THE INFLUX OF MICRO VC FUNDS — AND WHAT THAT MEANS FOR STARTUPS
A couple of weeks ago I came across two fairly recent articles by Adrià Hernández and samir kaji on new VC firms, and their significance in the startup ecosystem (here and here). The articles are interesting and reference a number of additional articles that all point out different facets of the ever growing number of VC firms around the world.
The trend is interesting, but one thing that has not been adequately explored is how this affects the startups themselves, beyond just more places to send a pitch deck. Specifically, I want to address three qualitative factors.
- VC COMPETITION
The increase in the number of new VCs is not unique to the US. Here in Israel there are about 260 entities that invest in startups (that I know of). Of those, six have popped up in the last half a year alone, and that doesn’t include the increase in new angel investors who are dabbling in the field as well.
These investing entities spar against each other in a weird type of Monopolistic Competition, where the core product (cash) is the same, so they lure founders through ancillary added value. I have written about this extensively before, but the core is that is new VCs need to stand out from the crowd through differentiation, either in their approach, their sectors, their stages, or any combination thereof.
PRO:
The good part about this, from a startup’s perspective, is that there are many investing options, more so than ever before, which theoretically increases the likelihood of getting funded.
CON:
Many of these new players are not going to give you the value-add you need. Some are purely financial entities, others may specialize in a sector that is irrelevant to the product.
BOTTOM LINE:
For startups, it is great that there are more people to turn to for funding, but it is critical to be honest about your expectations. Do you need just cash, or do you need other value-add services? Do you need deep sectoral knowledge, or are you fine with generalists? In short, just because there are a bunch of new VCs does not mean Spray and Pray with your pitch deck.
2. VC INTEGRATION
The rampant incessant media bombardment regarding startups makes it seem like it is a massive industry, especially to outsiders. The reality is the exact opposite. High tech is estimated to be just over 7% of US GDP (In Israel it is around 10%). That’s it. So startups are obviously a tiny miniscule portion of the US Economy. Take a look at the Fortune 500 list; it’s overwhelmingly filled with “low tech” companies in financial services, retail, insurance, manufacturing, etc.
The VC industry is the teeny-tiny pinprick at the top of the pyramid of the startup ecosystem. There are about 320 VCs in the Bay Area. The largest VC in the world, NEA, only employees 20 people who have direct investing responsibilities. I would estimate there are only about 2500 VCs total running around the Bay Area. The entire country of Israel has about 1000.
The tiny size of the VC ecosystem, coupled with the need for new VCs to quickly integrate and stand out, means that they talk amongst themselves a lot. They always have; swapping deal flow, gossiping, brokering deals, etc.
PRO:
All of this chatter, and the quick (and necessary) integration of new VCs to the ecosystem means co-investing theoretically increases as well. Again this means more funding options for startups. While one new VC may not be interested, another one might, and they pass info between them. Or, if an established VC is not interested for whatever reason, they can pass along to a new player.
CON:
Don’t think that just because a VC is new, or the managing partner is new, that they aren’t connected to the wider ecosystem.
BOTTOM LINE:
Yes, the VC world is getting bigger, but it is still tiny, and localized, by any account. So play nice, and play fair, because word will quickly spread otherwise.
3. VC SIZE
According to the recent report from Prequin on first-time finds, the size of first time funds is noticeably smaller than non-first-time funds. This shouldn’t surprise anybody. A first time fund is untested, even if the manager comes from a previous fund, and therefore LPs are probably going to hedge their bets a bit and commit less capital.
As I’ve written about before, fund size does have an impact on startups. Specifically, smaller funds require smaller exits to make their long term ROI or IRR targets.
PRO:
Great ideas for smaller, more niche markets, have a better chance of finding a home when it comes to fundraising. Too many great, but small, ideas get overlooked because they just don’t fit into the classic big-name VC model.
CON:
This scenario reminds me a lot of the fabled Series A Crunch (remember when that was a thing?). Back between 2011–2013 the concept was debated at length, but the core of it was the disproportionate ease of getting seed funding, and the subsequent hardship of getting A round funding. In many ways, the recent influx of new VCs could create this bubble again, with ample supply of seed funding, yet the same milestones/hurdles and traction necessary to justify further funding rounds.
BOTTOM LINE:
I think a lot of founders are going to be disappointed in the long run. New VCs need to take positions (they must deploy), and they will do so with less care than established VCs. They also have less money to throw around, so they will stick to the earlier stages, while the number of late stage investors remains largely fixed.
To be completely honest, I am skeptical about the recent influx of cash into the ecosystem. I am skeptical that there are enough good ideas out there to justify so many funds. I fear many of the new funds are backed by new LPs who are in it for the FOMO, and not much else.
Ultimately, for founders, I fear all of this pending frothiness (I hate that buzz word), will create a false sense of security, and only perpetuate the negative aspects of frivolous expenditure and poor business acumen.
Thoughts?
