As many of the readers of this blog know, Bullpen has a unique value proposition in the new venture eco-system. We do the “tweener” rounds after seed but before the big money traditional venture funds come in. Given this unusual spot we have some interesting data to share about the likely Series A Crunch and when it might happen.

First, let’s talk about the 3 kinds of deals that Bullpen does

(1) Seed Extension: (internally denoted A+). A seed extension is a “flatish” round to the initial seed and usually a similar total dollar size. A frequent example is a $1m on $4m seed followed by a $1m on $5m seed extension (or A+). We call them internally A+ because these rounds do indeed tend to be the second rounds of money into the company and are largely centered off the initial round. You could argue that should call these Seed+ and perhaps that is indeed a better name. These in general are companies that have good teams and good initial products but have not yet found the product/market fit. In our portfolio, Proformative was a good example when we invested almost a year ago.

(2) Rational B: (internally denoted B*). This round, whose name was coined by John Callaghan of True Ventures, is also a second round of financing but usually at a nice uptick to the initial round and perhaps about twice in size. So think of a $1m on $4m Seed/A followed by a $2m on $10m series B.  These companies in general are those that already have some preliminary product/market fit, but a small raise gets the company to a big milestone enabling a nice auction for the next round.  In our portfolio, Assistly, our first deal, was a perfect example.

(3) Seed Syndicate: Bullpen is occasionally invited to participate in seed syndicates. We do not lead seeds, and view leading seed rounds as a channel conflict with the Seed/Super Angel investors in front of us. We want those investors to introduce us to the Seed Extension and Rational B’s. If we jump into the seed game, that would be a mistake. That said, when we are domain experts, we are sometimes invited to participate in these initial rounds by the Super Angels as passive investors who can add value in an advisor capacity. In our porfolio, FlashSoft is a good example of this kind of investment.

If we strip out deal type (3) and look only at deal types (1) and (2) we have a very interesting barometer for the coming Series A Crunch. So let’s look at our screened dealflow by quarter in 2011. (Screened here means that it fits our investment model, has Super Angel investors in the Seed/A, etc. We naturally see many more deals that are outside of this rather tough screen).

We have only been in business for 1 year, therefore this is the only data we have to extrapolate from. For the year we saw about 30% of deals as B* vs. 70% as A+. This quite frankly was a much higher percent than we anticipated when we started the fund. We assumed our deal flow would be 90+% A+.

In my estimation Q1/Q2/Q3 are all in the same boat: between 30-50% of the deals we saw were B*. That is completely consistent with us being in a huge bull market for start ups. But what is interesting and perhaps the cause for some future concern is the significant drop in Q4. In that quarter 83% of deals were of the A+ type. Only 17% were of the “up”.  To me that is a very faint indicator that the Series A Crunch might be starting. It’s only one quarter of data, so we will watch closely in Q1/Q2 to see if this trend continues.

That’s the data part, now let me add my editorial comment: I think the Series A Crunch will not happen until the summer of 2013. There are several reasons for this

(1) The seed deals are still super competitive and many companies that might be in the seed extension category just close down and get re-seeded.

(2) Its an election year, and markets have a funny way of being bullish in those years. January stock action was a perfect example.

(3) Perhaps most important: there are  a great deal of IPO proceeds yet to be recycled into the ecosystem (Zynga, GroupOn, Pandora, LinkedIn, and the big one of Facebook). I think that coming stream of money delays the start of the crunch for one full year past when it “should” have started.  Do recall that bubbles seem to always last a bit longer than anyone expects.

Finally, there is no question that valuations are starting to come down in the follow on rounds for all but the big winners. But the seed action remains nuts. A friend told me recently about posting his new company on Angel’s List and getting 307 mails asking for intros in 1 day. That is just insane.

I look forward to your comments on this.

Paul