VCs rise to the top in start-up funding survey

A new generation of VCs spearhead start-up funding, but JOBS Act means change on the horizon

The investment climate for tech start-ups has undergone dramatic shifts over the last few years.

Since roughly 2008, institutional VCs have taken a hit, as angels, super angels and – to a lesser degree – accelerators and incubators altered the investment landscape with fast-moving seed and early-stage deals that VCs typically didn’t want. 

As these other investors eventually began to compete for deals classically scored by institutional firms, the VC world became divided between the have’s and the have-not’s in terms of where LP dollars were flowing, with a handful of firms raising enormous rounds, with some unable to raise funds and being labeled the “walking dead”.

But times have changed, according to our just-released survey of startup company CEOs. 

Not only is today’s start-up funding climate more robust than it was a few years ago, but institutional VCs have made a resounding comeback, particularly in major U.S. metropolitan areas.  The percentage of Metro startups that have secured funding from traditional VC firms increased sharply since we conducted our first survey in 2010 and the percentage who expect to raise a future round from traditional VC firms experienced a huge increase since 2010 as well.  When asked to write in their top 3 investor choices, startup CEOs conclusively identified institutional VC firms as their preferred investors.

How VCs evolved

What triggered these recent changes in the start-up investing landscape?  As their influence declined, many VC firms were forced to adjust their investment model and accommodate the new reality to stay afloat.  They began to close deals more quickly, established firms like Benchmark and Greylock recruited high-powered entrepreneurs able to attract the most promising tech startups, and investors like Marc Andreessen further upended the VC industry by fashioning himself as an early-stage VC willing and able to double-down with big bets that more resemble a late-stage institutional VC .  The data shows that such strategies have been successful in reviving the VC business model and keeping firms relevant in this new era of startup investing.

Hand in hand with the renewed prominence of institutional VCs, a new dynamic has also emerged around angels, super angels and incubators, a key part of the startup funding equation.  Instead of competing for early-stage deals, VCs and angels, etc. seem to have reconciled and found a way to work together – at least in metro areas – to effectively foster growth for startups.  Our survey data suggests that as angels, super angels and accelerators/incubators continue to fund smaller, early-stage funding rounds, institutional VCs dominate the market for larger, later-stage rounds.  Dividing up the startup investment market this way makes sense and allows each group to play to its strengths.  VCs, for example, can still make a compelling value proposition to entrepreneurs based on their deep pockets, industry expertise, and potential for funding subsequent rounds.

Change, however, is on the way, with the newly-passed JOBS Act, which portends a new era of start-up investing.  With its ability to hypercharge funding of early-stage startups, this new piece of legislation, will change the current investment dynamic substantially.   While there’s no crystal ball to predict the exact impact of the JOBS Act, there are nonetheless early indications of how it will play out in the startup funding world.

Because of its crowdfunding provisions – i.e. permitting unaccredited investors to invest in startups through registered funding portals – the JOBS Act may magnify the influence of angels, super angels and incubators.  As crowdfunding dollars flow to startups, we expect angels and other early-stage investors to take on a much bigger role in vetting companies, possibly lending their name to promote and endorse promising startups to unaccredited investors eager to invest in the next Instagram.  Likewise, it’s entirely possible that incubators and accelerators like Y Combinator and TechStars may even run their own funding portals to capitalize on the JOBS Act.  Not surprisingly, angels and super angels heavily supported the JOBS Act, along with heavy hitters in the tech industry.

Conversely, institutional VCs, who generally raise funds from LPs, may have little desire to open the door to the general public or leverage their brand name in this space.  They will, however, benefit from having a broader array of startups competing for their attention, particularly since other people’s money will provide early funding for these companies and help winnow down the best ideas before effectively passing them along.

Despite widespread support for the JOBS Act throughout the tech industry, critics worry that it will create a glut of startups with “me too” business plans that would otherwise go unfunded.  Our survey data also provides an interesting point of reference for the JOBS Act era.  With their larger rounds and more consistent funding outlook, metropolitan areas, which successfully adapted to the rise of angels and super angels, appear poised to benefit from the JOBS Act, providing cause for hope for the outcome of this new legislation. 

However, the lack of clear-cut funding trends, and a presumably less predictable funding landscape for startups located outside of the major metropolitan areas sounds a cautionary note.  While it’s possible that the JOBS Act will open up new capital to such areas, its ability to encourage sustainable startup activity there is by no means assured.  If companies secure crowdfunding in a less-than-robust funding environment – indeed, non-metro areas seem to experience greater fluctuation in the amounts and sources of startup funding – it begs the question of what will happen to these startups once they’ve exhausted their crowdfunding dollars and need to secure subsequent funds.  Under this scenario, the JOBS Act may create a house of cards that will eventually come falling down.

Interested parties can reach Ted at hollifield.ted@dorsey.com or can follow him via Twitter at @TechStartupLaw.