The Follow-On Funnel

Two weeks ago, I published a study for the Center for American Entrepreneurship titled America's Rising Startup Communities. The study looked at the growth and geography of venture capital first financings across U.S. metropolitan areas between 2009 and 2017. Rather than rehash all of the findings here, I encourage readers to take a look at it before reading on. Go ahead, I'll wait. Or, if you want a shortcut, here's a Twitter thread I posted that will catch you up to speed quickly.

One of the biggest questions that's come out of that work is: "what's happening beyond first financings?" That's a good question, because after all, if companies are unable to raise additional rounds of capital or reach a successful exit, optimism about a geographic dispersion of early-stage capital might be premature for many cities. This post is the first of at least two that will begin to address that question. Here I will look at national trends, and in a later post, I will examine geography of follow-on investments.

To begin to get at this, I'll look at subsequent financing rounds for companies by cohort—that is, for each annual cohort of first financings from 2005 forward, I'll look to see how many startups raised subsequent rounds of financing or reached a successful exit. The main finding here is that although the top of the funnel has widened (i.e., there are more first financings), the rest of the funnel has widened less so or even remained the same—indicating a growing mismatch between earlier and later stage funding opportunities.

To start, let's quickly recap on the time series for first financings between 2009-2017. As the data show, growth in first financings was explosive from 2009 to 2014—increasing by more than 150 percent over the five year period. Afterward, the number of companies entering the venture-backed pipeline fell—declining about 25 percent over the three years (note: figures in this post are slightly different from those in the CAE study; this is because PitchBook maintains a dynamic database which updates frequently).


The next chart here shows the same data on annual first financings, but grays out the bars in the background and overlays several lines. Each line represents the share of startups in an annual first financing cohort that reached a fundraising or exit outcome. As the data demonstrate, the share of companies that raised a first round of venture capital and went to raise additional rounds of capital or achieved an exit (M&A or IPO) has declined steadily over the last decade, at a time when the number of companies entering the venture-backed pipeline increased dramatically.

Now, it may be a little too soon to make a call on where this ends up for the latest rounds and exits, but it appears to be headed to a lower overall rate vis-a-vis the past. In order to get a better idea of that, let's try to make an apples-to-apples comparison across cohorts.

The numbers are slightly less drastic when comparing cohorts across a common timeline. To do this, I'll look at fundraising and exit rates five years from the cohort's first financing. That means the latest year for which this exercise is possible is 2012.


Even so, the trends are clear—a lower rate of companies are getting follow-on financings five years on compared with earlier cohorts. The declines have been the sharpest at the earliest stages—indicating that a greater number of companies receiving a first financing are unlikely to go on to raise a second. The one exception is exits, which have been about flat, but are down slightly in the last couple of cohorts.

This post answered some key remaining questions but raises some new ones as well—namely, does a widening funnel of freshly funded companies along with lower rates of follow-on financing at the later stages or at exit even matter? Are the wins now bigger, offsetting the greater share of losses? Or, has the deployment of venture capital become less efficient?

Anecdotal evidence suggests that the winners are winning bigger and investors know that more (and bigger) bets need to be placed in today's environment in order to find them, and to support the companies that are best positioned to make it big. This simple analysis doesn't tackle such weighty questions, but if it is true, funded companies—and the emerging regions that house them—may need to get used to a healthy amount of failure in order to uncover one or more big wins that will propel a startup community forward.