Is Silicon Valley may be becoming less relevant to software startups?  Probably not, but US Software investing as a percentage of global deals is down; how does that change the market today and in the future?  Are we starting to see the earliest signs of a long term market shift?  As the data below shows, software deals as a percentage of overall activity is down across the US.

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There are many questions that arise from the picture emerging from current investment trend data:

  • Is software at an innovation crossroads?
    • Does a slowdown in investment activity reflect a sense that the latest crops of startups are more iterative?
      • Innovation is not dead (don’t be stupid), but is the next big thing harder to spot?
      • Is there a lack of confidence that most of these startups have a chance to be the next Unicorn?
  • If investment activity in early stage software companies is declining, what happens next?
    • Does this mean there will be more competition for fewer Series A, B, and C deals in the future?
      • Good news for the entrepreneurs?
    • If fewer new software deals are funded, but existing companies continue to die-off at current rates, will this mean costs should begin to decline?

Silicon Valley in a Bubble?

There have been discussions from a long time about how different business practices, and investment economics operate in the SF Bay Area, and Silicon Valley, in comparison to other regions.  The Valley operates within a bubble, with a unique perspective and outlook.  Bubbles can take many forms, but at some point they all burst.  In 2008, the bubble burst across much of the global economy.  Today the Bay Area economy has recovered to a degree unlike anywhere else.  At the end of 2015 we noted a slowdown in the investment community. Part of a normal economic cycle, we are now seeing long term trends emerge.

While Silicon Valley’s growth and inflation rates have significantly outpaced the rest of the world, we believe that there may be signs of a current adjustment occurring that could have a long-term impact. The change we are seeing is in early stage company investments.

Silicon Valley v. the Rest of the World?

A long-standing complaint among startups is that when they are not from “the valley” they get asked “when are you moving here?” as part of the financing conversation. The implication, often explicit but always implicit, is that if your firm is not local to the valley, it is not going to get funded from a Valley based VC.

As a result of so much funding activity happening in such a small local area, an artificial surge in wages and other costs has developed.  A software developer in Victoria BC, where we are with a comparable skill set to one in the SF Bay Area earns less than half as much, and that’s just fine for everyone.  A company in Victoria can make a $5MM round go further, and retain key staff easier.  Conversely, the massive Silicon Valley ecosystem means constant churn and opportunity.  When a business fails in Victoria people notice.  In Silicon Valley, there is so much pent-up demand, people root for failures so they can fill job openings.

The SF Bay Area startup mentality is different. Not better or worse, just different.

Is the Global Investment Market Changing?

We appear to be seeing a shift, and if the trends continue, then it’s possible that Silicon Valley is on a different diet from everyone else.

Let’s look at the data using a series of graphs.  First off, as a percentage of early stage deal rounds, the U.S. continues to dominate the global landscape.
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Likewise, the Bay Areas received the lion’s share of investment dollars over the last 4 months.

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However, for Series A investments, the trend is not the same.  In terms of total capital raised, there’s a growing level of activity in Asia relative the to the US.  It’s possible that many Seed and Angel deals go unreported in Asia, but Series A deals are another matter.  Companies that raise a Series A are looking for expansion to broader markets.

The effect of the Brexit vote, and the subsequent change in exchange rates made many European deals more attractive; and the dollars followed.

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This is where the data becomes extremely interesting.  Software deals as a percentage of overall activity is down across the US.  But amount invested is up.

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When we look at Seed and Angel rounds is isolation, the trend is even more pronounced.  Please note, this does not indicate dollars invested, but rather shows rapidly growing diversification of investments.

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So, where are the dollars going?

Overall dollars invested is growing, and those investments are in more diversified sectors than we’ve previously seen.  This is exciting news for everyone!  Is the rest of the market catching up, or does this trend in early stage investments signal a more pronounced realignment?

If I’m a VC focused on B & later rounds, I need to consider re-prioritizing my market analysis team.  The deals that will be coming looking for capital in the future will be dramatically different.  The market is noisier.  But even a series A investor in the US should be concerned.  IF, the current early-stage deals that are getting financed are qualitatively better on average than during the prior period, then on balance the same number of “good” deals will get financed in the future. However, it’s unlikely that the quantity of higher quality ventures backed will have changed.

Software Innovation Stalled?

Absolutely not!  The data doesn’t show that at all.

Is software at an innovation crossroads?  No.

What’s Next

With other sectors receiving a greater percentage of the deals and the dollars, it is more likely that the valley will become more recession proof, as the local economy will not be as dominated my one sector alone.

This does mean however, Venture Capital investors who are interested in software will expand their horizons.  The best deals may no longer be local, and best deals will refer to valuation and prospects.  Software companies outside the valley always had the decided advantage of lower costs.  If they are able to raise more capital under better deal terms, and can continue to deploy this capital more effectively, then more successful companies will graduate either to later rounds of funding, or become cash-flow positive sooner.  This second scenario would mean fewer B and C round deals to choose from, as more companies would not require the capital infusions to drive growth: growth would be organic.

How would this change the market?

Silicon Valley Software Migrating?

We’re extracting more data from the database; Which regions are is picking up the new opportunities?

We will bring you this data shortly:   The regions receiving more investments today will reap the benefits tomorrow…

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