When I first entered the venture capital business 10 years ago after being an entrepereneur, my partners warned me that “my bar” for new investments would get higher over time. In other words, the criteria to make a new investment – clearing “the bar” – would get more strict with time as I developed more experience and saw more things. I found this to be very true, and the notion that investors get wiser and more selective over time has become common wisdom in the industry.
But there’s something very new going on in the last few years – something very striking. Simply put, the collective bar of the investment community to fund young companies has recently gotten higher – much higher.
The entrepreneurs I speak to are feeling it every day. When they pitch their new idea to investors, they are told to build a prototype first. When they build the prototype, they go get customers. When they get customers, they are told to show engagement metrics. When they show engagement metrics, they are told to run some monetization experiments. When they run monetization experiments, they are challenged to prove scalability. Maybe I have Passover on the brain this week, but it’s like investors are putting entrepreneurs through a nightmarish version of Dayeinu, where no matter what they achieve, it’s never enough (speaking of Passover, if you haven’t seen this Jon Stewart clip of Passover vs. Easter, it’s a must. I’ll wait.).
Why is the new investment bar so high today? Isn’t there plenty of euphoria and “animal spirits” to go around with the IPO market returning, marquee acquisitions (e.g., Instagram at $1 billion) and the impending, earth-shattering Facebook IPO?
I believe this new phenomenon of an extraordinarily high bar is an outgrowth of three related forces: (1) the Lean Start Up movement, which has trained entrepreneurs on capital-efficient start-up techniques; (2) the plummeting cost of experimentation and the cloud, which allows entrepreneurs to rent infrastructure that allows them to develop prototypes and pilots much cheaply than ever before; and (3) the proliferation of social media, which allows entrepreneurs to read innumerable books and blogs to educate them on building start-ups and effective fundraising.
These three forces have led to a major increase in the collective “Start-Up IQ” of both entrepereneurs and VCs, while at the same time putting in their hands inexpensive tools to progress with their ideas. Thus, if you are an entrepreneur, your competitors – not necessarily market-based competitors but simply other entrepreneurs who are pursuing capital – are that much more sophisticated and advanced than ever before.
A great example of this is Crashlytics, a compay we led a $1 million seed round along with Baseline last year and then a $5 million Series A, which was announced this week. At the seed round, the two entrepreneurs (who are in their mid-20s and, like many young entrepereneurs today, wise beyond their years) had already both been successful serial entrepreneurs, had completed a customer discovery and development process with 20 application vendors and had built an alpha product. In other words, before they had raised a nickel, they had made as much progress as a $10 million funded Series A start-up circa 1999 or even 2004. They had achieved initial customer validation and identified a precise experiment they were going to run with the first $1 million – whether they could get broad adoption for their crash reporting tool. Indeed, they crushed their milestones. By the time they had spent half the $1 million and were ready for a Series A round, they had over 500 organizations using the product across tens of millions of devices.
Crashlytics is a special company run by special entrepreneurs, but their story isn’t unique – it is playing out across the world as more start-ups are more sophisticated in their approaches and achieving more with less. That’s generally a good thing for everyone. But it does mean the bar has gotten higher, much higher comparatively speaking, to raise money.
Jeff Bussgang is a general partner at Flybridge Capital Partners. He is the author of Mastering the VC Game, is an insider’s guide for entrepreneurs on financing and company-building. Follow him at his blog Seeing Both Sides where this post first appeared.