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It was Mark Twain who popularized the idea that untruths should be split into three categories: “lies, damned lies, and statistics”. But even a sharp intellect like his may have struggled to work out the reality between two contradictory headlines that appeared in the last few hours.
Both purported to explain the state of the American venture capital industry, but with radically different conclusions. First CNet reported research from CB Insight that says VC funding continues record pace. Just a couple of hours later the Wall Street Journal wrote that, in fact, “financing is drying up” in a piece headlined Web startups hit cash crunch.
So how do you reconcile these apparently conflicting pieces of data?
Well, it’s worth pointing out that they aren’t necessarily as diametrically opposed as they may appear. Despite the headline, the WSJ piece is focused on a fairly narrow sector of the startup market — seed-level companies. As such, it’s entirely possible for the VC market to be sloshing around and investing more cash than it can handle, yet giving the youngest startups a headache by choosing to pour most of that money into more mature businesses. Certainly, when you look at blockbuster rounds raised by the likes of Twitter, this could easily be the case.
At the same time, the CNet piece says a booming $7.9 billion was invested in the last three months, while the WSJ uses numbers out earlier this week from the National Venture Capital Association, which said that VC funds raised their lowest amount in eight years in the third quarter. Again, these aren’t necessarily in complete opposition. Spending money that’s in the bank can be increasing while overall income is deteriorating… just ask anyone with a hefty credit card bill.
Still, that doesn’t mean we should accept stories at face value. Take the NVCA data: what the WSJ report doesn’t point out is that they also suggest that the rest of 2011 was much better than in recent years: in particular, that VCs had raised more than $7.6 billion in the first quarter, way ahead of recent trends. All you have to do is zoom out just a little bit, and the numbers tell a very different story from the one being put forward.
It’s also worthwhile to understand that most of the WSJ story is based around some very selectively chosen anecdotal evidence. There’s one quote from Navil Ravikant of Angel List, who says that only a small portion of early-stage startups on his site are getting funded. And there’s Jessica Mah of InDinero, whose major complaint seems to be that while she was able to get $1.1 million after graduating Y Combinator, a second round has been harder to come by.
If you want to know what some investors think, then Techcrunch has a good roundup of reactions, though people seem to have differing opinions on whether there is indeed a crunch happening or not.
The missing question: are these startups good?
To me, however, the problem with the argument that the WSJ gives voice to is a broader one. Whether or not it’s true that seed stage money is getting harder to come by, and whether valuations are maybe a little lower than they were a year ago, it is really beside the point. These are not bad things in and of themselves: they are only bad things if they are out of line with reality.
And there’s the thing. The Wall Street Journal seems to imply that investors should be simply handing over slabs of money to startups — and that their decision to be more picky is problematic. Yet that’s an argument which shows an almost total lack of interest in value.
Sure, only one or two percent of Angel List startups are getting deals each day. But the first question should not be whether that means there is a fundamental imbalance in the system: it should be whether the remaining 98 companies actually deserve the level of funding they are looking for. Whether or not other companies got funding in the past should really be no indicator of whether today’s companies should also get it.
I fear that this story is representative of problem that’s becoming more pressing over time: the assumption that being unable to raise funding is a symptom of a diseased industry, rather than a signal of its health.
One overlooked reason for this, I think, is that the startup industry has spent the last few years trying to perfect systems to make investing more efficient, whether it’s the rocketing number of accelerator programs, or the rise of services like Angel List and Seed Summit, or the spread-betting approach of super angels.
The fact that these ideas are all based around scale — lots of small investments instead of a few fat ones — makes it look like the answer is simple: if you put enough money in one end, you generate success at the other. That’s the argument that says every company that makes it onto Angel List should get money, or that every startup that burns through its seed round should be able to raise another. Except that point of view totally misses the fact that the decision about which companies get investment isn’t an indiscriminate one. The question of value — of quality — is crucial.
Even Start Fund’s decision to put forward $150,000 to every single company that leaves Y Combinator is not random. By the time the money is offered, Y Combinator has already done its due diligence on the entrepreneurs and trained these within an inch of their lives. Start Fund isn’t avoiding a decision, it’s just outsourcing it.
More evidence please
No system is perfect, of course. Not every company that has real value will get funding, and some companies that don’t have value will. But you have to remain rational — which means we should remain skeptical of claims like these until there’s evidence to form an opinion on.
If you need any more convincing that the whole premise rests on shaky foundations, then just take a look at the other statistic the WSJ uses to justify pushing this argument:
Between Jan. 1, 2009, and late last month, U.S. venture-capital firms raised $39.2 billion, down 76% from the $162.5 billion that was raised between Jan. 1, 1998, and Dec. 21, 2000, according to VentureSource.
That’s right, it suggests that today’s investment market compares unfavorably to the dotcom boom. Well, yes, it does. And if you remember the boom at all, you’ll remember where all that money got us.
This so-called cash crunch only matters if it’s killing companies that deserve to live but cannot do it any other way — and while access to seed funding for unproven startups can be problematic, particularly in younger markets, I don’t think the evidence suggests that good startups are having a problem. That’s a good thing — whether it provides a good headline or not.