Q2 2016 VC funding results are in, and the unicorns took the lion share of funding.  Early stage startup funding experienced precipitous declines as the cash crunch continues. 

This post is the second in a series on the state of VC funding and startup performance in the United States. The inaugural post How we know the tech funding bubble has burst? was published in May 2016.

While most people are preparing for summer vacation, young entrepreneurs are preparing for a long winter.

UNICORN FAIRY TALES?

Last Thursday Pitchbook released the 1H 2016 U.S. Venture Industry Report. Second quarter VC investment reached a staggering $22.8B. Not surprisingly, the majority of investment went to mature, late stage startups (many of whom are unicorns valued over $1B).

The stark reality is that startups falling in the Series D and Late Stage categories represent less than 1% of all U.S. startups (author’s estimate).

Even within this infinitesimal tranche of later stage startups, it is a ‘tale of two cities’ as mega-rounds from super unicorns like SnapChat, Slack and Uber significantly skewed totals. The less obvious point is that ‘almost’ or ‘fallen’ unicorns have had a tough time raising funds. Expect to see more layoffs and pivots among late stage non-unicorns given the frozen IPO market.

THE CREME OF THE CREME

The creme of the top 1% are mature companies that have reached hyper-growth mode. These darlings of the media and VC communities have produced solid results, gained traction and identified a path to profitability. VCs have separated the wheat from the chaff, and lack of funding will force the bottom 1% to pivot, sell or close.

Mattermark took a closer look at May VC funding results in their report: Venture Capital Cooling Trend: “Wait And See” Mode Continues. When the dust settles and we get under the May/June numbers, we are likely to see continued precipitous declines in non-unicorn investments. Keep in mind, before May, the Series D and Late Stage funding totals were down 20-37% YTD.

And that’s the good news.

THE 99% PERCENT

Back in the real world of startups (2-3 million companies in the US), raising capital is just plain ugly.

• May: Funding at the Seed/Angel, Series A, Series B and Series C stages was down 9-43%.
• Q2 2016: Early stage startups raised $5.8 billion, the lowest amount since early 2015. Only 554 deals closed, representing the lowest amount in three years.
• First half of 2016: Only 1.2% of startups with seed deals closed a Series A- the lowest percentage ever and a 15% decrease from 2014.

So early stage entrepreneurs, that headwind you feel against your raise is real!

My advisory firm spotted these trends real time while advising startups. The slowdown was particularly pronounced during investor meetings with the HBS Alumni Angels.

A NEW DAWN: REASON HAS RETURNED!

As outlined in our original piece, during the first half of 2016, investors pulled back investment in the overheated market. I mean, perhaps we don’t need the fifth on-demand dog grooming service? Just saying!

So what can entrepreneurs do to successfully raise funding?

Given increased volatility, low interest rates and inevitable surprises (like Brexit), we tell our startup clients the following:

1. Adapt: The funding environment and investor sentiment have changed. Investors are more cautious and want assurance. This usually means tougher due diligence questions and bigger data rooms. Be prepared for a raise to take 8-9+ months and don’t take it personally.

2. Spend Wisely: In this market, cash is king. Given the longer raise cycle, startups need 18-24 months of runway. The biggest wildcard is usually marketing spend. Unless a startup is a market leader, throwing cash at consumers with little return on investment will haunt the next raise.

3. Build, Measure and Learn: Small bets are the best way to stretch capital. Fully embrace lean startup principles and double down where there is traction. Entrepreneurs should prioritize achieving proof points and milestones. The best startups will keep close to customers and actively monitor feedback.

The road ahead for startups won’t be easy. The true irony is VCs have raised humongous war chests; but investments will be made cautiously.

Personally, I’m happy to wave goodbye to growth for growth’s sake. I’ve long felt it odd that there was so little focus on profitability and sustainability. Granted, the “get big quick” model generally works for specific verticals: namely SaaS startups with favorable economics, or platforms that enjoy network effects. However in the consumer and media sectors where I focus, that approach rarely succeeds.

Whether good, or bad, or just long overdue- it’s back to the basics. Entrepreneurs are putting in the hard work to turn innovative ideas into products/services that change the world.

Venture forth and carry on!

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Lockie Andrews is the CEO and Managing Director of Catalyst Consulting, a boutique advisory firm to retail and consumer brands, digital, media and technology companies, as well as venture capital and private equity funds. With 20+ years of general management experience, Lockie has assisted high growth companies (e.g. Nike, Lane Bryant, Limited Stores, and various startups) in diverse areas such as strategy, innovation, digital marketing, revenue enhancement, operational/financial improvement and M&A/capital raising. Lockie is also a sector lead for the HBS Alumni Angels of NYC.