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Having Trouble With Series A Funding?

Posted on Sunday, Dec 2nd 2012

There is a lot of talk right now that Series A funding has gotten difficult for the tens of thousands of entrepreneurs who have received angel financing over the last 18 months. Some data from PEHub:

According to the University of New Hampshire’s Center for Venture Research, the number of active angel investors topped 300,000 last year, up 20 percent from 2010. The ranks of the matchmaking service AngelList also swelled, with 2,500 investors joining the community last yearalone, most of them in the last six months. (When AngelList got its start in the spring of 2010, it listed 80 accredited investors.) A study from UNH shows that angels put a fresh $9.2 billion to work in the first half of this year, a 3.1 percent increase over the same period in 2011.

Meanwhile, the number of firms that are actually investing is dwindling, despite the best efforts of partners to save face. The NVCA pegs the official number of “active” traditional firms at 500, but according to NVCA President Mark Heesen, this number is misleading, because at least 200 of the firms only do a deal or two a year.

Last year, some 66,230 companies received $22.5 billion through angel investors, up from 36,000 receiving $15.7 billion in 2002, according to the Center for Venture Research at the University of New Hampshire.

If you take into account the fact that less than 1% of those entrepreneurs who look for money actually get funded, you can imagine the kind of frustration plaguing the startups right now! The frustration also oozes into the angels whose hard earned money will be written off as 99% of these businesses fail to raise follow-on funding.

Well, it doesn’t have to be so. There IS such a thing called customers. There IS such a thing called revenue. Those two things, when focused on, instead of a compulsive pursuit of investors, generally serve companies better.

If you are an entrepreneur failing to find follow-on funding, or an angel investor facing a write-off, please come share your business at a FREE 1M/1M roundtable. Or, enter your company for the 1M/1M New Year Challenge 2013.

We’d like to help.

We HATE the idea of infant entrepreneur mortality.

The idea of 60,000 fledgling startups dying prematurely is nauseating.

They don’t HAVE to die.

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Sramana –

The problem you discuss runs deep.

And clearly one way to solve it is to plan your venture so that it revolves around customers. We did that at Finisar and we do it here in the Small World Group Incubator in Singapore. We focus on customers and not “markets” for the seed level startups because customers pay for products, they validate ideas and they give feedback about what they want next. All good.

But we need to acknowledge that there are ideas and groups of people who pursue them that because of a variety of reasons they need outside funds. Seed funding to define and produce the MVP 1.0 to take to their initial customers and find out if they will buy it. But even when they get revenue from initial customers they may need more money – to reach real market scale, to grow the business fast enough so that they gain a dominate position ahead of other solutions, to be able to feed their families while products go through qualification and get into the main pipelines of their customers or users.

The big problem with Series A/B fundings in the world is that VCs want to be paid very highly – even while they are making the investments and watching them grow – and that means they want the cash flow from the “2” of their 2/20 investments to pay for their salaries and all expenses and at a lifestyle level that is pretty well off.

Let’s do some simple math. Series A funding for companies that have been successful with their seed money typically is in the $0.5-2.0M range … let’s say the average is $1M. So if a VC group raises $20M they could do ~10-12 investments and leave about $3-5M of the fund for follow on rounds. The fees on this fund would be 2% for 5 years or about $400K per year. The fund typically would have 2 partners, an office manager/accountant, some involvement with lawyers to help them keep in regulatory compliance, some external accountants to audit the results that they report to their limited partner/investors.

All of this will cost WAY more than $400K. It might even be that the partners think that they need to make at least $250-400K per partner!

So …

They decide to go out and raise a larger fund … say $100M then the annual fees are $2M and there is sufficient money to pay themselves, to pay the lawyers, accountants, office managers, pay for travel and meals with potential investees, etc.

But …

Now they still cannot manage more than a probably 10-20 companies total in the portfolio so the amount they MUST invest per company rises into the $4-10M range and so they are not doing Series A funding any longer … they are doing much later rounds.

And this explains why there is now an endemic and near universal starvation of Series A funding … it is not what fund managers want to run because it won’t support a lifestyle they want to lead.


Frank Levinson

Frank Levinson Tuesday, December 11, 2012 at 12:02 AM PT

Yes, this is something I have written about for a long time. The Management Fee issue in the venture capital industry, and the broken early stage model. Growth financing, btw, is not that complicated to raise, if you have a validated business model and customer acquisition strategy. If you can bootstrap to $1M in revenue and know what putting another $5M in the company would produce, that may be just fine. You can go raise $5M and scale. It is in the drip financing stage that things get complicated. You raise little money and get neither here nor there. No man’s land, as I call it.

Sramana Mitra Tuesday, December 11, 2012 at 7:59 AM PT