Startup Funding Is Shrinking
November 02, 2005

VC veterans predict that fewer companies will get early-stage funding this year.

Even as the amount of cash flowing into venture capital funds surges, the number of companies securing early-stage funding is likely to decline this year, say industry veterans.

Fewer than 700 companies will garner early-stage investments from venture capital firms this year, predicted Ann Winblad, co-founder of Hummer Winblad Venture Partners.

That would mark a decline from last year, when 720 companies raised $4.52 billion in seed and Series A capital, which represent the earliest rounds of financing for startups, according to data from Venture One.

In the first nine months of this year, 521 companies raised $3.55 billion in cash from venture capital firms. Those numbers typically don’t include funding startups received from either friends or family, or from wealthy individuals known as angel investors.

“The bar is extremely high this year to get your [Series] A round of funding,” Ms. Winblad told participants at the Women’s Technology Cluster’s Entrepreneur Venture Conference in Mountain View, California, this week.

“The number of startups getting institutional money in their first round is still very small,” she said. Instead, venture capital firms are competing to pour cash into companies looking for later rounds of funding, especially the round right before companies go public or get acquired.

For entrepreneurs, though, it’s the competition for early-stage funding that’s most intense, said Ms. Winblad and other venture capitalists speaking at the conference.

“There’s really a paucity of Series A and seed-round financing,” said Vincent Occhipinti, founder and managing director of the Woodside Fund.

VCs Reduce Early-Stage Investments
The share of venture capital funding going toward early-stage investments has fallen dramatically in the last decade, to just 17 percent of all disbursements last year from 43 percent in 1995, he said.

“This is despite the fact that the industry in the first quarter of this year raised more money than all of last year,” said Mr. Occhipinti. “So money is pouring into the industry but not at the seed-round and first-round financing stages.”

That may signal the industry is shifting away from its traditional role of seeding risky startups toward the safer investment strategy of funding companies that are more established and need the cash mainly to expand, said Stewart Alsop, a venture partner with New Enterprise Associates.

“There’s this tremendous flood of money coming into the venture capital business that’s moving the venture capital business up into really a different category, one that’s more oriented toward investing in growth capital and expansion capital,” he said.

Mr. Alsop said it is much harder for venture capital firms that range in size from $300 million to $500 million to focus on helping to start companies.

“They’re really much more focused on helping expand companies,” he said.

Ms. Winblad cautioned that not all venture capital firms fit that profile, however. Her firm just closed a $750,000 investment, and others are also still doing early-stage deals, she said.

But venture capitalists should resist the temptation to boost the size of their investments even if they are pulling the cash from larger funds and feel pressure to make larger investments, she said.

“If you’re an early-stage investor, you really have to size the deals to fit the company,” she said, instead of sizing them to fit the needs of the fund.

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