

The $4 Million Line - davidedicillo
http://techcrunch.com/2010/10/05/the-4-million-line/

======
jackowayed
This is a simple case of competition eliminating economic profits.

Right now, investors generally make extremely good returns. The reason the
LP's go with them instead of a mutual fund or some other safer bet is that the
returns are better so much better, even factoring in the risk. But consistent
returns that are better than the other options (better meaning enough higher
that it's a better option despite the increased risk) incentivize other people
to get in the game so they can get a share of those profits. But with more
investors out there, there's more competition for deals, which increases
valuations. In a perfect world, it'll find equilibrium at the point where the
expected value of investing in a VC fund is the same as the expected value of
investing in a mutual fund--the returns will be a little higher in good times,
but the risk of a bad fund will be higher. This is how the free market is
supposed to work.

Unfortunately, the market tends to overcompensate for things. So instead of
finding equilibrium at just the right amount of investment money, what's
happening is that we're going from too little money to what is probably too
much money. This means that valuations will get so out of control that
investors will start getting returns that are low enough that other investment
options have higher expected values. This is also a bubble, as it means that
startups will be overvalued.

The only bright side is that it looks like the bubble will mainly manifest
itself by VCs making no money and entrepreneurs making lots of money, rather
than tons of failed startups like last time. So far, this bubble is
characterized by good companies being funded at very high valuations, rather
than hopeless companies being funded at very high valuations. (Of course
people were probably sure pets.com would make tons of money in 1998.)

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bkrausz
From the article:

    
    
       "I wrote about two startups today ... 
       neither had involvement from the so called “super angels”"

...

    
    
       "except Hipmunk, which took an investment from SV Angel."
    

It's easy to make assumptions when you only have 2 data points.

How about inDinero, who raised $1.2M, some of which was from Dave McClure?

And GazeHawk, who also raised from McClure (full disclosure: I'm with
GazeHawk)?

How can 1 or 2 data points be considered enough to write a blog post about a
"trend"? I don't know how people can take this stuff seriously.

Also, most valuations that are mentioned with seed-stage YC investments aren't
pre-money. The YC convertible note doc has a valuation cap that is pre-money
on a Series A, so technically post-money on the note itself. That means that
Arrington's example actually nets the company 25%.

Additionally, Arrington's math is wrong. In order to make "any money" given:

    
    
       $1M investments at $4M caps
         (even if it gets you 20% instead of the 25% that it should - see above)
       Assuming all exits that happen are at $30M with no Series A

Each one nets you $6M, so 1/6 need to succeed to break even.

"7/10 or more" assumes $15M exits, which was the low bounds of his range.

This whole article screams "agenda", or at the very least ill-informed
reporting.

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robryan
Sounds like it's becoming a big gamble, something like hipmunk is pretty new,
with little traction and probably very small revenues to match. Given also
that the future of travel search is uncertain with Google buying ITA software
and the amount of similar companies appearing.

------
slowpoison
> _neither had involvement from the so called “super angels” (except Hipmunk,
> which took an investment from SV Angel)._

Neither followed by except! How about "only Alphonso didn't take funding from
Super Angels"?

------
staunch
> _...a company will raise $1 million on, say, a $4 million pre-money
> valuation. That gives investors 20%..._

That gives investors 25%...

$1 million into 10 companies for 25% of each. 7/10 of them exit for $15
million returns $26 million. A damn good return, especially if the time frame
is short.

Obviously dilution (and other things) can change things, but so can one or two
moderately large exits out of the 7.

~~~
othermaciej
No, 20% is correct. The share the investor gets is based on the post-money
valuation, which is the pre-money valuation plus the amount of cash the
company just gained.

Working this example in more detail:

Pre-money valuation = $4 million Cash invested = $1 million Post-money
valuation = pre-money + cash = $5 million Proportion of post-money stock
that's worth $1 million = $1 mil / $5mil = 20%

~~~
staunch
And I thought that would never confuse me again...thanks.

It's still a big return though, so I don't see the problem with valuations
that high.

~~~
zck
>And I thought that would never confuse me again...thanks.

In things like this, it helps to scale it up to 100% -- what happens if a $4
million company takes $4 million from VCs? Certainly the VCs wouldn't own the
entire company, so you can't give them a percentage based on premoney
valuations.

