We all know the big success stories, because they’ve become household names: Google, Facebook, and Twitter. Behind those success stories were a series of investors—angels, seed funders, and venture capitalists—who recognized potential in a nascent company.
The system by which early investors attempt to pick winners, out of the thousands of competitors whose names are destined for obscurity, has become increasingly formalized in recent years, according to an annual survey from Silicon Valley law firm Fenwick & West. The publication noted the “increasing participation of venture capitalists in seed financings, the growth of accelerators and ‘matchmaker’ platforms, and the use of venture capital-like structures in seed financings.”
At the same time, a smaller percentage of startups are taking the next step and receiving venture funding, according to the Fenwick & West data. Some see a problematic funding bottleneck, but TechCrunch describes it as the sign of a healthy ecosystem where only the best startups move forward.
Regardless of the funding stage or the overall health of the startup ecosystem, the core challenge for investors remains: pick the company that is going to hit big.
Canaan Partners is a venture capital firm with $3.4 billion under management and 148 exits since its founding in 1987. The company focuses on technology and healthcare, with offices in California, New York, Connecticut, India, and Israel. We asked Daniel Ciporin '86, a general partner at Canaan Partners, to talk about valuing internet companies, the funding landscape, and areas that promise the most innovation and growth.
He notes that there are huge opportunities emerging from the consumerization of enterprise software. He also points out that financial services, education technology, and healthcare IT all have dedicated accelerators in New York City, evidence of the strong interest in and promise of those fields.
And while the funding of startups is becoming more institutionalized, Ciporin says that it is still important for investors to make an emotional connection with new companies. Canaan Partners looks at thousands of startups every year, and invests only in the handful that the partners feel passionate about. And it takes a lot to move Ciporin: he looks for companies that will not only transform or disrupt their industry but have the potential to fundamentally reshape the way consumers interact with a market.
Q: How do you value internet companies?
Daniel Ciporin: Well, I’d be lying to you if I said that valuing internet companies is more of a science than an art. The reality is the first thing we try to do is really get to the kinds of companies that we really are excited about. We see, literally, thousands of companies a year and we have to select a few of those to invest in and the real trick is to determine which of those companies we’re really excited about and which ones of those companies do we think can actually transform or disrupt industries, can really be fundamentally impactful in a very, not just in a very financial sense, but in a very societal sense.
I think that when you find those companies, valuation actually becomes relatively easy. It becomes relatively easy because the fundamental basis of any valuation is all about growth. And grown assumptions are what drives valuation considerations and you can certainly do DCF models and come out with valuations that range anywhere from $10 million to $1 billion depending on the kinds of growth assumptions you use and you can modify those in different ways. Obviously, at an early stage company, we look at—one that we’re excited about—we look at what kinds of growth assumptions we think are realistic over the near term. We take a risk discount to that and then we have a discussion and negotiation with the entrepreneur around those valuation considerations.
But it is, fundamentally, first and foremost about finding a company that you want and then you can apply different kinds of metrics to those companies. There are lots of assumptions you can use all centered around how fast and how rapidly the company can grow and you back in to a valuation from there.
Q: What is the landscape for new companies seeking capital?
Ciporin: So, I think probably the biggest difference in terms of the types of companies and the evolution of investing in startup companies over the last few years is the rise of angel investing. The rise of individuals who have been successful in their own right and want to then invest in other companies that they see as promising, as innovative, as exciting, or simply those folks who see alternative investments, meaning investing in startup companies, as a better route financially to go down than very low yielding investments that are out there today.
You have the rise of what I would call angels and super angels and seed funds, meaning lots and lots of money that's focused on putting in to companies where they can have a big impact for relatively small amount of dollars. And the actual cost of building a company, a technology company, has gone down dramatically over the last few years and that has really led to the ability for angels and seed funds to be able to make smaller investments where you could actually invest $100,000 or a few hundred thousand to actually get a company up and running so that later stage investors or a venture capital— institutional venture capital investors can look at those companies and invest accordingly. So, lots and lots more seed money available for startup companies.
Q: Where do you see innovation happening on the internet right now?
Ciporin: There is an enormous ferment of innovation that’s going on with respect to the internet now and saying that a company is internet focused has become a little bit like saying it’s powered, it has electric lighting and water. It’s really an omnipresent aspect of any company, any business these days, but in terms of specific thematic areas that we think are very interesting and are very poised for enormous innovation and growth, enterprise is probably one of the largest significant areas that we’re particularly focused on now. Certainly the whole consumerization of enterprise is something that has been going on for some time now, for several years, but that process is really accelerating and the actual decision making of how enterprise decisions are made has tended to go much more decentralized than in the past where the traditional structure of the CIO making all those decisions. That’s starting to change. You’re now starting to have real constituencies within any given enterprise to try to focus the company on getting certain kinds of enterprise software that they need and want because they’re used to it from a consumer perspective. So that’s certainly a very significant area of innovation.
Other areas of innovation we think—we are tremendous believers in the growth of innovation in the financial services space. It’s an absolutely massive space. We’ve talked about consumer credit, again, $3 trillion dollars just in that aspect of financial services alone. This is an industry that has been very traditionally conservative and has not necessarily focused on innovation in the past and you now have the rise of a lot of extraordinarily interesting and innovative companies in that space that are poised to really disrupt that industry in a lot of different arenas.
Other areas that I think are also very interesting: education—edtech, if you will—I think is a huge arena, a huge sector poised for technology and disruption and innovation, and healthcare, healthcare IT in particular. Interestingly enough, there are now dedicated accelerators in New York City for those sectors: for edtech, for healthcare IT, for financial services . So you have accelerators rather than being just a broad-based accelerator like Y Combinator, for example, you have dedicated vertical accelerators focused on these different areas where it’s very clear that massive disruption and innovation will happen in huge industries and huge sectors.