Tsunami Continues to Rip Through VC Industry. First Wave Complete, Second Wave is Approaching
Wave 1 – The rise of the Seed Accelerator and Super Angel
Within the past 5 years, the cost of starting an internet company hit a floor. There is no cyclical effect here. It will not go back up. Today, all founders need to get a company off the ground is a roof over their head, food, internet access, a laptop and a whole lot of passion. That massive drop in costs has caused a tsunami, which has been ripping its way through the VC industry ever since. In it’s wake, Seed Accelerators, Super-Angels, and a new crop of Series A VCs, operated by former entrepreneurs, have emerged as the benefactors. Seed Accelerators like YCombinator, TechStars, and us at Bootup Labs are investing between $10k-$100k per startup. Super Angels invest between $10k-$250k, and reinvented Series A VCs invest as low as $250k-$2M per startup. Most are making healthy returns with more frequent exits in the range of $10M-100M in less than 5 years.
From my observations, regions with a higher concentration of super angels and/or seed accelerators, such as Boulder, New York and San Francisco have completed this transformation, While other areas including Boston, Seattle, LA and Austin are next, and Vancouver will get there in about 9 more months.
This wave took about 5 years to subside, and has changed some of the definitions of the words we use to communicate. So, before we talk about the next wave, we have to reconcile our nomenclature. For the sake of this post, let’s assume that $250k-$2m is no longer called a “Seed” round, and is the new “Series A.”
Wave 2 - Take it to the Bank!
The ripple effects are continuing to run it’s way through the VC eco-system, and are now challenging the economics of series Series B VCs. If Seed money is used to test if the market wants something, and Series A is to identify and mature user acquisition channels, then all we need Series B investment for is to grow an already proven business, right?
Take this for example: If I prove that google adwords produces 1,000,000 clicks of a certain keyword, and those clicks convert at 2% at a cost of $1.25 per click, and the lifetime value of those conversions is $113 each, with a churn rate of 5% per month, then the company should net about $2.2M over 20 months, and you can take that to the bank — quite literally. (here’s the model) It’s conceivable that banks (yes, banks) will get confortable that acquiring users has the same level of risk as collecting receivables. These banks will loan money (or factor) against individual acquisition channels, which have shown statistical significance. If you’ve been in the Internet industry as long as I have, you know that acquiring users becomes as predictable in terms of revenue generation as a signed PO from an enterprise customer.
What does this mean for the Series B/C/D investors? A lot. There is already a lot of competition for Series B investments, which makes sense; Risks are low, quality deals are scarce, and great upside potential. On top of that, when the first wave hit, the risk tolerance and economics for the incumbent Sereis A VCs forced them to higher ground, aka Series B. Over the next few years, I predict that specialty lenders or venture debt, and some progressive banks will provide some interesting options for founders of Internet companies. I’m just glad I’m not managing a VC fund over $50M. If I’m right, life is going to get tougher than it already is, and, as far as Internet investing is concerned, it’s never coming back. In fact, if I was in that position, I’d stick to biotech, cleantech, or any other capital intensive tech industry.
Wave 3 – Lights, Laptops, Launch
I don’t believe anyone can predict the future more than 3 years out but it doesn’t stop me from thinking about it. I’ll describe my admittedly “out-there” vision for what will happen when the 3rd, and final wave hits in another post.
I would be grateful for any comments and of course, criticism and counter-arguments are welcome.
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