Planning on raising money in 2018? Good, because there's lots of good news, like:
- More money than ever, overall. From 2014 to 2017, the average VC fund size doubled.
- A new sensitivity to racial and gender dynamics that has many VCs on their better behavior. Finally.
- More micro VCs and micro funds with capital outside of traditional startup hubs, so you can likely find capital closer to you than ever before.
- There are also more ways to raise money--from crowdfunding, to equity crowdfunding, to convertible notes in all their flavors, and of course, those famous token sales.
There are also some real challenges facing founders raising money in 2018.
It's nothing you can't overcome, especially if you understand the landscape. You knew it was going to be hard anyway.
So here's the new thing: the venture capital world is barbelling. It used to look like an egg--a tapering start of small funds, a big fat middle with lots of midsize funds, and a nice rounding off of mega-funds. Now, it's a barbell and it all happened in the last 3 years. Today, there are lots of smaller funds like my firm Valor Ventures, lots of bigger funds, and the middle is being whittled away. This has some strong implications for your most efficient path to raising capital. Whatever venture capital case study you're hearing in your accelerator from 3-5 years ago, it's too old--take the directional truth from the founder, but know the tactics likely need an update.
Don't compromise on whom you raise money from
As an entrepreneur, embracing the discipline of data early is not just a good decision, it's often a make-or-break one in attracting not just quality customers, but quality investors too. As venture evolves, data will be an increasingly important component of even seed stage investing. Today, 42% of startups fail after getting their first funding for one reason. Knowing this reason, the venture community is making adjustments.
"You can look left and right and see companies solving one-percenter problems raising new rounds of funding when they should be failing fast and cheap," shares Social Capital partner Ashley Carroll, writing on the company blog. "Or companies incinerating heaps of venture dollars in a spectacular fashion that would have been better served by less funding and more focus. But, it's not because there's too much money, it's because that money is chasing too few opportunities."
That's the barbell at work. Plus, since venture capital firms are 97% white and 93% male, for founders that aren't both, getting a fair shot remains challenging. According to NVCA,
- In the U.S., 90% of all VC capital still goes to white males even though they are 60-some percent of the entrepreneurs;
- Black employees are about 3% of American venture capital workforce;
- Hispanic or Latino employees are just 4% of VC teams and 2% of investment partners.
Clearly, these figures are out of wack with the demographics of the U.S. In an environment when the fastest growing pools of entrepreneurship are not white males, it means most VC teams have some inherent communication barriers.
I said most, but most definitely not all.
For example, Social Capital recently launched a Capital-as-a-Service data-driven model that backs companies that are showing incredible customer traction. By pure metrics, their beta test looking at company merit resulted in investments in companies that were 42% female-led and mostly non-white. This is similar to Valor's focus on hypergrowth early-stage businesses, and similar to our results so far. Focusing on high customer traction companies, 75% of our portfolio is nonwhite male. It's also similar to Endeavor, the global nonprofit investing organization for high impact entrepreneurs, which also has a diverse portfolio they've built by focusing on business results over pedigree. There are more.
Focusing on the right game for your stage
If you plan to raise your first capital in 2018, you need to know now that most VC firms have retreated from seed deals. There were 1500 seed-stage deals in 2015. Last year, only about 800.
The retreat from the early stage deal is driven by two things.
1. Larger funds. From 2014 to 2017, the average size of a VC fund doubled. Boom. Bye-bye $1 million dollar checks. Those funds now have to write $10 million dollar checks and the business cases to make them make sense.
2. Fewer funds. Last year saw a 26% decrease in the number of funds (even though the average size grew).
Raising money in the 2018 venture capital landscape your way
This is a reality that really works well for innovators with a plan. There are now hundreds of angels and micro VCs who can stake a seed stage investment in a tech company, but they're being choosier--because that first round has to last until there's significant enough traction to cross that skinny middle and get into significantly larger rounds. For that reason, on first rounds, the trend is to be more conservative on early stage valuations and look for entrepreneurs who build lean.
This landscape also really works for entrepreneurs who've bootstrapped a substantial tech company and want to know if it can be supernatural. Last year saw an 85% year over year increase in late-stage investment dollars. Meanwhile, the exit count for venture capitalists decreased about 27% (Pitchbook numbers from the 2018 Venture Capital Outlook). There's $600 billion in unrealized returns in companies valued at $1 billion or more. While unicorns show stunning paper gains for VCs, those same VCs have raised money on that paper money and now need companies that can provide capital back. Bingo--businesses with significant monthly recurring revenue will never be more in fashion in than in the 2018 investing climate. It's a different strategy than you'd use for raising money in the early stage--for the larger firms, high valuations will still be in vogue.
If you've built a company that really needs "the middle" of the barbell, it is still there--just whittling down. Your best friends in the middle are going to be really good early-stage investors--and your customers. Plus, keep in mind with $6 trillion in private equity overhang, while it may not be the exit you planned for, this market is opening up opportunities to exit tech to PE.
2018 is a great year for raising money
There's never been a more creative, resource-rich time to be an entrepreneur from a financing perspective. Smart entrepreneurs in 2018 will pursue a mixed strategy of perhaps some Kickstarter for an MVP, token sales if it suits their business model, lots of validating customer traction, and some strategic seed capital from insider angels or early-stage venture partners helping scale those customers. This toolkit approach can create an overall better return to the entrepreneur than straight equity financing and also create more options than ever to build a brilliant business.