The evolution of the Venture Capital industry has been fairly dramatic over the past several years. A trend that’s emerged prominently in the early stage market is the massive supply of seed stage companies relative to supply of Series A capital. Bullpen Capital is one of the early pioneers in providing stage specific financing related to this phenomenon.

The below is a transcript of a chat I recently had with Duncan Davidson, Founder and Managing Director of Bullpen Capital. Duncan has over 25 years of investment experience and was previously a Managing Director at VantagePoint.

By now, nearly everyone in the industry has heard of, and is likely fatigued of the term “Series A Crunch”. You and the rest of the Bullpen team identified this issue several years ago and developed an investment thesis around it.  Tell us more about the factors that led the team to identify the issue.

We’ve now seen a decade long plus era of cheap – it now takes a lot less money to get a company started than ever before, which has created a massive increase in start-ups and seed stage focused funds. During this era, the ability to rent the cloud from Amazon and use open source software has dropped the cost of capitalizing a start-up from ~$5M in 1999 to $500K in 2010. Our belief was that with the mass amount of activity at the inception stage along with the concurrent consolidation of the old venture industry, there would be a fundamental and pronounced funding gap as the post seed level. The seed rounds of today are akin to the old Series A of yesteryear from a company development standpoint, but the A rounds are getting bigger, “Super Sized” and more like C rounds, waiting for the deal to be de-risked.

Do you believe the relatively scarcity of A round funding will sustain?

If you look back in history, every one of the tech booms were characterized by some fundamental change. In this case, the era of cheap has fundamentally changed the venture funding landscape. As long as that continues, the Series A Crunch will continue. This is not just a temporary problem of capacity in the industry.

With this not being an ephermal issue then, how should entrepreneurs look at taking capital and planning out their seed rounds?  

Well, raising seed capital is now a process and not a singular event. An entrepreneur needs to understand that they will never get out of the money-raising business. They will be raising money all of the time and in most cases, in a series of smaller raises. At Bullpen, we are late in the seed process once a company has demonstrated things like product-market fit. When you’re in a Bullpen round, you are in the final stages of the seed process with the next round being a growth oriented “Super Sized” A round.

On the other side of the spectrum, the venture industry has seen a consolidation of capital where a select group of venture firms have and continue to raise massive funds. How does this side of the equation factor into the Series A market?

Series A rounds traditionally have meant the first traditional VC money in. Now those rounds are seed rounds, led by Seed funds and/or Angels. Fundamentally, it doesn’t make sense for large traditional venture funds to invest in seed rounds for a myriad of reasons. Instead, we will see larger firms filter out companies quickly in the seed ecosystem, and focus on what we think of as Super Sized A rounds. Once you know that a company is going to scale, why not invest $10M, $15M, or $20M instead of the typical $5M Series A? It makes for better fund alignment for larger funds. The number of “A” rounds isn’t reducing, but the profile is.

Speaking of Super Size A rounds, outside of potentially unnecessary dilution, is there any reason a Company should forgo a massive Series-A financing, especially in situations that the cash is not clearly needed at the time?    

The funny thing about raising a large amount of money is you sometimes feel trapped by the money to prove the thesis or business model you raised under was correct. Also, we’ve seen companies raise tons of capital at sky-high valuations relatively early on, only to come crashing down due to irrational expectations. If you take that path, be thoughtful as your margin for error can be razor-thin.

While so-called unicorns are very rare, there has been a huge recent uptick in private companies that have received massive rounds at billion dollar valuations. You were actively investing in 1999/2000 when companies with very little fundamentals were going public. Most companies going public right seem to have, at the very least strong top line metrics. That said, rumblings of a bubble are out there. Your thoughts on this subject?

First of all, we’re not in a bubble. If I had to make an analogy to 90s, we’re not 1999 yet. If you look at the stats in 1999, every silly company received ridiculous valuations. So when it’s a selective stupid valuation market, you’re not in a bubble, which is what I believe is the case now. I would say we’re probably 1997, but not necessarily on the same path of what happened in the late 90’s. We have had a couple of really good years with Facebook sort of being like the Netscape IPO of the mid-90’s.

Throughout history, most markets follow a periodic boom/bust cycle. It’s endemic to the industry that a boom has to occur. How else do you get people to put money into crazy ideas or adopt new technologies without the mentality that we have to do this? If this is missing, people will resist, incumbents will win, and challengers won’t break through. It’s part human nature. Therefore we must embrace boom and bust. We can’t think there’s something wrong or endeavor for some normal in-between. Sometimes booms do get out of control, which creates a bubble. We expect this era of cheap to go through a boom cycle and we’re about halfway through it.

Leave a Reply