Musings on Venture Capital & the Startup Ecosystem for 2016

Last year was a pivotal turning point in the startup ecosystem. High valuations, greater noise, and volatility and broader geographic ecosystems. Over the course of the year, I spent time in the VC world to explore trends and decision paradigms by venture capital, strategic investor and private equity investors. In exchange, and in some instances becoming engagements, for analysis in the marketing technology space and scouting reports for the Atlanta startup ecosystem.

After some generous time by investors from my hometown, Atlanta, the west coast, northeast and a few international ones, success for investors seems to be found at the intersection of instinct, foundational methodologies, a bit of good luck and a heck of a lot of hard work.

Here are seven key takeaways I learned from my research, experience and our discussions with later stage startups, venture capital, and strategic investors:

1. Redefining Unicorn

CB Insights created this great chart illustrating the concentration of new startups reaching unicorn status. So we wondered, is it now time to redefine unicorn? At first, it seemed to make sense.

Then again $1B+ is still a great valuation. While this may seem crowded, it still pales in comparison to the growth in the number of startups that have emerged since 2010. We may have a handful more needles on the stack, but we’ve added truckloads of hay in the mix. So let’s keep a unicorn a unicorn.

 

2. VCs focused less on early-stage startups and moon-shot unicorns

As more of the startup business models are being validated, more investors are taking a more middle of the funnel approach to entering into investment.

On the early stage side, consider the following post from Tomasz Tunguz (what a great name), a VC at Redpoint. His analysis shows that more VC investors are pulling out of the seed stage where there is an initial correction.

Others have cited that starting the drip on a company too early fails to validate the startup’s team, value prop, execution at early stages. If the ingredients of the startup are unable to survive without the excess oxygen of VC investment, then are they sustainable? One of the VCs put it plainly, “We are in the business of investing for a return, not charity [must have on-going investment] or gambling [a hope that an IPO will occur]”. Even social-good driven startup investors want to see the scalable impact. The exceptions are capital-intensive industries such as pharma or manufacturing.

Someone whom I consider one of my distant mentors, David Cummings, Atlanta Ventures has been a proponent of the bootstrap first strategy in one of those points on how 10 to 100 B2B SaaS customers can be found with the right formula in this post.

Paul Singh included this article, from Upstart Journal by Zach Ware, in his newsletter on why VC money too early could be a bad way to start a company.

According to Scaling Up, 94% of all companies and 99% of tech startups never generating over a $1MM in a calendar year. There is too much noise at the early stages.

On the unicorn side, the sheer number of startups in existence combined with the number of ‘investors’ has made it more difficult to get the at-bats for quality investment opportunities. In the MarTech space, the noise has become so significant and separating the wheat from the chaff is a challenge.

To invest in unicorn potentials, VCs are looking at four factors:

  • Availability of internal deep subject matter expertise.
  • Startup teams’ experience to scale.
  • The extent of customer pain and use of Kano Analysis to predict/validate.
  • Frankly, not obsessing over an investment becoming unicorn status.

While there are some benefits such as a larger pool of capital, liquidity, and PR, the cost, and risk of taking from startup to IPO in 2016 has soured recently as the appetite for public investment has, at least for now, evaporated. In the meantime, enjoy this Unicorn Book by VentureBeat Profiles, Spoke Intelligence.

 

3. Investment in Back to Basics Growth

As the notion of high-growth startups and the ecosystem has crossed the chasm, the impact of the mainstream begins to take hold. With it, comes the flurry of wantrepreneurs, satirists, and hype investing. Sounds bad? Not necessarily. Overall, evolving the traditional business model to a more entrepreneurial mindset, even a little bit, is a welcomed change in our smaller more connected world.

Until recently much of my investing has been in the traditional areas. Observing the influx of investors in those markets causes greater noise. This ‘noise’ translates to more sensitive volatility, up or down. Under the heated optimism, we see overvaluation and creative business models. Under the next correction, we will see a retraction to a ‘new normal’ of back to basics. This TechCrunch article speaks more to how lessons learned from a contraction can be good for us all.

For 2016, the startup and VC investment community will see a retraction to new fundamental metrics, business models, and investment strategies. Two common themes seem to be present: A 1) reduction in follow-on or new series investment 2) shift or a double-down on later stage startups that can demonstrate a level of self-sustainable growth.

For instance, Pitches that began with,”if we get only 1%….” are cliche. Now the new red flag has included, “…business model based on ad revenue.”

This year through Q2 of 2017 will see many early to post IPO startups fail or failing without VC funding. On the positive side, many validated ones will be worth paying attention to as well.

4. More than Silicon Valley for optimal investment

SV has shown to be resilient in times of growth and retraction. So, while never counting out the bay area, value investment and startup opportunity has shifted or spilled over to other geographic areas. We’re seeing growth in domestic areas such as NYC, Austin, Boulder, Boston, Nashville, Portland, Seattle/Bellevue, RDU (sorry if I missed yours) and of course the strong contender and my hometown Atlanta. Internationally strong and notable performers coming from Israel and India. All ecosystems will grow into their own way.

Rather than expanding what you may already know about SV’s challenges such as high-cost of living, talent, and high valuations, let’s explore a few examples of why the other areas are becoming attractive.

  • Greater focus and options with non-tech value props.
  • Lower investment burn-rate
  • Greater control
  • Longer average tenure of startup employee
  • Less Competition

5. “Boring” industries make great investments

Disruption is an overused term. Professor Christensen, well done or sorry depending on your perspective. In the MarTech space, my advice on disruption comes when business operations or strategic thinking have to change. UI/UX or operational improvements are just that.

Regardless, there are many other aspects of our lives to disrupt, providing enough market for scale, make an impact, and additionally provide defensible IP. Here are a few examples of industries that won’t be ‘boring’ for long.

  • Energy
  • Manufacturing
  • Transportation
  • Agriculture
  • Recruiting / HR
  • Education
  • Healthcare Innovation

6. Investing in talent cohorts

More investors, of any stage, are adopting people first, idea next philosophy of investing. Without vision, execution, and culture, an idea dies on a vine. So it may not be surprising that if an investor finds or cultivates a good entrepreneur, they are very likely to reinvest in them. Apparently, that is just the beginning.

In Atlanta, there is a tale of an amazing individual named John Imlay Jr. who took the nearly bankrupt company Management Sciences Associates, Inc (MSA) and turned out nearly 300 future CEOs and spawned 100 new companies. Many other high-growth companies and VCs seem to follow suit. Good leadership talent can perpetually breed and attract new good talent.

Another trend has been not to only evaluate the idea and the founders, but also the founder’s network.

Lastly, one of the more surprising investment strategies is to invest in a founder as ‘training’ for another venture. For instance, say a VC plans to go along with a couple of startups, but recognizes that it will eventually need more supportive experience. In order to fill those gaps, they may invest in another founder at an early stage regardless of it’s success. Even if it fails, the now more experienced entrepreneur can fit into another later stage startup. Of course, this all depends on the mindset and willingness of that early stage founder.

This shuffle game is one of the reasons a VC without operational experience will find it difficult to find sustainable cumulative success.

7. Seeking deeper and local SMEs

With greater noise, volatility and geographic dispersion in the startup ecosystem, strong VC firms are extending their subject matter expertise without additional partners. This is to increase the number of quality at bats.

  1. Recruiting and retaining analysts with deeper practical experience, vision, and an investment mindset.
  2. Find local scouts who engage with the communities, evaluate talent and separate the hype from substance.
  3. Operational, data-driven and talent minded individuals with some financial background (formal or practiced) who can see the potential beyond the resume.

As I’m engaging in these advisory and scouting efforts, these approaches are not new but also evolving. VCs, PEs and especially strategic investors are seeking people to evaluate with more intuition and instinct and can align those skills with their investment strategies. For all, you sales folks out there, think specialist SDRs for the VC.

 

Your Turn…

Question: What else are you seeing that will be a trend for startup investment in 2016? Why?