While the number of seed-stage funds raised since 2011 has increased five-fold, the global coronavirus pandemic and the ensuing U.S. stock market crash do not bode well for seed-stage funds or seed-stage startups.
There are some bright spots however. Like less competition among the surviving seed-stage funds, plus better selection of opportunities and lower prices.
There were about 900 active seed-stage funds in the U.S. market through the end of 2019.
But the trends from 2012-2019 did not look promising, regarding these funds, nor did they display confidence that these funds can handle the current economic status, according to Jeff Bocan, Okapi Venture Capital‘s managing director.
Bocan made these remarks as part of the VC Speaker Series at UCI Beall Applied Innovation on May 8.
Okapi funds early-stage tech startups. Its HQ is in Ladera Ranch.
Bocan’s credentials include being a venture capitalist for 16-plus years, with 40-plus investments and 30-plus board roles. While he was the SVP of Mophie, he led growth from $10 million to more than $250 million. He’s also an angel investor.
The 2012-2019 trends include:
– a scattershot approach to investing
– passive investment, which creates a low value-add
– barely any reserves
– young funds that have never experienced a global/domestic crisis like this
– investors with weak leadership and without deep pockets
Bocan’s assessment of the amount of VC money that will be raised by LPs this year and next is pessimistic. He based that opinion on data showing that VC fundraising fell by nearly 60% from 2008 to 2009, during the Great Recession.
He envisions a rebalancing of institutional portfolios due to what’s known as the “denominator effect.” Typically, a decline in the value of one asset typically results in other assets being sold, to equitably rebalance a portfolio.
But many assets, like VC and PE, can be challenging to sell in the short-to-medium term.
Another challenge: managing capital calls from prior commitments.
And, any short-term delay in M&A/exit activity hurts the ability to recycle and reinvest capital.
The good news is that returns typically increase after crises, as was the case after the September 11 terrorist attacks and the Great Recession.
So, as survival of the fittest goes, and some seed-stage funds dissolve, there will be less competition for the ones that survive.
That means better selection and lower prices.
Plus underfunded, existing seed-stage companies offer a higher quality of investment at lower prices.
As a result, Bocan envisions that active seed investors between 2020 and 2022 will see higher returns.
So, what does this mean for seed-stage startups?
Traditional VC-backing will not be an option for many startups, according to Bocan.
As a result, there will have to be more of a reliance on bootstrap/sweat equity and angel funding, as well as friends-and-family for longer than normal.
“Stretching money is more important than ever ,” Bocan said. “Money must drive value and progress. Rent, amenities, consultants, legal/IP costs, etc. need to be watched closely.”
Bocan said he sees potential for the SoCal innovation ecosystem to continue to grow and benefit from the continuing erosion of the historic San Francisco Bay Area/Silicon Valley dominance of capital and talent.
So, SoCal can expect to see a higher level of available workers and downward pressure on salaries.
And, look for laid-off workers and recent college grads to start new companies at a faster rate than usual.
As we’ve seen over the past few months, disruptions from the pandemic are catalyzing innovation and larger companies are more willing to try new tech.