Investors Talk Cluster F*ck Deals, Control Issues, and Series A Crunch

2/21/13Follow @jpruth

Wednesday night’s Enterprise Tech Meetup in New York ran like many panels where venture capitalists gab about what excites them in the market—until Ed Zimmerman called out a troubling trend he sees among some startup funding deals.

“Companies have started raising these cluster f*ck rounds,” he said. “In these rounds you’ll have a dozen investors, six of them will be actual venture funds but no one is the lead.”

Zimmerman, a venture lawyer and tech chair at Lowenstein Sandler and an angel investor, said in those instances, backers throw around money without developing an understanding of the companies they fund. “They’re investors but they’re not invested,” he said.

At the same time founders in such deals were not going out of their way to build relationships, Zimmerman said, which stems from some startups being coddled too much. “They’ve been kissed up to by the venture community in the last five years, which has fallen over itself to prove how founder-friendly they are,” he said. Furthermore, some founders have become fearful of terms in deals they believe might be used to unseat them from their startups. “That’s when you really worry about the Series A crunch because you don’t have that relationship or rapport,” he said.

Rather than raising rounds populated by a lot of investors who are apathetic, he suggests a different approach. “[When] you’ve got one or two funds and a couple of angels in your round, it is much easier to build a relationship and establish why it is they should continue to fund you,” Zimmerman said.

The market has changed, he said, from the days when there was talk of a Series B crunch. Companies back then might have raised Series A rounds up to $5 million based on their potential and background. “Then they’d actually have to perform,” he said. “That money would have to go to attaining the milestones needed to get them funded in the next round.” If they ran out of gas, that was the end of it.

Now seed rounds that once crested around $200,000 and $300,000 have evolved into $3 million rounds with convertible notes. “Which is a little insane if you think about how the math works on conversion,” Zimmerman said. “That’s really an A round.”

Zimmerman spoke at Lowenstein Sandler’s offices along with Shai Goldman, venture partner with 500 Startups; David Aronoff, general partner with Flybridge Capital Partners; and Thatcher Bell, managing director with DFJ Gotham Ventures. The panel, moderated by Bruce Upbin, managing editor at Forbes, offered their views on venture funding for the enterprise technology sector for 2013.

Aronoff, who leads Flybridge’s New York office, shared his own example of the disconnect that can happen if relationships are not established between investors and founders. He said he was surprised by the response he got when he recently tried to chat with a friend from a Silicon Valley-based VC firm about a company their firms had co-invested in. “I gave him the name and he said, ‘Never heard of it,’” Aronoff said. Such disassociation can happen, he said, if bunches of investors from venture and seed funds make $100,000 investments without involving the rest of their firms.

Given all the money put into startups in recent years, there should be a fair amount of controlled implosions along with the companies that grow. Everyone naturally wants to avoid a wholesale crash of the innovation scene. Aronoff said when the bubble burst in the early 2000s, it was not uncommon to see companies raise in excess of $150 million, yet go out of business.

“The difference is now we’re digging a bunch of potholes,” he said. “Ten or fifteen years ago we were digging craters.” Aronoff believes the attrition rate needs to be steep among startups because they cannot all be successful. “There should be a lot of failures because we’re funding so many goddamn companies,” he said. “The more companies we fund, the more that should fail. It’s just Darwinism.” However enterprise technology companies tend to fail less, he said, because there are fewer being funded compared with consumer-focused startups.

Perhaps some startups need to relearn the idea that additional funding is not always guaranteed after early wins. DFJ’s Bell shrugged off some of the chatter about a Series A crunch holding back the market. “The term ‘crunch’ implies there is a problem,” he said. “I don’t think it’s a problem that many of the companies that received seed financing in the last few years will not get additional financing.” He said this would be a problem if companies that were worthy of more funding could not secure additional backing, but he does not see that happening.

At the same time he believes it is good to see the barriers of entry come down for startups to at least see their ideas tested on the market. “The more of these ideas that get tried and we know whether or not they work, the better off we’ll be,” he said.

João-Pierre S. Ruth is the editor of Xconomy New York. He can be reached at jpruth@xconomy.com and followed on Twitter @jpruth. Follow @jpruth

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  • http://twitter.com/sardire Steve Ardire

    some great points by Ed Zimmerman

  • bob w

    I don’t know how accurately this reports the sentiments at the meeting, but what a bunch of misdirection. Founders being coddled and kissed up to by VCs? I am willing to bet my seed round that that is not the experience of my entrepreneurial peers. It certainly isn’t reflected in any statistics on rates of early funding.

    Founders are nervous about being thrown out by their investors? I would hope that founders take great caution when accepting investors and terms that can snatch away the vision they have pursued with dedication – much too common an occurrence.

    Darwinian economics is a notion that dies a thousand deaths, and continues to reappear like a drowned rat bobbing in the surf of hyperbole. Failure rates may indicate that high risk projects are being tested, or it may just indicate a poor analytical filter. In a funding universe with improving analytics and increasing experience, more companies should be funded and fewer should fail.

    Investors and entrepreneurs each have difficult roles, and opinion still doesn’t pass as analysis in either camp.

  • C. Benjamin

    Some interesting points, but hard to get past the language in your title (did you really need to use that specific and offensive quote?) and frat-boy image of a bunch of privileged men whining about how hard it is to break out of herd mentality and stand up for your own decisions…