While many have looked at the downfall of WeWork as a warning for corporations looking to enter the public market, the entrepreneurial ecosystem should focus on the greater macro-effects that WeWork’s demise has on early-stage ventures. These trickle-down consequences are accentuated by the current state of fundraising for both venture capital (VC) firms and startups alike. Those who are raising funds for new ventures have heard the saying, “Seed has become the new Series A”, but most do not understand the underlying implications. The simple interpretation of this, and change of investment standards, can be further explained by the 2018 and 2019 numbers in venture allocation.

Allotted capital to startups rose across all four quarters of 2018, while the number of deals decreased. This means round sizes became larger, average valuations higher, but fewer startups received funding. This is not necessarily an indicative sign for fundraising in an early-stage venture, but rather a signal of intent by larger firms to participate in the earliest stages. In 2019, specifically Q4, funding and the number of deals decreased. This portends a more ominous sign as it coincides with the current landscape of LP’s and change in investor preferences due to the WeWork debacle. In this article, I will attempt to explain how the attempted WeWork IPO debacle affected fundraising top-down, why the stages of investment are changing and finally what this means for founders raising capital in 2020 and beyond.

For starters, it is important to understand the top of the ecosystem’s current mindset when it comes to funding. Limited Partners (LPs), also known as the money behind the money, have self-admittedly overallocated to the larger VC Firms. With more data available to make safer investments at the earliest stages, as well as easier access to top-tier talent, larger VC firms are returning to LP’s faster than ever to raise more money. Furthermore, they are supersizing as a result of A16Z and Softbank’s mid-2010’s super-funds. This is problematic for Nano-VC (sub $25M) and Micro-VC (sub $100M) funds looking to scale, many of whom have emerged in the last decade.

The reason this is problematic for the smaller funds is LPs are finding that larger VC firms are taking much longer to return their investment to them. Part of this is due to tech companies focusing more on growth than profitability, and then not IPO’ing at the price firms are anticipating. General Partners (GPs) at VC firms are holding onto their shares and are waiting for companies, post-exit, to become profitable. As a result, there is currently a longer wait than normal for LPs to see their investment returned to them.

Another reason is super-sized funds, such as SoftBank, have raised a lot of money from LPs and invested a lot of dry powder into companies that have failed to exit, such as WeWork. These funds will be unable to return all of their capital. Softbank is now raising a new $100B fund where they are stressing the importance of profitability as a pivot from their original strategy. Whether they will be successful in raising this new fund is up for debate; however, when the industry leader changes investment strategy, the other established VC firms will follow in droves regardless of the current fund’s status.

With this being said, it is unquestionably easier for established later stage funds to dip into early-stage venture than it is for emerging managers in an early-stage venture to dip into a growth stage venture. During the next two to three years, we will see a significant decrease in the number of sub $50M funds; many of whom that invest at the earliest stages of the venture. At the end of the day, LPs are still going to stick by established managers of a large fund versus emerging managers of a smaller fund. The end result is seed-stage money will be harder to raise for founders and become smarter than it ever has been. Larger funds will gravitate back towards seed-stage investments, and safely be able to do so due to the data available to them, and use it as a way to screen a company’s potential profitability.

The potential death of the recently established institutional pre-seed round is foreshadowed by the impending dearth of smaller VC firms. Founders of successful startups, on average, were personally investing $30,000 before raising outside capital. Without smaller institutional players at the pre-seed and seed stage, my personal belief is founders of successful startups will have to spend a minimum of $150,000 to get their startup to the first round of outside capital. This is compounded in the context that larger firms are participating in seed-stage ventures with a greater focus on profitability than growth. Finding product-market fit as quickly as possible with a clearly defined path to profitability has never been more important for a founder. Ultimately, this means a larger gap is created between pre-seed and Series A.

Furthermore, smart angel investors will gravitate towards mature seed-stage startups that larger institutional players are cherry-picking, and help bridge the gap between Idea and Seed. This will be known as the new pre-seed round. With this being said, it has never been better to be a founder who has previously founded a successful startup and to raise capital for a new venture. Even those with deep domain expertise and networks can find capital raising to be a more seamless process. The ones who suffer the greatest are the first time founders who do not have the capital or time to allow their company to find their product-market fit, or the reputations to raise from the big players at the early stages.

In conclusion, while larger firms gravitate towards mature early-stage investments due to the impending gap of smaller funds, “The WeWork Effect”, has made larger firms focus on profitability and thus made raising capital for new founders a much more difficult process.

This article was originally published by Joshua Schlisserman on medium.