First Round Capital: Collapse or Return to Normal?

Yesterday, an article in the Wall Street Journal talked about some adjustments in the venture capital funding market. The general thesis: fewer companies are getting funded, those that do are raising more capital than ever, and those that don't are left to die (zombie companies). I don't have the time right now to re-assess or validate that analysis in a meaningful way, but on the surface, it appears to be relatively sound—though perhaps a bit over simplified.

However, it did make me curious about what's happening in funding markets, and since it's been awhile since I've done any analysis in the area, it prompted me to take a deeper look at funding trends. One thing that stood out to me was a sharp reversion in first-fundings since 2015—particularly compared with relatively stable funding trends in later rounds.

As the figure shows, the number of venture capital first fundings fell from a peak of 1,073 in the first quarter of 2014, to a low of 639 in the first quarter of 2017. That's a drop of 40 percent. The other groups of rounds I selected—second, third, and fourth or higher—have remained relatively flat since peaking in 2014 or 2015.

So, does this spell a total collapse of the first round funding market? It doesn't appear so, to me anyway, and if anything, it might simply be a return to "normal."

To test this, I plot the actual first round funding figures seen above, against a alternative series for first fundings—one that shows what the level of first fundings would be if the ratio of first fundings to all other fundings remained constant from what it was in 2008 and brought forward (in other words, growth in first fundings matched the rest of the market).

As the chart shows, if the number of first fundings had followed a similar path as the rest of the venture capital market between 2008 and 2017 it would have progressed in a somewhat linear fashion (red lines) to where it is today (blue lines). Instead, it took a humped path, growing faster than the rest of the market as a whole—particularly between 2009 and 2014—before regressing to a rate that is about what it was in 2008.

How one interprets this is in the eye of the beholder. However, what some have referred to as a "collapse" of the very early stage funding market, looks more to me like a return to business as usual. Furthermore, though not shown here, first funding sizes have gotten larger—meaning there is more funding up for grabs than there was at the beginning of the boom market. Either way, any calls for concern are a bit premature.