Silicon Valley & The Scent of Money

(Back in the day, I would occasionally write “A Letter from Silicon Valley” posts, often outlining what was going on in Silicon Valley. On a recent trip to New York, a few friends reminded me of that and wanted me to revive the series. With all this talk about angels, super angels and start-ups, I thought, “why not post a report on what I see pretty much on a daily basis?” Some see the current activity as Silicon Valley returning to health. Others think it’s kinda scary. To me it’s a movie that I have seen before…Om.)

Remember the Sequoia Capital doomsday presentation, RIP Good Times, that painted a dark future for the technology ecosystem? Today, it’s RIP negativity. Instead of bemoaning economic woes, Sequoia, like many of its peers, is busy making investments, especially in the seed stage companies.  Sequoia invested in 33 companies during the first half of 2010; Kleiner Perkins Caufield & Byers invested in 54 different companies and First Round Capital, an early stage investor, invested in 33 different companies. To be clear, not all those investments were in new companies and were follow-on investments, but the general trend is on an upswing.

Whether it’s a madness over geo-local technologies, the smartphone boom, or simply a realization that the web as we know it is changing, you can feel Silicon Valley shifting gears. The freeways are more crowded. The housing is tighter — renting apartments isn’t that easy. Folks are packing their bags and moving west, and bringing their friends along with them.

As a long time Silicon Valley resident, I can feel a distinct change in the tempo of the technology industry’s epicenter; it’s moving faster. You notice the scent of money as you walk down University Avenue or amble across SOMA. It’s spending season in Silicon Valley. The pervasive question among investors is not if, but when will they invest?

At every turn, a business plan seems to fly past your face. Walk into Crossroads Cafe in San Francisco’s SOMA district, and you have people drawing up their dreams on napkins and venture capitalists kicking around ideas with entrepreneurs. Startup-only co-working spaces such as Dogpatch Labs are packed to the gills with entrepreneurs and their coding armies hacking away at their next big idea. On Facebook, my friends openly talk about their startup ideas. Twitter links show startup lessons, AngelList, lean startups, enterpernuers getting together for dinners, startup weekends; it’s all startups, all the time.

According to National Venture Capital Association (NVCA), in the first half of 2010, venture capital (VC) investments totaled $11.4 billion in 1,646 deals, a 49 percent increase in dollars and a 23 percent increase in deals from the first half of 2009, when $7.7 billion was invested in 1,340 deals.

More importantly, NVCA says that there was a sharp increase in seed- and early-stage companies between April and June 2010. These small companies accounted for $2.3 billion in investments during the second quarter, while the actual number of seed-and-early-stage deals jumped 32 percent to 429 compared to the first quarter of 2010. ?It’s obvious that the excitement in Silicon Valley stands sharply against the backdrop of stark global economic conditions.

The increase in the number of angel investors (such as Keith Rabois and Chris Dixon) and super-early stage funds (such as one managed by Jeff Clavier, Aydin Senkut and Mike Maples) has made it very easy for companies to garner seed-stage funding. It’s not surprising to see startups raise between $1 million and $2 million from these angels. Perhaps that’s why many believe now is a good time to start a company and look for funding. But, to others such as Paul Kedrosky, this is a sign of a looming bubble/crash.

Recent Internet and Digital Media M&A deals (Click the image to expand)

Silicon Valley insiders believe the current pace of investment is going to increase in coming months. Why? Well, over the past few months we’ve seen some major acquisitions: AdMob got snapped up by Google for $750 million, Apple bought SIRI and Quattro Wireless for rumored $450 million, and Disney spent close to $800 million buying two mobile and social gaming companies: Tapulous (for about $30 million) and Playdom ($563 million + $200 million in earn outs).

These headline-making deals — along with media proclamations of Zynga being the next Google and Google’s move into gaming — are only going to attract more dollars to the social and mobile gaming sectors. Never mind that the VC industry is still shrinking and in recent months is underperforming public market indices. As an industry expert recently quipped in an IM chat: “There is an issue with opacity in the industry.” But headlines bring in capital, and “with no one really understanding deal terms, [what] people don’t realize is that most investors lost money, or made little.” Nevertheless, through cycles, you can see that whenever there’s exit activity, one sees investors get energized, which is a polite way of saying “more checks for early stage guys.” The attendance at the recent Y Combinator angel conference only supports that fact.

If on one hand, it’s easy to raise a seed or early investment round (which may fund a company for two years), it’s tough going for companies looking to raise Series B (or later) funding, especially for startups that don’t have blow-out growth and/or massive revenue traction.

During the first half of 2010 there has been healthy demand for companies with traction looking for series B funding.  The reason for this post-revenue investing boom can be explained by venture overhang in the industry; a large sum of money was not deployed between the fourth quarter of 2008 and the fourth quarter of 2009 (mostly because of larger macro-economic conditions). These venture funds are now looking to put that money to work, especially as they near their third-year mark for their funds, a point where they have to deploy a certain amount of capital. Given that the funds are late in their life cycle, these investors need to go after companies that have traction (in most cases, revenues). The result: valuations of companies with serious traction are going up due to demand.

From a start-up perspective, there are three key takeaways here:

  • If you’re looking to start a company,especially a consumer web company, and have a clever idea, this might be a good time to do so, as there are plenty of investment dollars.
  • Late(r) stage companies with good traction can raise money at high valuations.
  • The pace of  investing is going to slow during the second half of the year, not because anything fundamentally is going to change — it is just that the market needs to digest the capacity.

I hope to comeback with another edition of this report later this year.

?Related content from GigaOM Pro (sub req’d)What the VC Industry Upheaval Means for Startups

Silicon Valley traffic congestion Photo by Richard Masoner via Flickr.