Crunch, Class, Commoditization: 3 Trends of Early Stage Startup Investing

Date Updated: Thursday, July 31, 2014

It’s a good time to be an entrepreneur raising money. Venture capital funding in the first quarter of 2014 reached its highest mark since 2001, hitting $23.87 billion. New venture capital funds are popping up all over the place and incumbent firms are raising more dry powder to invest in new companies at the fastest pace in seven years.

While the money is flowing, that doesn’t mean it’s easier than ever to raise it for young companies. Much of the capital invested in today’s startups is flowing towards mature companies raising money at high valuations, sometimes in lieu of going IPO. While there’s more money available for seed rounds and later-stage investments, there appears to be a widening gulf of capital that’s earmarked for companies just beginning to ramp their operations.

For an entrepreneur raising money in this market, it’s crucial to become familiar with three core trends that are impacting the early stage startup market right now.

Trend 1: Series A crunch

Sure, money is once again flowing to startups, but it’s not doing so evenly. Early-stage investors who followed Sequoia Capital’s $3.5 billion profit on a $60 million investment in WhatsApp want a piece of the action - so they’re pouring money into seed funds. Seed funds typically supply the first ‘real’ money into a young company. The catch: when it comes time for these growth companies to raise more money (their A rounds), there are fewer sources of capital available to them.

What’s really at play here? It’s a perfect storm of bullishness towards startup investing, high quality accelerators building high aspiration startups, new legislation (the JOBS Act of 2012, for example) easier to access seed funding, and co-working spaces for startups.

Bottom line: There are just more deals happening at seed stage than at Series A.

Trend 2: The emergence of a new class of investor

As the perception of investing in startups has gotten more bullish, new types of investors have made their way into the market. Microfunds, popularized by Dave McClure’s 500Startups group, are taking small bets ($50,000 on average) on a much higher number of investments in their portfolios than venture capitalists have done traditionally. The economics for so-called micro VCs seem compelling as these firms rely on the strengths of their networks (non-employees) and their accelerator work to help shepherd their portfolio companies along (rather than having people on payroll do this). Equity crowdfunding platforms, though still a few years away from true regulatory launch, are already attracting tens of thousands of high-net-worth investors to their websites. Some of these platforms, like AngelList, are completely open, allowing any startup to fundraise within their platform.

My firm, OurCrowd, takes a much more active approach — we curate, diligence, negotiate terms, and invest our own capital before inviting our accredited investor community to join us on an investment. OurCrowd relies on multiple channels, including accelerators like Microsoft Ventures’, to build a quality deal flow pipeline of hundreds of companies we’re researching monthly. We’ll invest in just a handful, like Applango, a recent graduate of Microsoft Ventures Accelerator in Tel Aviv.

Trend 3: The commoditization of capital

The emergence of new sources of capital supplied by entirely fresh entrants to the startup investing ecosystem threatens the value proposition of traditional sources of capital. If capital were created equally, it really wouldn’t matter exactly where you choose to receive your investments. This adds pressure to various players in the ecosystem who attempt to differentiate themselves by the value they provide to entrepreneurs beyond the checks they write. For hot investments, investors have to work harder to convince entrepreneurs to take their money, giving startups more leverage in this environment.

The flip side of this dynamic means entrepreneurs have to work harder to understand the pros and cons of turning to different sources of fundraising. Of course, in reality, not all investors are created equal and like a marriage, these partnerships must stand the test of time - and stress. In a market where capital is readily accessible, entrepreneurs have the upper hand in diligencing their investors and can afford to be more selective in their partnerships.

Equity crowdfunding likely holds the most potential for startups in the long run; while the process of fundraising becomes more democratized and automated on these platforms, the value they can provide post-investment is becoming more and more de-commoditized. On OurCrowd’s platform, in a typical equity crowdfunding investment of $1 million, we could be joined by 50 to 75 talented, successful investors in a deal. That’s an army of 50 to 75 potential business development partners, all with skin in the game, incentivized to help their new investments succeed.

The current financing market has tipped in favor of talented entrepreneurs as commoditized capital has become more competitive in finding a good home. New players, like equity crowdfunding platforms, have entered the market, offering new options for startups raising money. The double-edged sword of these new opportunities correlates in the need for startup leaders to truly understand the differences in these various fundraising mechanisms, such as fundraising cycle times, how much time and energy is required of each process, and what added-value each side brings to the table.

Jonathan Medved is a serial entrepreneur and venture capitalist. Medved is the founder and CEO of OurCrowd, a new equity crowdfunding platform for accredited investors and angels focused on investing in Israeli and global startups www.ourcrowd.com.

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