The venture capital market in New York in 2013 seems to be a tale of two trends on a collision course. On one hand, seed funding continues apace, as New York City pumps out startups by the score. On the other, the funding at the A-round level, for slightly larger and more mature companies, is scant compared with the number of companies chasing it.
That means many companies, including some fairly promising ones, that emerge from the startup phase are likely to wither for lack of support in 2013. Overall, though, deal volume in 2013 is expected to match or surpass that of 2012, when New York saw 251 venture deals through the third quarter, up from 219 in the year-earlier period, according to venture tracking firm CB Insights.
“Deal volume is holding strong,” said Jonathan Sherry, co-founder of CB Insights. "What continues to boost it is the trend toward seed investing, which hasn't shown any signs of slowing down."
In the third quarter of 2012, seed-stage financings made up almost half of all venture activity in New York City, as venture capitalists competed — and joined — with angels to get in on deals early and cheaply.
But many of those seed-funded startups, especially consumer businesses, will find venture capitalists reluctant to give them serious money in 2013, especially in New York, where one VC estimated there are fewer than 10 firms active in the A-round stage.
"A seed-stage company funded 12 to 18 months ago, with traction but not breakaway growth, will have a more difficult time getting series-A funding," said Brian Hirsch, co-founder of Tribeca Venture Partners. "There's still a fairly short list of venture funds in the local market that will fund traditional series A, and there are hundreds of seed-funded companies. Something has to give."
At either seed or series-A levels, venture capitalists say they are keen on business-to-business plays and companies successfully using big data and mobile as platforms. Disrupters in virtually any industry are appealing, but especially in health care and financial services.
"The financial services market is so vast and segmented that even solving a prescribed problem can be a gargantuan business," said Roger Ehrenberg, managing partner of IA Ventures.
Investors say they still like consumer businesses, but with companies like Groupon and Zynga struggling to develop workable models, they predict the shift to enterprise investments will gather steam.
"People understand that's where the money is," Mr. Sherry said. "Facebook won the social media battle, but those business models are challenged. (Investors) are going back to bread and butter."
And, while it's almost axiomatic that these days anyone can start a company with a laptop, the cloud and Google Apps, the economics are more important than ever — revenue growth leading to profitability. Good ideas alone don't count.
"It's not that I'm looking (just) at companies with revenue," said Charlie O'Donnell, a partner at seed-stage fund Brooklyn Bridge Ventures. "I'm looking at companies that are revenue-minded — you have to know that someone is willing to pay for it."
Even revenue isn't enough if it can't be turned into profits.
"Just revenue growth doesn't cut it if you're spending more than you need to get customers and you have an unprofitable customer-acquisition model," Mr. Hirsch said.
What's at the bottom of their lists? Mr. O'Donnell, for one, has a high bar for companies with geographic business models, which try to tap local markets, and for edu-tech companies: "The idea that everybody can teach anything and we'll all learn on video, I'm not there yet."
For Mr. Ehrenberg, it's 'me-too' companies.
“Social shopping was the fruit of the day last year,” he said. "You see a lot of me-toos that don't … have core technology or … data assets. Unless you have one or both of those, it's hard to get traction.” Is the A-round crunch a sign of trouble in Silicon Alley? For the startups that don't get funded, probably. Not for the venture capitalists.
"It's a good, natural way that a healthy market evolves," said Matt Gorin, managing partner of Contour Ventures.
Judith Messina is a writer for Crain's New York Business, a sister publication of Pensions & Investments.
