Brave New Seed? How Fundraising Has Changed For Startups Since COVID

We are coming up to two years since COVID truly hit the US. The first three months after Mar 2020 markets were down, as was startup activity. But after Q2 2020 we have seen a boom in fundraising like none before in our careers. Law firm Fenwick & West publishes a quarterly report on Silicon Valley venture capital – their Venture Capital barometer in their latest report (Q3 2021) provides a good illustration: Tau Ventures is a Silicon Valley VC fund focused on early stage and as such, this post will describe our experience, focusing on what we have noticed and the pros / cons of it.

1) Brave New Seed

The data below is looking at 2,000+ deals / year within Tau’s focus (applied AI in digital health + enterprise + automation):

• Rounds – Up, the $2-3M is more like $3-4M.
• Valuations – Up, almost a 25% increase.
• Dilutions – Down, from 20-30% to more like 15-25%. Basically, a 3 on 8 i.e., $11M post (27% dilution) has become more like 3.5 on 14.5 i.e., $18M post (19% dilution). If it's a convertible note we use the cap as a proxy for valuation i.e., 11 cap is comparable to $11M post.
• Timing – Raising a seed, from officially kicking off to wiring, is taking 3-4 weeks rather than 5-6 weeks on average.

2) The Good

This is undeniably an entrepreneur’s market, perhaps the best time in history to do a startup. If you can raise more, at better terms, and quicker, it means unsurprisingly there will be more companies created, more innovation and more competition, which is beneficial overall to all of us. When it comes to VCs, it means those that provide more value and can move fast are obviously at an advantage. With “capital” being more fungible, the word “venture” becomes more important i.e., the knowledge / expertise / network that a VC brings to the table.

3) The Bad

Raising more than what you need at too high valuations has downsides. It essentially sets the bar too high for your next round and if there's a downturn/correction you pay a penalty with more dilution (smaller upround, flat round or even downround). It also affects your culture – instead of being lean and focusing on projects that will truly work, there is a much higher risk of getting complacent. At Tau we continue advising our startups to raise enough to last them for 18-24 months, not more than that. We also continue believing in leaving a margin of cash for a rainy day, with 10% being typically more than enough. Caveats about our framework: companies with significant hardware need a higher margin (not within Tau’s focus) and raising debt changes these parameters (we are talking about seed here, debt is more often a conversation for series A and beyond).

4) The Ugly

What we see as most dangerous is that too many startups getting funded too much, too early means projects that shouldn’t get funded will get funding. Building a successful company is still as hard as before so, as a society, we may be overfunding startups. The counterpoint is we believe the long-term effects of this “Brave New Seed” is there will be significantly more M&A post series A and Bs. So there will be recycling of talent and eventually we will stabilize into a new normal. It may also be that some other major world event creates a significant correction. But for now, and we believe at least for the rest of 2022, the party is on.

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Thanks to Amit Kaushal for the conversation inspiring this article. Originally published on “Data Driven Investor," am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr -- good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.