Startups hoping to secure seed funding in 2016 may find it more difficult as investors have become more cautious, but Mission tech workers aren’t expecting a crash and those in start-ups are more sharply focused on sustainability.
While venture capital investments reached a record high in 2015, the year was also marked by a plummet in public tech stocks and a sudden slowdown in investor funding in a matter of months. In North America, funding to venture capital backed companies reached $72.4 billion in 2015, but only $14.1 billion was raised in the fourth quarter, down $6.7 billion from the third quarter. While there appears to be a seasonal downturn, the $14.1 billion raised in the fourth quarter of 2015 was still lower than the $16.4 billion raised in the fourth quarter of 2014.
The number of deals made by investors dropped from 1,315 in the fourth quarter of 2014 to 1,026 in the fourth quarter of 2015, and slowdown is felt in the Bay Area.
“It’s a timing thing. There was a right time to [raise money] and we made that threshold,” said Lawrence Coburn, CEO of the mobile event engagement app DoubleDutch. “The companies that were planning to raise money now and that are almost out of money, they have a problem on their hands.”
DoubleDutch, a five-year-old company, raised $43 million from investors in the third quarter of 2015, right before the pronounced slowdown in funding. But other companies, especially those with high valuations that relied heavily on venture funding and and young startups in the early stages of seeking funding, could be facing tougher times.
For now, few of the crazier ideas are getting funded.
“Big venture firms are doing less seed deals, and there has definitely been a slowdown in funding,” said Analyst Matthew Wong of CB Insights, a research firm that tracks venture capital.
The problem with relying on future investors is that the company’s shares become increasingly less valuable so attracting good employees with the lure of equity shares becomes more difficult.
In 2015, some companies that snagged initially high valuations found themselves raising money at less than what they were previously worth. This situation – called down-rounds – means early investors lose and employees find their stock options less valuable, making some less inclined to stay with the company.
“If you pick the right startup, as an employee you can make a nice chunk of change,” said Coburn. “[Down rounds] can be really crushing for a startup because then they lose their good engineers who want to go somewhere else where the value of their equity is growing, not shrinking.”
Still, CB Insights’ analysts predict the funding slowdown to be a “short-term trend” resulting in investors shifting their focus onto startups with strong business models that detail a clear path to profitability.Okay, if you have heard that before, you’re not wrong and perhaps the operative qualification is now more than ever investors are looking for startups with a solid plan.
“A lot of startups haven’t found a clear path to becoming profitable and sustainable businesses,” said Wong. “We are seeing that investors are being more careful with giving startups money because that path is becoming less clear. Investors are waiting to see which startups figure it out.”
In the Mission, startups that pulled in cash before entering 2016 remain generally optimistic about tech’s future in the Bay Area.
“The world is not ending,” said Coburn. “The deals are still out there, but investors are taking a little more time and being a little more careful.”
Bhautik Joshi, a Mission-based software engineer, said that despite the slowdown “there is still a lot of excitement about tech in Bay Area, but you don’t hear as many crazy ideas floating around as before.”
“[Investors] are starting to collect on their debts now, and when that happens there is going to be a natural shrinkage in some of the excess we’ve seen in this city,” he added.
Investor Slowdown Felt Locally
Seeking connections and inspiration, Shehab Hamad, the founder a Dubai-based fashion startup, moved to the Mission in 2014 with the hopes of expanding his company locally.
“There’s so much knowledge sharing that takes place here. This is where experiments are tried first, and that’s always going to draw entrepreneurs here,” he said.
But Hamad has felt the shift from investors and is witnessing many of his peers struggling to keep money flowing. “Investors are still taking meetings and writing checks, but the bar is just so much higher now than it was six months ago.”
After securing seed funding from an investor in Dubai, Hamad said he is raising money outside of Silicon Valley but empathizes with many of his peers who he says are struggling with getting their ideas funded.
Coburn, of DoubleDutch, said that one way the “dramatic shift in investor expectations” is being felt is by companies hiring fewer people.
“As an unprofitable company you have to listen to market expectations,” he said. Over the course of a year DoubleDutch’s workforce nearly doubled, causing his roughly 240-employee strong company to trade in its Mission offices for a larger space in Potrero Hill.
But the company is not yet profitable, and while he took on 20 new employees in the first quarter of 2016, Coburn said that he, too, will “more conservative” about hiring this year.
“We are putting a little more focus this year on getting towards profitability than growing really fast at all costs,” he said. “We want to get within striking distance.”
Funding Opportunities Remain for Companies with Impact
German tech entrepreneur Nik Myftari believes that a good product will be a hit regardless of current market trends. Early this year, he moved to San Francisco seeking the sponsorship of Bay Area venture capitalists for his hyperlocal socializing app, Spotted.
Myftari spent three years bootstrapping his company while hatching a business plan. He recently secured $15 million during an early funding round from a German investor and is only slightly alarmed by increased prudence among investors here — his app comes equipped with a payment model that he is ready to roll out, should investors ask for it.
“A startup is successful when users love your product and you grow organically,” said Myftari. “If users see a realistic need for your service, they will pay you for it.”
Tracy Young, co-founder of the Mission-based construction startup PlanGrid, a mobile app designed to help architects and builders access construction plans, echoed the sentiment that companies identifying and solving a “real need” efficiently are still likely to receive ample funding by investors.
“Investors are starting to see that if they don’t put their money in the right companies, the ones that solve real problems and that people love and will pay for, then they are not getting a return on their investment,” said Young.
Since PlanGrid launched in 2011, the company has grown into a leading mobile construction software platform with some 40 employees. Plangrid raised $40 million from investors during a funding round last November, enabling the company to focus on growth while others are cutting costs.
“We grew ourselves, and that meant not paying ourselves for a very long time. We had $1.5 million in seed funding that we kept in the bank pretty much the entire time,” she said.
Young credits PlanGrid’s success in becoming profitable early on by tapping into a real industry need— digitizing construction plans— and because the company never relied solely on investor funding.
That focus on providing a service people actually want, Coburn said, is part of what sets this generation of startups apart