Heading Into Q4

I'm a big data person. I love looking at data and thinking about what it tells us about the world around us. My first job was an analytics coach for an NCAA hockey program. Then I went on to two data oriented startups before my current ventures. This week I took a look at some macroeconomic data and tried to think through how it might impact the future of our world. Startups and Venture Capital.

The first data set that caught my eye is below:

Source: Pitchbook

This chart is a report and custom metric that Pitchbook tracks on dealmaking in the venture space and weather or not the current environment for fundraising is more favorable to investors or founds and look at that line dipping quickly quickly below the median going back to 2006 (downwards trends = more founder friendly). Quick observation before I get to my larger observation. That line has been trending down since 2017 and yet it feels like the last 12 month there has been a really heavy narrative around the fundraising environment. Are we reaching a breaking point or has the pandemic simply helped bubble this point to the top of investors minds?

Either way, this data clearly shows that the funding environment is rapidly becoming pro founder. When I went to Pitchbook to read how they formulate their "VC Dealmaking Indicator" as they call it, I was caught off-guard a bit, first the formula and then I'll tell you why. First, the indicator is primarily two factors, capital availability (dry powder) and the number of venture seeking founders. A simple supply and demand curve and that sharp downward trend is purportedly the result of a glut in founder/startup supply and a shortage of venture dollars that can fund them which is partially why new investors from outside the asset class have stepped in (Tiger Global et all).

The reason I was a bit taken back by this is I had remembered a recent report I had see from Crunchbase on the pace and value of deals in the venture markets over the last 2-3 years. Below is a series of data sets from that article.

These three graphs represent the deal size and the number of subsequent deals over the last 12 months ending in Q2 of this year. Yes, record numbers of capital being deployed bolstered by those new entrants into the market. But what caught me off guard is that the number of companies (deals) that this funding is going into is either growing at a slower rate or is even decreasing in the case of seed stage deals.

What doesn't track for me is if there is a massive supply increase in venture seeking founders and and record levels of funding to fund those founders than how is it that the number of deals is slowing/contracting? Venture is a long-tail game and so often the cycles lag behind the current trends but the available dry powder is at record levels so why isn't the deal count? More evidence from pitch book on the increase in dry powder over the last two decades.

There are two things that could be happening that come to mind when I look at all this data, this is my humble opinion after looking through all this and just trying to rationalize it in my head. 1) The ratio of founders-to-investors if far more skewed than the Pitchbook report has highlighted, and by skewed, I mean that investors actually are outpacing founders at a much higher rate. And if that isn't the case then 2) this might be a sign of the venture market maturing in away that is similar to other capital markets and a "Secret" that all successful money managers will tell you, rally/consolidate around your winners.

My concern heading into Q4 is that while NAV and dry powder are setting records, the number of founders getting funded is contracting despite what these reports state is a massive supply increase in new startups seeking venture capital. While I appreciate that rallying behind your winners is a healthy way for investors to protect returns and manage risk, if we rally too much around winners are we setting ourselves up for a talent drop-off?

If founders find themselves unable to raise traditional venture will this have a ripple effect in the years to come on the numbers of bright and entrepreneurial thinkers and how many of them choose to start something on their own? The recent spike in valuations and the frenzied funding environment has been great for founders and employees who join fast growing companies early on but with the the numbers of companies that actually receive funding on the decline, do these people just elect to join these fast movers versus risking it out on their own.

Only time will tell and with startup-venture funding, there is often lag in the data so perhaps over the next few quarters those numbers will increase. What do you think? Would love to hear from you since this audience is mostly founders and investors. Is there an imbalance in the market? Is the data just lagging? Are we still feeling effects from COVID? Would love to get your thoughts and see you next time!

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See you next time, till then, stay SaaSy folks! ✌️