Why Early Stage Investing Continues to Excite

At Ascent, we firmly believe that the early stage is the ideal time to invest in emerging enterprise IT companies. Injecting capital during that sweet-spot inflection point  – after product or service development and initial customer feedback, but before the company has started to scale – can deliver high multiple returns when executed well.

But that’s not to suggest it is easy.  It requires significant expertise and judgment, as well as hard work. One of the most critical steps is selecting the right companies to back, and being disciplined about exactly what fits the selection criteria is key.  So let’s define what ‘early stage’ really means.

The early stage sits between seed/angel financing and growth/later stage capital.  Seed rounds help companies develop or flesh out their product or service and land the initial customers or users – the more technical the new offering, the longer this first phase may last.  Seed capital comes from friends and family, from angel investors, and increasingly from formal seed funds.  Financing rounds for seed or angel rounds typically range from $100K to a couple million dollars.

Growth, or later stage capital, is pursuing companies that have showed some scale, generally reaching revenues of $10 million or more with rapid growth rates and markets that show promise of reaching multi-billion dollar levels. Growth capital rounds typically range from $15 million – $50 million.

Early stage fits between seed and growth, helping those companies that are able to graduate out of seed and are looking to scale rapidly towards either profitable operations or a growth round or both.  Early stage rounds range from $3 million – $10 million in size.  Not all angel-backed companies want or deserve early stage institutional capital, and not all early stage companies want or deserve growth capital.

Now that we have covered the fundamentals, let’s examine some industry data.

In 2014, the general recovery of the economy and the growing excitement around new technologies has again driven up private company investments.  Venture capital dollars invested so far in 2014 already exceed the total for all of 2013 according to the MoneyTree Report from PwC.

Looking deeper, seed and angel financings have seen tremendous growth over recent years.  Today, raising angel funding has never been easier, with marketplaces like AngelList helping to connect startups and angel investors. Many seed capital firms have sprouted up and even some established VCs have shifted dollars to seed rounds.  From the period of 2008-2013, the amount of angel capital grew by almost 700 percent according to TechCrunch data.

Source: CrunchBase. 2014 is extrapolated from data for the first 3 quarters.

The improving market conditions also mean more interest from the large institutional pools of capital – pension funds, endowments, foundations etc.  These groups have shown an appetite for risk again, increasing their commitments to the venture category.  This has impacted the Growth/Later stage the most where generalist venture firms have been able to raise larger and larger funds.  The top 10 funds raised in 2014 are listed below:

Source: Dow Jones VentureSource

In fact, according to Pitchbook data, over 70% of the capital raised is flowing into larger growth stage oriented funds.  More capital at the growth stage, means more competition for growth deals.  This dynamic is reflected in valuation data which shows that there has been a steady increase in price for later stage rounds as competition rises.

Source: Pitchbook

A final set of charts shows that while overall fund raising is up within venture capital, the number of active venture funds (those that have raised capital in the last 5 years), has been declining.

Source: Pitchbook. 2014 data only includes Jan – Sept.                          Source: Preqin

This further suggests that capital has been flowing to a smaller number of larger firms who, given their size, have to focus on larger deals across many different industries and are not a great match for smaller more focused early stage rounds.

While there is tremendous growth in seed stage financings, and a large amount of capital competing for growth stage opportunities, the early stage has witnessed far less expansion over the same time period.  According to the data from CB Insights, Series A deals make up only 16% of the financings in 2014, and while valuations have increased modestly, the increase is no-where near those of later stage rounds.

So what conclusions can we draw from all this data?  For Ascent, it reinforces our conviction that not only is the early stage an exciting time to invest and help companies accelerate, but market conditions are also very attractive; there are more and more seed funded companies looking for Series A capital, and if you can start to scale the business effectively, there is an abundance of growth capital competing to lead the next round.  It is still far from easy, but it is a good time for early stage investors.