Each quarter Cooley does a VC market update. This quarter they interviewed me as part of it on Quarterly VC Update: Brad Feld on the State of Venture Capital Investing. The full Cooley Q3 report includes a bunch of data and trend graphs which I encourage you to go take a look at. The interview with me follows.
Based on Cooley data for the quarter, how does your experience in the market compare? Similar/different?
The tone of Q3 felt like a continuation of Q2 with summer vacations tossed in. The existential freakout that occurred in January and February seemed like the distant past with the lingering hangover being a clearer focus on valuation and overall funding needs from new investors. While there are a few clear trends in the data, such as lower valuations for Series A through C rounds and more flat rounds, the overall changes from Q2 is not dramatic.
As far as deal terms, is the pendulum favoring companies or investors? Will this continue through the year?
It continues to be highly dependent on company, stage, and location. At the early stages, raising the first $2m tends to be straightforward in most geographies that have meaningful startup communities. At the same time, if you are a clearly successful growth company, there is a huge amount of capital available once you’ve reached a point of clear success (often after $20m – $40m has been raised). The stage in between – what used to be called a Series B or Series C – continues to be extremely hard to raise unless you are clearly on a very rapid growth trajectory.
So – for early stage companies (Pre-Seed, Seed, Series A), the terms tend to be clean and simple, and valuation is in a modest range that probably has a median around $5m. For growth companies (usually Series D or later), there are pretty clear market comparables based on growth rate, revenue, gross margin %, and type of company. For everything in between, good luck and be flexible.
Any current trends that stand out to you that are changes from the 2015 environment?
The word unicorn was used about 1000 times more often in 2015. There is much less focus on a $1 billion private valuation (thankfully) as both entrepreneurs and VCs have again shifted much of their discussion to what needs to be done long-term to build a successful company. There’s a lot less whining about the public markets, although there continues to be many opinions as to whether going public is a good thing along with whether it’s smart or stupid to delay the decision as long as possible. I’ve already forgotten what the trendy things of 2015 were since AI, machine learning, bots, and autonomous cars are all the rage, although it’s almost 2017 so it’s time for something new. M&A activity on one hand seems very lively, although it’s less in everyone’s face. Most importantly from my frame of reference, the amount of activity at the early and seed stage seems to be extremely robust.
How many deals do you expect to make in 2016? Are you a bull or bear?
We make around ten new investments every year. We’ve made seven so far this year and have three more that are in process, so we are right on track. I expect we will make around ten new investments in 2017. Since we are early stage investors, it simply doesn’t matter if we are a short term bull or bear. We are long-term extremely optimistic about the opportunity to invest in and help build important, new, innovative technology companies.
For a couple of years commentators in the market has talked about a “Series B” problem. Do you see evidence of that issue, and if so it is the problem getting larger or smaller?
It’s the same. There is a huge capital supply gap for companies that are in between early startups and companies that are successful growth companies. As a result, the “Series B” problem is simply calling out something that has always been around – it’s tough to get the mid-stages funded. Early is a lot sexier, exciting, and easier – you are selling your future vision. Late-stage is more straightforward to evaluate. Mid-stage is when you are now selling reality and are often too early to show that you will be a large, long term successful business.
What is your advice to a company seeking its first capital?
Yoda was right – do or do not, there is no try. Decide to do it. Then do the work. If you want hints, my partner Jason and I wrote 200 pages of them in our book Venture Deals: Be Smarter Than Your Lawyer or Your Venture Capitalist* (*unless they are from Cooley…)
Do you see a substantial uptick in private and growth equity in the market?
If so, how does that influence the venture market or your investment strategy? This is mostly impacting the later stages. In 2015, there was a huge influx of hedge fund, crossover, and private equity investors doing late stage rounds. Clearly the moonbeams the unicorns were riding attracted them. This vaporized at the end of the year and in Q1 as the public markets corrected. Private equity investors seemed to shift primarily to acquisitions of these companies rather than investing while large amounts of international capital suddenly showed up. For us, none of this really matters as it tends to be short term in nature driven by a variety of often conflicting forces. We try to keep our heads down and just help finance our companies continuously through all stages.
What other “macro” trends do you see affecting the rest of 2016 and 2017?
Well, there’s this thing called an election which hopefully will be over soon. In addition to creating some certainty about the dynamics in our government going forward, it’ll also result in a decrease of political advertising in all media, which I generally think will enhance my life although some adtech and media companies will be bummed out about it. Beyond that, I have no real clue about the macro.
I got the following question from a friend yesterday.
“I’ve had a few conversations recently about how individual seed investors are getting kind of tapped out – for a variety of reasons, but in general it’s not that easy to find people who are still actively investing. I don’t recall your having blogged about this – are you seeing it too? Lots of talk about Series A crunch but maybe there is a seed crunch too?”
I blasted out a response by email, which follows. If you are an active angel, I’d love to hear what you think.
I’m not seeing much evidence of this – yet …
I have seen some of the more prolific angels start to slow down because capital is not recycling as fast as they are putting it out. That’s a pretty common phenomenon. But generally the pool of angel investors is increasing and the prolific ones who have a strategy (such as the angel strategy I advocate) seem to be keeping a steady pace.
There is also a huge amount of seed capital available from seed funds. Some angels are no longer competitive as they are overly price focused (e.g. if the valuation goes above $3m pre it’s too late for me). And the convertible note phenomenon hasn’t helped as many seed deals just keep raising small amounts of convertible debt.
The supply / demand imbalance is way off. While there is an increasing amount of seed capital / seed investors, the number of companies seeking seed investment has grown much faster in the last 24 months.
Also, I think some angels are just tired of the deal velocity. You have to work at it now more to stay in the flow because there’s just so much more of it, and that makes angels, especially semi-retired ones, tired.
If there is a big public market correction and angels feels (a) less wealthy and (b) less liquid (or not liquid), you’ll see a major pullback.
I feel like we are in a sloppy part of the cycle. Everyone is suddenly nervous. There are lots of uncomfortable macro signs, but it’s hard to get a feel for where things are really heading. And, at the same time, the cycle of innovation is intense – there is a huge amount of interesting stuff being created at all levels. And there is a massive amount of capital available that is seeking real returns, vs. low single digits.
We constantly hear about “product market fit.” But my post yesterday about The Power of Passion When Starting Your Company was about “founder market fit.” And I’ve come to believe that – especially among first time entrepreneurs – founder market fit is much more important than product market fit at the inception of the company.
I stumbled on the phrase a few times over the past year and it’s been rolling around in my head a lot since. The first time was on Chris Dixon’s blog Founder / market fit which led me to a guest post by David Lee of SV Angel on More Thoughts on What Makes Great Entrepreneurs Great.
I’ve seen this over and over in TechStars. Founders come in with something they are super excited about. As they get exposed to mentors and feedback, they quickly start moving around within the market (or domain) as they search for a clearer focus, which could be defined as product market fit prior to getting a product out there and doing any real testing. This search is usually qualitative – it involves real feedback from potential customers and users, but it’s not a measured, tested approach.
In parallel, there’s often a Lean Startup methodology going on that does more quantitative tests of the specific product. But in a lot of cases, the qualitative feedback at the very formative stages is just as, if not more, important to make sure you end up in the right zone to test.
Underlying all of this is the regular shift away from something the founders are passionate about. The Orbotix example in my post is a great one – it would have been easy for Adam and Ian to decide to work on something that had a better product market fit, like iPhone enabled door locks, instead of something that not only hadn’t been invented yet, but also wasn’t obvious what market would really want it (a ball controlled by your smartphone – ok – that’s cool, but who will buy it?)
They, and their co-founder and CEO Paul Berberian had a vision for who would want a ball controlled by a smartphone. And Adam and Ian were obsessed with the idea. The three of them had extraordinary founder market fit, well before they figured out the product market fit.
We’ve got lots of other examples of this in our portfolio. I can’t tell you the number of times I get asked “what would someone ever use a personal 3D printer for?” But Bre Pettis at MakerBot is completely and totally obsessed with bringing 3D printers to the masses. While product market fit is getting clearer with each new product release, the founder market fit in this cases was awesome. Or Isaac Saldana of SendGrid, who initially named the company SMTPAPI. He has a great chapter in Do More Faster where he wrote about how he “Looked for the Pain” as a developer, found it in sending transaction email, and created SMTPAPI (now SendGrid) to address it. Or Eric Schweikardt who is unbelievably focused on creating the next generation robot construction kit at Modular Robotics. Sure – the “market comp” in this case is Lego Mindstorms, but Eric’s vision for the market goes well beyond this, and the product follows.
I’m not suggesting that product market fit isn’t an important concept. It is. But at the very beginning, especially with first time entrepreneurs, founder market fit is even more important.