
Did everybody see what just happened?  The pendulum has swung.  - jaf12duke
http://42floors.com/blog/posts/did-everybody-see-what-just-happened-the-pendulum-has-swung
======
subwindow
This seems a little crazy. I think it should be _hard_ for a company to raise
money. Bad things always seem to happen when the money chases the startup.
Frequently when money is hard to come by, the bad startups die early and
everyone is better for it.

Maybe that's just because I've tried several times and failed (3-6 years ago),
and I'm being a grumpy old dude who thinks it should be this hard for
everybody. But I'm not even that old (28) or that grumpy. I just have the
wisdom of hindsight to know that my ideas and execution weren't that good, and
it would've, ultimately, been a bad thing if they had gotten funding.

~~~
motti_s
I don't think it's that easy for all companies to raise money. In fact, I just
watched an interview with Pinterest's founder who said that they were turned
down by virtually the entire investor community. I think the pendulum has made
a full swing for YC companies, but a partial one for others.

Deciding what to invest in is hard, especially in the seed stage. With the
market being so hot, investors have to decide quickly which makes it even
harder. When investors are agreeing to an 8 million cap on a YC company and a
4 million cap on comparable non-YC company, they are essentially saying that
the YC company is twice as likely to succeed, which I don't think is far-
fetched. You may also wonder whether this anticipation fulfils itself (a
company that seems more likely to succeed may get "better" investors, positive
media coverage, early adopters, etc, which may end up helping it becoming
successful).

I also think that the increased popularity of convertible notes is a
contributing factor. The 8 million cap only becomes 8 million valuation if the
company raises the next round at 8 million or above, so in a way it has to
live up to its promise in order for the increased cap to take an effect.

And finally, if a company becomes the next Google then the valuation at the
seed stage is insignificant. Therefore the valuation just represents the
perceived probability of that happening.

~~~
tatsuke95
> _"...they are essentially saying that the YC company is twice as likely to
> succeed"_

In my opinion, this is precisely what makes the business so frothy. I don't
really believe that YC backed companies are significantly (certainly not
twice) more likely to succeed.

The whole incubator thing could be the best or worst thing to happen to to
Valley; we just don't know yet.

~~~
il
Well, YC only takes the top 3% of startups. If you believe that they have any
skill at all at judging startups, that number should be a lot more than twice.

Investors are not just counting on the fact that YC makes a company more
successful- they also know YC filters for startups that are already more
likely to succeed.

~~~
larrys
"YC only takes the top 3% of startups."

This is exactly how legends are built in the media. YC takes 3% of startups
that apply, not "3% of startups". This is the same as when they say it is
harder to get into Techstars then to get into Harvard.

See this:

[http://www.forbes.com/sites/nicoleperlroth/2011/08/24/the-
mo...](http://www.forbes.com/sites/nicoleperlroth/2011/08/24/the-most-
powerful-women-in-technology/)

Figures like that ultimately don't mean much anyway other than creating a
appearance of scarcity. It is well know for example that colleges try to
increase the application rate to game the acceptance %. Nobody has access to
all the companies applying to YC in the 97%, (do they?).

Edit: To judge the quality (if possible) of the applicant pool.

Edit2: I don't mean to imply that YC tries to game applications. Only that
numbers get thrown around without any vetting.

------
jwwest
How much of this is "dumb" money? A lot has been written on how well folks are
doing fundraising, but not so much on what types of investors are willing to
throw money on the basis of a 2 1/2 minute pitch just because it has Y
Combinator attached.

Investments are much more than just money (duh), you're also gaining an ally
and potential business mentor. If I were to be offered 500k from an extremely
smart person who has shown personal interest in my product versus 2mil from
someone trying to play "startup darts", I'd take the 500k and work my ass off.

It scares me how much money is being thrown at name dropping these days.

~~~
pg
_investors are willing to throw money on the basis of a 2 1/2 minute pitch
just because it has Y Combinator attached_

I wish we could claim that. But YC's brand is not that powerful. There are
still startups that present at Demo Day and aren't able to raise money.

~~~
cperciva
Do you have any sense of how much this is a function of the demo and how much
it's a function of the idea? Or put another way: At the start of the YC
program, do you have any sense of which teams will have trouble raising
further funding, or does that wait until they've spent a few months writing
code?

~~~
pg
Sometimes we can predict which companies will have trouble raising money, but
it depends a lot on what happens during the 3 months. E.g. a pair of very
nerdy founders will ordinarily have trouble raising money, but if they can
make a graph rise steeply that problem tends to go away.

~~~
cperciva
Ok, so it's more often a function of the founders than it is you saying "this
idea seems like one which will be really hard to sell"?

~~~
pg
I just used founders as an example. Ideas can make it hard to raise money too.
Any music startup will also find it hard to raise money, for example.

~~~
cperciva
Ok, that makes sense, thanks!

------
jacquesm
Wise words and ones that anybody that ever wants to be funded or has attracted
funding would do well to heed.

YC has become a very strong brand, and one that attracts investors from all
over the globe because they have proven that their method for picking winners
works better than what those investors could ever achieve by themselves.

Keep in mind that the factors that differentiates YC from all these other cats
are very hard to replicate and so it is easier for them to ride on YCs coat
tails than it is for them to copy the process. Hence the glut of money.

This is good for everybody that gets 'in' to YC, they're more or less
guaranteed to find funding and find it on their terms. For once the recipients
of funding have a slightly stronger hand.

Still, that won't change the long term outcome for the majority, the majority
of such investments will still fail (and the investors are well aware of it),
and a smaller portion will break even or make it big. Picking the winners out
of the ones that got 'in' is just as hard (if not harder) than picking the
ones that got 'in' in the first place.

I like the tone of this article, it sends exactly the right message. Feet on
the ground and get to work, being funded is not the end, it is the begin. And
it definitely isn't a guarantee for success, that's up to you & your team, the
market and timing. And you only control one of the three.

------
jack-r-abbit
The pendulum will continue to swing back and forth. Is this going to be
exactly like the "dot com bubble" of yore? Of course not. We had quite the
cautious period after that burst. Surely we have learned from our mistakes.
But learning from our mistakes only means we're less likely to make those same
mistakes again. It's no guarantee that we won't make new mistakes. It will
happen in some form. But I do have fond memories of some of the IPO parties
and "just because we have buckets of cash" parties back in the day. They were
great. But maybe they should have saved some of that money for the cold, long
winter. Hindsight is 20/20. Let's see how this one plays out.

------
canterburry
Yeah...I see what just happened...we are back in 1999. Enjoy it while it
lasts.

~~~
Alex3917
This time the money is mostly coming from wealthy individuals. While some of
these folks have certainly shown regrettable judgment, this is completely
different than in 1999 when literally billions of dollars were flowing from
institutional investors and the general public. If this trend continues for
another 5 - 7 years then we may get back to where we were in 1999, but I don't
think we're anywhere near there yet.

~~~
bentlegen
That's changing, and fast. In Canada, pensions and retirement funds are
getting involved in the startup funding game - and that's up north where
funding is dry to begin with. I'm sure the same is happening here.

Source: [http://business.financialpost.com/2012/03/29/vancouvers-
hoot...](http://business.financialpost.com/2012/03/29/vancouvers-hootsuite-
gets-20m-omers-ventures-push/)

"OMERS Ventures, a $180-million fund established by the Ontario Municipal
Employees Retirement System last fall, said Thursday it has picked HootSuite
Media Inc. as its first major funding recipient."

~~~
swalberg
Many pension funds have had some sort of high risk component to their
portfolio. <http://www.cppib.ca/News_Room/News_Releases/nr_02031001.html>
talks about the CPP's, which has been going on since 2005. I'd suspect we're
only starting to hear about it because it's getting into our space.

Disclaimer - I work for one of OMERS other (earlier) investments. I guess
we're just not "major" :P

------
pagekalisedown
"Hot market" seems like an understatement.

I'm still waiting for salaries to catch up tho.

~~~
hkarthik
FTE salaries won't catch up until there's real money being made and profitable
firms start competing for talent.

A CEO with net profits of 10 mil/year is going to be a lot less stingy than a
founder with 15 mil in funding.

I hear that at this stage, the way to make money is to do hourly consulting at
a high rate. That comes with its own issues, but if cash is your motivation,
it is your best bet.

------
derefr
Here's a question for the thread: I'm a Canadian citizen, and still in
university (two years to go.) Which means that, as far as I'm aware in how US
immigration works, I can't just bound on down to SV and start a company right
this moment, no matter how hot the market is. So--should I be planning my next
five years around chasing this thing, or will it pop before I get there? ;)

~~~
cperciva
You're allowed to start a company in Canada, you know. ;-)

~~~
pagekalisedown
Can you tell us if it's easier to find employees in Canada (particularly
Toronto and Vancouver) vs the bay area?

I'm also curious to know if a startup's burn rate would be lower in Canada
than in the bay area.

~~~
motti_s
Here in Vancouver it's not very easy to find talent these days, but I think
that it's easier to retain talent.

Compared to SV your burn rate could be lower because salaries are lower and
you can get significant government funding (sometimes you get back most of the
salary paid to some employees, see SR&ED and IRAP).

When it comes to the ecosystem, especially mentors and angels / VCs, SV wins
big time.

~~~
cperciva
Do you have experience with IRAP? I've been aware of it from my student days
but now I'm looking at it from the opposite side -- I'd love to hear from
someone in our industry who has hired via IRAP.

~~~
motti_s
Yep I'm happy to discuss, email me: motti {at} wincode dot net

------
jroseattle
While true, I'm not sure the bubblicious times of the late 90s apply here.
Isn't some of this the effect of the rise of incubators like Y-Combinator?

With YC, investors also have the benefit of knowing/believing that Paul
Graham, et. al, have already vetted the team & idea substantively that the
risk factor is lower (at least, perceived lower.) So, while there may be more
dollars chasing fewer deals, some of that is the captive audience effect.

The advice offered is still good, no matter the environment.

------
Jabbles
The author mentions the strategy of the VCs: to find the next billion-dollar
company. One success of this magnitude will mask many, many failures. We
should not look on a large seed round as saying "X is worth Y" (although by
the definition of "worth", it is), but rather that "X has a not-insignificant
chance of being worth 100Y in 5 years".

------
iandanforth
Out of curiosity, how many founders know who put up the money that the VC is
dispensing?

After a friends and family or Angel round, is their any connection between the
investment and the people who stand to lose money?

~~~
rdl
Traditional VCs don't really advertise their LPs (limited partners; source of
funds) too much.

Sequoia sometimes uses that most of their LPs are charitable foundations,
schools, etc. as a marketing tactic, but it's Sequoia, so people probably make
their decision based on it being Sequoia.

Some of the super-angel type funds do -- I know Founder Collective emphasizes
that their partners are mainly entrepreneurs. It's a Boston/NYC fund -- Chris
Dixon and some other people.

------
rasengan
I strictly believe in bootstrapping a startup (most of them anyway). Hunger
creates hunters. Hunters catch game.

~~~
jsmith72
When it comes to funding there obviously isn't a one size fits all approach
that will work for everyone. I've done the bootstrapping too many times and it
works ok for little simple ideas or features companies. However it is not
nearly as good for getting bigger concepts out there.

------
mmayernick
Great thoughts, Jason. Your point about the change in valuations is more than
an observations, though. Implicitly, it suggests that valuations are less a
function of the companies themselves and more a consequence of exogenous
macroeconomic and industry specific factors.

This is sort of a scary realization to me, because it means that "crushing it"
isn't a strategy to preserving valuation. Perhaps the Dropboxes of the world
will always be able to name their price, but for the rest of us valuations
will come tumbling down if the outlook turns negative on the startup asset
class or economic activity broadly.

Startups taking a more conservative approach to valuation and amount of
capital to raise may be much better positioned to raise subsequent rounds of
financing when the market, as all markets do, regresses to the mean.

------
jsmith72
It seems to me that this situation only exists for those well connected in the
Bay Area. Perhaps smart money will be looking for new areas that are still
underfunded.

------
treelovinhippie
Meanwhile in Australia... Zzzz...

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nirvana
This is one of the reasons I'm kinda ambivalent about taking money. I've been
working for startups since the 1990s (and starting companies too). I've seen
the down years in 1995, 2001-2003, 2008-2009, and I've seen the manias of
1997-2000, 2004-2007, 2010-2012, and it just leaves me really concerned that
taking VC money is a whole lot about timing. I want to build a business, not
get rich with a stock market (e.g.: selling stock to VCs with perfect timing.)
This plus the generally hostile and irrational terms VCs require (liquidation
preferences, etc) have had me focusing on making our business profitable from
day one. (or at least from day one after the product launches.)

On the other hand-- man, it would really be great to have $500k in the bank to
hire some people so we could grow really fast. But we're not there yet-- that
would be a bad investment because we're still doing customer development,
we're still trying to discover our business, so to speak.

I feel like, if I go down the path of trying to raise money now, I'll be
spending a lot of time doing something that doesn't help us discover that
business. But if I don't, who knows what things will be like in a while, if it
turns out that we really _could_ use that money.

In the end, though, I side on the idea that money can be a nice accelerant, if
it is gotten on good terms (terms are more important than valuation) from good
people (and how in the hell do you figure out who those people are? I have
seen a lot of damage done by investors in my career.)

But at the end of the day, if the company is profitable, you can plow %100 of
those profits into growth. If the company isn't profitable, the _only_ way to
survive is outside investment.

I don't want my companies future in the hands of other people, so I'm pursuing
a highly profitable business that is super capital efficient and doesn't
require outside funding to launch.

I strongly recommend others consider this approach as well. Yeah, you might
get into YC and then not need this, but if you don't, find a business model
that makes you ramen profitable right away.

~~~
Terretta
The downside of nirvana's approach is when you build a solid self-funded
business, doubling year over year for half a decade, then VC shows up having
decided yours is an underfunded sector.

They'll pile hundreds of millions into dozens of "corporate" startups, most of
whom hit the ground running after market share through predatory pricing,
consequently destroying the sector.

Meanwhile, you'll find yourself unable to capture those VC dollars yourself
because the VC model needs hockey stick successes to make up for the companies
that go bust (recent stat here claimed 9 of 10 tech crunch startups are gone a
year later). A startup can promise a hockey stick, but you have a history.
Because of your solid 5 years of "just" doubling while remaining cash flow
positive in an extraordinarily competitive arena, you're not providing that
hockey stick.

And when that funding boom happens, and you're faced with multiple hundred
million dollar pocket "startup" competitors each with 2 - 3 years of ability
to sell at a loss before their inevitable rollup or death, and without deep
pockets yourself despite seven figures of revenue, you're in for a few years
of _serious_ hurt. You have to execute flawlessly, not a single misstep, just
to survive.

~~~
danbmil99
So true. But here's the hat trick: take the money, but keep your innocence.
Understand you are in a bubble, and you may be forced to play by the rules of
a hot market. But also be aware -- which your newly funded competitors are
almost surely not -- that a bubble is in play. Work hard to keep customer
loyalty a higher priority than maximizing the next round. Use your market
power (meaning the investment market) to go for quality of investors and
decency of terms (esp downside logistics); let your puppy competitors take the
crazy valuation with draconian preferences.

As to the "you have history, I'm investing in the blank slate kids" problem --
again, use the leverage to find the investors who really understand the long
term, and who themselves know that this is a frenzy, not a rational market.
Those people, if you get them, will not jump ship the second things start to
look a bit more realistic.

Focus on core competency, customer/employee loyalty, and creating great
products and services.

TL; DR: Take the money, but don't let it go to your head.

~~~
Terretta
It may seem noble to self-fund, but I believe your points are right. If you
can run the business: take the money, use it for multipliers.

~~~
danbmil99
It's not even just an issue of being noble and taking less. In a frenzied
capital market, your competitors can essentially tape $100 bills to every
offering in order to get 'traction' - and if you don't have the funds to
compete with that, you are going to lose. Customers simply don't have the
knowledge or wherewithall to pass up those loaded offers and pay up for your
noble, self-funded but ultimately more expensive proposition.

------
rhizome
Grammatically, the first two paragraphs should be combined into one.

~~~
stephengillie
Vulture Capitalism

