Venture Capital – Looking more like Mutual Funds

A lot has been written lately about the growing Series A gap. This is the funding void that has developed in the normal progression of startup financing. The problem has been particularly pronounced in the world of Silicon Valley technology firms. Typically, the founders of startup firms will tap friends and family for their initial funding requirements. The length of time the company can sustain itself with these funds depends on a number of factors including the depth and breadth of their F&F sources and their monthly burn rate. While a few firms are able to reach a critical mass with these types of funds that will allow them to become cashflow positive and grow organically from that point forward, most will not. Firms that outgrow their initial funding will subsequently turn to professional investors to meet their capital requirements. Individual angel investors and angel funds (groups of angel investors) will step in to provide the next round of funding, referred to as the Seed round. Seed round investments are typically $50 to $250k although it is not unheard of for these rounds to exceed $1million. Beyond this, startups usually look to the venture capital community to provide the Series A and successive rounds – and herein lies the problem.

Although the business risk profile tends to decline as businesses matures, early stage startup financing remains a risky proposition. Even by the time a company is out seeking Series A funding it may still be pre-revenue and a long way from cashflow positive. While angel investors seem to understand their role in the risk-reward tradeoff, venture capitalists have begun to back away from the level of risk typically associated with Series A rounds. A recent article in the San Francisco Chronicle’s online site, SFGate, discusses how VCs now forsake innovation in exchange for stable revenue and earnings growth. More and more venture capital funds are starting to look like mutual funds of mature private companies, giving up the potential for significant gains in return for steady bottom line income. This new aversion to high risk opportunities must be due, in part, to demands placed on these funds by new limited partners that no longer have an appetite to absorb significant losses in the portfolio in exchange for a few potential home runs. This leads to the obvious question, who will fill the Series A gap in the startup funding sequence? A number of possibilities exist including startup incubators and future developments in crowdfunding (see our previous blog entry) but none has yet to emerge as the norm in relieving this void in the financing market. We’ll need to continually monitor capital markets regarding this trend but it appears unlikely that most VCs will reverse their inclination to abandon Series A funding any time soon.

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