Summary:

Fewer venture firms raised more money during 2011. A smaller industry with more money, plus an active angel community that can put money in early stage deals, means entrepreneurs are likely to face the biggest fundraising challenge at the Series B round.

funnel

Fewer venture firms raised more money during 2011, and the money is being concentrated in the hands of fewer firms, according to the National Venture Capital Association. The venture capital industry group reports that 38 U.S. venture capital funds received $5.6 billion in the fourth quarter of 2011; but only nine of those were new funds,the data released Monday from the NVCA shows.

In 2011, 169 venture firms raised $18.17 billion from limited partners such as university endowments and pension funds. In 2010 the same number of firms raised only $13.78 billion– or 30 percent less. While more money would mean good news, but that isn’t the case.  The number of startups looking for money has gone up sharply. An active angel community and early stage investors that can put money in early stage deals, means entrepreneurs has helped many startups set-up shop. They are likely to face their biggest fundraising challenge at the Series B round, a problem that has been mounting.

From the release:

“This past year we saw more venture capital money raised by essentially the same number of firms, a sign that consolidation within the industry is continuing,” said Mark Heesen, president of NVCA. “We also continued to invest more money in companies than we raised from our investors. Both of these trends – if they continue — suggest that the level and breadth of venture investment is starting to recalibrate to reflect a concentration of capital in the hands of fewer investors. Our cottage industry is indeed getting smaller still and that will impact the startup ecosystem over time.”

For startups, which can find a few hundred thousand in seed funding or a Series A round, by hitting up angel investors or the smaller boutique firms that try to play at the seed and angel level, the impact is likely to be felt as the startup hits the point where it must move from the initial product and users to the massive scale that delivers the type of growth venture firms need. That growth will need more money, and that money is likely part of the Series B round.

Anand Sanwal, the CEO and Co-Founder of VC data provider CB Insights says what’s happening isn’t that Series B financings aren’t necessarily on the decline, there are just more startups firms competing for that money. The money, as Om predicted, has started to go to companies that having wind beneath their wings.

If one looks at venture capital as a funnel the top has gotten fatter, and the Series B point is where it narrows substantially, leaving a lot of orphaned companies. “Seed investments are kind of call option for these big funds so they can re-up at the series A or B if they want,” Sanwal said. “It’s low risk and a low investment amount.”
He stressed that this is for tech, as opposed to the life sciences or green tech industries, which require more capital to start up in general.

He also said that with the smaller funds which could be angels or micro funds of just a hundred million, there’s much less pressure on investors for a big exit, so building up a business to a Series A point and selling it would still make early investors happy. At the high end where the NVCA is tracking funds, such as the $1.05 billion fund Khosla Ventures raised during the fourth quarter, startups need to go big to make an impact on the overall portfolio.

So maybe a Series B raise is when an entrepreneurs needs to evaluate if he or she is in this for the big win rather than the quick flip. And it’s likely that in 2012 we’ll see a lot more entrepreneurs having to make this decision. Do they have the will and enough forward momentum to go big, or is it time to take the money and run? Or maybe just cut their losses and run?

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