Adeo Ressi predicted the so-called series A crunch in late 2011: A dearth of available Series A money caused by the concentration of venture funds in the top venture investment firms and the inability of many smaller venture firms to raise new funds from their limited partners. In fact, at the June 2013 PreMoney conference Naval Ravikant from Angellist confirmed that there is a gap in the market to write a $250 thousand to $1 million check, and to lead a round for a company that is not ready yet for Series A.
But not as many young start-ups have shut down as might have been expected. Instead, many have been able to raise follow-on rounds from their initial seed investors. These investors are willing to double down and provide additional funding hoping that significant traction can be achieved in another 9 to 12 months.
As opposed to traditional Series A territory these rounds often are not priced. Y Combinator (YC) in particular has changed how entrepreneurs have raised funds: In 2010 Paul Graham infamously tweeted that ‘the convertible note has won’, and start-ups beyond YC have raised $1 million or more of initial seed funding using a capped convertible note structure.
The vast majority of the follow-on investors seem to be perfectly happy to further invest using these note structures. Rather than demanding debt conversion into equity or a loan repayment, they are willing to extend the duration of the initial loan terms, and caps may be raised further. Actual price setting and governance are pushed out into the future. Implicitly, these additional raises are expected to last long enough to meet all milestones assuming execution is flawless.
Fast forward by a few years: Entrepreneurs will ask VCs for equity investments where multiple millions of dollars have already been spent and the corresponding valuation expectations from founders will be high. In fact, Aydin Senkut of Felicis Ventures spoke of a 'shadow series A crunch based on convertible notes'.
Professional angel investors can afford to just sit and watch if they so choose to. But the Series A crunch may present an enormous opportunity for experienced angel investors to exercise leverage, provided they are willing to take the lead. Professional angel investment groups in particular are in a unique position to exert leverage by pooling resources and applying their institutional and operational know how. With relatively little capital, professional angel investing groups have the opportunity to top up a follow-on seed round, convert debt into into a priced round, and take a board seat.
Ron Weissman implored angel investors to look in the mirror when it comes to angel investing in the seed round. But the postponement of the Series A crunch raises an additional question: Angel investors now have to ask themselves whether they are ready to fill the void created by the convertible note shadow Series A crunch and lead start-ups to the next stage.