Why Are These Tech Startup Owners Being Shut Out from Venture Capital?

A battle is being waged in Washington, D.C.’s tech scene — not the battle between tech companies and hackers that has embroiled the

majority of the industry. This battle is one intimately entwined with the Capital City’s politics, not its industries; it is a battle between the haves and the have-nots.

 

 

 

The economic overview of the D.C. tech scene looks positive, with local startups attracting around $435 million between April and June of this year, up 68% over funds raised during the same period back in 2013, according to a National Venture Capital Association analysis of Pitchbook investment data.

Buried beneath those numbers, however, is the fact that a larger percentage of those funds are being concentrated among a much smaller number of businesses than in the past.

“These numbers continue to reflect a hollowing-out of the middle in the D.C. area venture capital market,” local investor Jonathan Aberman said to the Washington Post. “This is a chronic problem in our market. Chronic and it gets worse all the time.”

The problem is expressing itself in two ways. First, the number of D.C.-area companies that have signed deals with venture capitalists has declined over the past few quarters. That means that investors are taking fewer risks when deciding which companies to invest in. Second, the top performers are taking a disproportionately large percent of the investment dollars.

In the third quarter of 2017, $190 million, or just over 43.6% of the total venture capital, went to Everfi, a company that creates online courses on topics like alcohol safety and sexual assault prevention.

But this is not a new phenomenon; rather, it’s part of a larger trend in venture capitalism, both in D.C. and across the nation. Companies such as Uber and AirBnb have both managed to raise remarkable funds in 2017.

The businesses that are being affected most directly are those at the seed stage, especially those run by relative unknowns. Instead, investors will turn to startups like Dor Technologies, which was founded by former engineers from Apple, the company famous for its nine generations of iPhones, first launched in 2007.

The result of these decisions is that investors generally see better and faster returns, but small businesses or those founded by people without high-level connections often languish.

Many of these startups then have to outsource basic functions in order to stay competitive. And while there are benefits to outsourcing — outsourced billing, for instance, can speed up receivables by up to three days in addition to improving cash flow — there are also drawbacks, including the risk of losing sensitive data.

These security risks are even more important for startups that deal with sensitive data like private medical information or court testimony. Today, 70% of all court reporters work outside of courtrooms, and startups are racing to digitize the industry. For obvious reasons, these types of companies have to keep large amounts of data confidential.

But in order to properly address those security challenges, startups need significant funding, something that is increasingly unlikely. As Aaron Gregg writes for the Washington Post, “Funding for seed-stage start-ups — the cash-strapped, unproven firms in their earliest phases of growth — has declined for eight consecutive quarters nationally, erasing half of that market segment’s value since 2015.”

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