Posts from VC & Technology

The Seed Slump

I have written a bit about this topic in recent years, at the end of 2017, and again when the 2018 numbers started showing up.

What has happened over the last five years in venture capital is the seed boom stalled out, the late stage market exploded, and the traditional venture capital business (Series A and Series B) largely remained the same except round sizes, valuations, and fund sizes have all gone up.

Mark Suster posted a great analysis last night of why the seed stage market has stalled out. It comes down to the fact that the traditional venture capital market has not changed much so creating more supply has not resulted in materially more demand.

This chart tells the story well:

As Mark explains, the seed market remains alive and well, but it has grown so large that it can’t continue to grow unless the traditional venture capital market grows too and that has not happened, at least not anywhere near the rate that the seed stage market has grown.

In a companion post, Mark lays out the new architecture of the startup capital markets:

In the first five years of this decade, we saw the seed portion of the market explode. In the last five years of this decade we saw the growth portion of the market explode. But over those last ten years, the middle part, the traditional venture capital market, has not changed much.

That’s an interesting observation in and of itself and something that makes me wonder if that is the next shoe to fall.

Raising A SAFE Or Convertible Note In Between Rounds

A trend we’ve seen in the financing of startups in the last five years is the “SAFE between rounds” which means raising a convertible note (or SAFE) to provide more capital and runway in between financing rounds. It often comes in the form of an offer by an investor who missed the last round and doesn’t want to miss the next round.

It is a tempting offer because there is no immediate dilution from the capital and it usually converts at the next round price or a small discount to it.

Most founders look at the offer and think “why not?”

Here is why you might not want to do this.

The SAFE or convertible note can “crowd out” new investors in the next round and make it very hard to find a lead investor or any high quality investors.

Let’s do some math to show how this happens.

Let’s say you did a seed round of $1mm where you sold 15% of the company and you did a Series A of $3mm where you sold 20% of the company. Your last round valuation was $15mm post-money and you’ve now sold ~35% of the company to investors. These investors will typically have “pro-rata rights” to participate in the next round. Which means 35% of the next round will go to your existing investors.

Let’s say you hope to double your valuation on your next round and raise a Series B at $30mm pre-money or more in a year to 18 months.

Then someone comes along and offers you a $2mm convertible note or SAFE which converts into the next round. You think “free money, that sounds great.”

But if you take the note, then you have a fair bit of the next round already committed for.

Let’s say the next round is $5mm. The existing investors take 35% of $5mm (or $1.75mm), the note takes $2mm, and you are left with $1.25mm to offer a new investor. It is very hard to find a lead investor who will price the round for only $1.25mm of a $5mm round. And if that round is at $30mm pre-money, $35mm post-money, you are only offering that new investor 3.6% of the company which is not a lot.

Let’s say the next round is $7.5mm, a reasonable amount to raise at $30mm pre-money (20% dilution). The existing investors take $2.625mm, the note takes $2mm, and so you have $2.875mm to offer a new investor to lead and price the round. That is a fairly small number as well and would only purchase 7.7% of the company.

You’d have to raise a $10mm Series B before you’d be able to offer a sizable allocation to a new lead if you have 35% of the round committed to pro-rata rights and a $2mm note converting into it. And even then the new investor can only purchase ~11% of the company and the round will be 25% dilutive at $30mm pre-money.

As you can see, taking a SAFE or convertible note between rounds can make it hard to create enough of an allocation in the next round to attract a high quality lead who will price the round.

So, if taking a SAFE or convertible note between rounds is not a great idea, what should a founder do?

I like to see if the investor who wants to do the SAFE or convert is interested in catalyzing a “Series A1” where you take their money and the pro-rata (or slightly more) from the insiders and price it at a significant markup to the Series A. If they are willing to do that, it often is better for everyone to do that.

That tends to be less dilutive, creates even more runway to get to an attractive B round and it avoids the issue of crowding out money in the next round.

Funding Female Founders

As a follow up to yesterday’s post, I asked Zach to calculate the percentage of teams with at least one female founder in our last two core funds.

Yesterday, I wrote “I don’t have the exact data on me and it would take more time than I have right now to calculate it, but my guess is that over the last four years, about thirty to fifty percent of the teams we have funded have had at least one woman founder on them”.

Well I am pleased and proud to let you all know that my guess was correct.

Here is the data:

Percentage of investments with at least one female founder:

USV 2014 Fund: 33%

USV 2016 Fund: 43%

Certainly we have more work to do, the female founder ratio is not 50/50 yet, and we have work to do on other areas like people of color, etc.

But I am quite pleased that USV is female founder friendly.

Changes In VC and Startups Take Time

Starting and investing in startup companies is a long lead time business. It takes on average seven to ten years for the seed and early stage investments we make to turn into something.

So looking at data across the entire VC landscape can be confusing. Important trends can be lost in the noise.

Look at these two charts from the All Raise and Pitchbook analysis of the funding of female founders:

The first one tells a troubling story. Female founders are getting a tiny amount of the supply of venture capital and the percentages are not changing much.

The second one tells a promising story. The percentage of teams getting funded that are all male founded is declining and the percentage of teams that have women founders on them, or are all women founders, is rising.

The first chart is dominated by late stage companies (think companies that are 5-10 years old) and the second chart is dominated by earlier stage companies.

Let’s look at this data in five or ten years.

I think we will see a different story.

I don’t have the exact data on me and it would take more time than I have right now to calculate it, but my guess is that over the last four years, about thirty to fifty percent of the teams we have funded have had at least one woman founder on them.

The times are changing in venture, thanks to the hard work by a number of women founders, women angels (like The Gotham Gal), venture capitalists, and some men too, and it is having a big impact. We just can’t see it in the aggregate funding numbers yet.

We will.

Video Of The Week: Our Partner Rebecca Kaden

Rebecca Kaden, who joined USV in late 2017, was on Bloomberg last May. Somehow, I had never seen this. So I am running it today. If you don’t know Rebecca, you should meet her. She’s leading our efforts in a bunch of areas that she talks about in this interview.

The Daily Dose

At the bottom of the first post on this blog is a widget that contains links to recent blog posts by other USV team members. Many USV folks blog regularly and this widget surfaces those posts to all of you and everyone who visits the various blogs of the USV team members.

Other than me, there are a few other USV team members who blog regularly; Albert, Nick, and Bethany are the most prolific writers at USV. Andy and Brad are the best writers but we don’t get a lot of production out of them.

Since the start of the year, Bethany, who runs USV’s portfolio network, has produced a dozen blog posts, on topics like Hamilton In Puerto Rico, Nostalgia Creep In A High Growth Company, How To Measure A VC Firm’s Platform Efforts, and a lot more.

I am just one window into USV and the VC/startup world in general. I encourage those who are interested in this stuff to seek out other voices as well. Right now, Bethany is one fire. You should check her blog out.

More Data On VC’s Big Year In 2018

Last week I wrote about and linked to the PWC/CB Insights round up of venture investing in 2018.

Well less than a week later Crunchbase is out with its own data on 2018.

The Crunchbase numbers are much bigger, they report about $330bn of global deal volume.

But otherwise the trends are roughly the same. Flattening deal volumes and amounts raised in the early stage market with massive expansion in the late stage market.

Make no bones about it, there is a lot of money in the venture capital ecosystem right now.

Cause Or Effect?

In the wake of Erin Griffith’s piece in the NY Times suggesting that venture capital is toxic for some entrepreneurs, there has been a fair bit of debate about the causes of that situation.

Dan Primack tweeted this yesterday:

I pushed back on that notion in a series of tweets yesterday morning:

It is tempting to look at what is going on in the startup/tech landscape and say that the growing amount of capital under management is the problem.

But the capital market for startups is a complex system and I don’t think it is as simple as that.

It may well be that as entrepreneurs have had more negotiating leverage over the last twenty+ years, they have pushed valuations up significantly and the capital markets (ie VCs) have reacted to that by accumulating more capital so that they can try to buy the same amount of ownership at the higher prices.

That hasn’t really worked and the VC industry typically owns a lot less of a company at exit and the founders and team own a lot more versus 25 years ago. We have seen that clearly in our own portfolios over the last fifteen years and I would assume that is true across the industry.

So while it is tempting to suggest that big bad VCs are the reason for all the problems in the startup sector, I would caution everyone from coming to that conclusion. Like all relationships, it takes two to tango, and both sides have had something to do with where we are right now.

Audio Of The Week: Marc Andreessen and Ben Horowitz

I listened to this 40min interview of Marc and Ben earlier this week.

I enjoyed it. Marc and Ben are smart and witty and know how to work off each other.

I got a few really good laughs too, which is always a bonus with these things.

I hope you enjoy it as much as I did.