By: Jared Sorin
New York’s economy is rapidly transitioning from one based largely on the financial services sector to one that is becoming far more heavily reliant on technology, new media, and other entrepreneurial startups. New York-area entrepreneurs have been replacing yuppie investment bankers as the heroes of the economy. In the past two years alone, venture funding for companies in their very earliest stages of development increased substantially. Dow Jones VentureSource measured a 52% increase in venture-capital seed investments, based largely on the dramatic number of consumer Internet companies. Similarly, just last month a report from CB Insights stated that quarterly seed-stage funding for Internet companies has increased exponentially over the past ten quarters. For example, in the first quarter of 2010 there were 20 seed deals; by comparison, in the most recent quarter ended June 30, 2012 there were more than 110 seed venture deals, a greater than 500% increase.
A seed investment typically is the first money a startup gets, ranging from a few hundred thousand dollars to as much as $2 million. A growing number of venture-capital funds specialize in seed and early-stage investing, and even big funds with institutional investors are setting aside money for the youngest startups, hoping to cement relationships early on and cash in on the this wave of entrepreneurial activity and technology innovation.
In a scene eerily reminiscent of the asset bubble of the turn of the century, investors are eager, perhaps overeager, to get a piece of seemingly promising startup companies for a relatively small investment. In today’s era of the lean start up, these companies are far less capital intensive than were the startups of the past. As a result, if a company fails and the investment doesn’t work out, investors’ losses are less material. Perhaps, then, it is not surprising that more seed money is available. With the numbers of angels, incubators and accelerators proliferating in NY and nationally, the competition for the promising deals is intense and growing.
While the numbers of startups and seed investments are indeed proliferating, the jury is out with respect to whether or not the abundance of startups and the dramatic rise in seed investments will actually lead to an increase in successful companies and an appropriate return on the seed capital invested. After all, the amount of money for larger, post-seed stage financings, the Series A and B rounds associated with emerging and later stage companies, has not kept pace. In fact, many such investors are staying on the sidelines, waiting for the improvement in the IPO market. After all, a robust IPO market or a strong sell-side market is critical to monetize these investments. This suggests that many of the current startups, despite having successfully secured seed financing, could well be unable to raise the cash they need to grow, expand or survive. One renowned early-stage investor predicts that “the mortality rate [among startups]will skyrocket” because “there is a dearth of series A and B relative to seed-stage investing. Something has to give.”
There is good reason for optimism based on the strong spirits of entrepreneurship and innovation that abound. The availability of seed funding is a critical element for success. But, it is not enough. There also must be capital for emerging growth companies in subsequent financing rounds. Attracting such capital will require strong and sustainable performance by startup companies and an ability on the part of investors to cash out in IPOs or M&A transactions. Without that, today’s sunny forecast for startups may well yield to storm clouds ahead.