08 12 / 2012

The “Series A Crunch” and what will happen in Europe

Since I first started to discuss topics related to the now called “Series A Crunch” some months ago we have seen a fruitful discussion among VCs and founders. Journalists and bloggers picked up the discussion and brought in their view and observations and journalists did some number crunching.

The only issue we face at the moment is:
The numbers don’t add up to a common view of the future. 

So when reading those articles, tweets and blogs something came to my mind: It is not a different view of the experts but the different starting points they are coming from. So here it is, what I see around the Series A Crunch for the coming months.

  • In absolute numbers we see an increasing number of Series A deals from 2011 to 2012. So there is no Crunch from this perspective. 
  • We see more interesting deals in India, China, Southeast Asia and Latinamerika with high potential to become successful. So there is enough hunger and potential for VC deals in the coming months. 
  • There is an increasing amounts of VC fund capital in the US and Europe by VCs and PEs raising more funds in total over the last years. Enough ammunition to fund those promising deals. 

So the world for investors and founders is fine - go back to baking cookies and enjoy holiday season with Gluehwein (at least in Europe).

Sorry for breaking the news: "Enjoy the party as long as it last - winter IS coming"

So what? - But all those experts telling us we will be fine!

If you look at numbers, there needs to be a common ground - or better to say: use the same metric to understand each other.

With an even higher number in absolute seed deals, crowd-funded projects and bootstrapped companies it is in its nature that absolute number of Series A deals will increase. But the ratio of available deals and Series A funded deals is decreasing. So those who can close the Series A round are lucky ones - while the increasing part of founders will need to close down their businesses (and hopes) in the near future because they did not close that much needed round.

Investors are flying abroad and digging into new startup ecosystems to find those interesting and promising deals in Brasil, India, Korea, Japan, Singapore, Indonesia, Baltics, Romania and such - VC lands where no US/European investor has ever invested before. But why are those deals are interesting for VCs? Why don’t they invested in the regions they have invested traditionally? Why turning their back on their homeland and focusing on this new lands of hope? - Because the profit expectations are much higher than elsewhere. For any deal made abroad at least one deal is not signed in the homelands of those VCs - not talking Angel kind of deal machines (e.g. handling deals below $50k). You can watch experienced investors from the US and Europe turning their focus away from Western Europe towards those new regions from VC perspective. The Series A crunch is not happening on a global level but on a regional level. This is missing in a lot of discussions. A deal not signed in Berlin is not compensated by a closed deal in Brasil. Same is true for a declined Silicon Valley deal compared to a closing in Korea or Singapore. There is a shift of deals on a regional level from traditional markets to emerging markets. From investors perspective that is no change - for the founders of this traditional regions it is fundamental.

Recent figures showed the amount of funds raised by VC firms from their LPs. In most regions this seams a bit stable with some exceptions of the rule. What has decreased is the number of firms getting new funds. So the same amount of funds went to fewer VC firms. In most industries this wouldn’t be a problem - because ressources would shift to those firms having the funds. But VC firms are different. Partners in VC firms are LPs of their own funds. They have to stay in most cases to make sure their investments in the current funds will turn to profit. In a simple way: they can not leave their firm without risking losing the control of their assets. For a more transparent way we should investigate which investment managers have left one firm to join another firm. We have seen a very few new partners in VC firms - most of them are successful entrepreneurs with good relations to those firms. It has not happen that the ratio of shift of funds from many firms to few has triggered a move of investment professionals moving from firms without funding to those who got funding. 

All of those issues will lead to the development in those traditional VC regions in the coming months:

  • a few investment professional will handle the larger part of the VC funding.
  • those investement professional will not handle the same amount of deals in total than the VC firms would have like in the past but they will put more funds in their own deals - meaning participating in later stage rounds they traditionally would not take part in. In total the number of Series A deals will decrease in those regions.
  • While having more funds at hand and more choices of good deals - within the same region and additional new regions - those funds will be distributed globally leaving less funds in traditional regions in total. 

So here is your Series A crunch: From a local perspective of founders and angels less Series A deals will happen. Founders and angels are focused on local deals - not in emerging markets. Those will raise their voices in the coming months calling the dilema of loosing their investments and contribution in local ventures compared to earlier years. Those angels will not like invest again in the Venture Capital asset class because they got burned in deals they have done in 2011/2012. All discussions of chances and opportunities of new deals in emerging markets are correct - but only a few global active angel funds will benefit from those opportunities. 

Of cause additionally there are those deals “its a product but not a company”. Those deals will be profitable for founders and angels based on break-even of those companies in a very early stage and a dividend kind of turn out. They will get a high interest rate on their investment over a couple of years, which is very attractive in a world of Euro crisis and low interest rates from savings or bonds. None of those deals are venture deals nor will need a Series A funding. 

In Europe we will see two impacts following this development:

  • Traditional regions will have less deals in total but interesting consortiums of investors in those promising companies - in early stages and late stage deals.  
  • In emerging regions we will see those VC firms being active who raised funds and can adapt to the challenge moving out of their comfort zones. 

On a local level in Europe the Series A Crunch will have an impact. But as always there are chances raising from this situation:

  • One chance for founders will be to focus their talents in fewer companies. Building teams of experts instead of every expert starting their own venture will be a promising journey. 
  • Another successful trend will be “kill it fast” - if founders discover their venture will not turn into a profitable trend they should liquidate their venture right at the beginning and start a new one. Pivoting will consume valuable time and ressources. Restart within a new setup is much more promising and profitable. 

Founders will need to adapt and investors will find new ways to manage investments in those times of change. There will be “Crunchtime” - but it will feel much different than the last minutes of a sports game as we think.