VCs: Don't value your startup for future dilution

Duncan Davidson got VCs to admit that they get caught up in the tech themes too

Investors and entrepreneurs have been talking a lot lately about whether there is a Series A crunch, if most companies even need a Series A and if now is the apex of a bubble. Duncan Davidson, managing director of Bullpen moderated a panel full of VCs at Venture Shift, hosted by Bullpen Capital and Vator, to see just what the people behind the checkbooks are saying about it.

This lively conversation included some serious insight about what VCs think about when a company gets a blockbuster valuation, who invested in Fab somewhere between when it was "gay Yelp and gay Groupon" and who loves a good bubble.

Meet the panel:

Jeff Clavier, founder and managing partner with SoftTech VC. Clavier has invested in roughly 100 consumer Internet startups since 2004.

Stewart Alsop is a partner with Alsop Louie Partners and has led investments at New Enterprise Associates with TiVo, Glu Mobile and Xfire. 

Chris Hulls, CEO of Life360, has helped build a mobile application marketplace for people to sync all of the needs of entire families via smartphone devices. The company is about to cross 20 million users which puts them on track to beat FourSquare usership in a year.  

Renata Quintini is a partner at Felicis that has led investments in various e-commerce and education opportunities, including Bonobos, Dollar Shave Club and Baby.com.br.

Craig Sherman, managing director of Meritech Capital, was previously the CEO of Gaia Interactive, an interactive platform for social games and online communities.

Here are highlights from the discussion: 

Duncan Davidson: If you follow the lean approach, you have a better, happier outcome in the end. But is there too much activity going on for the front end?

Or is there a structure difference that has made the Series A less crucial?

I also include a term I coined here: FOMO Deal – Fear of Missing Out. Could some of the ballooning action on throwing money on deals similar to firecrackers be a big issue right now?

Viddy is an example. Facebook tweeked their newsfeed to help video show up and suddenly SocialCam and Viddy were seeing record signups and usage, then SocialCam sold for $60 million and some are left wondering if Viddy is a real deal or a FOMO deal.

What do you guys think? Is there a Series A crunch?

Jeff Clavier: Yes. There is too much deal activity on the front end. The percentage of companies that can get a Series A will have to decrease because more companies are heading in. We invested in Fab at the stage between when it was gay Yelp and gay Groupon. Not every company has the traditional behavior of exciting those investors at the Series A. Some companies can actually even bypass the Series A and do a $10 million - $14 million Series B type of round.

Chris Hulls: Yes. Based on the math we are in a Series A crunch. If there are more C deals then there are less, that is just how it goes. But that isn’t necessarily bad. A lot of companies say that they don’t need the Series A, but some of those aren’t going to head to a place where they have a successful exit that angels will be excited by.

Stewart Alsop: No were aren’t in a Series A crunch. I have been around for a long time and recognize patterns. I have seen this before. There is no series A crunch, there are too many investments occurring. But, the two signature deals creating a bubble here to notice are Yammer and Instagram. There are a lot of companies that are going to go out of business because there is no money left for them.  Just because Fab is attracting money, doesn’t mean that it will go public a la Groupon.

I want to remind you all of the term “overhang.” In 2001, 2002, 2003, there was way too much venture capital raised and not deployed. Now, we are in another part of the cycle.

When you raise capital, remember it is a process and you have to guess right, otherwise you dilute how much of your company you own.

Renata Quintini: Looking at the data, in 2008, the Series A and C were equal. Then fast-forward to 2011 and you see twice as many C deals. What you should take from that is: don’t try to optimize for the dilution. In the past 12-24 months, you nned to remember that it can be hard in 12 months to get a revenue that will get Series A guys to pay attention so, when you can, take more money than you need and really make your company work.

Craig Sherman: We hear the valuation of the last round and then extrapolate where the next round should be. It is quite dangerous to get a high valuation in your first round and a lot of companies fall into that trap of wanting to get a huge valuation and prove they are the company in that market, but that makes the next round of investors really scrutinize the future revenue goals.

Duncan: Are you seeing a bubble in valuations?

Jeff: Yes and no.

Chris: The early stage guys are valuing on promise and the bigger are more conservative.

Stewart: I love a good bubble. They create incredible social good. I mean, really, money is just going out into the social system and not coming back, it’s really quite remarkable.

Renata: Look at a Y Combinator that has 60 companies and all are exiting completely funded. It is easier than ever to start a company but it’s harder than ever to really build and grow a company.  There is a definite disconnect.

Duncan: How do you advise companies in the middle?

Renata: Know your milestones well. And make sure you control your own destiny. Raise for 12-15 months of runway so you have firepower to hire the best talent and move forward well. Also tell a good story.

Jeff: You have to understand all of the components. Figure out what will make you Series A fundable in 16-24 months. Look to your investors to get a better sense of what it is going to take.

Stewart: From an entrepreneurs point of view, you have to focus on who your investors are. You should take this as a life event. You want to make some thing of real serious value. You want partners to work with you on that. The thing that is irreplaceable as an entrepreneur is you have to keep your eye on the ball. I would much prefer to work with an asshole that knows his base than someone polite.

Duncan: Any advice to get to C and D rounds?

Craig: I think that we are going through a cycle -- the high-end of a cycle. I have lived through the opposite end. In 2001 we couldn’t raise anything for Ancestry and only survived by moving to Utah and getting support from Mormons, who put a high value on family history.

If you are an entrepreneur, it is not that easy to raise money still. All of us on the venture side are caught up on a set of themes, and if you are not in those then don’t be discouraged because there is still an opportunity.

Jeff: Later-stage VCs have also been investing in Series A lately and that sometimes created some tension in the sector.

 (Coming soon: Be sure to check into VatorNews for the video version of the panel.)