"A-Round Crunch" isn't a funky new ice cream flavor. But it is giving plenty of Silicon Valley entrepreneurs an upset stomach.
In recent years, more valley startups have been launched than at any point since the dot-com era, thanks to the shrinking costs of building an Internet company and the rising number of wealthy "angel" investors.
But as those fledgling companies now go hunting for the next funding round to help them grow, they're smacking up against a harsh reality: Widespread consolidation in the venture capital industry means there are fewer places than ever to find big cash infusions.
"A huge number of startups are going to run out of money next year," said Peter Relan, who runs a Burlingame incubator for mobile and gaming startups called YouWeb.
CB Insights, a New York firm that analyzes investment trends in private companies, just released a report predicting that 1,000 startups will be orphaned over the next 18 months -- the bulk of them in California.
Anand Sanwal, the firm's CEO, calls his prediction "simple math," noting that while the number of startups landing "seed" deals of $1.5 million or less spiked to 4,000 over the past three years, the number that have gone on to raise Series A rounds has remained just a fraction of that.
Sanwal said the meltdown will force early investors to write off more than $1 billion they've poured into fledgling companies.
Not everyone is convinced it's time to panic. Naval Ravikant, the influential founder of AngelList, a matchmaking service for startups and investors, suggested it's too soon to say whether the crunch is real.
"Companies that assume the next round after seed is a $5 million 'A' round are poorly positioned," said Ravikant. But because it costs less to grow a tech company than in years past, thanks in part to the ability to "lease" rather than build key infrastructure like data centers, Ravikant said the traditional boundaries of seed and A rounds are shrinking.
In other words, he said, entrepreneurs who can keep their belts tight should be fine.
Venture capitalist Duncan Davidson, on the other hand, argues that the problem is even worse than people realize. He says what's looming isn't a crunch, but a cliff.
"People say, 'There always have been too many companies that get seed money, what's the big deal?'" said Davidson. "The big deal is the rise of funds that specialize in seed rounds." So-called super-angel and micro-VC funds, backed by wealthy individuals, have burgeoned in recent years, even as the number of traditional funds that invest in larger Series A rounds has shrunk.
And with Wall Street still displaying limited appetite for initial public offerings of stock by tech companies, even those venture firms that remain in business have become much choosier about writing checks.
"If you do the math, there's only something like 97 venture funds have invested more than $1 million in each of the last four quarters," Davidson said. "Yet people think there still hundreds of funds that are actively investing."
While most valley startups are so thinly staffed that their failures won't throw huge numbers of people out of work, Davidson and others say the risk for the valley is that if seed investors end up losing so much money that they stop funding new companies, innovation will suffer.
"You don't know what ideas that could become big companies could just fall through the cracks," said Davidson.
He saw the A-round crunch forming two years ago, when he and several partners created Menlo Park's Bullpen Capital. With cash infusions as small as $1 million, the fund aims to tide over selected startups between their seed rounds and eventual A-rounds -- much as, in baseball, pitchers come out of the bullpen to provide a bridge between the starting pitcher and the closer.
Others hope the rise of "crowdfunding," enabled by new federal legislation that makes it easier for companies to raise money from a wide pool of investors, will provide a way forward for startups in need of cash. Ravikant recently added a new service, AngelList Invest, which lets accredited investors put as little as $1,000 into a startup.
But, Ravikant acknowledged, such platforms will take time to fill the hole left by traditional venture firms. "Lots of small investors added together still equals a small investment," he said.
Gary Flake, a Yahoo (YHOO) veteran who's now CEO of a Seattle-area Internet startup called Clipboard, said the lousy climate for A-rounds has forced him to become more creative in seeking growth capital.
"Clipboard has taken a mixture of seed and strategic investments from individuals, institutes, and companies," he said. "I believe that the startups that survive (or at least find a soft landing) will do so because they identify other, nontraditional fundraising paths. But none of this is the end of the world for entrepreneurs."
YouWeb's Relan, for his part, said the best times to put money into early stage companies are times like these, when momentum investors flee to the sidelines.
"It's like Warren Buffett said: 'Buy when everybody's selling.'"
Contact Peter Delevett at 408-271-3638 or email@example.com. Follow him at Twitter.com/mercwiretap.
To read the CB Insights report on the Series A funding crunch, visit www.cbinsights.com/blog/trends/seed-investing-report.