Booming startup market sparks investment rush for ever-younger companies

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Blank Street has a simple business: it sells coffee, sometimes in carts, usually in small shops. It opened its first location 17 months ago, before starting to dot Manhattan and Brooklyn with baristas.

Just a few years ago, a fast-growing, low-cost, no-frills coffeehouse chain might have struggled to capture the interest of tech investors. But in today’s booming early-stage startup market, the New York-based company has received pledges for its third round of funding in one year. The $ 35 million investment comes just three months after the still fledgling company received $ 25 million, said Vinay Menda, managing director of Blank Street.

“We live in a world where capital is available,” said Mr Menda, a 29-year-old former venture capitalist who co-founded the coffee company in 2020 with Issam Freiha. Fundraising “was much easier than it would have been” in the past, he said.

Over the past year, there has been a noticeable rush of funding in the high-risk category of early-stage startups as investors have clamored to go into businesses before they even have staff or a product. While the startup industry has been inundated with increasing amounts of cash for much of the past decade, most of it has traditionally gone to late-stage private companies that have tested business models.

In 2021, investors poured $ 93 billion into so-called start-up and start-up companies in the United States through December 15, a record. That compares to $ 52 billion for all of 2020 and $ 30 billion in 2016, according to PitchBook Data Inc.

With more money coming in and the number of new startups funded by venture capitalists relatively stable, valuations have risen. The median valuation of startups and startups funded in 2021 was $ 26 million, up from $ 16 million in 2020 and $ 13 million in 2016, according to PitchBook.

Investors betting on the space say they see a lot more room for startups to grow. They are emboldened because many VC firms have posted their best returns since the dot-com boom, thanks to a thriving software industry and multibillion-dollar profits on companies like Snowflake. Inc.

and DoorDash Inc.

The combined valuations of private startups around the world have reached trillions of dollars, becoming a huge investment category.

The current rush for capital has prompted some leading investors to warn of the overheating market. The angst among Silicon Valley insiders about rising startup valuations is not new, but the willingness to air these concerns is notable.

Fred Wilson, Union Square Ventures Partner and Twitter Primary Supporter Inc.

and Coinbase Global Inc.,

said in a November blog post that he had seen quite a few investment rounds in which companies were valued at $ 100 million before they had a sustainable business model.

“They are deluding themselves, comforted by the likelihood that someone will come and pay a higher price in the next round,” he said of investors. “The numbers just don’t add up.”

Sam Altman, former president of startup incubator Y Combinator, which has backed hits like DoorDash and Airbnb Inc.

-predict in a December tweet that returns on venture capital this decade “will be much worse than those of the 2010s.”

To be competitive, many venture capitalists report spending less time checking their background and doing other research before investing. A recent rout in high-growth tech stocks has particularly strained investors, as startup trends often follow public markets.

Traditional venture capital firms quickly raised new funds, while hedge funds and private investors entered the market. Much of the hedge fund money goes to late-stage startups, but the crowded field has prompted other investors to seek out earlier-stage companies.

Tiger Global, a New York-based hedge fund and startup investor, participated in more than 340 startup investment rounds in 2021, up from 78 the year before, according to PitchBook. A few years ago, the most prolific investors usually made a few dozen.

Among Tiger Global’s investments is Blank Street, which has ambitious growth plans but involves more physical construction than tech investors often like. Mr. Menda, CEO of Blank Street, says the company’s no-frills approach gives it strong profit margins for its stores, and annualized revenue has quadrupled since raising funds in September.

Mr Menda said his business model was inspired by a group of Asian companies, including Indonesian Kopi Kenangan and Chinese Luckin Coffee. Inc.,

which has launched a similar approach by enticing customers with cheap drinks and apps that promote deals.

Luckin, by far the largest of this group, presents a tricky comparison. The company, which at one point planned to overtake Starbucks Corp.

in China, saw its stock price drop more than 95% in 2020 after telling investors that up to $ 310 million of its 2019 sales were made by employees. Luckin reached a settlement with the U.S. Securities and Exchange Commission over allegations of accounting fraud, which he neither admitted nor denied.

Venture capitalists often shy away from an industry when its best-known company suffers such a disgrace, but that hasn’t happened with coffee startups. Luckin’s business persevered: it grew rapidly in its last quarter and its stock recouped some of its losses.

Mr Menda said Luckin does not make a good comparison with Blank Street given his past management issues. Instead, the company is turning more to many other take-out coffee chains that have recently been able to raise funds and grow rapidly, including Kopi.

Despite the allegations of accounting fraud and its settlement with the SEC, Luckin Coffee’s business has persisted.


Photo:

Yan Cong for the Wall Street Journal

Multiple rounds of funding in a booming business can happen within weeks of each other today, especially in areas that investors find attractive, like cryptocurrency or corporate credit cards. In quieter times, venture capitalists often encourage companies to raise every nine to 18 months.

Los Angeles-based Upfront Ventures partner Mark Suster said the mid-size start-up company he looked at in the mid-2010s was valued at around $ 15 million, down from today. ‘hui about $ 25 million and that companies often have not yet generated income.

To adapt, he’s making “faster, earlier bets,” largely based on the caliber of the founders and the few initial hires rather than the quality of the product, he said.

“Before, I could wait nine months. I could look at how your customers are using your product, ”he said. Now, “I really support the talent and then over time I’ll determine if you can perform. “

Others are turning to more unconventional bets.

In September, startup Colossal Inc. raised more than $ 16 million for its plan to bring the woolly mammoth back to the wild as a species, by modifying the genomes of the Asian elephant so that the animals look and act like woolly mammoths.

Much of the Jurassic Park-like business plan calls for making money from new technology, said Ben Lamm, CEO of the company. But Colossal also told investors in 2020 that there was potential for “gigantic park attractions,” among other potential revenue streams, according to a slide presentation.

Mr Lamm said the company had only planned to raise $ 8 million, before finding much larger demand than expected.

“It was the right time,” he said. “People’s mindsets and visions were in the right place and on the right scale. “

Many venture capitalists have posted their best returns since the dot-com boom thanks to hits like DoorDash.


Photo:

carlo allegri / Reuters

Write to Eliot Brown at [email protected]

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