What is happening right now in the Silicon Valley

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I’m in the valley every day in many meetings with CEOs, VCs, angels, corp dev folks, etc. with most meetings tied to fundraising. With a constantly changing market here’s my view of where things are right now.

The IPO performances of Facebook, Zynga and Groupon laid an egg in the public markets and that proliferated through the entire chain of late stage pre-IPO financing, venture financings and all the way down to angel rounds. This hit us in the spring pretty hard and the summer was kind of “wait and see what this means”. By the time September and October arrived we knew what this meant. It meant that raising new VC funds was on hold. That meant smaller exits for VC or angel backed startups. That means harder again for VCs to raise new funds from LPs. That means less VC funding to go into startups at any stage. It meant that the terms for early stage funding rounds got worse for entrepreneurs. Pre-Facebook IPO there were tons of seed rounds for Y Combinator type deals with a $19m cap on a convertible note or no cap and sometimes no discount rate or an insulting discount rate.

Now we have $4m caps. This is back to what I always said was $2.5 to $5m caps which can be shifted for first money in and climb as the round fills in to reward early investors and punish the investor that delayed and came in last. Simply put, prices have come down. Probably too many companies got funded in 2011 and 2012. These companies are now facing tough decisions.

It’s one thing to raise funding when you are a new idea with an enthusiastic team ready to go out and conquer the world. It’s another thing when you burned through $750k to $1m and failed to get market traction and want to go back to the same or new investors and raise more money now that you figured out the excel financial model hockey stick is not even remotely happening.

Reality is setting in for these companies and they need to stop seeking investors and start seeking cash paying customers. The focus needs to shift from investors and press coverage to product, market traction and cash. These companies also need to cool their burn rates. Engineers should figure this out and join a company with revenue or go to a large company that can meet payroll.

When the market moves like this investors move along the continuum from seed and early series A investment to later stage series B and beyond. Venture capital starts looking more like private equity. The firms on Sand Hill Road are now investing in series B and later. Angels are filling in the seed and series A. There are a few firms like Floodgate that are doing genuine series A, but the usual suspects are not.

Regardless of economic cycles the Valley will always be a “winner take all” place where there is always a red-hot startup that raises its seed and series A round effortlessly at sky high valuations with everyone on Sand Hill Road (SHR) scratching and clawing to get their money into that deal. So when there is not a drop of water to drink for the unwashed masses there is always a team that gets a super hot buzz going and closes trainloads of cash and launches a rocket business. That will never change.

There will always be a new graduating flock of Y Combinator, TechStars, 500Startups and other new shiny objects and angels will take a punt. These guys should expect to close smaller sized rounds and move faster into revenue than a year ago.

We are now looking at a sheer numbers game. Tons of companies raised angel funding rounds of $500k, $750k, $1.5m and a few chunkier angel rounds of $2m – $7m. These rounds closed in 2010, 2011 and 2012 and now these companies are running out of cash. The VCs will not invest in more than 10 to 15% of them. Angels will only tank up those that have market traction.

When this happens B2C drops out of favor and B2B comes back in style. Why? Because B2B generates cash revenue faster and that makes investors comfortable knowing where the next meal ticket is coming from.

The Valley has always been infected with “herd mentality”. Like a mob, investors jump into cleantech one day, into games or social networks. Then sectors are orphaned. Right now games and social networks are dead. Solyndra put the death nail in the coffin of cleantech. Reputable VCs on SHR have fired their cleantech partners and just exited the building. Games and social networks are dead zone sectors too. 

What remains somewhat hot are cloud computing, mobility, big data and social (despite also being dead).

BTW, I never roll with the heard. I’m always open to buck the market so send me your deals. I do know that if I get into an orphaned sector there may be no funding for my deal and I need to see enough cash to get us through 2 years or to profitability. That’s reality when the flavor of the month expires.

What’s coming in vogue now? The low cost revolution has hit hardware manufacturing and so hardware deals that were once impossible to fund are coming back in style. Enterprise deals are becoming sexy again. Particularly if there is a consumerization of enterprise technology.  Keen Systems is a good example. Big data is now generating revenue and market traction. Go Palantir! Big data is a good fit with venture capital and investors get it. This space will gain more momentum.

My advice to entrepreneurs is to focus on revenue, product, team, industrial partners, distribution deals and real business. Make investors find you. I heard a friend recently say “Startups these days are unfundable until they are oversubscribed.”

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