Seed Investing is Drying Up

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As we outlined in a previous post, the seed-stage venture funding market is dropping fast. It’s cold out there.

In her October 18th post Seed-Stage Activity Fumbles Amidst Increases In Late-Stage Dealmaking, Joann Glasner writes that the drop-off is stark:

The total number of investment rounds for U.S. seed-stage startups hit the smallest projected quarterly total in five calendar years in Q3 2017… Investors have also put fewer dollars into seed deals this year compared to the prior two [years].

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And not only are there fewer rounds, but fewer dollars too:Screen Shot 2017-10-31 at 2.23.44 PM

Glasner wonders if hot job markets are one reason that seed funding is falling.

Our feeling is that the big startup wave of 2007–2017 is over. This wave really got moving with monetary policy after the 2008 crash. It coincided with three major developments, which fed each other: cloud, social networking, and mobile. Facebook (2004), iPhone (2007), and Dropbox (2007) all launched in the same time-frame. Amazon Web Services began in 2006. Ruby on Rails came out in 2005.

The combination of cloud, mobile and social fed itself into a hyper-growth feedback loop. But now the market feels saturated. Most software startups are doing small things that are not deeply technical or interesting. We generalize here, but it’s hard to escape the feeling of saturation.

And now, finally, the investing landscape reflects that saturation. Meanwhile the unicorn market is overvalued and due for a correction.

Interesting times ahead.


Windigo Bay Group is a merchant bank serving creative, consumer and tech companies. We finance and develop businesses, negotiate new markets, sell and acquire assets, and more. Based in Toronto, our clients are in North America and around the world. Contact us for a private discussion about your needs.

Lessons from 525 CEO Interviews

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Adam Bryant did 525 CEO interviews over the last decade as part of his Corner Office column. In this morning’s New York Times, he summarizes the lessons he learned.

It’s valuable piece and we won’t spoil it by citing too much. Read it (links are below). Then save it for future reference.

Here are a couple of points we really liked:

“[CEOs] share a habit of mind that is best described as “applied curiosity.” They tend to question everything. They want to know how things work, and wonder how they can be made to work better. They’re curious about people and their back stories.

“And rather than wondering if they are on the right career path, they make the most of whatever path they’re on, wringing lessons from all their experiences.”

Bryant writes that enjoying discomfort is a recurring pattern too.

“C.E.O.s seem to love a challenge. Discomfort is their comfort zone.”

And interestingly, they got to be CEO by concentrating on excellence in their current job at every step of the way.

“They focus on doing their current job well, and that earns them promotions.

“That may sound obvious. But many people can seem more concerned about the job they want than the job they’re doing.

“….[F]ocus on building a track record of success, and people will keep betting on you.”

It’s a wonderful article and there is much more than the tidbits we’ve cited here. It’s full of goodness. Go read it here. And you can find Bryant’s Corner Office interviews here. Bryant has published two business books, which you can see on Amazon here: The Corner Office and Quick and Nimble.


Windigo Bay Group is a merchant bank serving creative, consumer and tech companies. We finance and develop businesses, negotiate new markets, sell and acquire assets, and more. Based in Toronto, our clients are in North America and around the world. Contact us for a private discussion about your needs.

The Unicorn Fantasy

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Valuation is the most misunderstood concept in technology finance. Almost nobody seems to understand the obvious, which is that venture financings are not appraisals of businesses. In a financing, the only thing being sold is an instrument. And that’s also the only thing that is priced.

If a company does a Series B financing, the only “valuation” is what was paid for the Series B shares. A Series B financing says nothing about the value of the company itself. This is true in every form of preferred financing.

Common shares are bottom shares.

A venture preferred share is worth more than a common share. Period. And usually it’s worth a lot more than a common share. Venture preferred shares come with priority on liquidation, price protection, often accrued dividends, and a whole bunch of special shareholder rights that are particular to the investor—such as the power to block exits or financings.

You cannot work backwards from instruments to get at the valuation of a startup business. Instead, you start with an appraisal of the assets and then distribute the result across the various instruments.

Unicorn is just another word for “bubble.”
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If only that were true.

We’ve said for a long time that most unicorns are valuation fantasies. Turns out we were right.

With this in mind—something that 99 percent of the tech media and industry seems to not understand or want to admit—we turn to yesterday’s piece by Andrew Ross Sorkin. Writing in the Times, he says: “The average unicorn is worth half the headline price tag that is put out after each new valuation.” He continues –

…if the special side deals that most unicorn companies offer to certain investors…are taken into account, almost half of the companies would fall below the $1 billion threshold.

The research that Sorkin quotes was done by Professor Ilya A. Strebulaev (Stanford) and  Professor Will Gornall (UBC). In Squaring Venture Capital Valuations with Reality, they write:

Many finance professionals, both inside and outside of the VC industry, think of the post-money valuation as a fair valuation of the company. Both mutual funds and VC funds typically mark up the value of their investments to the price of the most recent funding round. The $6 billion assessment of Square was reported as its fair valuation by the financial media, from The Wall Street Journal to Fortune to Forbes to Bloomberg to the Economist.

That’s the problem. In most stages of a startup, that is plain bad logic, as we’ve said for years.

Our results show that it is inappropriate to equate post-money valuations and fair values. However, even sophisticated financial intermediaries make this error.

What’s astounding is that this basic error of financial logic is made by legions of MBA finance professionals managing billions of dollars. And it’s made by mutual fund managers and family office managers.

This is not hard stuff. And what’s amazed us over the years is that the very investors creating complex instruments seemed to miss the basic fundamentals of company valuation.

The right way to do it is:

  1. Start with the asset.
  2. Value it.
  3. Allocate that value across the stakeholders.
Why has this silliness gone on?

Because people see what it profits them to see. VCs are anxious to show good returns. Entrepreneurs want to brag about their valuation. The tech media wants a story.

Everybody benefits through reality-denial—for a while, anyway. (Later, the pain comes.)

Bubble markets depend on reality denial to keep the party going.

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Who knew Pooh was in tech?

We saw this in 2001 with tech. We saw it in 2008 with mortgages and derivatives. And in 2013 with gold. It’s always the same.

And already we can see the signs of reality poking its unwanted nose into the tech tent. For example, many big VC investees are unable to exit because of their absurd paper “valuations.” Nobody will buy them at half the price. So insiders have keep funding these mighty “unicorns.” And seed funding is starting to tank too.

We call that “getting stuck in the honey jar.”

But more about that another time.


The unicorn image is from Spreadshirt; you can buy that image on a t-shirt here. Pooh is owned by Disney. Images are © their respective owners.

Windigo Bay Group is a business & corporate development firm. We help our clients enter new markets, negotiate strategic relationships, settle disputes, and raise capital. Based in Toronto, we serve clients in North America and around the world. Contact us for a private discussion about your needs.

 

 

Seed Funding Tanks

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As reported a month ago, the U.S. seed funding market is crashing. Deal volume is down 40 percent from 2015 highs. And the massive influx of cash has propelled leading funds to seek much larger financing rounds—which effectively excludes true seed-level deals.

At the NY Venture Summit we attended in July, VC panelists were emphatic that seed valuations have contracted. One early-stage NY VC partner said “it’s all back to 2012 [valuation] levels now.” Another recommended that seed-stage companies should be raising 18 months of capital, to have enough runway.

As Reuters reported:

…the zeal that prevailed just two years ago has faded. Seed and angel investors completed about 900 deals in the second quarter, down from roughly 1,100 deals in the second quarter of 2016 and close to 1,500 deals during that time period in 2015…

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“Seed-stage” has lost its meaning

On the ground what this means is that what VCs term a “seed” round is really a “pre-A” round.

What we’ve seen is that the hurdle for seed-stage funding is not truly seed-stage any more. It’s become pre-A, meaning software companies are judged primarily on established growth rates (AI and deep tech companies still avoid that filter, for the most part). If a company is growing fast, it’s not seed-stage, by any meaningful definition. We’ve actually heard VCs use nonsensical terms like “pre-seed”—and that shows how contorted the market has become by massive inflows of cash.

Put simply, “seed” VCs want deals that are safely on their way to being Series A rounds.

Why is this happening?

All markets run their course. VC has had up and down cycles since it began as an asset class in the Seventies. But this time a few reasons are clear:

First, unicorns are overlaued in many cases. They are avoiding IPOs for that reason. And nobody will buy them out (bailout), so the paper values cannot get liquid. The capital doesn’t re-circulate.

Second, some seed investors are anxious at the speed at which their investees are liable to competitive assault:

San Francisco seed fund Initialized Capital, for example, has slowed its investment pace to about 20 companies a year, down from 50 to 60 just a few years ago, even though its fund size more than tripled to $125 million, according to managing partner Garry Tan.

Among his concerns: dominant players such as Facebook Inc. have amassed so much wealth they can quickly challenge a hot startup, diminishing its value.

Having watched these market cycles before, we’re skeptical things will turn around. In a future post, we’ll explain why.


Windigo Bay Group is a merchant bank serving creative, consumer and tech companies. We finance and develop businesses, negotiate new markets, sell and acquire assets, and more. Based in Toronto, our clients are in North America and around the world. Contact us for a private discussion about your needs.