Looking to fund your Internet startup?

If you are fundraising for your new consumer Internet startup, here is some thoughtful input from Bill Burnham, a former VC and early stage technology investor.  Bill writes about The Great Abdication:

“Anyone who has recently spent anytime fundraising for a consumer Internet start-up in Silicon Valley quickly comes to an inescapable conclusion: there is effectively no Venture Capital available to Consumer Internet startups.

“How could that be?” you say. After all didn’t Twitter just raise 100 large @ $1BN post? Didn’t Facebook raise $200M @ $10BN pre? Yes indeed they did, but rather than confirming the health of Consumer Internet Venture Capital, these deals merely provide prime examples of how screwed up the space is.

Too Many Deals Needing Too Little Money
To be sure, there is plenty of investment capital available for Consumer Internet companies that have demonstrated significant market traction in terms of traffic or revenues, but there’s almost none available for what (up until recently) would be considered the sweet spot of true VCs: Seed or Series A startups. Alas, the “days of a bright entrepreneur thinking up a great idea, putting together a business plan, and then having a Sand Hill VC take a leap of faith to fund the business are effectively over, probably for good.”

Burnham goes on to describe some of the trends affecting VC investments in consumer Internet ventures.  With launch costs falling and VC funds increasing in size, the traditional VC model must move to bigger investments in more proven companies. Combine that with the random nature of success in the space, and it’s no wonder VC’s have pulled back from seed investments.

“Implications of the Great Abdication
There is nothing inherently wrong with what the VCs are doing. They are arguably acting very rationally given the market trends they are faced with and more than a few will probably generate good returns with this strategy. However, their behavior does have several long term implications for the Consumer Internet space including:

1. Angel investors are becoming the dominant force in Consumer Internet Venture capital. The vacuum created by the withdrawal of VCs from traditional Seed and Series A opportunities in the Consumer Internet space has been filled by a motley collection of angel investors. It is angel investors, not VCs, that are writing checks based on good ideas, business plans, and “alpha sites”; not VCs. The importance of angel investors is such that it is not unusual these days to see an internet startup publicly announce its round of angel funding, when in the past such events didn’t merit a public mention. Yes, angel investors have always provided seed money, but today they typically provide 100% of what was once considered Series A money as well.
2. VCs are boxing themselves into a pretty tight investment window. VCs retreating to the expansion stage makes a lot of sense in theory, the only problem is that if all of them retreat at the same time, it can make for some screwy market dynamics. I can count on two hands the number of VCs in the last 3 months who have told me something along the lines of “this market is crazy, anything with traction is getting multiple bids at huge valuations without even putting together a powerpoint presentation, while everything else is just roadkill.” The reason this is happening is that you have a ton of VCs sitting on a ton of capital (which they have to deploy) and they all are holding out hope that they will be the one person to realize that a company has started taking off before anyone else does. The reality is that the traction is obvious to everyone (quantcast anyone?) and they all swoop in at the same time. What’s more, because of the dynamics in the consumer internet market, most “hot” companies entering the expansion stage will end up spending very little time there. It seems as though if you blink, a company can go from interesting alpha site to 50 million uniques and at 50 million uniques the companies are demanding what would traditionally be considered late stage valuations. Thus there is a very short window of opportunity to fund “hot” internet startups and way too many VCs with way too much money chasing just a few “hot” deals within this window.
3. Only “small ball” ideas are getting funded. Because VCs generally won’t back Seed or Series A startups, these startups must rely on angels for financing. Now putting together $100K or even $250K in angel financing is doable for most entrepreneurs, but much more than that can be difficult to accomplish. This is leading to kind of natural selection in that only internet companies that require $250K or less to get off the ground are even being started. If you have a really big idea that requires $5M before it can launch, you might as well not bother because your chances of getting funded are close to zero. Now big ideas aren’t necessarily better, just look at WebVan, but the current state of consumer Internet VC is so biased against big ideas that one has to wonder: are there big ideas that are being left on the table simply because VC’s aren’t willing to stomach the upfront risk?“

While Bill is dead on in his analysis, it’s not all gloom and doom for Internet ventures.  Angels continue to invest in these deals, and new investment models are beginning to fill the VC gap.  Incubator/investment programs like Y Combinator and Techstars have achieved success by providing great mentoring and a structured program in addition to a small amount of capital.  The Founders Fund and fbFund REV use a metric driven development model to guide internet startups, thus creating a scalable investment infrastructure.  And more traditional VC funds continue to make a name for themselves in this space (Union Square Ventures, First Round Capital).

So don’t despair, but be aware of the current market conditions.