The law firm released the results of its 2012 Seed Financing Survey today, which found that the number of startups obtaining Series A financing after a seed round declined significantly in 2012.

“Of the companies funded in 2011, 27 percent had raised a Series A financing by the end of the following year [2012], while 45 percent of the companies funded in 2010 had raised a Series A financing by the end of the following year [2011],” the report said.

The Series A crunch is a Silicon Valley urban legend of sorts. Some say it is fact, and others dismiss it as myth. The basic idea is that the number of seed-financed startups far outnumbers the amount of venture capital firms willing to invest in an institutional round. The cost of launching and operating an Internet startup is fairly low, and a strong angel investment community supports young companies as they get off the ground. However, companies that are unable to quickly establish a revenue stream or get acquired need venture capital to keep going, which is where the “crunch” comes into play. Without additional financing, they go under and turn into “zombie startups.”

A significant driver of this phenomenon is a changing scene for seed financing. There has been rapid growth in seed financing over the past few years. As opposed to 472 deals in 2009, Fenwick & West found that there were 1,749 seed deals in 2012, while the number of Series A rounds only rose from 418 to 692.

A few key trends are behind this bottleneck. First, venture capitalists are becoming increasingly involved in seed-stage deals. The percentage of seed deals that venture capitalists led increased from 27 percent in 2011 to 34 percent in 2012. Furthermore, accelerator programs are multiplying like rabbits, which adds to the number of promising startups getting attention from investors. The JOBS Act and the emergence of crowdfunding provide more flexible alternatives to traditional seed financing, and platforms like Angelist help establish a cohesive network between early companies and investors.

Basically, it is easier than ever before for a startup to nab seed funding. The challenge is creating a product strong enough to attract venture dollars (or sustain itself on its own).

“These results show a continued strong and diverse seed stage financing environment in the internet/digital media and software industries,” said Steve Levine, a partner in the Fenwick & West Startups and Venture Capital Group.  “However, the decreased percentage of seed funded companies that had received Series A investment by the end of the following year emphasizes the importance of companies demonstrating traction with the seed investment they receive, in order to obtain Series A funding.”

The survey also found that seed stage deals are beginning to look more like traditional, institutional deals. The number of deals structured around “preferred stock structures,” as opposed to convertible notes, increased, and valuation caps increased in deals based on convertible notes.

Fenwick & West drew these results from an analysis of 61 transactions in 2012 with a high concentration on Silicon Valley. It is a small sample pool that does not necessarily reflect “the larger, geographically dispersed, seed financing environment,” but like sightings of Bigfoot, the thrill is in the mystery.

Photo Credit: Ben Cumming/Flickr

Over the holidays, friends and family with a bit of extra cash might choose to invest their money in risky, albiet exciting, startups.

Given the meteoric success of Instagram, why not give in and fund that crazy brother-in-law with an idea for an iPhone app that just might work. All he’s asking for is $25,000 from a handful of investors to outsource the cost of a developer in India or Russia to build a prototype.

The barriers to entry when starting a tech company these days are low. It’s easier and cheaper than ever to get an idea off the ground, and you need little or no programming expertise. As a result, the number of startup ideas that receive seed funding from angel investors has exploded.

It’s all rosy until the entrepreneur decides it’s time to raise a first round in institutional funding, say $1.5 million or above. With increasing competition for a steady amount of available dollars, we’re hearing plenty of resounding “no’s” from Sand Hill Road. The press have labelled it a “Series A Crunch,” which sounds looming and suggests it’s only going to get worse.

To shed light on the reality of this trend, investment firm CBInsights produced a report analyzing 4,056 seed investments. The research indicates that 1,000 recently-funded seed companies will be orphaned, meaning they are unable to raise follow-on financing. The author refers to this as the “process of natural selection.” They also make the case that the eventual death of these startups is a good thing for the tech ecosystem — it will mean there is more available talent for startups that have raised venture capital rounds.

The explosion in seed funding will result in over $1 billion of investment into these companies being incinerated. However, this is to be expected, as seed investments are the riskiest bets an investor can make.

“With at least twice as many companies getting seed funding this year, it’s not surprising to me that there’s a crunch,” said Rob Coneybeer of Shasta Ventures, a Silicon Valley-based venture firm that views Series A as its sweet spot. In a phone interview, Coneybeer said he’s not taking more meetings than usual and inferred that many of these companies funded with dumb money aren’t solving particularly unique and challenging technology problems. “It hasn’t changed things for us because there are four times as many photo-sharing companies,” he said.

In a recent story about the big, dumb angel bubble, VentureBeat’s Jolie O’Dell argued that institutional investors are not to blame, and it’s not an indication that entrepreneurs are producing less deserving or less fundable startups. The problem is that easy “dumb” money from inexperienced investors, like friends, family, or former colleagues, often does more harm than good.

“Finding the right investor at the seed stage is critical,” said Jenn Wei of Blumberg Capital, a firm that specializes in early-stage startups. Untrained investors often lack connections and influence and haven’t done their homework. “We have seen an increase in the number of angel investors who do not do proper diligence, and oftentimes, those companies are under-funded,” said Wei.

Wei explained that most seed-funded startups receive about $200,000 or $500,000 from angels, which is not sufficient to carry the company to a complete functional product and obtain customers, the “milestones” that she typically looks for.

To avoid hitting a wall, entrepreneurs need to get smarter about fundraising. Entrepreneur Sameh Elamawy is currently in the process of fundraising for his Series A. He advises raising a larger seed round than expected. To get to a stage where you’re ready for a Series A investment, you may need to fund your developers and ramen-habit for well over a year. He also advises raising tiny consecutive seed rounds — $25,000 here and $50,000 there — rather than betting on a huge chunk of first-round financing.

As the power shifts to investors, CBInsights’ analysts predict that it will take longer for entrepreneurs to raise follow-on financing. Currently, it’s about 13 months, according to the report.

Above all, avoid taking “dumb” money; ideally, your angel investor is a prominent figure in Silicon Valley and is connected to a venture capital firm. “You want your seed investors working for you to make the next round happen,” said Elamawy. The report also found that seed deals in which VCs participate have a historically higher rate of getting follow-on financing compared to seed deals in which VCs are not participating.

The Series A Crunch is very real, but there’s nothing and no one to blame but simple economics. “The category is doing well, and this is the natural course of capitalism,” said Coneybeer.

Bamboom Labs is headed by Chaitanya “Chet” Kanojia who’s last startup Navic Networks was acquired by Microsoft in 2008.

The company’s technologies allow customers to access free over-the-air broadcast signals over the Internet and direct it to connected devices.

The team includes people from Navic and Microsoft as well as RF and digital technology engineers from Andrew Corporation, Lucent and others.

Copyright laws make distributing the TV programming over the Internet quite tricky. There needs to be some creativity from Bamboom’s side. The company cannot just redistribute the TV signal over the internet without facing the wrath of copyright holders. That means Bamboom would need to license content to retransmit it over the net — a costly and complicated process that even Google has had trouble with.

Bamboom’s way around copyright issues at the moment is to rent a personal antenna to the customer. That way the customers, not the company, are responsible for recording and retransmitting. And that should take care of the issue, LA Times reports.