Future Tense

Tech Startups Are About To Start Dropping Like Flies

startups face series a crunch

Startups display their wares at the TechCrunch Disrupt SF 2012 conference on Sept. 11 in San Francisco.

Photo by Kimihiro Hoshino/AFP/GettyImages

One thousand startups will be orphaned; many will die. One billion dollars will have gone for naught. Bright young minds across the country will be out of work. 

This isn’t a Mayan prophecy. It’s the conclusion of a new report on what’s being called the “Series A crunch,” an impending Darwinian shakeout that is expected to reshape the technology industry in 2013. The report, from the venture-capital tracking firm CB Insights, corroborates what industry insiders and pundits have been predicting and fearing for months. A recent boom in seed funding for tech startups, particularly those in the Internet and mobile apps sectors, is going to result in disappointment for a lot of would-be world-changers.

The crux of the crunch is that the flood of seed funding—the money that angel investors give to entrepreneurs to help them get an idea off the ground—has not translated to an increase in “Series A” investment rounds from venture-capital firms, which can help turn a promising startup into a real company. Those that get seed funding but do not find Series A money are said to have been orphaned. The hardiest will find a way to survive on their own. The rest will perish, taking a total of more than $1 billion in seed financing down with them, by CB Insights’ estimate.

But here’s the kicker: That might be a good thing. After all, the people of the world only need so many options for sharing photos, managing their personal budgets, or splitting a check after a dinner out with friends. Of the startups that will fail, many provide services that are nifty but not essential. Some aren’t even that nifty. Meanwhile, bona fide, fast-growing tech companies around the country are starving for engineering, coding, and design talent (just look at what Facebook pays its interns). They’ll quickly snap up the best founders and employees from the ventures that turn belly-up.

And while no one likes to see $1 billion go poof, that’s part of the game. Smart investors will adjust and retarget their money at those sectors that are proving more profitable. CB Insights’ report finds that Internet and mobile startups are getting the most seed money, but it’s computer hardware and services that are most likely to win follow-on funding. Geographically, New York-based ventures seem to have the hardest time going from seed to Series A, while Boston- and Seattle-area startups are looking more sustainable, on average. Meanwhile, another recent CB Insights report found that startups aimed at businesses are more likely to hit it big these days than those trying to appeal to consumers.

It may sound counterintuitive, but all of this is more evidence that fears of a tech bubble are overblown. As PandoDaily’s Sarah Lacey points out, the Series A crunch shows that big investors are proceeding with due caution, rather than hurling millions at anything with a “.com” in its name like they did in the late 1990s. A few big flameouts like Groupon and Zynga aside, Lacey is right that “the bulk of the froth in the Web 2.0 world was mostly just in the private hands of insiders, not the public markets or broader economy.” The coming year may be a brutal one for startups, but those left standing will be better off than before.

series a funding by quarter
Two charts show how seed funding has boomed while Series A funding has held steady.

Images courtesy of CB Insights