Investing in startups is all about valuations. Everyone is looking for the next unicorn, disrupter, to whoever is “building a better mousetrap,” and many investors are on the hunt to find these companies at their earliest stages. The later you invest, the more you’re going to end up paying for less of the company.
Once the company’s minimum viable product “MVP” is out there on the market, it has revenue flowing in, and it’s showing customer growth, valuations tend to rise. More recently, that rise has been exponential.
That’s why we’re seeing more and more Institutional investment funds spending more time investing in Seed and Series A stages that they historically have not looked at. Why are these institutional investors that have historically focused on later stage venture going earlier and earlier stage and investing in what are not yet fully fleshed out businesses. They hope to catch a unicorn on the upswing and get in before anyone else or they are equally concerned about investing in companies with inflated valuation in a weak equity market, a market they are dependent on for exits.
The numbers back this up. According to Crunchbase, the average Series A round increased from barely $6 million a decade ago to more than $18 million in 2021. And that holds for even earlier rounds, too. The median seed round was approximately $1 million as of 2010 but that jumped 4x to $4 million in 2020, according to a multi-year study conducted by Wing VC. Even our internal data at Techstars reflects this trend.
Simply put: Early-stage valuations today are significantly higher than they used to be, but the reality of investing at this stage is the same as it ever was. However, given the run up in later stage venture valuations and the volatile equity markets, the ability to invest in early stage companies at their lowest valuations is increasingly attractive to investors.
According to Burgiss, the one-year performance of a 2013 vintage fund was 102% in those heady days but that has dropped to 22% over the nearly a decade since. Compare that to 2021 vintage funds, which saw one-year performance of just over 20% last year. Only time will tell how those funds play out.
There’s always risk in seed-stage ventures due to unproven business models, untested leadership teams and quickly changing market conditions that can snow under even the most promising small startup. And that’s what “new” entrants are overlooking – early-stage investing is fundamentally different from even Series A and later. At this level, you need to get comfortable with the idea of doing less diligence and making more investments in smaller companies.
You also need to think bigger – at this level it’s not uncommon to see hundreds or even thousands of companies in a successful portfolio. There are simply too many variables at play to spot the winners this early.
At Techstars, we’ve been playing at this end of the pool for over a decade and know firsthand that none of this is as easy as it looks. That’s why we maintain a fixed valuation cap and check size on every company we invest in and a fixed check size of $120,000 for initial rounds. That’s also why we’re never the lead investor in any deal and limit even our later round involvement to the low seven or eight figures. But our results speak for themselves: More than 2,900 companies have gone through our portfolio, including 350 exits and 19 unicorns, and our graduates have generated a cumulative market cap in excess of $68 billion.
That’s not an accident, but it’s also not typical in seed-stage investing. It’s about not only understanding the risks involved but also adjusting your investment thesis to maximize potential returns given the limitations of this asset class. And it’s a lesson that other later stage VC firms need to understand.
Techstars Chief Investment Officer
Techstars Chief Capital Formation Officer