European start-ups halted by series-A chasm

Of the 2,283 US seed deals between Q3 2011 and Q4 2012, between 1,000-1,500 of these will be left with no further funding, said Bullpen Capital's Duncan Davidson, when presenting at a venture-focused event in the US in July. In 2009, the growth in seed investments shot up against a relatively small number of series-A investors, which usually make only one or two investments per partner each year. According to Jeff Garbow at Ernst & Young, the practice of raising angel capital via platforms such as Kickstarter and others, combined with the relatively low dollar amounts needed to start a business, has led to an abundance of angel-backed companies.

A 2012 study carried out by the European Commission's Enterprise and Industry arm estimated there are around 250,000 recorded business angels in the EU, the informal number being significantly higher. EBAN, the European Business Angel Network, predicts €5bn of angel investments in Europe in 2013, while series-A VC activity in the region is considerably less, at around €2.5bn for the first six months of this year.

Has the series-A crunch spread from Silicon Valley to Europe? Some VCs believe Europe has had its own seed boom and will experience the same subsequent chill. London-based Invrep founder and angel investor Stephen Findlay says: "The amount of angel activity has increased dramatically in Europe recently, while the VC community has stayed broadly flat, not growing at a similar pace. At a certain point in time, angel-backed firms want VC funding. The number of start-ups predicted to go bust creates 'the crunch'." Findlay has studied the behaviour of start-ups and says the crunch is more likely to occur to a particular type of company, and is avoidable.

What are the dynamics behind the crunch, and is Europe next?

According to Findlay, there are two types of start-ups. 'A-companies', which predict a large market opportunity and desire to grow quickly, often expanding their team rapidly and investing heavily in marketing with a view of racing through the 'proof of concept' and 'proof of market' phases. Most start-ups during the 2000s belonged to the A-group; which is also the category most likely to end up in the series-A crunch. "Five years ago it was difficult to take a different route than this one," says Findlay. What he terms 'B-companies', on the other hand, are those focused on breaking even to control the destiny of their funding strategy, growing their team more slowly and as a result scale more gradually than 'A-companies' do. At the end of their angel funding, they have the option of continuing as is, or double down with VC funding and expand the team, accelerating forwards.

Findlay emphasises that the crunch is not a systemic failure, but rather a predicted outcome based on how the market behaves today. "There are a few companies that may fall into the gap; but I think getting a real understanding for the market-opportunity up front and how to resource against this can enable today's web companies to take a more sensible and shallower trajectory to break even post angel-funding. There is an alternative route," says Findlay.

Some European VCs argue there's always been a comparative lack of early-stage funding in Europe and hence harder to raise series-A rounds, meaning the crunch has less impact in Europe than the US, or not at all. One such VC is Scott Sage, partner at European technology venture firm DFJ Esprit, which launched an angel co-investment fund last year. According to Sage the series-A crunch hasn't hit Europe yet but he expects it to reach the UK at "some stage in late 2014".

Sage has a European VC investor's take on the phenomenon, appreciating its Darwinian aspect. "The series-A crunch hasn't been a bad thing in the US. Start-ups are meritocratic, so only the best will get funding. The same holds true here in Europe. Not every start-up should raise follow-on money. In addition, an influx of angel and seed capital is great for entrepreneurs as more of them will be able to raise money to test a hypothesis and further build out a product, and its great for VCs as there will be a larger pool of start-ups to choose from later on," he says.

However, as the markets ebb and flow, Sage deems most of this to be irrelevant in the long run because start-up financings are becoming more regular. "Let me explain; start-ups used to raise a seed round, then a traditional series-A round of $3-5m. Now, we are seeing companies raise rounds of $200,000-1m several times before raising their first institutional round of equity. These rounds are still on average $3-5m, but I believe that they will start to get larger over time as the super angels and seed funds invest more money in the earliest stages of a start-up," he says.

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• Topics
• Early-stage
• Venture
• DFJ Esprit
• Ernst & Young