Beware the Valley of Death

While horse and hero fell,

They that had fought so well

Came thro' the jaws of Death

Back from the mouth of Hell,

All that was left of them,

 Left of six hundred.

– Lord Tennyson, The Charge of the Light Brigade


My partner Michael recently blogged about an interesting dynamic that is occurring in the venture industry, namely that for the last 2 years, and in aggregate for the last 10 years, the US Venture industry has been investing more into portfolio companies than it has been raising from investors.  For 2010, the numbers were $21.8 Billion invested and $12.3 Billion raised and for the 10 years between 2001 and 2010 the numbers were $245.5 Billion invested and $224.8 Billion raised.  Clearly this trend is not sustainable and the investment pace will need to decline. 

There are two other dynamics underway that are worth considering.  The first is, as many have noted, that it is easier then ever to raise seed funds and get companies off the ground.  At the other end of the spectrum, the second dynamic is that more and more of the dollars being invested are going to a smaller and smaller group of companies.  In 2010, 6% of the dollars went to 10 companies and if you include secondary purchases and recent investments from traditional VC firms in only three other companies (Facebook, Groupon and Zynga; Twitter is already in the top 10 deals), this number is more like 11-12% of the total capital invested.  In 2007, by comparison, more like 3-4% of the total capital invested went to the largest 10-15 investments. 

So what does this have to do with the Light Brigade charging into the Valley of Death?  Over the next few years in the face of a contracting venture industry, with more dollars going to very mature companies and very young companies, anybody in the middle (i.e. the prototypical Series B and Series C financing) is going to find life far more difficult.  In some ways this process is good: only the strongest of companies will survive.  But the risk is that companies pursuing real and valuable opportunities, especially those whose business models may not lend themselves to early explosive (often non-revenue based) metrics, may get caught in the crossfire.  So what is an early stage entrepreneur and investor to do?  A few possible suggestions for navigating the Valley of Death come to mind: 

  1. Build a syndicate that surrounds your venture with all the potential capital you need such that you don't have to go externally for subsequent financing rounds if you don't want to.  In so doing, be explicit about milestones and ensure you and your investment partners have aligned expectations.
  2. Alternatively, make sure your seed investors have an extensive track record of attracting up rounds from middle stage investors.
  3. Either way, take the time to cultivate relationships with potential financiers to both establish relationships and develop credibility as you lay out (and achieve) critical milestones
  4. Aggressively consider nontraditional sources of capital.  Early customer funding is obviously the best approach, but we are also seeing more corporate VC activity at earlier stages than we have in the last 10 years.  Corporate VC may come with strings that need to be carefully navigated, but executed properly there can be real benefits.
  5. Finally, and most importantly, from a company development perspective, make sure the size of the opportunity you are pursuing is commensurate with the amount of capital you require.  This sounds obvious, but we see many companies that realistically needs tens of millions in capital to create a company with less than $20M in revenue.  At the same time as ensuring the pot of gold at the end of the rainbow is large enough, focus aggressively on reducing risk and generating early momentum.  At the end of the day the middle stage investor is making a risk-reward tradeoff between your company and another investment opportunity in an environment when they can no longer make both investments.

Any other suggestions?

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