Collective, a back office platform that caters to ‘businesses of one,’ just landed a hefty seed round

Americans and other global citizens are increasingly self-employed, thanks to great software, the need for flexibility, and because skilled services especially can pay fairly well, among other reasons.

In fact, exactly one year ago, the Freelancers Union and Upwork, a digital platform for freelancers, released a report estimating that 35% of the U.S. workforce had begun freelancing. With COVID-19 still making its way around the country and globe, prompting massive and continued job dislocation for many tens of millions  of people, that percentage is likely to rise quickly.

Unsurprisingly, savvy startups see the economic power of these individuals — many of whom aren’t interested in managing anyone or anything other than the steady growth of their own businesses. A case in point is Collective, a 2.5-year-old, 20-person San Francisco-based startup that’s been quietly building back office services like tax preparation and bookkeeping for what it dubs “business of one” owners, and which just closed on $8.65 million in seed funding.

General Catalyst and QED Investors co-led the round, along with a string or renowned angel investors, including Uber cofounder Garrett Camp, Figma founder Dylan Field, and Doordash executive Gokul Rajaram.

We talked yesterday with cofounder and CEO Hooman Radfar about Collective’s mission to “empower, support and connect the self-employed community” — and what, exactly, it’s proposing.

TC: You previously founded a company and, even before it sold to Oracle in 2016, you had jumped over to VC, working with Garrett Camp at his startup studio Expa. Why shift back into founder mode?

HR: What I saw throughout across AddThis and Expa and my angel investing is that managing finances is hard. Accounting, taxes, compliance — all that set-up as a small business is annoying.

Two years ago, [Collective cofounder] Uger [Kaner] came into Expa and he basically pitched me on a startup-in-a-box-type program that we were talking about building from an incubation perspective, but [with more of a pointed focus on back office issues]. He’s an immigrant like me, and because he didn’t quite understand the system, he wound up having tax penalties — penalties that are even worse when you’re a freelancer. Some startups have come up with a  bespoke version of what we offer, but we were like, ‘Why do they have to do it?’ These are commodities, but if you put them together in a platform, they can can be powerful.

TC: So is what you’ve created proprietary or are you working with third parties?

HR: Both. We’re an online concierge that’s focused on the back office as the core, meaning accounting and tax services. We also form an S Corp for you because you can save a lot of money [compared with forming a business as an LLC, which features different tax requirements]. So there’s an integration layer plus a dashboard on top of that. If you’re an S Corp, you need to have payroll, so we have partnership with Gusto that comes with your subscription. We have a partnership with Quickbooks. We work with a third party on compliance. Our vision is to make this easy for you and to set this on autopilot because we understand that time is literally money.

TC: How much are you charging?

For taxes, accounting, business banking, and payroll, for the core package, it’s $200 a month. We are piloting bookkeeping and a fuller service package that’s probably [representative of] the direction we’ll head over time, and that will be an additional fee.

TC: How can you persuade these businesses of one that it’s worth that cost?

HR: There are almost three million people in the U.S. who [employ only themselves and] are making more than $100,000 a year and if you think about how many of these [different products] they are already using, it’s a great deal. Quickbooks and Gusto is cheaper with us. You see savings through expensing. The magic is really running your S Corp the right way. Part of that is normal income tax, but you also have a distribution and it’s taxed differently than an income — it’s taxed less. So we pull in salary data and look at expenses and across states, and say, ‘This is what we’d recommend to you based on how your cash flow is coming in, so you recognize this distribution in a compliant way.’

TC: Interesting about this useful data that you’ll be amassing from your customers. How might you use it? 

HR: Our first concern is making sure the right people are seeing it [meaning we’re focused on privacy]. But there’s a lot we can do with the aggregation of that data once we’ve earned the right to use it. Among the things we could do, theoretically, includes creating a new level of scoring. If you’re a business of one, for example, it’s very difficult to get mortgages and loans, because credit agencies don’t have the tools to assess you. But if we have your financial history for years, can we represent that you’re a great person, you have a great business.

Another interesting direction as we reach more members — we’ll get to 2,000 soon — would be to use our power as a collective to get our members less expensive insurance, [help facilitate] credit, [help them with a] 401(k).

TC: There are a lot of other things you can get into presumably, too, from project management to graphic design . . .

HR: Right now, we’re want to make sure our core service is nailed.

Think about the transparency and peace of mind that Uber brought to ride-sharing, or that Uber Eats brings to food delivery. You know when something is cooking, when it’s on its way, when it’s arriving. We’ve gotten used to that level of transparency and accountability with so many things, but when it comes to accounting, it’s not there and that’s crazy. We want to change that.

TC: Going after “businesses of one” means you’re addressing a highly fragmented market. What kinds of partnerships are you striking to reach potential customers?

HR: We’re having those conversations now, but you can imagine neo banks make sense, along with vertical marketplaces for nurses and doctors and realtors and writers. There are a lot of possibilities.

Pictured, left to right, Collective’s cofounders: CTO Bugra Akcay, CEO Hooman Radfar, and CPO Ugur Kaner.

The Chainsmokers just closed their debut venture fund, Mantis, with $35 million

Alex Pall and Drew Taggart are best known as The Chainsmokers, an electronic DJ and production duo whose first three albums have given rise to numerous Billboard chart-topping songs, four Grammy nominations and one Grammy award, for the song “Don’t Let Me Down.”

Soon, they hope they’ll be known as savvy venture investors, too.

They already have some major-league believers, including investors Mark Cuban, Keith Rabois, Jim Coulter and Ron Conway, who are among the other individuals who provided the Chainsmokers’s new early-stage venture firm, Mantis, with $35 million in capital commitments for its debut fund.

It’s a surprisingly traditional vehicle in many ways. Mantis is being managed day-to-day by two general partners who respectively offer venture and operational experience: Milan Koch graduated in 2012 from UCLA and has been an investor ever since, including as a venture partner with the seed-stage fund Base Ventures; Jeffrey Evans founded the record label Buskin Records and the mobile communications platform TigerText (now TigerConnect), among other companies, and has long known the Chainsmokers’s business manager, Josh Klein.

With fundraising begun earlier this year, the firm has already made a handful of investments, too, including the fitness app Fiton (Pall says they “squeezed into the A round after its close”), and LoanSnap, a mortgage-lending startup that was founded by serial entrepreneur Karl Jacob.

Pall and Taggart take their health seriously, so the fitness app is easy to understand.

As for why the world’s highest-paid DJs would be interested in such a seemingly staid business as mortgage lending, Taggart says the firm’s mission is ultimately to find and fund a wide range of startups that could potentially benefit its young audience, and that he and Pall are happy to use their star power to help related founders when a particular technology catches their eye.

In the case of LoanSnap, he says that he and Pall were impressed by LoanSnap’s promise to process loans more efficiently than other lenders. By getting involved in the company, all sides also recognized a “massive press opportunity for LoanSnap at a time when COVID was hitting and there was going to be billions of dollars in refinancing going on that [the company] wanted to participate in,” he says.

Indeed, despite investing a relatively small amount — $250,000 — in what was ultimately a $10 million round for LoanSnap in May, Mantis was credited in numerous reports as being the deal lead.

Taggart and Pall say they also take inspiration from singer Jimmy Buffett, who has co-created numerous businesses to both benefit, and capitalize off, his own fan base. Though Buffett started with Margaritaville — a hospitality company with a casual dining American restaurant chain, a chain of stores selling Jimmy Buffett-themed merchandise and casinos with lodging facilities — he has more recently begun building retirement communities in Florida for aging Buffett acolytes, and Pall and Taggart say the strategy resonates.

“When we started eight years ago, our fans were primarily all in college,” says Taggart. “Now they are dealing with paying back their college loans, and they’re probably applying to buy their first house, so a company like LoanSnap feels like one of those startups whose services our fans have grown into needing.”

Pall and Taggart aren’t entirely brand new to investing. Pall says they’ve been making seed-stage bets as angel investors for several years, including in Ember, an eight-year-old, LA-based company that makes temperature-controlled mugs and travel mugs and has raised roughly $25 million altogether, shows Crunchbase.

“I’d like to say that we were like thinking in this incredible way about the business at the time, but we were just like, ‘This is a really great product and we love the founder,’ ” Pall says.

In fact, the two got into a number of “diverse deals,” he continues, but “all of it was inbound” until two years ago, when they “decided to kind of change our strategy and go seek out the opportunities that we thought were out there…  We thought that maybe if we institutionalize this process, [we’ll discover] a lot more opportunity out there for us to work with dynamic founders and interesting founders who are going to change the landscape of tomorrow.”

Soon after, Pall and Taggart were introduced to Koch and Evans, who had already joined forces and were looking for an investment partner who was a market influencer. The group spent the next year getting to know one another, and things began coming together from there.

Pall and Taggart — who say that all four members of the team have to want to do a deal for it to move forward — are certainly entrepreneurial themselves. Aside from performing roughly 100 shows last year before beginning work this year on a fourth album, the two also run a production studio. And they are stakeholders in a small-batch spirit brand called JaJa Tequila.

Last year, they also co-founded YellowHeart, a ticketing platform that aims to put more power in the hands of performers, rather than scalpers.

Mantis was originally targeting $50 million in capital commitments, as reported by Bloomberg. Asked if that target proved too ambitious, Koch says the original idea was to raise $30 million, and that though the fund’s limited partner agreement stated that it could raise up to $50 million, the team “just decided that for a first-time fund, in order for us to produce a great IRR, we’d just rather stick to the target.”

You can find our interview with Taggart and Pall at the 21-minute mark.

Pictured at the top of the page, left to right: Jeffrey Evans, Alex Pall, Drew Taggart, Milan Koch.

Where have all the seed deals gone?

When it comes to big business, the numbers rarely lie, and the ones PitchBook and other sources have pulled together on the state of seed investing aren’t pretty. The total number of seed deals, funds raised and dollars invested in seed deals were all down in the 2015-2018 time frame, a period too long to be considered a correctable glitch.

The number of seed deals, defined as U.S.-based deals under $1 million, dropped to 882 in Q4 2018 from 1,500 three years earlier, a 40% drop. The number of seed funds raised and the total dollars invested in seed rounds were both down roughly 30% over the same time period. And the trend isn’t limited to the U.S. — venture capital investment volume outside the U.S. dropped by more than 50% between 2014 and 2017.

The rise before the fall

To discover the reason behind the precipitous drop in seed deals requires a trip back in time to 2006, which was the start of a seed boom that saw investing rise 600% over a nine-year period to 2014. If you’re an internet historian, 2006 should ring a bell. It’s the year Amazon unveiled their Elastic Compute Cloud, or EC2, its revolutionary on-demand cloud computing platform that gave everyone from the government to your next-door neighbor a pay-as-you-go option for servers and storage.

Gone were the days of investing millions of dollars in tech infrastructure before writing the first line of code. At the same time, the proliferation of increasingly sophisticated and freely available open-source software provided many of the building blocks upon which to build a startup. And we can’t forget the launch of the iPhone in 2007 and, more importantly for startups, the App Store in 2008.

With the financial barrier to starting a business obliterated, and coupled with the launch of an entirely new and exciting mobile platform, Silicon Valley and other innovation hubs were suddenly booming with new businesses. Angel investors and dedicated seed funds quickly followed, providing capital to support this burgeoning ecosystem. As more capital became available, more companies were formed, leading to a positive reinforcing cycle.

Enter stagnation

But this cycle began to slow in 2015. Had investor optimism waned, or was the supply of founders dwindling? Had innovation simply stopped? To find the answer, it’s helpful to understand a key role of the traditional venture capitalist. Once the Series A round of financing closes, the lead investor will join the company’s board of directors to provide support and guidance as the company grows. This differs from the seed round of financing when investors typically do not join the board, if one exists at all. But even the most zealous and hardworking of VCs can only sit on so many boards and be fully engaged with each portfolio company.

An old-fashioned logjam

If you’ve ever ridden Splash Mountain at Disneyland, you’ve likely experienced a moment when the boats stack up due to a hiccup in the flow somewhere farther down the route. This is what happened with seed companies looking to raise a Series A round of financing in 2015.

Venture capital remains a hands-on business.

With venture investors limited by the number of board seats they could responsibly hold, a huge percentage of seed-stage companies failed to successfully raise more capital. Inevitably, many seed funds also felt this pain as their portfolios started to underperform. This led to tighter availability of capital, which led to a tougher fundraising environment for seed-stage companies. Series A investors could not absorb the giant wave of seed opportunities — the virtuous cycle had turned vicious.

The scaling of venture capital

In its simplest form, venture investing has three distinct phases: seed, venture and growth.

Because seed investors are not weighed down by the constraints of active board roles, they have the ability to build large portfolios of companies. In this sense, seed funds are more scalable than traditional early-stage venture funds.

At the other end of the spectrum, growth funds are able to scale their volume of dollars invested. With the average age of a company at IPO now being 12 years, companies are staying private longer than ever, which affords growth funds an opportunity to invest enormous amounts of capital and raise ever-larger funds.

It’s in the middle — traditional venture — where achieving scalability, by quantity of deals or dollars, is the most challenging. It was this inability to scale that led to the great winnowing of seed companies hoping to raise their Series A.

It’s a situation that is unlikely to change. Venture capital remains a hands-on business. The tight working relationship between investors and founders makes venture capital a unique asset class. This alchemy doesn’t scale.

The irony for traditional Series A venture investors is that the trait they find most desirable in a startup — scalability — is the one thing they themselves are unlikely to achieve.

What seed-stage dilution tells us about changing investor expectations

Round sizes are up. Valuations are up. There are more investors than ever hunting unicorns around the globe. But for all the talk about the abundance of venture funding, there is a lot less being said about what it all means for entrepreneurs raising their early funding rounds.

Take for instance Seed-stage dilution. Since 2014, enterprise-focused tech companies have given up significantly more ownership during Seed rounds. What gives?

Scale is an investor in early-in-revenue enterprise technology companies, so we wanted to better understand how this trend in Seed-stage dilution impacts companies raising Series A and Series B rounds.

Using our Scale Studio dataset of performance metrics on nearly 800 cloud and SaaS companies as well as Pitchbook fundraising records covering B2B software startups, we started connecting the dots between trends in valuations, round sizes, and winner-take-all markets.

Bottom line for founders: Don’t let all the capital in venture mislead you. There’s an important connection between higher Seed-stage dilution and increased investor expectations during Series A and Series B rounds.

These days, successful startups are growing up faster than ever.

Founders face an important trade-off decision

Is seed investing still a local business?

According to CB Insights, the number of seed-stage funding deals in the U.S. declined for the fourth straight year in 2018, continuing a trend that has seen the number of deals steadily drop, while the average size of deals increased. It’s safe to say this is the new normal. Yet, there continues to be a huge surplus of available capital and there are more funds out there than ever before.

For new entrepreneurs, as well as repeat founders of early-stage startups, these changing conditions are having a dramatic impact on how, where and from whom they raise early capital. In years past, raising a seed round often boiled down to finding a local VC or angels that would invest a few hundred thousand dollars on just an idea for a company. It was more about who you knew and where you were located, rather than actual traction or feedback from the target market.

But as competition for the best deals has ramped up, legacy investors in Silicon Valley are now beginning to seek investments in startups all over the world, due in large part to the proliferation of elite tech talent. While that may seem like a potential goldmine to entrepreneurs operating outside Silicon Valley, founders need to understand how investors think about investing in startups, particularly outside their home markets.

Here are three things entrepreneurs must remember when investors come calling from abroad.

Distributed teams are no longer a liability, but proximity to market is still a must

The prevailing school of thought historically was that in order for startups to have a legitimate shot at making it, they all have to be located in Silicon Valley or in another top U.S. tech hub. After all, the U.S. is where all the investors and best talent are located. However, that isn’t necessarily the case anymore. Yes, it is still crucial to have a foothold in the U.S., mostly on the business side of the company, as this is where so many potential customers are — but having a distributed team is no longer viewed as a red flag to many investors.

Other markets, like Israel, have proven track records of churning out elite tech talent. We have seen a number of successful startups that set up the company headquarters and at least one founder (usually the CEO) in the U.S. to be near customers and investors, while the rest of the engineering team remains in Israel.

Prudent investors will still require the CEOs of their companies to be in the U.S. market, but that doesn’t mean the R&D team can’t stay in the home market. This means that the other founder/CTO staying back with the R&D team must have the leadership skills necessary to keep everything on track, while the CEO establishes the business headquarters in the U.S.

Investors are hunting for value, often relying on local co-investors

Much has been made over the past few years about the soaring valuations of Silicon Valley startups. Every day it seems like a new company announces a $50 million-plus round of fresh funding, along with a new sky-high valuation. The frenzy created around all that activity has a profound impact not just on those companies themselves, but on all the smaller startups in the broader ecosystem, as well. The overwhelming competition for capital in Silicon Valley is forcing many seed investors to mitigate the inflated valuations in their portfolios by looking for more undervalued and underappreciated opportunities in other markets.

The best investors are not necessarily the biggest.

Valuations for startups outside of the U.S. are typically lower, and represent prime opportunities for investors that are being squeezed from the biggest VC funds that are writing checks earlier in the pipeline and driving up those massive valuations. Typically, late-stage investors would be the ones taking a “gamble” on outside opportunities like those in Israel or Europe, but competition is forcing seed investors to look for early-stage opportunities outside of their immediate geography.

As a result, seed funds are now becoming more open to co-investing with foreign funds. As mentioned above, investors are sourcing deals outside their home markets, but funds are still not comprising much of their portfolio beyond the U.S. These select deals are happening on the edges. In order to find the best deals in a foreign market, U.S. funds often seek local VCs to collaborate with, someone they have maybe done a deal with before that knows the local startup scene inside and out. They are still looking for a process of familiarity, even if it is overseas.

Not all investors add value

As a founder, who you take money from matters a lot. Is it a benefit or to your detriment to take money from investors who are not local to you? How involved will they be?

Startup founders need to think long and hard about the non-monetary value that investors provide. If they are removed from the day to day operations of the company and unaware of challenges the company faces, then what is the point in having them there?

Lately, there has been a rush of large funds to invest at the seed level, offering piles of cash but without any guarantee of long-term value and support. With this new “spray and pray” approach, billion-dollar funds just don’t have the bandwidth and attention to support their small investments the same way they do the larger, more capital-heavy investments.

The best investors are not necessarily the biggest. Instead, the best are the ones constantly adding value to actually help the business grow, whose core focus is to invest at the pre-seed and seed stages of a company. Are they making introductions to potential customers and partners, opening doors to new markets, etc.? Who are the investors that are going to actually help you work through problems? Who will be a partner to you?

Seed investing, like all venture capital, is changing in a meaningful way. What used to be a local, almost neighborhood-oriented process, is now a global business — at least in terms of deal sourcing. Yet, most investors still require physical proximity to the founder/CEO and the company HQ to ensure they can truly help the company execute on its vision.

Dilution: The good, the bad and the ugly

Since 2013, SparkLabs Group has invested in more than 230 companies, and my general advice to our founders and portfolio companies hasn’t changed: I always tell them not to overthink valuation, know what they need in terms of capital for their seed round and how there is “good dilution” and “bad dilution.” Whether your dilution ends up being good or bad (or ugly) generally depends on how well you execute.

To solidify my advice, I sometimes go through the math of possible seed rounds and how future rounds can play out. To keep the discussion simple and focus on my core points, I keep the amount of investment the same and assume the company is starting with a 20% stock option pool, which venture capital firms typically require by a startup’s Series A round.

Three scenarios

I map out three valuations, representing a standard Silicon Valley startup with a pre-money valuation of $5 million (Scenario “A”), a “hot” startup with an $8 million pre-money valuation (Scenario “B”) and an outlier with a pre-money valuation of $12 million (Scenario “C”).

Let’s look at the typical pathway where the founders raise a $2 million seed round on a pre-money valuation of $5 million. They build their product, launch, gain great momentum and successfully raise an $8 million Series A, where even though they don’t get that many lead interests, they get a decent $20 million pre-money valuation.

Let’s assume this startup is in a mature startup space where investors are looking for good revenue traction.  With the $8 million raised, a startup team can face “The Good,” which I define as executing on all cylinders, or “The Bad,” which I would define as a struggle.

Sometimes it’s not about executing poorly or mismanagement. A product can be too early, deal with longer than expected sales cycles or face other factors outside a startup team’s control. Regardless, “The Bad” situation can be where a company isn’t able to raise their Series B at all — or struggles to find investors that still believe in the product and team, and gets funding but not at the best valuation for the founders and team ($15 million raised on a post-money valuation of $50 million).

“The Good” would be a startup hitting traffic, revenues, clients sales or whatever metrics help drive success.  Here the same startup raises a $15 million Series B on a post-money valuation of $95 million.

Scenario “C” was the startup with the outlier valuation at their seed stage that raised a $2 million seed round with a post-money valuation of $14 million. Probably a company founded by a co-founder of Twitter or a hot YC company. Their Series A continues on a similar trajectory, raising $8 million with a post-money valuation of $38 million. Their fork in the road is similar to the prior situation. “The Good” is a Series B that raises $15 million with a post-money valuation of $115 million, while the “The Bad” raises the same amount but has a post-money valuation of $85 million, and the founders owning 39.9% of the company versus 45.1%.

Don’t overthink or overplan your fundraising rounds

The easy conclusion is that it is really hard for founders and a team to predict and plan their fundraising rounds over the next several years, much less how well their product will turn out.

But you can make sure you’re better prepared as entrepreneurs by asking yourself some basic questions:

  • How much capital do you really need to last you 12-18 months?
  • Will this amount allow you to hit milestones to raise your Series A or Series B?

Some startups don’t need much capital to take off, while others need more. An entrepreneur’s problem can be raising too little or too much capital.

During my second startup in 2000 — during the first internet boom when money was flowing easier than today — we raised $7 million as our first round. I would describe that experience as “big rounds are like meth for entrepreneurs,” which typically ends in “The Ugly.” Money burns quicker than most entrepreneurs think. It’s not paper, it’s paper soaked in kerosene. Luckily, while facing bankruptcy, we closed an additional $7.5 million and the company became profitable — but not without a lot of pain and torment.

We have seen a fair number of our founders underestimate their cash needs at the seed round. Then they have to raise additional seed capital, which isn’t easy. Some might have been too confident in their sales ability or how efficient they would be with their capital. Investors might assume those were issues, plus question whether the market is really there, or whether the management team made too many missteps. Be prepared to answer these types of questions if you need to raise additional seed capital.

Pitching the valuation game

We typically remind our founders that the best way to increase their valuation is to execute well and gain enough interest to be offered at least two term sheets.

If you are raising a Series A and your seed round was a convertible note or a SAFE, that cap really isn’t your valuation, so don’t get fixated on that as a minimum. We’ve had portfolio companies with valuation caps of over $30 million pre-money, but their Series A was priced above $20 million. We’ve also had a founder overzealously focused on their valuation cap from their seed round on, who ruined negotiations with a top 10 VC firm because they wouldn’t go lower than their cap.

If you have one potential lead, I generally recommend knowing your value and negotiating reasonably. If your lead lowballs you, of course you should walk away. But if it’s within range, don’t nickel and dime on the valuation.

Your goal is to create investor interest from multiple firms while generating the least amount of friction to quickly close your round. It might be a difficult balance between knowing your value but respecting what investors are looking for, but don’t kill your fundraising efforts by not being flexible on valuation. Remember, it’s not all about the money and your ownership percentage. If one of our portfolio companies had a term sheet for a $10 million pre-money valuation from an unknown family office or an $8 million pre-money valuation from a top-tier venture capital firm, we would tell them to take the lesser valuation, even if it’s a smaller gain on our books.

Although raising money while navigating dilution can be tricky, with the right preparation and mindset, it’s possible to close your round with the best value for your company.

The case for corporates to fill the seed vacuum

Over the past five years, there has been a clear drop in seed investing. Between 2010 and 2014 there was an influx of “micro” VCs, perfectly equipped to deploy seed capital. Since then, we have seen a gradual decline.

One key reason is that the Micro VCs were successful. Turns out that investing at the seed stage is a really strong strategy for generating returns. Their portfolios performed very well and, as a result, were able to raise a much larger second and third fund.

Unfortunately, once your fund size exceeds $75 million, I’d argue, it is very difficult to focus on the seed stage. It is simply too difficult to identify enough quality opportunities to deploy all that capital. Instead, you need to write bigger checks. In order to do that, you start to focus on later rounds. This leaves a gap at the seed stage, which I’d argue, is the most exciting.

Because of that, I believe there is an incredible opportunity for this gap to be filled by corporate venture funds. We, at dunnhumby, have invested here, successfully, for years. And by successfully, I don’t mean just financially, though we have returned far more than we have invested; I also mean strategically. There are incredible strategic benefits to investing at the seed stage.

Innovation

The seed stage is where the greatest innovation is happening. We invest to inform our own strategic direction and identify new technologies and business models prior to their impact on our own business. We also use it to identify and embed with emerging companies who could, one day, be great partners.

In the recent surge of corporate innovation efforts, venturing is not leveraged nearly enough. There are few ways of exposing innovation better than aligning with a company that is innovating daily as a means of survival. There is no better inspiration than watching a team of two grow into a team of 100-plus, often pulling the slower-moving corporate along for the ride.

Collaboration

There is a flexibility and eagerness with early-stage companies that allows for greater collaboration. They are not so large as to have their own, built-out bureaucracy, and are actively willing to work together. For many, it is why they take money from a strategic, in the hope that there is more than just capital that comes from the relationship.

In many cases, these synergies do not emerge right away. However, there is a closeness that forms between the two companies that begins to bear fruit, from my experience, about one year post-investment.

For the startup, there is increased exposure to the investor’s client base and resources. For the corporation, there is firsthand insight into the success of the startup’s business model, technology and market. From this, partnership and acquisition opportunities emerge.

M&A and partner pipeline

Because of the strategic nature behind these investments, they also act as an incubator for future partnerships and acquisitions.

Participating at the seed stage does not require significant capital contributions.

By aligning at the seed stage, you have the unique opportunity to watch the company grow. What is the market demand and is there an opportunity to enter a new space before others have realized the opportunity? Often, we will take a board or board observer position with the company, which brings even greater insight into their performance, as well as the potential upside of an even closer relationship.

Also, nearly as important, is that you gain an even greater insight into the company culture and their alignment with your own. In most cases, these discussions will emerge from early collaborations, where your broader teams will have the opportunity to interact and form a culture of their own. This cultural alignment will increase the likelihood of a successful outcome, whether that is a partnership or full acquisition.

Value

Participating at the seed stage does not require significant capital contributions. For one later-stage investment, you could make three to four seed investments, which increases your exposure to the above items and drastically reduces the financial impact on your balance sheet. If done right, within four to five years, the fund should contribute much more than it costs.

Does this mean that the corporate should finance the entire seed round? Not typically. In fact, for almost all of our investments to date, we are participating as part of a syndicate of investors. Often this syndicate is made up of other corporate investors (often referred to as “Strategics”). This reduces risk as well as the financial burden for each investor at this stage. The goal is to get a seat at the table. For strategic purposes, there is little difference between owning 5% versus 20% at this stage. Once the company grows larger, this dynamic will change.

Conclusion

At dunnhumby we invest in less than 2% of the companies we meet with. We are diligent about where we invest. However, I’d argue that the 98% we pass on are nearly as important. Because we have an investment arm, we are exposed to incredible innovation across a range of industries that most companies, that lack a seed investing strategy, do not see. At least, not until it is too late. Capital gives us a seat at the table.

These conversations provide signals into emerging trends in our industry, as well as our clients’ industries. When we pass, often the relationship does not end. Many times, they will lead to partnership discussions, referrals and introductions that are equally beneficial to the startup.

The opportunity is there. Corporations just need to seize it.

Co-Star raises $5 million to bring its astrology app to Android

Nothing scales like a horoscope.

If you haven’t heard of Co-Star, you might just be in the wrong circles. In some social scenes it’s pretty much ubiquitous. Wherever conversations regularly kick off by comparing astrological charts, it’s useful to have that info at hand. The trend is so notable that the app even got a shout out in a New York Times piece on VCs flocking to astrology startups.

This week, the company behind probably the hottest iOS astrology app announced that it has raised a $5.2 million seed round. Maveron, Aspect, 14w and Female Founder Fund all participated in the round, which follows $750,000 in prior pre-seed funding. The company plans to use the funding to craft an Android companion to its iOS-only app, grow its team and “build features that encourage new ways get closer, new ways to take care of ourselves, and new ways to grow.”

TechCrunch spoke with Banu Guler, the CEO and co-founder of Co-Star about what it was like talking to potential investors to drum up money for an idea that Silicon Valley’s elite echo chambers might find unconventional.

“We certainly talked to some who were dismissive,” Guler told TechCrunch in an email. “But the reality is that interest in astrology is skyrocketing… It was all about finding the right investors who see the value in astrology and the potential for growth.”

“There are people out there who think astrology is silly or unserious. But in our experience, the number of people who find value and meaning in astrology is far greater than the number of people who are turned off by it.”

If you’ve ever used a traditional astrology app or website to look up your birth chart — that is, to determine the positions of the planets on the day and time you were born — then you’ve probably noticed how most of those services share more in common with ancient Geocities sites than they do with bright, modern apps. In contrast, Co-Star’s app is clean and artful, with encyclopedia-like illustrations and a simple layout. It’s not something with an infinite scroll you’ll get lost in, but it’s pleasant to dip into Co-Star, check your algorithmically-generated horoscope and see what your passive aggressive ex’s rising sign is.

In a world still obsessed with the long-debunked Meyers-Briggs test, you can think of astrology as a kind of cosmic organizational psychology, but one more interested in peoples’ emotional realities than their modus operandi in the workplace. For many young people — and queer people, from personal experience — astrology is a thoroughly playful way to take stock of life. Instead of directly predicting future events (good luck with that), it’s is more commonly used as a way to evaluate relationships, events and anything else. If astrology memes on Instagram are any indication, there’s a whole cohort of people using astrology as a framework for talking about their emotional lives. That search for authenticity — and no doubt the proliferation of truly inspired viral content — is likely fueling the astrology boom. 

“By positioning human experience against a backdrop of a vast universe, Co–Star creates a shortcut to real talk in a sea of small talk: a way to talk about who we are and how we relate to each other,” the company wrote in its funding announcement. “It doesn’t reduce complexity. It doesn’t judge. It understands.”

Why convertible notes are safer than SAFEs

As the saying goes, where you stand on an issue often rests on where you sit. Translated into startup law and finance, your views on how to approach fundraising are often heavily influenced by where your company and your investors are located. As a startup lawyer at Egan Nelson LLP (E/N), a leading boutique firm focused on tech markets outside of Silicon Valley — like Austin, Seattle, NYC, Denver, etc. — that’s the perspective I bring to this post. 

At a very high level, the three most common financing structures for startup seed rounds across the country are (i) equity, (ii) convertible notes and (iii) SAFEs. Others have come and gone, but never really achieved much traction. As to which one is appropriate for your company’s early funding, there’s no universal answer. It depends heavily on the context; not just of what the company’s own priorities and leverage are, but also the expectations and norms of the investors you plan to approach. Maintaining flexibility, and not getting bogged down by a rigid one-approach-fits-all mindset is important in that regard.

Here’s the TL;DR: When a client comes to me suggesting they might do a SAFE round, my first piece of advice is that a convertible note with a long maturity (three years) and low interest rate (like 2 percent or 3 percent) will give them functionally the same thing — while minimizing friction with more traditional investors.

Why? Read on for more details.

Convertible notes for smaller seed rounds

Convertible securities (convertible notes and SAFEs) are often favored, particularly for smaller rounds (less than $2 million), for their simplicity and speed to close. They defer a lot of the heavier terms and negotiation to a later date. The dominant convertible security (when equity is not being issued) across the country for seed funding is a convertible note, which is basically a debt instrument that is intended to convert into equity in the future when you close a larger round (usually a Series A). The note’s conversion economics are more favorable than what Series A investors pay, due to the greater risk the seed investors took on.

Where seed and early-stage funding is growing, contracting or holding steady

In startup circles, it’s trendy to talk about how entrepreneurs are leaving high-tax, high cost-of-living metros for cheaper locales. While Silicon Valley remains ground central for hobnobbing with investors, the common wisdom goes, early-stage funding stretches much further elsewhere.

As memes go, it makes sense. But does the data bear this out? Is Texas turning into the new California? Is Salt Lake City edging out Seattle? Are the largest U.S. startup hubs losing their edge in luring promising early-stage startups?

In a somewhat eccentric data crunch, Crunchbase News set out to see the extent to which certain regions are gaining in early-stage and seed activity. We also attempted to see whether any of the big, established startup ecosystems are showing obvious signs of decline.

To lay out our case, we looked at four metrics. First, we measured total reported annual seed funding and round counts by state for the 18 largest venture capital ecosystems. Next, we looked at seed through early-stage investment and deal counts across three size ranges. They include moderately sized rounds of $1 million to $5 million, larger ones of more than $5 million and less than $50 million and really big early-stage investments of $50 million and up.

The idea with the size-range data sets was to see how tech hubs stack up in terms of launching well-funded startups. It’s one thing to have a lot of seed-funded startups. It’s quite another to see them go on to close follow-on rounds in the millions or tens of millions. We also wanted to see whether the top startup hubs are retaining their dominance in launching companies that go on to secure the biggest early-stage rounds.

(If the round sizes seem overly large for seed or early-stage investments, keep in mind that in 2018 and the current boom, traditional buckets for rounds have been breached; so what was once a Series D in terms of dollars, can now in fact be an early-stage round in some contexts.)

Here are some of the broad findings:

  • Top hubs hold pretty steady. The largest venture ecosystems aren’t showing signs of significant contraction this past year at seed and early-stage. Across the metrics we measured, the three largest (California, New York and Massachusetts) are hanging on to similar shares of funding as prior years.
  • Utah and Pennsylvania outperforms. Two states stood out in terms of posting gains across several seed and early-stage funding metrics: Pennsylvania and Utah. Pennsylvania benefited from heightened investment in biotech, transportation and robotics, areas in which it has large talent pools. Utah, meanwhile, prevailed in enterprise software.
  • Texas sees big gains in larger rounds. Texas didn’t see an annual rise in total reported seed funding, moderate-size deals or really big early rounds. However, the state was red-hot in producing startups that secured rounds of more than $5 million and less than $50 million.

Below, we’ll flesh out these findings, as well as take a look at the overall breakdown of seed and early-stage funding.

Here’s how the top states for venture funding stack up

To begin, let’s take a look at the breakdown for seed-stage funding and rounds among the 18 states that account for the overwhelming majority of investments:

As you can see, the top six states take in the lion’s share of seed funding, with California the leader of the pack by several multiples.

Moderately sized rounds by state

Next, let’s look at how the top states rank by another metric: Moderately sized seed and early-stage rounds of between $1 million and $5 million.

The reason we included this metric is because it includes very early-stage companies that have a lot of runway ahead, but have already attracted some serious investor interest. We also provided a year-over-year comparison, as it may be an early indicator of a state’s venture ecosystem gaining or losing traction.

Without further ado, here’s the chart:

As you can see above, the top five states for venture investment didn’t see big gains or losses in their share of investment at the $1 million to $5 million round size. Where we did see big increases was in two aforementioned states: Pennsylvania and Utah.

Early-stage rounds between $5M and $50M

Another metric to gauge a tech hub’s momentum is its ability to produce startups that raise pretty big seed and early-stage rounds.

With this in mind, we summed up deal counts and total investment by state for rounds of more than $5 million but less than $50 million for companies founded in the past four years. The results are charted below:

 

For mid-sized tech hubs, we see a good amount of year-over-year fluctuation in share of total investment for this category. A single big round or two can really move the needle, so it’s probably wise not to make to much of a single year’s fluctuation.

Texas, however, really is showing momentum: The Lone Star State is the largest tech ecosystem where we saw a really big year-over-year increase in rounds over $5 million and under $50 million. In 2018, Texas had 30 rounds in this category (see list), bringing in a total of $366 million. That’s up from just 13 funding rounds in the category bringing in $138 million in 2017. While we can’t point to clear-cut causes for the increase without deeper analysis, it’s apparent this is a bullish indicator for the Texan startup scene.

Early-stage rounds of $50M and up

Last, we looked at really big seed and early-stage rounds of $50 million and up for companies founded in the prior four years.

This is a funding category that barely existed several years ago. However, giant early-stage rounds have really mushroomed in recent quarters with the emergence of super-sized venture funds like the SoftBank Vision Fund and a greater willingness among investors to throw hundreds of millions at nascent sectors like scooter sharing.

The data indicates that really big early-stage rounds still primarily occur in the biggest startup hubs. The San Francisco Bay Area, New York and Boston were home to more than 85 percent of companies in the 2018 list for the category. No other state brought in more than one deal.

We have more details on how the numbers stack up in the chart below:

 

More power to Pennsylvania and Utah

In conclusion, we’d have to say that rumors of the slow death of California’s startup scene have been greatly exaggerated. Although all three of the top states for startup funding are high-tax, high cost-of-living locales, they’re also continuing to hit high marks in launching entrepreneurial companies and raising capital for them to grow.

Nonetheless, the data does reveal some apparent up-and-comers among startup hubs. Two that we notice are Pennsylvania and Utah.

Pennsylvania outperforms: I grew up in the Philadelphia area, so naturally I’m pleased to see the state ranking deservedly higher across our seed and early-stage metrics.

However, Philly can’t get all the credit for the rise. Pennsylvania has the good fortune of housing two startup hubs: Philly and Pittsburgh. Traditionally, Philadelphia has been a strong contender in biotech, with strength also in fintech, media and other sectors. Pittsburgh, as we’ve reported previously, is emerging as a hotbed for robotics, AI and transport.

Between those metro hubs, Pennsylvania saw a big rise year-over-year in round counts across all the categories we tracked (except for $50-plus million rounds, which were tied with 2017). Investment totals were also up markedly.

And don’t forget Utah: Utah has also been moving up in the ranks, delivering a particularly impressive performance given its population of just 3 million. By our estimates, Utah is the least-populated state to rank as a major startup hub.

Enterprise software is the dominant sector among sizably funded Utah companies. However, we also see a lot of non-SaaS business models pop up, in areas including fintech, audio devices and even peer-to-peer storage.

The takeaway: It looks like emerging early-stage startup hubs don’t need to siphon talent from the largest tech ecosystems to thrive. California, New York and Boston don’t appear to be losing their dominance. But that isn’t stopping smaller startup hubs from thriving too.

Methodology

The data set looks at funding levels by state. In most states, the vast majority of venture activity is in a single metro area. Exceptions are California, with the San Francisco Bay Area, Los Angeles and San Diego, as well as Pennsylvania, with both Pittsburgh and Philadelphia. For rounds above $5 million, we limited the data set to startups founded after January 1, 2015.

We did not compare 2018 seed funding totals to prior years due to the fact that a sizable portion of seed rounds are reported and recorded in the Crunchbase data set months after they close. As a result, reported figures for recent months undercount total funding activity.