The market correction has come for Series A and seed startups
After being largely spared the pressure that market turmoil has placed on big tech companies, early-stage startups are starting to feel the chill.
Changes in market sentiment often happen quickly, but these trends can take a while to show up in a full data set. But trade by trade, anecdotal evidence gives investors a good idea of where the winds are blowing.
As a sponsor in close contact with early-stage venture capital firms, Michael Kim has a particularly clear window into the early-stage venture capital market. His company, Cendana Capital, is a fund of funds that backs dozens of seed companies, including Lerer Hippeau, Susa Ventures, Freestyle Capital and Uncork VC. Kim also regularly checks with Series A-focused funds about their funding needs.
His conclusion is that VCs have recently taken a significantly more conservative approach to early-stage deals.
Over the past two to three months, valuations of seed and Series A deals have fallen significantly and startup investors have become more selective, focusing on startups capable of achieving revenue targets greater than those required. in the past.
Last year, the typical best-in-class Series A deal raised about $20 million for a post-money valuation of $120 million, according to Kim. But recently, those round sizes and valuations have dropped to around $10 million and $50 million, respectively, he said. As a result, the founders accept increased dilution of the stakes they hold in their own companies.
In addition to falling valuations, some investors are placing more emphasis on revenue growth. Kim said some venture capital firms, including Sequoia, were beginning to require companies to demonstrate stronger earnings before seeking a Series A. A Sequoia spokesperson declined to comment.
For the past three to four years, the minimum to raise a Series A was around $1 million in annual recurring revenue. But that bar has now risen to between $1.5 million and $2 million in ARR, Kim said.
“A company cannot simply show that [revenue] overnight,” he said.
This suggests that early-stage startups will need more time and capital to reach their next round of funding.
Some of these companies are now starting to run seed extension rounds, which helps them hold on until they raise a Series A, Kim said. An extension is a small grant at the price and terms of the previous cycle.
The seed stage also sees valuations drop significantly, he said.
“One of our fund managers was considering a funding round for a Mexican company, and they wanted to raise $4 million of a $25 million round. [pre-money] evaluation,” Kim said. “In reality, it will probably happen at $12 million [pre-money] Evaluation.”
An exception to the trend is Web3 and other crypto-related seed offerings.
“On the crypto side, it’s crazy,” Kim said. “We hear about $7 million rounds going to $30 million [pre-money valuation].”
Although the value of coins and shares of crypto companies like Coinbase have fallen recently, Kim said he expects investors to continue to pile into early-stage Web3 projects. Some investors may be encouraged by the fact that crypto assets have rebounded from past downturns.
“The last crypto winter was in 2018,” Kim said. “If you were investing throughout 2018, you did really well.”
Image featured by DNY59/Getty Images