
Is There a Y Combinator Valuation Bubble or Not? - fraXis
http://www.launch.co/blog/is-there-a-ycombinator-valuation-bubble-or-not.html
======
Matt_Mickiewicz
If you look at the distribution of exists/mergers/sales, it is infinitely
easier to grow and sell a company for $20-$50m than it is for $100m+. The
number of potential buyers rapidly diminishes, once you get into 9 figures,
deals get more complex, take longer to execute, and have a higher chance of
failing.

Over the past 18 months, I've seen four of my friends "cash in". Most of these
guys were at it for 7-10 years before the exit, and all but one of these was a
sub-$30m deal.

In order to justify these "NEW" valuations, entrepreneurs & investors have to
hold out for VERY high value exits, which will dramatically reduce the chances
of success and statistically extend the exit time for the angels and
entrepreneurs by over a decade.

For most entrepreneurs who are on their first business, $5m or $10m is a life
changing amount of money - by declining exits at prices that could achieve
that outcome, they are forced to keep rolling the dice, over and over again,
hoping that growth continues, a new competitor doesn't emerge, someone doesn't
undercut their pricing, and everything is going at 110%.

It doesn't seem to make sense on the surface of it.

~~~
paul
Obviously small exits are more numerous, but most of the returns actually come
from the larger exits. Of the first 200 yc companies, Dropbox is worth more
than all of the others combined (at current valuations, maybe in five or ten
years it will be airbnb or one of the others, but I expect that the general
principle will still hold true). Therefore, the value of a high-priced startup
is determined by estimating the odds that it is the next DropBox (or Google or
Facebook).

~~~
il
I think he's saying that, because many first time entrepreneurs would happily
take a $XX million offer to sell, most will sell early rather than holding out
for a chance to be the next Dropbox. So even if the potential/expected value
to be a billion dollar company is there, factors that are harder to calculate
might ultimately determine exit value.

~~~
paul
That's part of the "odds that it will be dropbox" calculation. It's also why
we invest primarily in founders and not ideas.

~~~
eldavido
Interesting point. I view YC's strategy as playing the central limit theorem
-- taking a high-volatility random variable (startup returns) and increasing
the sample size until the sample mean tends arbitrarily close to the
population mean.

Smart, guys.

------
spitfire
Bottom line:

(a) We're not in a bubble. We're in a revenue tsunami like nothing any of us
have ever seen in our lifetimes.

Instagram didn't have a single dime of revenue. and the CEO basically waved
away any thoughts of revenue when pointedly asked about it in an interview.

Facebook, who has 800M active, engaged users has only $4B in revenue. Is that
what passes for a revenue tsunami these days? Guys, a revenue tsunami looks
like double digit income growth quarter after quarter.

NB: Kudos to the CEO of instagram for making out like he did. But it's not an
example to follow. Unless you like failure.

~~~
corford
I couldn't agree more. Apple, Google and Microsoft are revenue tsunamis.
Instagram, Uber, Airbnb etc. may as well be operating in a different universe
in comparison.

~~~
pbreit
You mess up your argument by including Uber & AirBnB in that list, both of
which make good and growing revenues.

~~~
corford
I wouldn't class either as tsunamis and doubt they will ever be in the league
of an Apple, Google or Microsoft.

~~~
pbreit
You realize you just named 3 of the very largest companies the world has ever
seen and all just a few decades old. That's a pretty high bar.

~~~
corford
Yes I do, that's why they are called revenue tsunamis. I guess my issue is
that I don't see why if a new online startup is managing to make some revenue,
this suddenly means it is a "revenue tsunami". Comapred to Instagram ok,
compared to Apple et al - no.

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jboggan
I'm not qualified to opine whether there is a bubble or not, but having
recently visited the tech start-up scene in SF & SV from my economically
depressed corner of the country it definitely feels unworldly. The rest of the
country is slogging along with poor growth or outright contraction and I think
it is wonderful that somewhere people are still bringing good ideas and hungry
money together. As we say down South, "make hay while the sun's still
shining."

Bubble or no bubble it's a good time to make something happen.

~~~
benmathes
The ability to be more productive via automation is a stronger force than the
macro-stagnation of the US/Global economy.

~~~
philwelch
Or even the micro-stagnation of regions dominated by dying industries.

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aresant
Fun lesson in line with some of the comments.

I worked with an app co that stuck on millions of users and never earned a
dime in revenue.

While the CEO was going manic about potentially running out of money, one of
the advisors (who had recently sold for $100m+) emphatically insisted that we
NOT generate revenue.

His reasoning?

The minute you turn on revenue you eliminate the "story" about the revenue
potential.

The result?

A beautifully large exit to a entrenched and old school player.

Hook. Line. Sinker.

~~~
retube
instagram???

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kapilkale
_I'm guessing, due to Paul G's awesome track record, that 50% of YC startups
will get A rounds (I pulled that number out of the air, someone fact check
me)._

Not accurate. Out of ~45 companies in the W11 batch I think 4-8 have raised A
rounds. There's still time for others, but I don't think there's any way that
number will approach 20+.

~~~
tptacek
Isn't that in part because the pre-A funding options have gotten so much
better? In the early 00's, a normal progression might have been "~100-500k
angel", followed by "2MM-4MM A". Now it's "~100-200k seed", followed by "up to
maybe 1.5MM in rolling convertable note financing", so that by the time you
need to pull the trigger on an A, you're already pretty far down the road.

~~~
danssig
Who do I need to talk to for that kind of seed? :)

~~~
tptacek
Look one comment up.

~~~
danssig
My understanding of "seed" was that it was used to get the thing off the
ground, i.e. "I don't even have a real demo yet, but I really believe in
this". I don't think YC is going to let you in on that, right? Even if they
do, forcing me to move back to the US for 3 months is a pretty steep price. :(

------
pkaler
It only feels like a bubble because of structural unemployment.

We wouldn't be talking about a bubble if blue-collar workers had the same
opportunity that white-collar workers do. (Yeah, I know, I can't find a better
term for the groups.)

Also, the vast amount of economic activity is happening in SF/SV and in NY.
Raising money outside of these two centres is much harder. This is one facet
of structural mismatch between supply and demand. One part of the 500 Startups
thesis is to find under-valued startups that don't happen to be in the major
tech centres.

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lubujackson
More like a funding tsunami, where there's a lot of easy money floating around
from all those finance guys and tech vets who cashed out last time around. I'm
sorry, but when you start talking about how many users a site has and then
using that metric as a comparison for the valuation of the site that acquires
it... you're in a bubble. Why? Because nowhere in that thought process does
revenue come into play.

------
confluence
A relevant graphic/talk from a board I found on Quora:

[http://www.quora.com/the_edge/Long-wave-boom-and-bust-
cycle-...](http://www.quora.com/the_edge/Long-wave-boom-and-bust-cycle-from-a-
talk-called-Innovation-in-a-disruptive-environment-by-Steve-Jurvetson-at-
Stanfor)

In it Steve Jurvetson (a Draper Fisher Jurvetson VC) shows the cyclical nature
of capital, and how we seem to go from a PE boom and bust, to a VC boom and
bust every ~7-10 years, with recessions interspersed in between.

YC appears to be near the centre of this new growth period, bubble or not, and
is hence probably a beneficiary of the long term swings in global
credit/capital.

Guess we'll just have to see how it plays out.

I hope it isn't that, and we have great companies, with solid business models
(profit/revenue), without the mania that we had before.

But who knows, with the JOBS act passed (last week), and the consequent
relaxation in securities regulations we may have sown the seeds of an
unpleasant moment in the near future.

Talk:

<http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2288>

JOBS Source:

[http://en.wikipedia.org/wiki/Jumpstart_Our_Business_Startups...](http://en.wikipedia.org/wiki/Jumpstart_Our_Business_Startups_Act)

JOBS Act criticism:

The Consumer Federation of America characterized an earlier version of the
legislation as "the dangerous and discredited notion that the way to create
jobs is to weaken regulatory protections"

Criminologist William K. Black had said the bill would lead to a "regulatory
race to the bottom" and said it was lobbied by Wall Street to weaken the
Sarbanes–Oxley Act.

"gutting regulations designed to safeguard investors", legalizing boiler room
operations, "reliev[ing] businesses that are preparing to go public from some
of the most important auditing regulations that Congress passed after the
Enron debacle" and "a terrible package of bills that would undo essential
investor protections, reduce market transparency and distort the efficient
allocation of capital".

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rollypolly

      It assumes that you can a) get into the YC rounds
      (which 95% of angels can not) and b) there are
      other deals out there as good as the YC deals
      (80% of angel deals I see are not as refined as YC
      startups).
    

So true.

That's probably where YC derives most of its value.

------
khangtoh
I've always thought that the OMGPOP buy was an excellent deal for Zynga and
the Instagram buy a terrible deal for Facebook.

OMGPOP is adding a significant amount to Zynga's topline revenue. Last
reported, OMGPOP was bringing $250k per day.

Instagram? $0/day. Not harsh but just the truth.

OMGPOP doesn't scream bubble at all. Instagram's deal does. So are we in a
bubble? The answer is in the eye of the beholder.

------
lubujackson
Also worth noting, when a bubble forms people are yelling BUBBLE the whole
time. It goes on for quite a while, more and more people screaming about the
BUBBLE until pretty much everyone agrees it's a bubble. Then it goes on a
little longer still. Then suddenly it pops and everyone says "who could have
known???"

~~~
garry
This is actually not true. Previous bubbles were surprising to most everyone,
because the general accepted reality was that of a "New Economy." The previous
tech bubble did not become widely known as a bubble until it popped.

~~~
akharris
It's not that it isn't true, it's that it doesn't matter. There are always
people screaming bubble - look at the housing market collapse. The thing is,
there are always people screaming the opposite. A bubble continues because
more people are saying the price should be higher than are saying it should be
lower. That continues to build until, suddenly, the tide shifts and then
accelerates in the other direction.

------
adahm
The question is, can it continue to not be a bubble? With so many investors
vying to invest in YC companies in angel rounds the demand is eventually going
to reach an unsustainable frenzy. Good for them, as the author assumes, if
they are being more conservative and not really asking what they could (25mm
priced rounds) just because they could. If prices keep going up, and there's a
bad batch or two (not saying there will ever be ;)) then it could go away in
true bubble fashion. What won't go away is the consistency in tutelage and the
invaluable, growing alumni network. The question is if there is a way to keep
YC Companies from hitting that bubble and then bursting it, just by sheer
force of demand and consistency of investment in an otherwise inconsistent
environment?

------
corford
I have a bit of a problem accepting one of the arguments in this article
(under the heading "Is There a Bubble?").

The author seems to be arguing that if you look at the actual and projected
growth rate for both Instagram and OMGPOP (measured in number of account
signups) as a percentage of the userbase of their suitors (i.e. Facebook and
Zynga respectively), then the money paid for these companies represents
"EXCELLENT" value.

To me that is an absolute fallacy. OMGPOP was going for 6 odd years and almost
out of cash before they stumbled upon something that worked. Draw Something
caught on like wildfire but the buzz will eventually die. What comes after it?
i.e. how does past performance guarantee future performance (especially given
the majority of past performance wasn't great)?

Similarly, Instagram has caught on like wildfire but even the CEO admitted
that they have no way to monetize the user interest. So what we have is a
freebie product that people love to use to send photos and an accompanying
strap line of text. Yes it's cool but it isn't curing cancer and the users are
using it as a fun throwaway service. They have no loyalty to Instagram and
would drop it in a heartbeat if a charge was attached to using it.

So, where is the inherent "value" in all of these user accounts & signups?
Having millions of user's doesn't automatically translate to a long term money
printing machine like Apple or Google.

You can apply this argument to Zynga and Facebook themselves. Facebook has 800
million users but its total yearly revenue is half of Google's annual profits
(according the wikipedia entries). Zynga IPO'd at $10 a share. Almost 6 months
later and the share price hasn't moved. That doesn't look like explosive
growth to me.

Given all of the above it really does feel like a bubble (at least to me). All
the valuations seem to be based on a house of cards...

P.S. It's 1am where I am and I'm not an econ or finance guy so if my
assumptions or arguments above are wrong , I'd love to have it explained to me
rather than being flamed to death :)

~~~
jasonmcalacanis
Quick note: According to reports Draw Something from OMGPOP was generating
$250,000 in net revenue per day. That's a lot of money.

~~~
corford
True that's a lot of money but Draw Something would have to continue pulling
in $250K a day for over 2 years straight just to cover their purchase price of
$200 million (assuming Zynga paid cash - not sure on this).

------
jyothi
there was a recent blog which dealt with rationality behind such high absurd
evaluations: [http://continuations.com/post/19000949472/a-rational-
interne...](http://continuations.com/post/19000949472/a-rational-internet-
venture-valuations-bubble)

 _4\. The winner-take-all nature of network-effects businesses in which the
dominant business can be an order of magnitude more valuable than other
competitors.

So it is entirely rational given the Internet environment to see a dramatic
stretching of the valuations for market leaders with network effects. It does,
however, not bode well for aggregate returns for the venture capital asset
class:

1\. In a race to pick the winners ever earlier, valuations get stretched even
for companies that have not yet proven that they really have strong network
effects and that they will be the leader in their respective market.

2\. These stretched early stage valuations will lead to depressed returns in a
large number of companies and will also make many of these companies harder to
fund. There will be more of these companies and more capital invested in them
(in aggregate) than in the winners._

------
j45
Does it matter?

The fact is during this bubble, or non bubble, all of society is now online
and connected and using the internet to make purchases for goods and services.

It wasn't the case during the last boom. If someone could enlighten me a
little on how an exploration of things like this help move a startup forward,
when we know there's plenty of profitable bootstrapped and funded startups
that have become businesses.

------
distanlo
<<The $210M sale of OMGPOP and the $1B Instagram purchase feel like a bubble,
but you have to step back for a moment and realize that OMGPOP was purchased
for 2% of the value of Zynga and Instagram for 1% of the value of Facebook.>>

how can relative valuations prove/disprove bubble valuations? poor point in my
mind.

------
dr_
A priced round has 25-35K in legal fees? I'm assuming this depends on the size
of the round. A priced angel round, yes they do still happen, should not incur
25-35K in legal fees, or the angels will walk.

~~~
mnutt
At least in NYC I believe the startup is expected to pay both sides' legal
fees, usually with a cap.

~~~
jasonmcalacanis
If you're paying your VCs legal fees you're making a mistake. You don't need
to do that any more. :-) You can also cap it (i.e. $10k of your legal fees).
Fight for this point by saying "you want as much money in the company as
possible").

$25k is fairly standard on a $4M raise.

------
perlgeek
Is there a bubble bubble?

With all those people talking about bubbles, what happens if the bubble bubble
burts? People get back to work and are actually productive? A horrifying
thought indeed.

------
budley
Systematic overvaluation vs equivalent non ycomb companies plus the real value
created by the network but not a bubble.

------
halayli
I feel it's money flowing from the left pocket to the right pocket of the same
pants.

------
prakster
The upcoming Crowdfunding tsunami might also help keep valuations high.

~~~
cluda01
If it comes. I remember reading the details of that bill and if I recall
correctly someone mentioned that accepting crowd funding will make the
founders personally liable to lawsuits over the company.

I can't seem to find the bookmark, anyone have one by chance?

------
xxiao
it's certainly a gigantic bubble, from what I can tell.

~~~
jboggan
Opposing your assertion, I will note I went to a VC party two weeks ago and I
did not see a single ice sculpture. They did however have popcorn infused with
truffle oil.

~~~
Tyrant505
My new thing is to make my own popcorn in a pot as a healthier evening snack.
I must try this!

~~~
rdl
Paper bag (plain brown lunch bag) and some regular kernels, with the top
folded over, in the microwave for 2-3min.

~~~
ktizo
Careful now, that might be patented.

[edit] I was intending sillyness, but then thought to go check if putting a
bag of corn in a microwave was patented. Turns out it depends on how you fold
the bag. - <http://www.google.com/patents/US5200590>

~~~
xxiao
well after being here for a few months I found if I ever put some none-hype
comments I got negative scores, this by itself tells me ycombinator and many
of its followers are on drug and ignoring reality.

~~~
ktizo
That's lovely and definitely sounds like the most likely explanation.

However, more importantly, would you like some popcorn? We had an accident
with a corn silo and an industrial cyclotron, so there's loads to go around.
Needs more butter though.

