Early Stage Financings Drop

When I read the Techcrunch article on the early stage finance drop it resonated with me. It is where we invest in as a fund, and it’s what HPA did when I co-founded it way back in 2007.  Virtually all of my investments since 2007 that haven’t failed are still in process.  Most are doing quite well, but you don’t ring the cash register until they actually exit.  Fred Wilson blogged about it and his points also hit home with me.  Especially this,

When I talk to my friends who do a lot of angel investing, I hear that they are being more selective, licking some wounds, and waiting for liquidity on their better investments.

When I talk to my friends who started seed funds in the past decade, I hear them thinking about moving up market into larger funds and Series A rounds.

He also said, “For investors, it means seed rounds are going to be the place to be. When others leave the market, it is time to get in.” and I agree with him again.

Howard Lindzon weighed in as well. Howard is no stranger to investing in two people and a box. His fund Social Leverage is a seed fund. His blog post is great and he summed it up by saying this,

I do not think the cycles can be timed. I have learned that investing consistenly, in great founders, at reasonable valuations over a long period of time is a fantastic way to make outsized returns. It helps that I keep investing time in my network and living in the future by playing with all the toys.

But, I think both of them missed something a little bit deeper I want to explore.  Techcrunch didn’t explore it either.

We have all-time highs in the stock market.  If we make the assumption that most people are risk-averse, then a stock market at all-time highs should see a huge drop in the number of startup companies and angel activity.  As an angel, if my opportunity cost of capital is the return of the S&P 500, well it’s easier to understand.
SPY Chart

SPY data by YCharts

As Howard and Fred correctly touch on, the valuation of early-stage rounds has jumped a lot. Combined with the stock market run-up and the opportunity cost of capital, that drives investors away.

Over the past many years, the fervor of entrepreneurial activity in the US has dropped.  Fortunately, in all OECD countries, it’s had a slight uptick.  The Kaufmann Institute has some very good data on the US here.  Entrepreneurship is steady.  It had been waning but maybe that is a trend that will change.  There are a few signs of life where companies that were started are lasting more than five years (48.73%).  Companies are being started by people who weren’t unemployed (86.25%).   They saw an opportunity and took it.

In the past, I have hypothesized that the Millennial Generation is more risk-averse than other generations.  It is a gut feeling with no data to support it.  Why do I think that?

  1.  They were affected by the financial crisis.  They were in high school, college or a first job.  The Millennial generation is similar to The Depression generation which saw decreased economic opportunity for their entire lives.  Salaries were lower and so were savings.  It can be chalked up to the severe economic challenges of 1930-39.
  2.  Millennials have record levels of college debt which tends to make people more risk-averse
  3.  The stock market is at all-time highs making it easier to get a traditional job.
  4.  Unemployment, as measured by the BLS, has been low for the past few years.
  5.  GDP over the past 10 years has been historically low.  Low growth means less opportunity.
  6.  Social Media makes people more risk-averse.  It’s harder to go against the herd.  It’s also harder to make mistakes since they are public and stored on a server forever.  It drives conformity.  Entrepreneurs are non-conformists.
  7. Exits are harder because of public policy, high corporate taxes, and 0% interest rates.  Hold times are longer tying up liquidity.  If you are an employee of Uber and have an idea, how do you monetize your stock and go start a new company?
  8.  The next wave of companies won’t be built in a dorm room with hackers and a fridge full of Red Bull.

One of the thesis we have at WLV is that people with experience in Fin Tech will start businesses. You need the seasoning of working in Big Finance to understand where the opportunity lies. It also gives them time to get a firmer foundation and pay off some debt, build a network and be ready to take a little risk. The data show that, and so far the entrepreneurs we have invested in are proving that out.