Too many start-ups and not enough investors equals a competitive game of musical chairs

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The Exchange is part of an ongoing series on The Hive tackling the questions facing Boston’s entrepreneurs, investors, and innovators. This week, we ask participants if they think there’s a tech and investing bubble that’s going to burst in 2013.

Below Todd Dagres, co-founder and general partner of Spark Capital, says the tech bubble will likely burst because the industry has too many start-ups and not enough investors, forcing companies into a fierce game of musical chairs.

For more opinions, read the rest of The Exchange. Have your own opinion, or an idea for another topic? E-mail Hive@Boston.

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Will the tech bubble burst in 2013? It could feel like it to some, namely the bumper crop of seeds funded over the last two years. Here’s why: The number of seed-stage investments has nearly quadrupled since 2009 to more than 1,700 so far this year. A growing percentage of those seeds surpassed $1 million in initial funding. The seed round has effectively become the Series A with Angels and VCs investing early and often. The traditional B round, when the start-up is beginning to generate revenue and has taken much of the technical risk out, has gone the way of the bison.

Seeds can take a company further than ever before due to lower capital requirements for Web-based start-ups. With open source software, cloud services, cheaper offshore development and the power of the Web as a distribution platform, a company can launch a product with far less than $1 million. Just a dozen years ago it might have cost five times as much to launch a minimally viable product. Programs such as Y Combinator, Techstars, and Mass Challenge alone are producing nearly 200 start-ups annually.

In the wake of Facebook, Twitter, DropBox, and Instagram, angels, seed funds, incubators, and VCs fell in love with seeds. But here’s the rub – with all the seeds, there aren’t appreciably more Series A rounds being done. Just because there are more start-ups doesn’t mean there are more VCs, VC funds. or sources of capital. The VC industry has actually gotten smaller over the last 12 years – not to mention the last four years.

This means there is a veritable game of musical chairs with four times the players and roughly the same number of chairs. The result is a lot of players left standing. This form of Darwinism, however, is not necessarily a bad thing. More entrepreneurs can get off the ground in pursuit of their dreams. The quantity of early stage companies available for VCs to fund is far greater. With more quantity generally comes more quality. There has been a dilution of talent with so many start-ups seeded. However, more companies mean more chances to pick a winner. Seeds allow investors to see if the start-up can capture lightning in a bottle before putting real money to work.

With more companies seeking post-seed funding it could seem like a bubble is bursting. More start-ups will fail and money will be lost. The good news is that failure will happen quickly, usually within a year or so. Better to fail quickly than slowly.

At Spark, we have been in the seed funding business since we started eight years ago. About a third of our investments are seeds. The mortality rate for our seeds has been lower than we expected – less than 30 percent. Admeld (sold to Google) and Tumblr were seeds. We have funded more than few Y Combinator and TechStars graduates.

We are fans of the seed, but we aren’t high on the “spray and pray” approach in which investors carpet bomb start-ups with $50,000 to $250,000. After all, seeds are like kids – too many unsupervised can run amuck. So let the music play, but keep an eye on the kids as they run for the empty chairs.

Todd Dagres is co-founder and general partner of Spark Capital.

Weigh in on The Exchange: Read the rest of the submissionsand then let us know if you think that a bubble is going to burst for entrepreneurs next year at hive@boston.comor on Twitter at @HiveBoston. This week’s exchange was compiled by Sanjay Salomon.