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October 19, 2015

Are We Eating the Seeds of Disruption?

The numbers are unbelievable. In the first three quarters of 2015, CB Insights found the amount of money dumped into private companies by venture capitalists exceeds $98.4 billion, already more than the last year’s record tally of $88.7 billion. However, much of that investment has been funneled into several record-breaking “private IPOs” to fuel expansion of companies like Uber and Airbnb. At the same time, the numbers suggest a troubling future trend where the next round of disruptors may not have access to capital.

Unicorn Glut

When the term “unicorn” was coined for privately-held companies valued over $1 billion in 2013, there were only 39 of these rarities in the world. Just two years later, CB Insights estimates that there are now 142 unicorns in existence and that list is dominated by companies that have disrupted established industries with new technology and business models. The list includes companies disrupting transportation (Uber and Lyft), lodging and real estate (Airbnb and WeWork), and finance (Square, Stripe, and Credit Karma).

Economists and experts are still trying to make sense of this dramatic change in investment strategy and what it means, but there are some clear signs there are near term side-effects. While the total amount of money flowing into private companies continues to rise and the number of mega-rounds (deals of $100 million or more) has gone way up, the total number of deals is shrinking. Aggregate deal activity fell to 1,799 deals, the lowest volume of deals since Q2 2013. And it could have dangerous consequences for future disruptors.

Eating the Seed Corn?

According to CB Insights, a slowdown in seed-round funding from VCs is responsible for the decline in the number of deals. A recent PitchBook report suggests this is a “alarming” trend with a “a rich-get-richer effect, in some cases, which could signal the approach of a peak in the [investment] cycle, especially as early stage numbers are sliding considerably.” Indeed, by several accounts, the number of companies receiving checks for the first time is falling as wealthy individuals who tend to be the first investors in start-ups are exercising more caution.

It’s far too early to tell if this is a minor blip or a long-term trend, but it’s troubling if venture capitalists are reallocating funds away from first-time investments to the safer waters of fueling the growth of more established disruptors, like Uber and Airbnb. Without continued investment in early stage companies seeking to disrupt new industries, the next round of disruptors may never have a chance. At that point, we truly will be eating the seeds of disruption.

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