
Paul Graham's Dilemma - BrandonWatson
http://www.manyniches.com/entrepreneurs/paul-grahams-dilemma/
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grellas
A few observations:

1\. A convertible note, however favorable its terms, is still fundamentally a
_loan_. This means it will have a due date at which the holder may demand
payment unless the amounts due have been converted into equity before then.

2\. Item 1 in turn means that there will be no coasting for the YC companies
upon receipt of this money or even necessarily a break from the pressure of
fundraising. Why? Because the investment is not from a relative who is looking
to get a high-interest-rate return on his investment but rather from a venture
investor who fully expects that the company will make a good-faith effort to
raise funds as appropriate to meet the minimum funding threshold at which his
note will convert into equity. That means there will be considerable pressure
to do a Series A round within the term of a typical note of this type, which
means within the first 9 months.

3\. What this money does then, in my view, is strengthen the negotiating
leverage of the YC companies in terms of getting further bridge funding to
carry them out to Series A. They won't need to worry about survival money
during their first steps and they can in turn be more selective about whom to
talk to and what terms to consider in taking further bridge money for their
early build-out.

4\. The terms of these notes will undoubtedly have provisions covering what
happens if the startup is acquired before a triggering event for the note
conversion. Those terms might vary widely but my guess is that they will be
such as to motivate the founders to push for funding so as to effect a
conversion. There is nothing wrong with an investor building in reasonable
safeguards to make sure he doesn't get abused and the safeguards here might be
such as to make it unattractive for the founders to exit via M&A prior to
conversion, which again means that there will be great pressure to get the
larger funding.

The biggest impact here will be on those investors competing for early deal-
flow and on what should be a broader pool of applicants who can now seek to go
the YC direction. I doubt that it will relieve the fund-raising rigors of the
YC companies themselves very much, if at all.

~~~
harryh
> A convertible note, however favorable its terms, is > still fundamentally a
> loan.

Ya, but it's a loan to the company. If the company goes bust the owners of the
company aren't liable.

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javert
The tone of this article makes me nervous. It became clear to me why, when I
got to this:

 _Talent selection in the hands of too few is one sort of problem, but
financial engineering concentrated in the hands of too few, especially those
who think of themselves as smart, is really, really dangerous._

No, it's really not _dangerous_. Dangerous is something that can deprive
people of their life or property without them choosing to take on that risk;
it's normally something the government is supposed to prevent. The markets are
designed for investors to take risks, and overall, it's a great system; it's
the _opposite_ of dangerous.

(In fact, if people supposedly having knowledge about venture capital start
shouting about how "dangerous" it is, that's only going to increase the amount
of government regulation, which is a lose-lose for everyone involved in
venture capital or startups.)

The whole article takes on sort of an end-of-the-world gloomy tone. Y
Combinator just doesn't have _that_ big of an impact. If Y Combinator were to
disappear tomorrow, things would keep on going, _at least_ just as well as
they were before Y Combinator was brought into existence.

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qeorge
I've been wondering this, so here goes.

By accepting this money, is YC basically saying that $10-20k isn't enough to
startup? Or at least that having the next $150k promised is beneficial to
startups in general?

If that's true, why doesn't YC just give more money to teams to begin with? I
thought the low amount was part of the secret sauce - constraints leading to
creativity and all that.

~~~
cosgroveb
YC isn't accepting this money. YC doesn't seem to be saying 10-20k is not
enough to startup. This money is being offered directly to YC companies and if
I've followed the news correctly there is no contract or formal agreement
between these investors and YC.

That being said, I think YC has probably funded startups knowing that they
would need far far more than 20k to properly startup. That's what demo day is
for.

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staunch
What is Yahoo! Combinator?

~~~
jf
It's a high-order function that computes the fixed point of Yahoo!

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imkevingao
I don't really get the whole controversy with the angel industry. It's not a
friendly world, it's vicious out there. You can't honestly just sit there, and
expect the game to stay the same for the next century... It's a fast moving
world. To stay competitive, new investment ideas should be developed, like
Yuri's genius plan.

People are criticizing how it's a bad investment, but come on DST has earned
god knows how much money from the three social network/deal/gaming giants,
they can afford to lose some money. Bottom line, these offers are great for
the entrepreneurs, which is what i believe pg would want, therefore he allowed
Yuri/Conway to propose such deals to them. If these were horrible deals with
massive strings attached, pg would never allow that to happen to his YC peeps.

The main reason i love what Yuri is doing is because this deal has increased
the possibility of the American Dream. If you're brilliant enough and hard
working enough, you don't need a rich family to become successful. Even if you
lack in startup capital, YC, and soon many startup accelerator, as well as the
increase flow of angel money (if angels want to stay competitive), will open
endless doors of opportunities.

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catch23
pg already gets tons of applicants per round, I don't think Yuri's plan will
triple the number of applicants so I doubt it will be a problem in the short
term at least.

~~~
ptn
If you are offered more money if you get it, even if the extra money doesn't
come from the original source, more people will be tempted to apply. "I can do
more with more money", "it's not as risky as before", some will surely be
thinking.

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acconrad
Why is this viewed as a problem? He's already said he has never (and won't)
set a cap limit on the number of startups he accepts, so if he gets more great
companies, there will be more great companies. And also, when has people
fighting for your product (his product, being this mentor program) ever been
an issue? If anything, this is going to skyrocket his clout and prove that
what he's doing works (and very well).

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wccrawford
tl;dr = The influx of potential startups due to Yuri's $150k investment offer
is going to cause problems for PG and YC.

~~~
BrandonWatson
You're not quite right with your conclusion. Sorry you didn't read all the way
through.

~~~
g0atbutt
Could you set the record straight then? The site is already down. Perhaps you
could post a text only version here?

~~~
BrandonWatson
Site went down for a moment there...bluehost to the rescue.

The main issues revolve around some topics I hadn't seen elsewhere.

1) Will Paul's talent filter function work as the influx of applicants grows?
One poster suggested he doesn't think a 3x is possible. I disagree.

2) What happens when older, more seasoned folks see this? Will they see this
reduction of risk as the opportunity they have been waiting for to start
something? Don't underestimate the power of "what if" and "what could have
been" for people who have been working for 10+ years, but kids/mortgage got in
the way of starting something.

3) What will the angel response be? Offering more money in the next go round
isn't the right answer. Yuri have removed the risk premium from angel
investing. That's huge.

4) Is it possible that there is too much of a choke point, now, for talent
selection for YC? Will the ecosystem continue to flourish, or does it run the
risk of stagnation, because the selection criteria doesn't allow for random
mutation?

5) Will financial engineering take hold? With a few players doing this, things
could get messy.

~~~
sokoloff
Your argument in #2 seems to imply the potential for a different quality
(higher in some dimension of quality) of candidate to now apply to YC.
Assuming that's true, it's strictly positive for YC.

I suspect that the profile of applications that YC gets are 1-3% "We should
definitely interview this team" (bucket 1), 75% "these are quick rejections
for one (or many) reasons" (bucket 3) and 20-25% that need a deeper read to
handle (bucket 2). Even if applications tripled (which I also doubt), a small
number of the "extra" applications will fall into the first bucket (and may
well be a consequence of #2 above), which may crowd out a few of the
applicants in the second bucket who may have gotten interviews and ultimately
selected but will now miss the interview cut. Loss for them surely, and maybe
a small loss for YC, but one that is being more than offset by the increase in
applicants from the first bucket.

I think the Start Fund announcement is certainly damaging to the other
"competing" programs as it makes it slightly more likely that a "bucket 1"
team will apply to YC rather than TechStars et al, probably has harmed other
angel investors' prospects slightly, but in the short term is an enormous win
for YC and the startups that best fit the YC "mold" (to the extent that there
is one).

But I'm still a little confused by the collective hand-wringing that's going
on in the last 72 hours. It's not like the Start Fund has cornered the market
here. Anyone else could come along and say they'll match or could do it with
Tech Stars or any of a number of other responses. I think that Yuri is being
especially bold (some would read as reckless) and that's naturally going to
cause some disruption. I don't view that as bad, unless my own application to
YC S11 is a "bucket 2" application that is now de-selected for interviewing,
an outcome that I view as a quite realistic possibility, but even then I have
to say that it caused YC to select for "better" applicants, and I need to dust
myself off, pull on my big boy pants and get back to working on it.

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k3dz
is the failure rate of startups so high because a lot of the people involved
are inexperienced?

will the 150K improve the success rate by motivating more experienced people
to join?

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whoeverest
I got a notification from my antivirus program about a malware. I am not sure
what it said exactly though because I pressed "Deny Access" quickly. So,
beware.

~~~
BrandonWatson
Someone posted to me about this on twitter...looking more into it, it's a
false positive. You can check at <http://onlinelinkscan.com>.

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chailatte
"That[Yuri's uncapped convert notes] drives up the check amounts, removes the
incentives for the angels (uncapped converts…really?) and doesn’t really allow
any one angel to take the mutual fund model, which means they would be
investing with no due diligence. "

Yikes...I never thought about it that way. Basically Yuri is encouraging the
speed at which the angel/super-angel bubble is hyper-inflating. I wonder if
most incubators/angels have responded/will respond with refusal to go along
with Yuri, or up the ante with larger amount of angel investment?

~~~
damoncali
Anyone can offer that deal that Milner did. There is nothing stopping other
angels other than that fact that nobody else seems to think it's a good idea.
There's a fundamental disregard for risk in Milner's approach. They are paying
the same price as later investors, but taking more risk. They are basically
building in a down round just to get in the deal. Since when is a seed round
worth _more_ than a Series A?

I get that they're trying to get into every deal that's been prescreened, but
the valuations are totally upside down _by design_. I may be missing
something, but I the only way I can see this working out is if you're going to
deploy _lots_ more money on top of these notes, which are basically an
expensive marketing scheme. That's a pretty big gamble. Perhaps $6 million is
play money to these guys. In any case, I'd be more worried as an early stage
VC than as an angel.

I can't put my finger on why I think that's a bad idea, but there problems
just seem to follow people who are this free with their money. It smells of
hubris, but it's not like these guys are pikers.

~~~
BrandonWatson
That's the beauty of his approach, in my opinion. He deploys the money in one
shot, to many companies (portfolio theory says this reduces risk), and does so
with little diligence. He may be pricing many angels out of this type of deal
because they won't have this same appetite for risk as Yuri does. What he
finds acceptable for risk is not what most angels would, thus he can price out
the risk premium with the uncapped convert.

~~~
damoncali
That's just it - why is he more tolerant for risk than everyone else? Risk is
not a personal thing - it just is. It's not like he gets his money cheaper
than anyone else.

Either he's wrong and everyone else is right, in which case he's burning
money, or he's right and everyone else is wrong, and he's burning less money.

Either way, I don't get it. These guys are very well connected. Is it so hard
to participate in Y Combinator Series A round that they need to spend this
much money just for the opportunity?

~~~
Zaak
Everyone has a different level of risk aversion. Some people want to play it
very safe, and others are willing to take large risks if the possible rewards
appear worth it.

