Snapchat's Giant Series F Round Signals Health And Changes In Startup Funding

Snapchat Shows us that Startup Funding has not Dried up, but Change has come to the Venture Capital Market.

As the CEO of the equity crowdfunding platform + early stage venture fund, Crowdfunder.com, I have a front row seat to the rapidly changing dynamics of Venture Capital. 

On May 26th, Snapchat announced it closed a Series F round of $1.8 Billion, at a $20 Billion valuation, jumping $5 Billion from its Series E raise in March of 2015 and up $10 Billion from its Series D raise in December 2014. This valuation shows strong confidence from investors. Snapchat is currently #6 on the Forbes Unicorn list behind companies like Uber and AirBNB. To many readers unfamiliar with Snapchat, it may come as a surprise that it is so highly valued. What is this ghost app you keep seeing?

Snapchat is a photo messaging platform that enables users to send photos or videos to friends. The company differentiated itself from competitors in the social media sector by making the photos or videos disappear 10 seconds after viewing. Snapchat has focused its last year on building out new features that make the platform “sticky”. Introducing features like flower crowns, rainbow vomit and face swapping has created a steady and viral growth in user engagement. Currently ⅔ of Snapchat users create content daily. Snapchat is quickly taking the place of platforms like Facebook and Twitter for younger American users and has been very successful globally.

Leaked pitch deck information shows very optimistic user and revenue growth projections. I believe Snapchat’s latest funding round reflects a changing venture landscape. We’ve heard many ominous predictions about the future of the startup and venture ecosystem, with fears that we are approaching a drought in startup funding. Snapchat shows us that funding is not dried up, just evolving. So what does the future hold?

Slow Down in Pre-Revenue Startup Funding

Gone are the days of venture capitalists throwing money at any and all startups that have a granular possibility of being the next Uber or Facebook. In recent years, we’ve seen a multitude of startups receive huge sums from investors pre-release and pre-revenue. This trend made it difficult for startups with real revenue projections to compare to those of the fairy-tale pre-revenue startups. It’s easy to assume huge user and revenue growth before actually deploying to any users. With the failure of several highly-funded pre-revenue startups, we’ve seen venture capitalists adjust their strategy.

One example is Amazon rival, Jet, who raised $225 Million before deploying to any users. Investors continued to throw money into struggling Jet after a lackluster initial response from customers. It remains to be seen if Jet will live up to early hype or end up in the startup graveyard. Venture capitalists are beginning to steer clear of this type of investment, choosing to invest in companies with a proven profitability track. They are looking for sustained user and revenue growth, and taking less gambles.

Snapchat is bullish on their revenue growth, expecting to grow from $250-350 Million in 2016 to $1 Billion in 2017. This year, the company has focused on adding supplemental revenue models like advertising and partnerships to the platform. User growth and engagement is the most impressive part of Snapchat. The company continues to see sustained growth both domestically and abroad.

This week, Snapchat surpassed Twitter’s 140 Million daily user base, boasting 150 Million daily users. The fact that a four year old company is surpassing 10 year old Twitter speaks to the level of engagement from its customers. Similar to Facebook, Snapchat has successfully created a “sticky” platform that proves addictive to users. This type of growth and engagement is music to the ears of venture capitalists. I believe we will continue to see a slowdown in investments into pre-revenue startups and a focus on companies with proven track records.

More Money, Less Startups

We’ve seen huge growth in venture investments over the past 10 years, reaching peak levels in 2015 with $59 Billion invested. In the era of “easy funding”, investors threw millions at unproven startups in order to stay in the game.

Following the failure of hundreds of startups, venture capitalists are slowing and appear to be weary, creating a buyer’s market. VCs are investing more money in less startups, starting at the seed round. The median seed round in 2015 was $2 Million compared to $750K in 2012. This number will continue to rise, with 2016 seed projections averaging at $2.5 Million. This upward growth trajectory is happening at all funding levels.

Data from Mattermark shows the average Series A round size was $8M in 2014 compared to $11M in 2015. In addition, 24% more capital was deployed into 19% less deals in 2015 versus 2014.  

In a saturated startup market, the cost of technical talent and user acquisition continues to rise. Translation: startups need more runway to be successful. Because of the high burn rate, investors are pouring money into new and existing investments in order to protect the companies from failure.

In a buyer’s market, the due diligence process is more stringent. Startups must have evidence to back up their claims, wherein past years startups could raise money with little track record of success.

Given Snapchat’s strong revenue and user projections it’s not surprising to see investors supporting the company with big bucks. We will continue to see deal size rise in coming years and a decrease in the number of deals.

Mark Suster of Upfront Ventures recently posted about changes in VC investments saying “In Q3/Q4 2015 the market changed noticeably for VC funds and the market started to realize this by Q1 2016. While a slowdown is hard to pinpoint to a single event, I’d say the most telling “Black Swan” event was the day that LinkedIn and Tableau lost 50% of their public market caps in a single day. It had come on the heels of a long, public slide at Twitter and the beginning of a questioning about valuations overall.”

Careful IPO Strategy

In 2015, well-known tech companies like Square, Box and Etsy experienced dismal IPO debuts. With over-hyped expectations, these companies crashed and burned in public markets. When Square priced at $9 compared to its promised $15.46, the company had to pay $93 Million to investors that were guaranteed a bigger debut. These “ratchet deals” guarantee investors a certain price and have proved problematic and costly to startups facing a turbulent public market. Many highly valued companies continue to pursue private funding versus risking going public.

Following the failure of several tech IPOs, investors are noticeably cautious. Instead of pushing their portfolio companies to cash out in the public markets, they are investing more funding in private rounds to ensure success. On May 26th, Twilio filed for an IPO, becoming the first private company valued at over $1 Billion to seek IPO in 2016. Depending on the success of Twilio’s IPO, we may see the floodgates open once again. Look for investors to low-ball public-offering prices, in order to protect themselves against another loss. Snapchat has announced that it has plans to IPO in the future but is clearly taken the more strategic route to public offering.

Final Thoughts

There looks to be fear in the venture market currently. In the media there are regular questions about an impending bubble waiting to burst, triggering a startup funding drought. Snapchat shows us that conditions might not be as dire as they appear. Investors are slowing down the market, hoping to correct the overflow of cash into unsuccessful startups. Looking forward, investor confidence remains high and funds remain available. In the first quarter of 2016 venture capitalists raised $12 billion to invest into the startup economy, the strongest quarter in 10 years.

Startups demonstrating growth and revenues will continue to have success in this fundraising environment, and the early stage VC market will continue to thrive in years to come. But the days of the quick momentum-fueled early stage funding round, predicated on the promise of finding future growth and a large market opportunity, have certainly slowed.

Follow me on Twitter @chancebar

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*Disclaimer: I’m the CEO of Crowdfunder.com, have been a participant in JOBS Act legislative and regulatory efforts, as well as a startup founder and early stage angel investor.