It is typical for seed-stage startups to fizzle out before they really get going, oftentimes unable to raise the next round of funding or gain traction with customers. But a new study out from CB Insights offers some harrowing insights on the next chapter for these companies.

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According to the report, an estimated 1,181 seed-stage startups that raised cash between the third quarter of 2011 and this quarter will be “orphaned,” meaning they won’t be able to raise their next round. That means more than $1 billion in investment capital into those companies will evaporate. And that’s the best case scenario, taking into consideration that 39 percent of companies can actually raise the next round. The report looked at 4,056 companies that raised seed funding since 2009.

But the authors of the report note that the coming carnage actually won’t be the worst thing for the industry, one which is struggling to fill open technical positions. Many of the folks who worked at those seed-stage companies will get recycled back into the tech economy.

They write:

The process of natural selection that will happen with seed companies (and which we’d argue should happen) will result in over 1000 recently funded seed companies becoming orphaned, i.e. unable to raise follow-on financing. This will result in over $1 billion of investment into these companies being incinerated, but again, this is nothing new. Seed investments are the riskiest bets an investor can make and the reality is most will not return money. Again, the death of startups and the loss of investment dollars is part of the process of separating the best companies and investors from the rest.

Interestingly, the report comes at a time when we are seeing massive amounts of cash flowing into the Seattle startup community. (The fourth quarter is on pace to be the biggest yet this year for VC investments, though that has been buoyed by some very large rounds in companies like Smartsheet, Qumulo and Zulily).

According to the CB Insights report, there were 207 companies in Washington state that received seed-stage funding between the first quarter of 2009 and today. (Washington ranked fourth behind California, New York and Massachusetts).

However, seed-stage companies in Washington had the second highest rate of follow-on financing, something that the VCs and angels here would say is due to the high quality of investment opportunities in the region.

Comments

  • BIll

    In the startup world, the smartest money seems to go to the stage where everyone else is not. Many quality investors who were at the cutting edge of seed financings a few years ago, like Chris Sacca, seem to have moved on to doing some Series A and B deals. You can get businesses that show traction for a lower valuation because of the scarcity of real Series A and B money.

  • http://adamlieb.me/ Adam Lieb

    This doesn’t take into account 4 phenomenons. 1. Startups that exit off of their first round of capital of funding (increasingly common). 2. Startups that achieve profitability and have no need for additional capital. 3. Startups that raise a second round of NON venture financing (2 angel rounds are becoming more and more common). 4. Firms that are able to be cash efficient or raised enough in their seed round to not need additional financing for 2+ years.

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