A New "Valley of Death" for Venture Financings

27 March 2014 Privacy, Cybersecurity & Technology Law Perspectives Blog

Finding funds for early stage companies has always been a great challenge. In past venture financing cycles, it’s been the gap between the first venture financing (Series A) and the growth capital or mezzanine financing that many emerging companies were unable to bridge. This gap, called the “valley of death,” was attributed to a number of factors, but that valley of death has shifted in important ways in the recent past.

Historically, the valley of death happened when:

  • Companies ran out of money before the next value inflection point – too soon for institutional investors looking for lower risk.
  • Classic venture capitalists moved up the food chain – looking for larger and less risky investments, leaving early stage companies in the lurch.
  • Companies underestimated their capital requirements for early stage growth and ran out of money.
  • The venture markets shifted, and once “hot” investment categories (which had no problem attracting funding during their “hot” phase) became saturated or unpopular.

Today, that valley of death occurs earlier – between seed funding and the conventional Series A financing. In other words, companies have a relatively easy time raising their first $200,000 – $1,000,000 from friends and family and angel sources, but then are faced with the absence of follow-on investment opportunities at the Series A level.

Why the change?  To a large extent, it’s attributable to the supply side: more early stage money is available from more sources. To begin with, the cost of creating a viable business has plummeted, thanks to capital efficiencies brought about by cloud servers, virtual companies and highly competitive and efficient outsourcing. As a result, early stage investors are willing to “sprinkle” small amount of funds among many new companies to see which one proves to be a viable business – with the use of minimal cash.

Second, the emergence of a new crop of incubators and accelerators has provided additional sources of early stage funding for start-ups.

Third, angel funding has become more popular and accepted and, consequently, a large number of additional angels have entered the market.

At the same time, many less successful venture funds of the traditional kind – those investing in the $3,000,000 – $10,000,000 range – have folded. The more successful funds could therefore become more picky and risk-averse. This leaves a gap where a large volume of early stage companies created through more plentiful friends, family, and angel support are unable to raise their next round of financing. The valley of death is littered by these companies, some of which should deserve to be financed, or at least consolidated with other businesses in the same industry.

This may be a great opportunity for new seed funds seeking low valuations for promising businesses. Out of the valley of death may grow tiny flowers of success.

This blog is made available by Foley & Lardner LLP (“Foley” or “the Firm”) for informational purposes only. It is not meant to convey the Firm’s legal position on behalf of any client, nor is it intended to convey specific legal advice. Any opinions expressed in this article do not necessarily reflect the views of Foley & Lardner LLP, its partners, or its clients. Accordingly, do not act upon this information without seeking counsel from a licensed attorney. This blog is not intended to create, and receipt of it does not constitute, an attorney-client relationship. Communicating with Foley through this website by email, blog post, or otherwise, does not create an attorney-client relationship for any legal matter. Therefore, any communication or material you transmit to Foley through this blog, whether by email, blog post or any other manner, will not be treated as confidential or proprietary. The information on this blog is published “AS IS” and is not guaranteed to be complete, accurate, and or up-to-date. Foley makes no representations or warranties of any kind, express or implied, as to the operation or content of the site. Foley expressly disclaims all other guarantees, warranties, conditions and representations of any kind, either express or implied, whether arising under any statute, law, commercial use or otherwise, including implied warranties of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Foley or any of its partners, officers, employees, agents or affiliates be liable, directly or indirectly, under any theory of law (contract, tort, negligence or otherwise), to you or anyone else, for any claims, losses or damages, direct, indirect special, incidental, punitive or consequential, resulting from or occasioned by the creation, use of or reliance on this site (including information and other content) or any third party websites or the information, resources or material accessed through any such websites. In some jurisdictions, the contents of this blog may be considered Attorney Advertising. If applicable, please note that prior results do not guarantee a similar outcome. Photographs are for dramatization purposes only and may include models. Likenesses do not necessarily imply current client, partnership or employee status.