Return of the Series A Crunch

Today’s big VC brands were built by funding start-ups from birth to acquisition, IPO, or death; whichever came first. There were no Y-Combinators and other microVCs. But it isn’t true that “lean” investing strategies didn’t then exist.

Electronic Arts, whose birth I have a blood relationship with, was “seeded” by Sequoia Capital, and two other firms, with a $2 million Series A round, equivalent to $4.4 million today. It took all of that, and a Series B follow-on less than six months later, to get EA to market. EA, as much money as it took, was actually a “lean” deal. It was software. Software of all kinds was the “lean” play of that hardware dominated era.

Does the following sound familiar:

Because it was cheap to start software companies (relative to other kinds of deals), too many were started. Those VCs that made the pivot from hardware to software were the lean thinkers of their day. They understood the efficiency of their capital could be maximized by going lean.

But as this caught on, the industry collectively followed the same rule they follow today…when it’s cheap enough to do so, make sure to start many more deals than you can possibly finish.

The number of seeded companies always exceeds the appetite of investors for follow on funding. It is inherent to the process. Start-ups are fields of dreams, and the VC business attracts dreamers. (The tougher-minded go to Wall Street or to the PE firms). When dreaming is cheap, throwing around lots of early money just happens. The subsequent crunch isn’t news. It’s the business.

According to CB Insights, in 2012 seed deals outpaced Series-A by a ratio of 2.5 to 1. A year later, the numbers created by those seed deals looking for their Series-A will certainly exceed the appetite of the follow-on funders.

The companies not getting money will have failed the product/market fitness test. They will still be “pivoting.” The tolerance for internally bridging “the next pivot” is waning, which puts companies at the mercy of new investors, who have even less tolerance for funding pivots. That dynamic sets up the crunch.

Is this “crunch” more dramatic now than in EA’s day? I don’t think so. It is true that the proud old Venture Capital brands, bloated by eschewing the lean lessons they once knew so well, have turned over today’s lean world to the Y-Combinators, microVCs, and Bullpen type funds. And that passing-of-the-guard has made for a drama that has gotten mixed into the crunch story, even though it doesn’t really belong there.

In our role of extending the lean rounds, we take account of the coming crunch by continuing to apply our usual (and very simple) criteria for judging deals:

• Has the company reached product/market fit?
• Does the company know with total clarity how another lean round of capital will get it to its next, much larger financing?

Because of the crunch, we will likely see more deals. The intensity levels will be higher. The sorting process may take a little more work. But the opportunities will never be better. Crunch time is a good time.

One comment

  1. Elyce Melmon · · Reply

    I always learn so much from your “lean” and lucid writing. Happy to be reassured that “crunch time is a good time.”
    Keep writing!
    E

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