October 31, 2017
Jason D. Rowley is a venture capital and technology reporter based in Chicago.

A little over a week ago, Techcrunch’s Jon Evans made a boldly suggested that “big businesses and executives, rather than startups and entrepreneurs, will own the next decade.”

Why? The average entrepreneur lacks the specific domain expertise and access to huge pools of capital necessary to bring new, more high-tech ventures involving AI, virtual reality, and other domains to fruition. The level of technical sophistication required to build a mobile app or website is much lower than building a drone delivery network. But those massive technological movements have now lost their head of steam.

If the twin booms of the internet and mobile devices were the steam that maintained the velocity of U.S. venture capital investment for over a decade, then the cooling of those markets would presumably result in a gradual slowdown in deal-making. And that’s what the data suggest.

Follow Crunchbase News on Twitter & Facebook

According to our findings from last week, the pace of deal-making in the US peaked somewhere around the end of 2014 or beginning of 2015. How far it’s fallen since is not quite clear yet due to reporting delays in venture capital data. But this slowdown in deal-making comes despite near-record highs in dollar volume in the US during this post-Dot Com Bubble cycle. And, globally, deal and dollar volumes broke previous post-bubble records in Q3 2017 according to Crunchbase’s projections.

So what is the disconnect here?

Early-Stage Deal Flow Is (Probably) Slowing

There appears to be a slow but consistent hollowing-out of the domestic seed and early-stage end of the deal pipeline.

Out of the roughly 55,800 venture deals we analyzed last week, all struck with US-based startups between Q1 2012 and the end of Q3 2017, nearly 44,200 of them had dollar values associated with them. Using this data, we were able to find that the ratio of venture dollars going to seed and early-stage companies has steadily declined over the past eighteen quarters.

Here’s the chart, which slows the slow decline of seed and early-stage startups’ share of total VC dollar volume invested in US-based companies.

This is likely a reflection of two separate, but related, trends:

  1. The general maturation of the overall population of startups.
  2. The increasing dominance of a small handful of companies that are deeply entrenched in particular ecological niches within the overall economy. (Examples include Amazon’s expansive and growing footprint in e-commerce; Facebook and Google’s dominance over web and mobile advertising; Facebook’s rather unique gatekeeper role in social media; and Uber and Lyft’s overwhelming share of the American app-based ride hailing market.)

To this latter point, back in March 2017, Crunchbase News took a look at startup funding in the travel accommodations and hotel market. One of our most remarkable findings was that between 2013 and the end of 2016, Airbnb had raised close to half of the total venture capital invested into startups serving that market.

The following chart shows Airbnb’s proficiency with raising capital.

There is little doubt that the chart for Uber and Lyft’s collective share of the VC funding into US-based public transportation and ride-sharing startups would look very similar. (However, on a global scale, companies like Didi Chuxing, Ola, and others have garnered a large chunk of funding as well.) And so would a chart displaying, say, WeWork’s share of the venture-backed real estate development funding, Coursera and Udacity’s share of the venture funding into online courseware providers, and for any number of other market niches.

The New Kids On The Block Will Pull No Punches

Even though most of the companies we mentioned above are relatively young and not quite at the scale of Facebook or Amazon, they will make for fierce competition for any upstart treading onto their market territory.

Here, we can see that the first and second wave of startup gold rushes have served to create the very incumbents that new startups have to find a way to compete against. And as these new incumbents continue to grow, they raise more capital in later and later rounds. Over time, as more and more market niches are filled, there are fewer and fewer opportunities for new startups to enter the market. And here’s why these new incumbents are particularly formidable: they’re still in the process of burning through the proverbial underbrush, the remnants of the industries they “disrupted.” Fighting fire with fire is hard.

All of this points to a generalized pattern: a number of upstart companies start up in new markets on relatively equal footing, a small handful of companies get the most traction, and those with traction will receive the bulk of future fundings in the sector. Very rarely does the dark horse contender go on to be the champion of a particular market, especially when all the bettors have goosed the odds by wagering on the fastest-growing company. If the majority of a new market goes to a tiny handful of companies, there’s little benefit to betting on the also-rans.

This results in a kind of perverse dynamic where more VC investment is concentrated in a progressively smaller number of companies as a new industry matures, creating a kind of top-heavy market with a very narrow base of companies playing in it. If one or more of those dominoes fall, it’s easy to view the whole market as a failure.

Narrowing The Base

It’s not that there are more late-stage venture deals, necessarily. Since 2012, seed and early-stage venture accounted for roughly 82 percent of the total deals in the US, and that hasn’t wavered by more than a few percent per quarter. See the chart below for the relative share of seed and early-stage deals over time, based on recorded (not projected) Crunchbase data.

What has changed, though, is the number of seed and early-stage venture deals being struck. This serves to narrow the base upon which the rest of the market stack rests.

To find this, we followed a similar methodology to the last article we wrote about peak VC activity. We indexed all values to the number of seed and early-stage deals struck in the first quarter of 2012, which, once plotted in the chart below, shows the steady upward climb in deal volume through the beginning of 2015, and its equally steady (if slightly more precipitous) decline from that point onward.

It’s best to look at these numbers directionally, not literally. For many reasons, there are reporting delays in venture capital deals, especially for seed and early-stage rounds. But to reiterate a point from last week, even if actual seed and early-stage deal volume is the same today as it was at the beginning of 2012 (e.g. at that 100 percent level on the chart), it’s still significantly off from mid-cycle highs.

Making The Market More Top-Heavy May Create Instability

So what does this mean for startups and investors?

If fewer companies have entered the seed and early-stage VC deal pipeline over the past two or so years, there will be fewer companies entering the late stage pipeline (Series C and beyond, by Crunchbase’s classification rules) in the coming years.

This might not be a problem now, but late-stage dealmakers will eventually face a pipeline problem as the cohort of companies that raised seed or early-stage rounds eventually pass through the window for raising late-stage rounds.

There are those who like to read stock charts and try to identify patterns and make predictions for how the price of that security will behave in the future. To critics, this obsession with trend lines, supports, channels, and other patterns is just as sophisticated a predictive model as reading goat entrails and tea leaves. But to believers, a double-top pattern is a bearish signal for the price of publicly traded stocks. It means that share price increased to a certain peak, declined somewhat to a support price, rallied again to the previous high, failed to break higher, again shrank back to its support price, and only proceeded to go even lower.

So is the US venture capital market was a camel, would it be shaped more like a dromedary or a bactrian? In other words, will there be one hump or two in this cycle? In the chart above, did all US venture capital activity – deal and dollar volume alike for all stages of company – peak in late 2014 and early 2015? That’s what the numbers suggest, and unless there’s a significant uptick in funding activity in the future, Q1 2015 is still the overall high water mark.

Or will there be a second peak when late-stage activity reaches some new, to-be-determined high as the glut of companies with early-stage rounds of the 2014-2015 vintage continue to grow up and hunger for more capital? At this point, there’s no real way to know. However, one thing appears clear: in the US, whether it’s due to broad macroeconomic reasons or technical change, the field of early-stage startups is looking increasingly deserted.

If Evans is right, the deepest pools of technological opportunity – AI, VR/AR, autonomous vehicles, and drones. – may be oases, but not for startups. So don’t be surprised if there’s a dry spell.

Glossary of Funding Terms

  • Seed/angel include financings that are classified as a seed or angel, including accelerator fundings and equity crowdfunding below $5 million.
  • Early-stage venture include financings that are classified as a Series A or B, venture rounds without a designated series that are below $15M, and equity crowdfunding above $5 million.
  • Late-stage venture include financings that are classified as a Series C+ and venture rounds greater than $15M.

Illustration: Li-Anne Dias