has been a fair bit of reaction in the tech blogs and I thought I'd toss into the discussion some things we are seeing:
1) There are so many startups out there raising money. I don't think this is a bad thing. It's a good thing. Entrepreneurship is in vogue. Innovators are innovating. Makers are making. But I cannot remember a time when we have gotten more inbound traffic. It is not just coming from entrepreneurs. It is coming from angels, seed investors, VCs, lawyers, accountants, friends, aunts, uncles, you name it. I'm waiting for the guy who sits at the front desk in our building to pass me a business plan on my way into the office.
2) There are a lot of "me too" investments out there. And the delineation between startups is getting narrower. Almost every investment that comes our way these days causes us to ask ourselves "is this too close to xyz?" with xyz being one of our exisiting portfolio companies. The startup market is hypercompetitive. The user base is finite at some level. The capital markets are finite at some level. And the number of startups chasing these markets seems to have doubled or tripled in the past couple years.
3) VCs are having a tough time raising money. The conventional wisdom is that 10-20% of venture funds produce 100% of the returns in the asset class. LPs (that's what we call our investors) are all chasing that top 10-20% and that leaves 80-90% of the VC firms struggling to raise money. The one bright sign in LP land is that emerging managers (what USV was a few years ago) are getting more attention from LPs. I'd rather be a new firm raising a first fund than a mediocre firm raising fund five right now.
4) Angels may be topping out, at least temporarily. This is more of a guess than the previous three. What happens to every angel is that they start making investments. They get excited. They make a bunch of them. And then two things happen. First, a few of their investments struggle and fail. And second, a few of their investments can't raise money and come back to them for a second round. They begin to realize that startup investing isn't so easy and that they have a finite amount of money they can invest or that they are willing to invest. They pull back a bit, see how things are going to play out, and become a bit more cautious. Given the massive amount of angel capital that has come into the market in the past few years, I wonder if we are seeing some cooling of that market as all the new investors take stock of where they are and where they want to go next.
5) The internet investing market is transitioning. Social was the driving force for the past three or four years. In the wake of Facebook and Twitter, how could it not be? Mobile has also been a hot theme. Both sectors have consolidated a few winners and a number of additional interesting emerging companies. But how many social platforms of scale will there be? Five, ten, twenty? And mobile is hard because distribution continues to be limited to the app store model where you get on the leaderboard and win or you don't and you don't. Investors are moving into new areas like cloud, peer to peer marketplaces, and trying to take what worked in consumer into the enterprise. There is no lack of interest in internet investing, but investors are having to learn new markets and new sectors. And that kind of transition takes the heat out of an overheated market.
So, is there a "cash crunch" for web startups? Not that we are seeing. Our portfolio companies have all been able to finance themselves when they have wanted to. And we have made more investments this year than any year we've been in business (maybe 10-20% more, not 2x more). But I do believe we are in for a bit of a reality check. We've had quite a run here and all big runs are followed by pullbacks. The public markets for stocks and bonds has been relatively weak all year and that has to have some impact. It is likely that we will see more startups having trouble going from the seed round to the A round, or from the A round to the B round.
That's a good reason to take money from a firm that stands behind its portfolio companies. At USV, we have never failed to do at least one follow-on round with the sole exception of Delicious, which sold to Yahoo! instead. We don't promise the next round. We don't commit to it. But we are supportive to a fault. And we are proud of it. Being an entrepreneur is hard. Having supportive and caring investors helps. In the market we are in (or heading into) it will help more.