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Investors Warn of Tech Startup Funding Frenzy

A steady influx of funding from angel investors and venture capital firms that are hoping to find the next LinkedIn or Facebook has sparked a potentially dangerous financing frenzy for the technology-startup industry, according to investors and market participants. And the recent market turmoil has done little to slow the stampede.

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“There are a lot of people made instant millionaires [through recent IPO successes],” said Kevin Rose, one of the technology industry’s most visible entrepreneurs and founder of the popular social news site Digg.com, which launched in 2004. “Everyone wants to become an angel investor…and there’s a lot of cash out there. ”

So-called angel investments, which typically come from affluent individuals who fund early-stage companies, spiked 14 percent last year to $20.1 billion, according to a University of New Hampshire study, and academics say that if the markets remain relatively stable, that figure could grow by double digits this year.

In a display of just how much capital is available in this market, it’s not unusual for some startups to raise millions in remarkably short periods from a pool of eager investors.

Zaarly, a crowd commerce startup born out of a camp-like retreat Startup Weekend, raised $1 million in a mere 48 hours. CEO Bo Fishback pitched the Zaarly concept to investors at the conference in an impromptu one-minute presentation. He was immediately flooded with offers.

“To put in context, we could easily have raised $20 million if we wanted,” Fishback said. “We’ve had offers from everyone you’ve ever heard of…I’ve never seen anything like this go so fast or so big.”

While Zaarly’s launch story is indicative of a thriving startup funding climate, some investors worry things have gotten out of hand.

“Over the past 6 months, I would say that the funding environment for early stage startups has become a bit crazy,” said Jeff Clavier, Managing Partner at SofTech VC, a venture capital firm that specializes in funding internet startups.

Clavier’s main concern is the lemming-like mentality of newly minted affluent individuals eager to throw money, at times blindly, at technology startups. He sees it as a bubble-like environment that could lead to major unrest in the startup community.

“People are going to start losing money and realize, hey, it’s cool to be an angel, but it’s like playing in Vegas. The one thing that is assured is that eventually you will lose your money,” Clavier said.

Paul Lee, a partner with Lightbank, the prominent Chicago-based startup investment firm spun out by Groupon's founders last year, said the beginnings of a correction process could already be underway—thanks in part to recent market turmoil.

“I imagine with this volatility, it’s going to give people some pause when looking to make aggressive investments [in early stage startups],” said Lee, noting that, on an anecdotal level, he’s already hearing valuations have begun to unwind.

But whether recent shocks to broader equity markets will provide sufficient momentum to spark a wide-ranging correction at the startup valuation level remains in question.

As a cautionary tale, investors often point to Color, a Palo Alto-based mobile phone app that raised a remarkable $41 million before it had a single user, but quickly suffered several crippling setbacks including a lackluster product launch and the recent departure of its co-founder and president Peter Pham.

Color was a resonating warning shot across the bow for the startup fundraising community, but it—along with recent volatility in broader equities markets—has yet to significantly dampen the current craze to find, and fund, the next big social media company.

But startups like Zaarly are quick to highlight the advantages of that funding environment, which can give lesser-known or more experimental ideas a chance to grow.

And Zaarly for its part, has so far taken advantage of the opportunity.

Since its launch just three months ago, the mobile platform, which offers users the ability to buy or sell goods and services with other users around them, has seen transaction volumes spike to $3.0 million and has grown its user base to a respectable 50,000. That growth has impressed some of its backer so far, including Lee whose Lightbank is an early stage investor in the company.

And while Fishback said his financing success largely resulted from his networking connections and the appeal of his concept, he does agree that, for better or worse, the current influx of fundraising for startups could be the best he’ll ever see in his lifetime.

“It’s pretty great for entrepreneurs,” he said, cautioning “[but] it’s pretty dangerous for a lot of investors.”

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