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1
Stay in Check: The Sky Is Not Falling
2
The One Question Every Founder Should Ask (But No One Does…)
3
The Market Has Spoken: Go Horizontal, Not Vertical
4
The Middleman Strikes Back
5
The Real Reason Bitcoin Startups Are Struggling to Fundraise

Stay in Check: The Sky Is Not Falling

A few weeks ago, a company I’m close to reached out to me seeking advice on their upcoming fundraise and expressing concerns about the increasingly negative sentiment in the market. When I got off the call, what struck me most was the amount of negative energy from every team member – a real shame given that they are amongst the most positive, optimistic people I know.

And it wasn’t that they’d gotten 100 rejections on the new round. They hadn’t even started fundraising yet. They’d simply been reading the negativity in the tech media and chatting with their existing investors who’d communicated that there was “blood in the water.” It occurred to me that numerous entrepreneurs with real, growing businesses are getting the RIP Good Times communique, and losing hope before they’ve even started.

That’s crazy. And it makes me angry. So I decided to publish the note I sent them. Look, no one disputes that valuations are likely to come down or that low-discipline, high burn companies may struggle. But tech/startups aren’t just collectively dead as an asset class. And that’s how many entrepreneurs seem to be feeling it. [All numbers etc have been changed to protect the company.]

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Hey gang –

Here are my thoughts after our chat yesterday. I’ve tried to break it up into a few sections. I know its a bit long, how I roll.

1. First things first, you guys have a built a really impressive platform. Think about it, you raised your first money barely over 18 months ago and you are going to process $X million in sales this month. $XM!!!!! So let’s start with that mindset. Holy crap, we’re building a real business here. We have real customers who depend on us, we drive meaningful lift to their bottom line with a beautiful frontend product. We help them gain back productivity and earnings. We are a mission driven company – and it is working. In spite of the general negativity of external market around tech startups, we are building something really special. That needs to be the mindset 100% of the time. We are building something great, we have amazing potential. Repeat, repeat, repeat.

2. The next 6 months for the company are all about re-discovering that spark from the founding days that excited the whole world and made everyone want to work with you, no matter what. The truth is this: you are going to have to hustle and grind harder over the next 90 days than you have over the past 2 years. You cannot take a break. You cannot take anything for granted. You need to grind, grind, grind with the same energy you did on the road to your first $50k in sales. The two of you have only one real job for the next few months: close a round of financing. That and keep your employees energized and in great spirits about the future of the biz.

3. I would re-calibrate your raise expectations on two fronts: (a) You need to forget all about valuation. I’m serious. Don’t mention it again to any investor. If anyone asks if you have a number in your head, you should answer: “We did our last round at an $XX post and we believe we’ve made material traction since then, but it’s up to the market to put a price.” Here’s what Josh Stein, GP at DFJ said yesterday at the Upfront Summit: “We have an expression at DFJ that is, ‘A1 is the new B.’ We invest flat to last round, & people are open to it.” Of course, we all hope that’s not the case here, but there has to be no ego. Absolutely no ego. Investors are resentful of being gamed by entrepreneurs running fast processes with little diligence over the past 4 years and repulsed at the first sign of arrogance or ego. Confidence? Yes, bring it in droves. Ego? Kill it. It is all about humility. (b) I would basically cut your raise # in half. Don’t go out to raise $XM. Your burn is really healthy and, yes, we want to pump more money into sales&marketing, so let’s say we are worst case burning $X/mo at the peak post-raise. $.4-.6XM should be the go to market number here. Here’s the thing: you want to oversubscribe, you don’t want to fall short. Last time around, there was what $8M of demand for your $3M round? That’s the goal here. $XM rounds are really tightening. Let’s go to market at $.4-.6XM, hope to hit $.7-1XM and give ourselves a solid 18+ months of growth.

4. Concurrent with the fundraise you need to go immediately to your corp dev contacts at companies X&Y who’ve expressed interest in the business before and start talking about strategic investment possibilities. No we do not want to sell the company right now, but the reasons for this are twofold: (a) Ideally one of these guys says: hmm, we actually want to buy this thing. And they give you an LOI. I don’t care whether you’d take that and yes it’s a time consuming process but like I said: no sleep for the next few months. It will do wonders for your fundraise if you can say companies X&Y have both approached us about M&A in the $XX range. It de-risks the investment for a potential investor in a climate largely devoid of M&A. It makes liquidity appear both practical and obvious. (b) In the event that we don’t find an institutional lead for the round (unlikely, but look this is a tough market), it gives us both the time and the energy to close a strategic investment from one of those parties. I’d rather have that option than no option. Remember, we are looking to generate both optionality & leverage.
 
5. You need to work with investors X&Y to develop the proper target list of new investors to approach. These intros all need to be warm. We need to cast a diverse, yet, focused net. My feeling is to basically hone in on ~12 people we think are really likely to write a check based on a historical interest in the business or the model. You can put together a spreadsheet or just go to people individually, whatever. But you need to coach each of your existing investors (who are making intros) on what the story you’re going to market is, what your milestones are, where you see the money taking you, etc. The new investors are going to call us, they’re going to ask us what we really think and we need to be really sure that we all understand exactly how you view the next 18 months.
 
6. Let’s talk about the next 18 months. And milestones. I’ll help you work on the deck & financials, but imo, here’s how you need to think about it:
– If we raise $X, $Y or $Z what numbers do we need to hit on a top-line basis to reach operational break-even?
– If growth isn’t meeting plan, what are the levers we can pull to cut burn and reach breakeven? (options are: cut staff in departments X or Y, cut marketing spend, cut engineering spend, etc.) AND – given that we have a consistent $XM (and growing) flowing through the platform just from existing customers, there should at least be enough room to have a breakeven biz in a worst case scenario.
– What milestones will we need to likely achieve in order to hit top line numbers (and therefore break/even)? X# of new customers via sales team, X# of new customers per/mo via paid marketing, increase in conversion rate from X to Y, increase in gross margin from X to Y, etc?
– New investors are going to want to feel that you’re really fluent and comfortable with these questions and issues so you need to put a lot of thought into them over the next few days.
Growth matters, but so does sustainability. You need to prove that you are thinking about how to build a sustainable business, not just a growing one. We all buy you can acquire more customers at a cost, but what else do you do to amplify the health of your business?
 
Myself (and other investors) can work with you on the story, etc, but this is a more of a coaching/pump up letter to get everyone aligned on how to approach the next 90 days. You guys have many of the elements and data points of a great story, but it will require the right perspective and energy to get this round done quickly.

Lots of love,

Ezra

The One Question Every Founder Should Ask (But No One Does…)

“What percentage of your investments have raised legitimate follow on rounds?”

Entrepreneurs have become a lot more savvy about fundraising over the past decade. And that’s a very, very good thing. Thanks to bloggers like Brad Feld, David Hornik and Mark Suster, founders have a legitimate window into how VCs assess people, theses, even financial returns.

Further, because horror stories still abound, founders have become very good at optimizing for people they can trust. That’s why newer investors (and firms) such as Hunter Walk at Homebrew and Jon Triest at Ludlow Ventures have quickly emerged as a top target for founders raising money – with said founders often eschewing the bulge bracket firms (and deep pockets) in favor of those personalities. Why? Simple: founders know they won’t get screwed. They have a material window into the firm’s personality via Twitter & digital content, and they know they’ll have a tireless advocate as they do the hard work of going from zero to one.

I’m glad founders are optimizing for good people and avoiding jerks. That’s how I try to live life too. But here’s the thing – what actually is the role of your seed investor? Is capital sufficient? Is being “nice” sufficient?

I believe there is only one truly fundamental role of a seed investor – to ensure your company doesn’t die. That’s the #1 metric of how I judge myself as investor: what % of my investments either raised a sufficient amount of follow on capital to reach profitability/next milestones or happily exited voluntarily. But here’s the thing – investors have different opinions on how they should run their firms to give entrepreneurs the best possible shot of getting there – some want to offer you tons of “services,” others want to get dirty with you on go-to-market or hiring, others may think that “brand” or press are paramount, or that networking with other VCs is foremost.

I am ultimately agnostic as to which strategy[ies] a fund wants to employ. But I do care about results. And my personal conviction is that good results will be found in funds that employ a healthy mix of all the tools: focused on building their own brand as a value-additive smart-money fund, strengthening relationships with upstream investors, broadening local networks to help with hiring, etc.

Hopefully this gets the conversation started about what a good benchmark is (I really don’t know). But I do think it’s an important metric for founders to focus on because it really answers the question: will my investor be able to do the job they’re selling me on? Appreciate any feedback or conversation.

The Market Has Spoken: Go Horizontal, Not Vertical

When I entered the venture world in 2012 and started learning the ropes, one of the lessons that was repeated heavily was the importance of vertical specificity. Namely that consumers were becoming more demanding, expected lower friction and better workflows, and vertical focus was the only way to service these behavioral shifts.

From Andreessen-Horowitz partner Jeff Jordan’s seminal post at the time, “People Marketplaces”:

While many of the horizontal platforms are doing interesting things, we tend to think that the vertical approach is resonating more with consumers.  Most of the companies that are showing early signs of breaking out tend to target one vertical.  Our hypothesis is that the horizontal plays may suffer from a potential “paradox of choice”: Consumers could be getting overwhelmed by the seemingly infinite array of potential service options presented by horizontal platforms, but consumers can easily understand the highly specialized value proposition of a company offering services in one vertical.  When you use the Lyft app, for example, it’s immediately obvious that you can get a ride from where you are to where you want to be.

My partner Chris Dixon points out that vertical approaches have additional advantages.  From a product perspective, the vertical apps can tailor their workflow to the unique characteristics of that vertical—the best way to find someone to clean your house is different than the best way to find a ride.  And from a marketing perspective, a narrow focus on one vertical lets the company do things to potentially accelerate each side of the two-sided marketplace.

But sometime in 2014 or 2015, that started to change. Jeff Jordan, writing nearly 30 months later, about his investment in OfferUp, an unequivocally horizontal platform noted:

Yet one of the categories that has been resistant to disruption has been the “for sale” verticals — everything from bikes, boats, cars & trucks, computers, furniture, garage sale, motorcycles, musical instruments, RVs, camping equipment, baby clothes, cribs, sporting equipment, and so on. We believe OfferUp has the potential to truly be a category killer — in the existing category of buying and selling goods between people locally — by providing a trustworthy and easy mobile-first experience.

Let’s get real: “for sale” isn’t a vertical – unless eBay is a vertical. No – used kids clothes are a vertical. Furniture is a vertical (a big one). Electronics are a vertical. “For sale” is horizontal.

But it’s not just OfferUp. The once discussed opportunity for the unbundling of Reddit to build deeply vertical specific, transactional communities – well, that’s started to push horizontal and get rolled up too. Take Massdrop for example, the hyper fast growing digital transactional community, that initially focused on headphones, but now covers over a dozen topics – from its Series B announcement:

The company focuses on what it calls “community-driven commerce.” It allows people who are interested in things like high-quality audio, men’s fashion and quilting (yes, those are all actual Massdrop communities) to connect with other enthusiasts, discuss products, make purchases with group discounts and even help design new products.

Massdrop has already created communities in 11 categories. Co-founder and CEO Steve El-Hage (pictured above) said the oldest communities (namely, the ones for audiophiles and for fans of mechanical keyboards) are the most popular, if only because they’ve had a head start. Massdrop says it now has a registered user base of more than 1 million people.

El-Hage plans to launch four new communities before the end of the year, and then add a new community every month in 2016.

Josh Breinlinger, an early OfferUp investor, and Partner at Jackson Square Ventures actually noted this shift 9 months ago. Writing in Vertical or Horizontal, he tried to unpack the danger in funding every available vertical:

The high price vertical is dominated by marketplaces for cars and homes, e.g. Zillow, Redfin, Beepi.  These are infrequent purchases with a very high ticket price.  Consumers in these verticals care about price, selection, and service more than turnaround time and convenience…

Now, let’s look at a different vertical.  Let’s take locksmiths. Does an “Uber for Locksmiths” make sense? I’m sure it would be a wonderful buyer experience to be able to push a button and have a locksmith show up in 5 minutes to fix a lock for $75.  So, if somebody built this, would it be successful?  I believe the answer is a resounding “no.”  The economics of customer acquisition and usage patterns just don’t work because a consumer may only use a locksmith once every couple years and only pays a small amount of money…

The way to address this problem is to get horizontal usage.  Let’s imagine that same locksmith marketplace also offers plumbers, gardeners, housecleaners, and carpet cleaners.  Now a user can sign up to get a locksmith, but also use the service for every other home service.

What Josh is really saying, and what the public markets seem to be affirming is that TAM (Total Addressable Market) is becoming one of the major if not the absolute primary considerations in valuation and health of a business. Growth, in and of itself, isn’t the predictor of value it used to be because growth can be manipulated by heavy marketing spend AND will taper hard when companies try to pull unit economics in line IF the TAM or network effects are insufficient. Here’s a subset of the recent multiple contractions – Enterprise Value against TTM Net Revenue – across the tech/marketplace sector just over the past two quarters (Q2 of 2015 –> Q4 2015):

The Sad State of Verticalization-Img1

The Sad State of Verticalization-Img2

 

While its an imperfect analysis given that eBay and TripAdvisor – the two most stable companies in this sample – are materially more mature than the other comps, there remain some clear takeaways:

  1. For example, while Shutterstock is nearly as mature as TripAdvisor (founded in 2003 versus 2000) it is the biggest loser on a EV/Net Rev basis. It’s also has the smallest TAM of any company in the sample ($16 Billion).
  2. Etsy’s contraction is comparable which makes sense given that its TAM is arguably similar…I made the case back in Unpacking Etsy’s S1 that no one actually knows Etsy’s TAM but that their aggressive community policing and regulations have unquestionably constrained its potential.
  3. In spite of LendingClub’s hyper growth, one might have imagined that its multiple contraction would have at least been in line with its peer set, if not actually lower, given its dislocation. My belief is that $LC is still trading at a material premium to the market because its TAM as the premier marketplace for “lending” with potential expansion far beyond consumer and SMB loans is absolutely massive. Of course its 100% Y/Y growth helps, but its TAM is absolutely massive.

In summary: what I learned in 2012 still appears to hold true – consumers love vertical specific workflows. But investors love massive markets. And therein lies the dislocation. Heading into 2016’s bearish investor environment my belief is that startups targeting niche verticals (even those into the $billions) – without a clear story or understanding of how to expand horizontally, will be at a considerable disadvantage.

The Middleman Strikes Back

The following article was originally published on TechCrunch on December 30, 2015

One of the great promises of the internet – a democratic, transparent, open network that would dis-intermediate entrenched industries, remove fee-taking middlemen, and thereby lower the costs of goods – has seemingly been realized. The OTAs such as Priceline and Expedia mostly killed travel agents, Prosper and Avant are fast disrupting bank loan officers, and the car salesman has been diminished in favor of eBay, Autotrader or Craigslist.

And yet, just as surely as we thought they were gone for good, the middlemen have come surging back to life. Only this time rebranded as our best friends: the personal concierge.

Case in point, personal shoppers were once a luxury – a sign of elite class and prestige. No longer: hundreds of thousands of consumers are now communicating with personal stylists (or data-driven human/Artificial Intelligence hybrids) via next gen fashion platforms such as TrunkClub and Stitchfix – two platforms with demonstrative value (Trunk Club was acquired more than a year ago for $450M and few experts would reject Stitch Fix’s $300M recent valuation).

And while fashion is an obvious use case, the concierge economy is thriving –spanning verticals from wellness to design, with a whole host of broad based horizontal concierge services also trying to impress their worth.

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ET TU, AMAZON?

The logical question is: why? Why, given all the advantages of a fricitionless, democratic playing field, are concierges suddenly surging back to popularity?

I see three likely explanations –

Amazon: If you sell practically any physical good online, Amazon, the internet’s most powerful retailer, is a perpetual threat. With their distribution, leverage, and logistics expertise they have the wherewithal to undercut on price, process and deliver product faster than practically any startup – not to mention, operate at a loss if necessary.

So where is Amazon exposed? On a services level.

Amazon’s operating margins – already tight at 1.3% – don’t allow for much room to train and mobilize a large human concierge force. Which means that building a human-focused, relationship-driven personalization platform actually provides for a tangible differentiator against Amazon – one of the few ways to effectively compete against the giant. And – perhaps more importantly – one of the few ways to build defensibility in a commerce segment traditionally dependent on “brand” as its only de facto moat.

One further point: Amazon is a predominantly a destination for directed search – either on a specific product or specific category basis. But as purchasing increasingly shifts to mobile, it turns out that it continues to be difficult to search, discover and catalogue individual items. Concierges – especially when leveraged via a mobile interaction point – reduce that friction and enable a new purchasing behavior.

Too Many SKUs: We exist in a world of overwhelm. That overwhelm via multi-tasking is affecting how we learn and think, and the overwhelm via optionality and availability of information is also affecting how we process, “shatter[ing] focus,” and deferring decision making as long as possible.

That problem of information overload was initially solved via curation, the mid-point on the spectrum in reduction of cognitive noise:

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But based on the hyper-growth of concierge facilitated platforms, it appears that curation doesn’t go far enough for the emerging set of millennial buyers – that they demand even more assistance and personalization than before.

The question that operators and investors should be asking is not whether consumers are connecting with digital assistants, but if – and at what point – we actually acquire too many concierges, thereby repeating the cycle of cognitive overwhelm, and forcing the next iteration of the operator/customer relationship.

Customer Acquisition: One of the curiosities of the concierge resurgence is that it may have opened the door for the next generation of customer acquisition.

The middlemen – when incentivized via a pay for performance model – actually become de facto customer acquisition agents for the company, serving as outbound salespeople. Trunk Club was one of the innovators of this model and our portfolio company, LGS has leveraged it as well with great success.

It replicates much of the power/incentives of a Multi-level-marketing model without the pyramid-like upfront capital commitments and obligations. MLM is a powerful model (Herbalife is one example of many), but social selling can generate abusive aggressiveness, poor customer relationships, and low return purchase rates. Because the concierge model is instead formulated as an expert/amateur relationship, there is an understood value in paying for guidance and reduce price sensitivity.

A concierge-turned-salesperson model isn’t a customer acquisition fit for all verticals, and it also can’t be as well leveraged by hybrid AI assistants, but it does solve some of the scalability concerns that most consumer businesses experience once traditional digital channels (FB, Google) begin underperforming.

THE DEATH OF THE COMMUNITY

Until recently, there was a strong hypothesis that a thriving, active community would unlock an unprecedented ability to facilitate native transactions. Andresseen-Horowitz General Partner Chris Dixon, when announcing his investment in Soylent, noted:

He said he was interested in companies that appear to be focused on selling X but are really online communities that happen to make money selling X. This helps explain why many investors are confused by the sustained success of these companies. One example he cited was GoPro. Many investors decided not to invest in GoPro because they saw it as a camera company, and camera companies generally get quickly commoditized. However, investors who properly understood GoPro saw it primarily as a highly engaged community of sports enthusiasts, something that is very hard for competitors to replicate.

And yet, at least on a macro scale, the presumed value is very much in doubt.

Last month, it was reported that native buy ads on Pinterest during the holiday season did not meet expectations:

The company began inserting Buyable Pins into its iPhone app in late June, and just added the feature to its Android app in early November. The company says more than 10,000 merchants have joined the program, including big retailers and brands like Macy’s, Nordstrom, Neiman Marcus, Cole Haan and Tory Burch, but at least one of these big partners is seeing fewer than 10 purchases a day on Pinterest, according to a person with direct knowledge of the sales figures. This source and another also said that Pinterest insiders have privately admitted to being disappointed with early sales numbers.

According to the same report, results are similarly disappointing at Twitter and Facebook. One time startup darling, community leveraged shopping portal Polyvore was acquired by Yahoo in 2015 for $200M – a healthy price to be sure, but certainly lower than once hoped. Even GoPro, noted by Dixon as a community outlier, has lost nearly 75% of its enterprise value in the public markets over the past 12 months. True, it trades at a premium to commodity manufacturers, but it appears its community purchasing may not be as strong as once imagined.

Nevertheless, transactional communities with more vertical specificity (such as Soylent) do outperform bare bones e-commerce. And is it clearly the very early innings in Pinterest and Twitter’s efforts to sell product directly through its platform. But don’t be surprised to see the larger horizontal community players continue to struggle, and ultimately acquire companies in the concierge space in order to boost their conversions, order sizes, and frequency.

THE ECONOMICS

The upside of human driven assistant/concierge services is that in most scenarios, they add value to an end user experience. The downside is that they add material costs to a company’s P&L.

Take for example any of the listed wellness apps (Rise, Talkspace, Big Health, etc) which, if it operated on a purely software basis would boast 80-90% gross margins. But a human focused component affects that in one of two ways:

  1. Either the company employs (W2’s) any number of wellness professionals who are expected to interface with a given quota of customers. Although that model enables the wellness app to maintain their gross margins, it cuts deeply into their contribution margins because of the additional labor expense.
  2. The other option is to view the wellness professionals more like marketplace suppliers, and connect them to customers on a 1:1 basis, while paying them a percentage of every transaction, say 70%. Though this does have the effect of removing the wellness professional costs from the G&A line, it also changes the nature of the business – from a 90% margin software business to towards a marketplace model with a 30% take-rate.

Given those two options, it’s clear why a hybrid AI/Machine Learning model is the holy grail for several verticals – replicating the level of personalized service while minimizing overhead labor costs and maintaining extraordinary software level gross margins.

That said, it is still unclear if hybrid AI assistants can provide an end-user experience powerful enough to materially affect purchasing, conversion, and frequency.

For the time being, within the fully human powered services, the winning business models will be ones that can hire relatively inexpensive, untrained people, who can then be empowered via software or leveraged workflows to deliver a meaningfully improved end-user experience. This has the added benefit of yielding greater supply/expert-side scalability in that the pool of potential concierges is far larger (if performance does not require deep inherent expertise) and the level of consistency, even across expertise levels, will be more stable.

Startups trying to wedge into the market using a high level of service need to be highly cognizant of, and focused on, controlling costs. Especially as the investor market continues transitioning away from high cash burn models, obsessive attention on how to deliver a high quality experience, deepening long-term scalability, and leveraging lower-cost labor will yield many compelling outcomes.

Special thanks to Rebecca Kaden, James Conlon, and Peter Christman for their assistance on this article.

[For disclosure, Chicago Ventures is an investor in LGS, Mac&Mia, Rise Science, Retrofit, and Havenly.]

The Real Reason Bitcoin Startups Are Struggling to Fundraise

If you’ve read my blog over the years, you know I’ve written extensively on bitcoin in the WSJ, re/code, and Coindesk. And yet, a couple of years after my initial interest in the bitcoin sector, neither myself nor my firm Chicago Ventures is yet to make an investment into a bitcoin tech startup. And that in spite of my taking a large personal stake into bitcoin itself, and many “altcoins” such as Ethereum, Maidsafe and Factom.

Let me be clear: I am an unequivocal bitcoin bull. I believe that bitcoin may well represent the greatest transfer of wealth in my generation. I also believe that bitcoin itself, as the fuel underlying the blockchain, is exceedingly vital – as very clearly outlined by my friend Nick Tomaino in The Blockchain is Important and so is Bitcoin.

For the past 12-18 months I have intentionally passed on nearly every early stage bitcoin related business because of what I believe to be a systemic funding gap that is not easily reconcilable. Simply put: given the macro level of consumer adoption within bitcoin (below) it is exceedingly difficult for most new entrants to reach a level of traction compelling enough to warrant follow on capital. And because the majority of these businesses are not generating substantial revenue, availability of continuation capital is a pre-requisite to any current funding round.

So where is consumer adoption of bitcoin? One of the better breakdowns I’ve seen is by Tim Swanson on his blog Of Numbers – where he chops the data multiple ways and finds at best 2x year/year growth: A Brief History of Bitcoin “Wallet” Growth (whereas most VC-backed consumer companies are shooting for 5-10x+ Y/Y growth).

bitcoingap1

EARLY STAGE CONCERNS

My hesitation towards investing in the sector comes from the following analysis (the data behind my analysis, as well as copied graphs are via Coindesk). Here’s the data as I’ve assessed it –

bitcoingap2

2015 saw a nearly 50% decline in total bitcoin related VC deals from 99 to 57. Though that reflects a macro-level hesitancy on the sector (or perhaps over-exuberance in the 2014 bull market), that – in and of itself – is not debilitating.

But the two disconcerting trends to most early stage investors are:

  1. Of the 78 newly funded companies in 2014, only 21 raised follow on funding in 2015 (6 of the 27 follow-on rounds in 2015 were for companies who had first been funded in 2013).
  2. Funding is fast consolidating quickly around “platform” investments (as expressed by the graphs below) – which I characterize as either “universal” or “infrastructure” focused. These are the startups least exposed to the short-term volatility of consumer adoption as they touch multiple parts of the ecosystem.

The evidence appears in these two charts:

bitcoingap3

bitcoingap4

Universal and Infrastructure related investments now make up nearly 50% of all bitcoin funding, but more importantly, are the buckets into which all of the year’s largest funding rounds fell into: Coinbase, $75M (Universal), 21 Inc, $116M (Universal), Circle, $50M (Universal), and Chain $30M (Infrastructure).

With that in mind, let’s unpack those two points –

(1) With 57 of the 78 funded companies in 2014 not raising publicly disclosed follow on funding round in 2015 that means that there are either (a) a lot of likely zombie bitcoin startups or (b) a large number of non-disclosed bridge/extension rounds.

Though bridge rounds are a sub-optimal situation for founders and investors alike, they are a reality and we’ve done our share of them at Chicago Ventures. The problem here is that an extension is fundamentally a “bridge to an outcome” – and in the case of most of these bitcoin startups, neither the market nor macro adoption has converged to the point where a meaningful “outcome” is achievable in 6-18 months.

When investors consider making a new investment in the space, they are increasingly cognizant that bitcoin adoption will not explode overnight and that the funding duration for any consumer-facing company is likely to be 5-10 years before generating material revenue. Given the technical nature of these businesses – and the consequent requirement to staff expert engineers – it’s a very cash intensive proposition to take on and a tough hurdle to overcome.

Nevertheless, of the 30 newly funded startups in 2015, a full two thirds touched payment processing, financial services (transfers) or wallets – the exact categories that are hardest to generate outperformance in the current macro environment.

(2) Over the past two years, much investor commentary has focused on discovering and funding “bitcoin’s killer app.” It is unclear to me whether that was simply a nascent understanding of the ecosystem or intentional misdirection, but it is a misunderstanding. The inherent flaw in that thesis is that it naively assumes that bitcoin is missing a UI, whereas in reality, the blockchain – because it can be leveraged by existing experiences – already has millions of beautiful interfaces to tap into.

Given that, it makes sense that funding is converging around platform plays: those that are either the building blocks of the emerging blockchain ecosystem or those with demonstrable network effects. The struggle for early stage investors wanting to make platform bets is that being a laggard into a space where competitors’ network effects are already strengthening is a recipe for disaster.

Here’s what the funding shift looks like in graphical form as the smart money transitioned towards platform focused opportunities as opposed to discovering a “killer” front-end app.

bitcoingap5

THE NEXT 24 MONTHS

At the time of this writing, bitcoin is once again buzzing: after nearly a year of price decreases and stagnation towards $200, bitcoin has been on a roll, surging past $500 and now holding strong in the mid $400s. In addition, both Wired and Gizmodo believe they’ve uncovered the actual Satoshi Nakamoto, an eccentric, iconoclastic, tax dodging entrepreneur: Australian Dr. Craig Wright, although those who’ve communicated with Satoshi in the past disagree.

It sure does seem likely that 2016 could be another boom year for the broader bitcoin ecosystem.

But the described concerns remain – without a discernable shift in adoption, the vast majority of bitcoin related opportunities, both consumer and b2b blockchain focused, are exceedingly difficult to fund by early stage funds. Consumer, because of largely stagnant adoption, and, b2b, because of the relatively small size of most pilot contracts signed for ledger-focused blockchain-related record keeping. The exceptions, of course, are Barry Silbert’s Digital Currency Group and Dan Morehead’s Pantera Capital, both of whom are committed to expanding the overall bitcoin ecosystem via early stage bets.

Naturally, this equation is also different for larger funds that are opportunistically investing downstream for the right entrepreneur or idea – in that case, they have the pockets to support a company throughout the funding gap. But that is the exception rather than the norm.

My estimation is that smart money at the early stage will largely stay on the sidelines in 2016, waiting to see if new platform opportunities emerge via the 21 Bitcoin Computer, or other decentralized networks, especially as incumbents such as Coinbase, Circle and Chain prove the strength in their networks and multi-faceted applicability.

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