There has been a lot of discussion recently on the changing landscape of venture funding and what it is leading to. I thought that it would be worth digging into this a bit and, as most of the discussion and data is from the United States, put a Canadian spin on it as well.
There are two driving factors that are shaping the current startup landscape – the extremely low barriers and costs to start a tech company and the availability of seed or angel funding. Now, I am the last one to think that there should be any barriers to starting a company, but you need to make sure you are not just starting a company because you can. You need to know what you are getting into and, if you plan to raise any capital, know what is lying ahead.
The number of new startups we are seeing has been increasing at an alarming rate over the past couple of years across North America. Did you see Paul Graham’s recent tweet that Y Combinator was receiving an application a minute? All that starting a legitimate company takes these days is a couple of smart people with computers. Getting to the next stage is a different story though.
The seed and angel funding market has exploded with many new “super angels” as well as emerging seed funds entering the space. It was joked that a Google engineer could quit, walk onto the street and get a $500K angel investment to start a company. This is not far from the truth as anyone in the upper echelons of web development and design talent has a good chance of getting seed money these days.
So, what is starting to happen to all these companies? Well, like most startups, they need more money. Some need money to fuel massive growth – these rounds have turned into highly competitive financings and are attracting crazy valuations. However, most (~99%) are going to run out of money while showing some progress, but not enough to have VCs scrambling to write checks. To make matters even more challenging, VC fundraising continues to drop to levels not seen since before the dotcom boom. This scenario is even more alarming in Canada.
Despite all these changes one thing still remains – it costs a lot of money to scale a company. Sure getting started is cheap, and that is great, but you are eventually going to need money to build a big business. If you are really fortunate you will be able to do this through sales, but few have that opportunity. The result is a large demand of startups needing Series A and bridge funding and a smaller supply of available funds. Many believe that this is a healthier environment as the returns of venture capital since the dotcom boom have been less than desirable as the industry became bloated. It is important to know that most VC funds have a 10-13 year life so all that money raised in the late 90s and early 2000s is just now starting to wind up.
So what about Canada? Well, whether you believe it or not the border is becoming much less relevant when it comes to venture funding so Canadian startups (and VCs) are all in pretty much the same boat. The complaint most commonly heard in Canada is that there is not enough early-stage funding. I disagree. Great companies in Canada are getting funded and acquired. However, with the increased competition for Series A funding there are a lot of good companies that won’t be able to raise money. This does not mean that they won’t be successful, but they are going to have to take a path that doesn’t rely on venture funding. Unfortunately many don’t plan for this reality.
With all that said I, like many, are concerned with the direction venture capital fundraising is going in Canada. While it is great that US funds are now starting to ramp up investing in Canada they usually do it alongside Canadian funds – such as the recent case of Union Square’s investment in Wattpad alongside Golden and W Media. Also, Canadian funds are valuable in actively recruiting US funds into local companies. While it is great having talented investors from the US active up here it does not replace the feet on the ground that are needed and Canadian investors fill.