The benefits of the Series A crunch

An entrepreneur recently asked me what I thought about the upcoming shortfall in Series A funding. This topic has been widely covered in articles such as Fortune’s Series A crunch: By the numbers. After reading such articles, it’s easy for entrepreneurs to feel pessimistic. This is especially true for first time entrepreneurs who haven’t experienced the ups and downs of a tech cycle in the past. The pessimism is also greater for entrepreneurs who recently launched their venture, with or without seed money, and are thinking about raising a Series A round within the next year or two. The short-term cost of a shortfall in Series A funding is clear. In particular, many seed stage companies will not survive the crunch. However, this short-term cost is greatly outweighed by the long-term benefits produced by the crunch.

The first positive impact of the crunch will be to separate the wheat from the chaff. Those startups who survive the crunch, whether by fundraising or by cutting their burn rate, will prove their resourcefulness during tough times. What is a startup if not a team of people who can do a lot with little? By learning to do even more with even less during the crunch, these startups will find themselves on very solid footing once the market starts to pick up again in the future.

The second outcome of the crunch will be the return of seed stage valuations to normal levels. As I covered in the post Why high convertible debt valuation caps harm both investors and entrepreneurs, seed stage valuations are currently unjustifiably high. This is in large part due to new investors who are bidding up valuations simply for the kick of being part of a sexy startup. Once these investors experience the pain of losing money and startups are no longer sexy, they will exit the market and valuations will return to normal levels.

This leads to the third positive impact of the crunch. In an environment of normal valuations, only those entrepreneurs who are truly passionate about building an enduring business will choose the startup path. Those chasing a quick buck or simply following the herd will leave to pursue safer jobs. Similarly, investors who support entrepreneurs only for the possibility of a future payout, without enjoying the act of working with talented and motivated risk-takers, will also exit the startup ecosystem. Only the most committed entrepreneurs and investors will remain. It is when these two groups of people work together away from the external clutter and noise that magic happens.