The Series A crunch boils down to this: Too many seed fundings, too few follow-on A financings. In other words, excessive supply and limited demand.
So if you want to get your arms around the expected funding shortfall, do the math. That’s what CB Insights did in a recent study and here is what it found: between1,000 and 1,400 startups could be left without follow-on support and potentially $1 billion in invested capital could be lost.
The formula is relatively simple. Add up the number of seed financings completed in the past several years and compare the total to the average number of Series A deals done during the same period. As the cause of the problem, what the report uncovered is that seed activity has accelerated since 2009 while the volume of Series A rounds has remained relatively stable, hence the imbalance.
Here is how the math works. The CB Insight report examined 4,056 seed investments of typically less than $1.5 million in size made in U.S. technology companies since the first quarter of 2009 and 2328 Series A financings since the start of 2009. It discovered that on average, 39.4% of seed companies go on to raise new money.
So, put the numbers together and here is what you get. Of the 2283 companies that received seed funding since the third quarter of 2011, 102 have already secured follow-on funding and 212 have been acquired. That leaves 1969. If 39.4% of these companies get funding, or about 776 startups, roughly 1,193 will be left without funding.
The CB Insights report suggests the number of stranded companies could vary depending on the percentage finding funding. A higher percentage, say 49.5%, and all but about 1,000 companies will get funding. A lower funding rate of 27% will mean more than 1,400 companies are orphaned.
In either case, it is a stark forecast of what might be ahead.
Of course, Series A volume could increase in the next year and throw the report’s calculations off. And some of the “orphaned” companies could find other sources of financing, perhaps through crowdfunding, or by relying on present cash flow to survive. Still, the study is an interesting guide to perhaps a worst case scenario.
The report offers several other insights worth mentioning here. First, the Internet sector is the primary spot for today’s seed activity, with 68% of company financings.
Also, California is the top spot for activity, with 1,409 deals since the first quarter of 2009. Next is New York, with 559 deals, and then Massachusetts, with 273 deals. Washington is in fourth place with 207 deals. The recent New York boom suggests it might be the spot to see the highest proportion of orphaned companies, the report says.
Finally, the report detailed the acceleration in seed deal making since 2009. For instance, seed deals rose from a quarterly average of 118 in 2009 to a quarterly average 468 so far in 2012. Here is the year-by-year breakdown:
- The 2009 quarterly average is 118;
- The 2010 quarterly average is 193;
- The 2011 quarterly average is 266;
- The 2012 quarterly average through three quarters is 468.
In contrast, the number of Series A deals remained relatively stable over the period, rising slightly in 2011 and 2012. Since 2010, the average quarterly deal total has been 164. Here are the annual numbers:
- The 2010 quarterly average is 129;
- The 2011 quarterly average is 176;
- The 2012 quarterly average through three quarters is 187
Press Release from PEHub