(A) Bloomberg Bata

Using data from Bloomberg over the years 2005-2014 (and Preqin for angel, seed, series and venture debt funding transactions up to $3 billion for private US Internet companies), I find the following trends.

  • (i) Firms are smaller. Figure 3.1 shows that the percent of US companies that are small companies, defined as firms with fewer than 250 employees, has been increasing by 1.8 % each year over the entire period.
  • (ii) Employees are fewer. Figure 3.2 shows that the number of employees at small firms has been decreasing at a rate of 0.46 per year or each firm is shrinking by one employee every two years.
Small firms as a percent of total firms

Fig. 3.1 Small firms as a percent of total firms

Number of employees

Fig. 3.2 Number of employees

Both Figs. 3.1 and 3.2 support the notion of granularity in firm size.

(iii) Investors are financing very young startups more than mid-stage or later-stage startups. Paralleling the rapid change in technology, seed funding, or very early-stage funding of technology startups has been increasing as shown in Fig. 3.3. The annualized growth rate of seed funding, over the period 2004-2015, is the highest, at a compound annual growth rate of 35.4 %, followed by angel funding at a compound annual growth rate of 10.6 %, and late stage funding growing the slowest, as depicted in Fig. 3.4.

In general, the time line of funding of Internet startups is as follows. At the idea stage entrepreneurs seek seed capital. Angel funding comes next, but is conditional upon reaching certain developmental milestones. Typically, angel refers to an individual, not an investible asset class, but angel investors have been rebranding themselves as seed investors, which might partially account for the phenomenal growth of this asset class. Additionally, startups are now pursuing several rounds of seed funding instead of directly raising venture capital. Finally, there is the staged series funding, each larger than the previous one and each contingent upon pre-assigned growth parameters.

(iv) Initial public offerings (IPOs) in the US technology sector have been increasing at a significant rate. The final stage is the exit stage, where early investors can cash out their investment when the firm goes public in the equity market, in an IPO.

The growth rate of tech IPOs in Fig. 3.5 is lower than the IPO growth rate during the boom years of

the late 1990s and 2000, when hundreds of tech companies went public annually... Today’s companies are also waiting longer. In 2014, the typical tech company hitting the markets was 11 years old, compared with a median age of 7 years for tech I.P.O.s since 1980. [38]

One of the reasons that firms can remain private longer is that private investors are fueling their growth, especially in the later stages, as shown in Fig. 3.4.

There is a feedback effect at work in the venture funding industry. The IPOs of companies like Facebook, Twitter and LinkedIn created

Number of seed investment deals

Fig. 3.3 Number of seed investment deals

Growth of VC funding

Fig. 3.4 Growth of VC funding

Number of US tech IPOs significant wealth, both at the individual level and at the fund level, which was then recycled into additional new entrepreneurial ventures

Fig. 3.5 Number of US tech IPOs significant wealth, both at the individual level and at the fund level, which was then recycled into additional new entrepreneurial ventures. For entrepreneurs, discovering angels was a “kind of trophy collecting” though not without some risks [39]. The growth in early-stage financing of firms, as depicted in Figs. 3.6 and 3.7, supports the observation of renewed entrepreneurial activity and addresses the point made by Dinlersoz et al, who claim that workers in young, entrepreneurial firms have less net worth than workers in the corporate sector and hence, it is financial frictions and borrowing constraints that limit entrepreneurial activity rather than labor market frictions [37].

Granularity or incremental funding in the form of staged investments, as shown in Fig. 3.4, mitigates this financial bottleneck. Initial funding is a bet across a large number of highly uncertain ventures. Most of these bets fail, but the successful and promising candidates are granted additional funds allowing them to scale up. Financing proceeds sequentially and is experimental as each stage reveals more information about the quality of the investment. The funding at each round depends upon the uncertainty that is resolved at that round - will the technology work and does the product have positive sales growth? Choosing to not reinvest is equivalent to not exercising the option to buy further equity investment in the startup.

Contrast this with mutual fund investors who are unable to participate in this staged funding, which requires an early and risky initial investment in order to gain entry into later-stage funding of successful startups. Venture capital firms reverse the process “by starting small and owning a larger share of the firms that turn out to be successful, while attempting to cut their losses on the unsuccessful ones as early as possible” [35].

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