The expanding birthrate of Web startups

Y Combinator, Techstars and Seedcamp are having an impact

There is a general consensus that Web startups are being created at a faster rate than ever. The impact of accelerator programs like Y Combinator, TechStars, Seedcamp, and dozens more are one factor. The expanding pool of angel, seed, and super seed funds is another. And the most important factor is how cheap it is to build and launch a Web service these days. You can bootstrap your way into existence.

I like to think of the venture capital business like parenting. When I invest in a company, I am committing to the care and feeding of the company until cash flow breakeven (the startup equivalent of adulthood). That care and feeding includes the decision to call it quits and give up on the project sometimes, but honestly that doesn't happen that much in our portfolios.

So when I look at this expanding birthrate, I think "Who is going to house, feed, school, and send all these kids to college?" 

Part of the answer is that this crop of startups is going to be way more self sufficient than what has come before them. I believe that is certainly true. We invested about a half a million of seed capital into a company last year and it is already profitable and there is a good chance that company isn't going to need any more capital from us. But it will continue to need advice of other sorts.

Part of the answer is that this crop of startups will get bought out earlier than those who have come before them. Look at Hot Potato. Josh Kopelman said "we've only been investors for a couple of months" about Hot Potato. That is a good outcome for the founders. Not so much for the investors. But it is going to happen more and more as large tech companies look for teams that have a proven record of building and launching strong products.

But even with these two very positive factors, I worry like a parent with too many kids. "Who is going to take care of all of these kids?"

I am an investor in some of these super seed funds personally. I see the capital calls. When a fund has called 40% of its committed capital six months into its existence, I worry. What happens when the money runs out? Will there be more?

Flatiron Partners came into existence in 1996. Today we still manage a portfolio of four companies. That is down from something like 55 total companies we funded. But the fact is fourteen years later we still have four portfolio companies.

Union Square Ventures' first fund was raised in 2004. We invested in twenty-one companies and we still have sixteen active companies. And we still have $25mm on reserve for them. Christina and I calculated last week that about half of those sixteen active companies still might need more funding from us. So we have eight "kids who have not yet reached adulthood". That is six years after we raised the fund.

The thing that nobody understands until you've lived through it is just how long it takes for some companies to get profitable and self sustaining. And just how long it takes for some companies to get liquid and leave the portfolio.

The VCs I talk to who have been doing this for 25 years or longer aren't so much worried about the "dipshit companies" (as if there were such a thing). They are worried about the entry of so many new investors with relatively small funds birthing so many companies. These veterans may not be as connected to the latest web startup, but they sure are connected to the realities of the venture capital business. They've lived through it and they know what is involved with getting a company all the way to profitability and exit.

The venture capital business is contracting. There are less VC funds than there were a few years ago. And there will be fewer in a few more years. And the birthrate of web startups is expanding. That is the challenge we all face.

So, if you are an entrepreneur you should be very focused on either getting to profitability or getting a VC firm or two with deep pockets into your company (or both). If you are a seed investor, don't go quite so fast. Reserve some funds for follow on investments. And help your portfolio companies get to profitability or get a VC firm or two with deep pockets into your company.

I think this expanding birthrate is a great thing. Entrepreneurship is alive and well all around the world. Smart and scrappy entrepreneurs are imaging new products and services and building them. But we all should be careful to think about how we are going to fund all of this company creation. Not just the first part of it, but all of it.

(For more from Fred, visit his blog)