Perspectives on entrepreneurship, startups and venture capital from K9 Ventures.

The New Venture Landscape

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In May 2011, I wrote the post: Investor Nomenclature and the Venture Spiral. That post got a lot of attention because back then all the buzz was about “Super Angels.” The venture landscape was evolving and had reached a point where Super Angels were an important part of the ecosystem. Well, now in 2014, almost 3 years to the date, things have changed again. The funding landscape has shifted and is now even more confusing than ever. Here’s what’s changed in my opinion:

The Super Angels are now Micro-VCs.
Yes, almost everyone who was operating as a Super Angel, went on to raise a venture fund. Most of these funds are <$100M, with the majority of them being clustered around the $40M mark (that’s the point where the fund economics start to work in terms of management fee and ability to take a meaningful stake in portfolio companies).

In keeping with the thesis of the Venture Spiral, as the Super Angels matured into Micro-VCs, the style of investing changed because now the Micro-VCs had more dollars to put to work, and became sensitive to ownership. The party rounds, which were the range in late 2010 and early 2011, became less common and we started to see the smaller funds begin to lead rounds.

Significant tightening for follow on rounds
We heard about this in the press as the Series A crunch, but it wasn’t really a Series A crunch. Instead, it was more of a result of over-funding at the seed stage. There was simply too much money coming in to the seed stage, which increased the supply of companies at the seed stage. The Series A investors could therefore be a lot more picky. Even if they did the same number of deals as they did before, it felt like a crunch because of the increased supply of funded seed stage companies.

Massive late stage rounds
The late stage (Series B and Series C) investors are hunting for breakout companies that have serious traction. But there are few companies that breakout, and there is a high supply of capital looking to invest in the companies. The low supply and high demand is driving up the valuations and deal sizes. The companies that get to traction have a lot of capital chasing them. But scaling is hard, and these companies can suffer from The Curse of Over Capitalization. However, the bet that these investors are making is that it will be a winner takes all market.

Threshold for an IPO is higher
Ten years ago, if you had $20M in revenue you were ready to go public. Today, you need almost 5x or 10x that number to even be eligible. If you have <$100M in revenue, you’re probably going to stay private. These companies now end up raising more capital in private rounds than they raised in public offerings 10-15 years ago. And the players for these massive rounds basically decided that they can’t wait for these companies  to go public and so the hedge funds that used to take positions in companies once they IPO’d are now taking those positions before the companies go public in these mega rounds.

Hiring costs are up dramatically
The cost of hiring top quality talent in the bay area has gone up dramatically. Top engineering talent today has a bimodal distribution. You will find top engineers either being founders or working at super early stage startups where they can expect a big outcome based on their equity if the company succeeds, or, you will find the top engineers at companies that can pay top dollar, sometimes with pay packages (salary+benefits+equity) that approach low to mid hundreds of thousands of dollars and sometimes even hitting the million dollars a year mark for select super stars.

 Now what are the implications of all this? Well…

It’s hard out there for a Startup
Companies that are just starting out have it really tough for getting to the next round. They can probably cobble together an initial round of funding because a) there’s a lot of money in the early stage ecosystem right now (both individual money and institutional money), and, b) they’re raising the initial round on hope (see Hope and Numbers). But in order to get to a “Series A” they need to show a lot more traction than they did before (because the supply is higher and the Series A investors will pick the best companies).

At the same time, since the hiring costs are much higher, the companies need to spend more money on recruiting and retaining top talent. Remember all the rhetoric about how it’s so much cheaper to start a company these days? It’s not true in my opinion. Yes, the CapEx is significantly lower and has been replaced mostly by variable costs, but the people costs are a lot higher than they used to be. Also it’s becoming harder for companies to break out of the noise and so the marketing costs are a lot higher than they used to be.

The traction bar is higher, which means the companies need to survive longer in order to cross that threshold. And the hiring costs are higher. Taken together, it means an early stage company needs to survive longer, with higher expenses. Startups have realized this and investors have realized this, which is why these days a “seed round” is usually closer to $2M! Yes, a $2M “seed round.”

Re-jiggering of deal stages and sizes
Two years ago, a seed round used to be $500K, now it is $2M+. A Series A round used to be $3M – $4M, now it’s $6M – $15M. A Series B round used to be $10M-$15M, now it’s… well, you get the picture. The deal stage and sizes have changed dramatically.

Seed is not the first round of financing any more. In fact after noticing this trend last year, I have transitioned to calling most of my initial investments “pre-seed” rounds, where the company raises close to $500K, before raising a full seed round. The Seed round is larger — closer to and sometimes upwards of $2M. The Series A is now the fourth round of funding for a company — the first is usually friends and family, or an incubator (~$50K), then pre-seed (~$500K), then seed (~$2M), then Series A (~$6M-$15M).

Note that I’m describing  what I’m seeing these days as a typical fundraising pattern and it is somewhat simplified. Some companies may be able to “skip stages,” others may end up raising money on a rolling basis. In fact, I’ve seen companies use a convertible notes to do an add-on or “seed-extension” round as well. Sometimes the seed-extension round can be done to just provide more cushion for hitting the Series A traction mark, in other cases it is because the company mis-executed, or didn’t achieve product-market fit and wants to get another shot at the Series A goal.

The new normal and new nomenclature
The institutionalization of the early stage means that it has now matured (Super Angels are now Micro-VCs). They’re starting to use similar metrics and structures as what the old Series A folks used to. For example, doing equity rounds only, no convertible notes, leading rounds and taking on board seats. The seed round is bigger. The Series A is bigger too, and the Series C/D are even bigger yet. Effectively, we’re approaching a new normal in the venture landscape, where the criteria for and the size of the round has shifted up a level, but we simply forgot to adjust the nomenclature (yet again).

Here is how I think about it today:

 Pre-Seed is the new Seed. (~$500K used for building team and initial product/prototype)
Seed is the new Series A. (~$2M used get for building product, establishing  product-market fit and early revenue)
Series A is the new Series B. (~6M-$15M used to scale customer acquisition and revenue)
Series B is the new Series C. 
Series C/D is the new Mezzanine

Welcome to the new venture landscape!

(When I was starting K9 Ventures, I used to describe it as a “seed stage fund”. I’m now adapting to this new nomenclature by coining the “pre-seed” phrase for the stage at which K9 likes to invest. The goal for K9 is to be the first significant round of funding for a company regardless of the nomenclature.)

You can follow me on Twitter at @ManuKumar or @K9Ventures for just the K9 Ventures related tweets. K9 Ventures is also on Facebook and Google+.

  • Thanks very helpfull, a Q would your firm Invest in early stage outside of the US – in EU? Kind regards Frederik

    • @Fredrik: No, K9 only consider companies that are based in the San Francisco Bay Area. The post at outlines my thinking on this topic.

  • I cannot agree with you more Manu. The paradigm shift is clearly seen in the startup ecosystem today. We see angels & superangels grouping together as an entity to conduct their investments in a VC fashion, in terms of structure, period, ticket size, interests and so on.
    The advent of booming internet and mobile enterprises has create a wide interest in all wealthy individuals to include startups into their investment portfolio at a growing rate.
    The risk appetite seems to be high, and yet the caution is observed clearly at the thinning follow-on rounds like you mentioned. Irrespective of the nomenclature, this seems to be a natural trend around the world, and the level shift ups will continue to happen with some stakeholder filling every stage going forward.

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  • I missed this previously… Steph from Softtech pointed it out to me. It’s brilliant and it really helped shed some light on things I was seeing.

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  • Nice Manu! Could not agreed more!

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  • This article should be assigned reading for all first-time entrepeneurs out there.

    Your observation that the “seed” round is typically the 3rd round of financing is important. Due to the opacity of the prior rounds (i.e. they don’t get covered on Techcrunch), entrepreneurs get the mistaken impression that fellow startups are raising massive initial rounds. These entrepreneurs then waste precious time and energy pitching to the same “seed” investors when they’re not yet ready.

  • Ned Gannon

    Thank you for this excellent post Manu. I wondered if you could provide some insight on the typical valuation ranges at the funding levels you describe (Pre-Seed, Seed, Series A). Thanks.

    • Ned, It’s very tough to assign valuation ranges as they really vary a lot based on the background of the team, the idea, the amount of progress, amount of money being raised, etc. What doesn’t change is that most institutional investors have a target ownership they like to get. It’s never set in stone (that’s a blog post in itself), but most professional investors do think that way. My best guess and a *rough* rule of thumb is: Pre-Seed (10%-20%), Seed (10%-25%), Series A (15-25%), Series B (10-20%).

  • Well said Manu – spot on with all the changes in the venture landscape. Having stepped back into the entrepreneur side from 7 years as a VC, i still find myself re-learning fundraising as the landscape has indeed changed even in a year!

  • Good observations Manu. I think of it as first round sizes are still the same ~$500k, but the traditional $4M A round is being split, with $2M going earlier into the new “seed” and the other $2M going towards a traditional small B.

    It will be interesting to see if accelerators reduce the need for the new seed round by validating market fit through their programs.

  • ned renzi

    Manu – great post and a good perspective. It will be interesting to see how effects of latency in seeing trends & opportunities changes the landscape going forward, capital & talent.

  • well said Manu thanks for the insights.

  • Manu, this is spot on. Thanks!

  • Great post. As many said it here, clear and efficient framing of the topic =)

    I see this is as basic inflation problem, where demand exceeds supply, and thus prices rise. As you said it, talent is scarce in the Bay Area and has a limited output, and because of the attractiveness of Venture investing, many more people are pumping up money in the industry looking for companies. Talent is gonna be picky with whom invests in them, driving prices for venture rounds up and that’s why the rounds are inflating so much and even getting new names.

    I’ve never been to the Valley but maybe it’s the time to look for cheap talent elsewhere and bring it to the Valley as part of the investment workflow and not as exceptions (like ZenDesk and other European companies that only moved to the valley after getting investments).

    The bottle neck would be immigration laws, but who knows? The cost of importing talent could be lower than the cost of relocating internal talent.


    • I’m just wondering about this but, you make it sound like success is dependent and exclusive only to being in the Bay Area. Is there not hope for other regions of the country and/or world? Does talent *have* to move to the Bay area to be truly successful? My instincts say ‘no’ but i’m wondering what the rest of the group here thinks.

      • Karen, I only invest in companies that are wholly located in the San Francisco Bay Area and therefore my posts are written with that context in mind. You can certainly be successful in other parts of the country and the world — my first two startups were based in Pittsburgh, Pennsylvania. However, there is something about the Bay Area that is very unique and hard to replicate elsewhere. I talk about this in more detail in a previous blog post:

        • Would the increasing cost of engineering talent change the focus on the Bay Area? Housing prices are getting crazy there, so you not only have to pay a premium for the top people but everybody else as well.

          • @Arpad: You’re correct that the increasing cost of engineering talent in the Bay Area is a real issue. And it is creating a bubble of it’s own with incredibly high compensation, high real-estate prices and squeezing out small business and non-tech workers. I’ve felt that problem first hand with rents in downtown Palo Alto and the soaring rents in downtown thanks to companies like Palantir, Samsung, Amazon, Verizon, AT&T, Comcast and more all wanting to be in downtown Palo Alto is part of what made me leave downtown Palo Alto and move to the edge of Palo Alto. So I guess i’m acknowledging the problem, but don’t have any prognosis to offer.

  • Thanks for the article. Totally agree that pre-seed (Angel?) and Seed have split out entirely. We are currently looking at a Seed round and noticed this when discussing with our initial investor.

  • Love it Manu…

    Did you read my “Silicon Valley – Startup Valley of Death” piece?

    Video Here:

    Would love to catch up some time….

    keith at archimedes labs dot com

    • Keith, Just opened it in a tab and look forward to reading it. Would be happy to catch up.

  • hunterwalk

    I like everything about this post with exception of “pre-seed” term because I don’t think more jargon is the solution to increasing confusion about jargon. It just sounds to me like you’re unafraid to invest early in a company’s lifecycle. Great! The amount of money someone is raising at that stage varies wildly based on the type of business, credibility of the founders, state of the marketplace, etc.

    In Homebrew’s 1st year we’ve found ourselves sometimes being first dollar, sometimes investing after an incubator/accelerator experience and sometimes after <$1m have already been committed. If you had to classify us I'd just say Pre-A – we want to get to conviction and back you as quickly as we can.

    Also psyched you're writing more in general.

    • Hunter, I struggled with whether to give it a name. And in fact a couple of people have pointed out that “Pre-Seed” was not the best choice of a name either! (See 😉 Although it may not be bad comparison if your product is your baby.

      The big realization for me/K9 is that I want to be involved super-early and the landscape had changed yet again, to where I couldn’t really describe K9 as a seed stage fund any more. The best description I’ve heard yet of the stage at which K9 invests is “frighteningly early.”

      And I agree 100% about getting conviction. Conviction can come in two forms. The rational form is when you know something others don’t that gives you a different perspective or the company has amazing numbers. The non-rational (note that I didn’t say irrational) and more emotional form is when you just happen to fall in love with the founders and want to work with them.

  • Narayan Chowdhury

    Manu, William Hsu wrote a supplementary article in ReCode that you might enjoy.

    • Thanks Narayan. I’ve had that article open in a browser tab for a few days now, but haven’t read it yet. Will read it soon.

  • Clear and helpful framing. Thanks Manu

  • TJ

    Do you think crowd sourcing from non-accredited investors(once it becomes legal) will bump the number higher than today?

    • Crowdfunding is an interesting topic that deserves a post by itself and so I intentionally avoided touching on in in this post. The two-line version of that post is that: Crowdfunding is not what it seems. In most cases companies that are successful in crowdfunding have already raised capital before they do crowdfunding. Crowdfunding right now is more about testing product-market fit, the money it brings in is just the icing on the cake.

  • Interesting to see how the public and private markets both have higher expectations for companies. Hitting it out of the ballpark has new meaning — great overview!

  • Chris Yeh

    I think I’m going to have to become a pre-pre-seed investor!

  • Great post, thank you.

  • As large funds have gotten larger they are putting more money to work in the same round but dont want to change their PPT and prospectus to their LPs on the stage they invest in. So its just easier to move the goal post.

  • Great post Manu!

  • Dave Ashton

    simply put, well done

  • Excellent explanation of the new landscape. I’ve seen this change from the recruiting side for years. It’s a vicious cycle of higher Eng offers/salary that in part causes this shift to larger investment rounds at every stage.

  • Manu, well written ‘reset’ of the landscape. At Bee Partners, we’ve been using the term ‘Genesis-stage’ to describe that pre-Seed, and we share your continued enthusiasm for this stage of venture creation! All the best, Michael