A booming startup market requires an investment race 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 launched its first venue 17 months ago, before starting dotting Manhattan and Brooklyn with bartenders.

Even a couple of years ago, a fast-growing chain of no-frills, low-cost coffee shops may have struggled to find interest from tech investors. But in today’s booming market for early stage startups, the New York-based company has received pledges for its third round of funding in a year. The $ 35 million investment comes just three months after the still fledgling company received $ 25 million, said Vinay Menda, CEO of Blank Street.

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

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

Investors in 2021 pumped $ 93 billion into so-called early and early stage startups in the United States through Dec.15, a record high. That amount compares with $ 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 venture-funded startups relatively flat, valuations have risen. The median valuation for funded seed and early stage companies in 2021 was $ 26 million, up from $ 16 million in 2020 and $ 13 million in 2016, according to PitchBook.

Investors betting on space say they see a lot more room for startups to grow. They are encouraged because many venture capital firms have seen their best returns since the dot-com boom, thanks to a burgeoning software industry and multi-billion dollar profits on companies like Snowflake. Inc.

and DoorDash Inc.

The combined valuations of private startups globally have risen to trillions of dollars, making it a huge investment category.

The current capital rush has prompted some major investors to sound alarms that the market is overheating. The angst among Silicon Valley insiders over the rise in startup valuations is not new, but the willingness to convey those concerns is remarkable.

Fred Wilson, Union Square Ventures partner and first Twitter supporter Inc.

and Coinbase Global Inc.,

He said in a November blog post that he saw several investment rounds where companies were valued at $ 100 million before they had a sustainable business model.

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

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

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

To compete, many venture capitalists say they spent less time on background checks and other research before investing. A recent defeat of high-growth tech stocks has investors particularly strained, as startup trends often follow public markets.

Traditional venture capital firms quickly raised new funds, while hedge funds and private equity investors entered the market. Much of the hedge fund’s money goes to late-stage start-ups, but the crowded sector has prompted other investors to hunt down early-stage companies.

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

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

Mr. Menda said his business model was modeled on a group of Asian companies, including Indonesian Kopi Kenangan and China’s Luckin Coffee. Inc.,

which pioneered a similar approach by attracting customers with low-cost drinks and business-promoting apps.

Luckin, by far the most important of that group, presents a difficult comparison. The company, which at one point had plans to overtake Starbucks Corp.

in China, it saw its share price plummet more than 95% in 2020 after telling investors that up to $ 310 million of its 2019 sales were fabricated by employees. Luckin reached an agreement with the United States Securities and Exchange Commission on reports of accounting fraud, which he neither admitted nor denied.

Venture investors often shun an industry when its best-known company suffers such a fall from grace, but that hasn’t happened with coffee startups. Luckin’s business persevered: it experienced rapid growth in the last quarter and its shares recouped some of the losses.

Mr. Menda said Luckin is not a good comparison to Blank Street given its previous management problems. Instead, the company looks more to numerous other takeaway coffee chains that have been able to raise funds recently and grow rapidly, including Kopi.

Despite allegations of accounting fraud and its deal with the SEC, Luckin Coffee’s business persevered.


Photo:

Yan Cong for the Wall Street Journal

Multiple funding rounds in a vibrant company can come a few weeks apart today, particularly in areas that investors see as hot, such as cryptocurrencies or corporate credit cards. In quieter times, venture capitalists often encourage companies to increase every 9-18 months.

Mark Suster, a partner at Upfront Ventures based in Los Angeles, said the early-stage media company he surveyed in the mid-2010s was valued at around $ 15 million, while today it is around $ 25 million, and the companies often they still have to generate income.

To fit in, he makes “faster bets first,” largely based on the caliber of the founders and the few initial hires rather than product quality, he said.

“I could have waited nine months. I could observe how your customers use your product, “he said. Now,” I’m really supporting talent, so over time, I’ll figure out 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 revive the woolly mammoth as a species in the wild by modifying the Asian elephant’s genomes to make animals look and behave like woolly mammoths.

The Jurassic Park-like business plan largely involves making money from new technologies, said Ben Lamm, the company’s CEO. But Colossal also told investors that in 2020 there was the potential for “mammoth park attractions,” among other potential sources of revenue, according to a slide presentation.

Mr. Lamm said the company decided to raise just $ 8 million, before encountering much greater demand than expected.

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

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


Photo:

carlo allegri / Reuters

Write to Eliot Brown at eliot.brown@wsj.com

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