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Easier and Cheaper to Start a Company? Current Influences on the Startup Ecosystem

February 5, 2014

The notion that it is cheaper and easier than ever to start a company is a widely accepted trend shaping the startup ecosystem. This is true for a variety of reasons.

The Cloud. On the tech side, the widespread adoption of cloud infrastructure has made it just as easy to set up shop in a market like Cincinnati or Nashville, as it is in hotbeds like Boston or San Francisco.

IPOs. The high profile public offerings of consumer-facing companies like Facebook and Twitter have brought the ideal of entrepreneurship to the forefront of culture in ways we have not seen since the late 1990s.

Startup Communities. Throughout the US and beyond, startup communities are uniting. The public-private partnership StartupAmerica helped drive this activity, especially in states with moderate growth activity. StartupAmerica counts 32 different regions and more than 14,000 companies among its membership. It’s not just a theoretical possibility for a programmer in Peoria to dream of coding the next new thing, it is actually possible.

Accelerators. In the last decade, the success of thought leaders like Y Combinator and TechStars has led to a massive surge of accelerators, incubators and other entrepreneurial support organizations. These groups distinguish themselves in a variety of ways: industry focus, mentor networks, capital commitments and geographic location. It is interesting to read Paul Graham’s description of how he and his now-wife, Jessica, came up with the idea for Y Combinator during a walk home from dinner in 2005. Within a couple of days, they had recruited a few others to help with time and a total commitment of $200,000 in capital. Less than a decade later, Y Combinator has successfully launched companies like AirBnB, Weebly and Dropbox, and over 500 more with aggregate marked valuations in excess of $13 billion. There are dozens of similar entities in Silicon Valley, and a quick look at the Incubator section of AngelList shows more than 1,500 accelerators and incubators providing capital and services to companies all over the world. The entrepreneurial movement is widespread and proliferating in new places like never before.

While it may be easier than ever to start a company, in most cases it still takes a long time and a great deal of capital to truly scale businesses to become candidates for the type of M&A exits or IPOs which drive the returns of the VC industry. According to the 2013 NVCA Yearbook, the average time from funding to exit for VC-backed companies rose to more than seven years in 2012.

Venture Backed IPOs

Source: 2013 NVCA Yearbook

This is good news for general partners managing venture capital funds because the rising tide of innovation will continue to produce businesses that need fuel to grow.

As the macro trends in innovation have played out over the last few years, so too have several trends within the VC industry. Among these are consolidation of total number of funds, smaller fund sizes and shift in the makeup of types of funds. Mark Heesen, NVCA President Emeritus, noted some of these trends a year ago when he said, “The venture capital fundraising environment has settled into a ‘new normal’ which is characterized by a barbell structure of larger funds which are stage and industry agnostic on one end, and smaller, early stage, industry or region specific funds on the other. It is on these two ends of the spectrum where capital is concentrating and successful firms are raising follow-on funds.”

This shift in the industry has been underway for several years. As active participants in this marketplace, we have seen how the changes are felt most in the secondary regional markets which, historically, have been led by a small number of medium-sized funds. These funds filled the “middle” of the barbell within the asset class, and have found that raising new capital commitments has become harder as LPs are drawn either to larger national funds or the very small and flexible new crop of firms. Bryce Roberts of O’Reilly AlphaTech Ventures noted this trend in 2011. With his unique perspective given his current role at a Silicon Valley-based firm and prior experience in the much smaller startup community of Salt Lake City, Roberts noted, “Local investors can play a meaningful role in helping to shape the next generation of leading local technology companies. Helping them scale to the point where follow on capital is willing to get on a plane to invest rather than make them move out of the area.”

It is easier to understand the impact of this trend on smaller, regional markets by looking at an example such as North Carolina, where I spend a great deal of my time working with early stage entrepreneurs. Over the last five years, North Carolina has averaged 10-20 Seed or Series A financings per year. In the past, it was normal for one of the medium-sized ($100-$300MM fund) local VC firms to serve as the lead on anywhere from three to seven of these types of deals per year. As some of these firms have stepped away from funding new deals as they work through their own firms’ fundraising plans, there is an immediate ~30-50% reduction in first round institutional capital available to local entrepreneurs. There has been abundant discussion of the “Series A crunch” in markets like Silicon Valley, where there are a great number of companies looking for an institutional A round. However, it is in these secondary and tertiary markets where the disconnect between the capital markets and companies is the most painful.

The speed of changes within the innovation economy is much faster on the company side because the cycles for LP commitments and fund formation are slower given the nature of the participants. In short, there is no lean methodology for asset allocation. Adding intrigue are changes in legislation related to crowdfunding via the JOBS Act, and the rise of AngelList as a platform to encourage the efficient flow of capital without some of the restrictions of formal funds or different geographies.

Hypothetically, capital is the most malleable of all the assets within the entrepreneurial ecosystem. Conventional wisdom is that capital will continue to find the best companies regardless of their location and as we move further into 2014 and beyond, opportunities will arise from all corners of the globe. It is easier and cheaper than ever to start a company. As a result, it may require a new paradigm for asset allocators, fund managers and entrepreneurs to efficiently match companies with the fuel they need to build successful businesses.

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