Funding of $25,000 per startup (funding plus costs) x 210 = $5,250,000 in funding costs. To factor other costs and be conservative, double that to $10.5 million.
YC usually takes 6% equity. Assume that's diluted in half, conservatively again, to get 3%.
Total current valuation of 4.7 billion: $4,700,000,000 * .03 = $141,000,000
So... using all conservative numbers, YC's return has been .... $141,000,000 / $10,500,000 = 13.4
Whoa... did I do that math right?
A return of 1340%
That's... pretty astounding. Talk about a win/win/win situation for everyone involved... if the order of magnitudes here are even close, well, massive congratulations to everyone involved. Wow. Wow.
I'm not arguing against pg's methodology, as I realize it's fairly consistent with standard practices, but the ycombinator investors are nowhere near as wealthy in real terms as these numbers would suggest. If airbnb were to fail that would destroy a huge amount of that wealth, with no ability to extract any value before then.
None of this is meant to rain on YC's parade. I have a great deal of respect and admiration for all involved, and congratulate them heartily on the very real successes they have had and continue to have. I'd simply be heasitant to describe YC as being "worth" 5BB, given a reasonable expected cash return.
AirBnb could end up being worth $0, but it could also be worth $10 billion. A $1 billion valuation would be a bet that it's expected value is substantially more than $1 billion. You may disagree with that assessment, but the people making that bet have a pretty good track record.
But it would be far more valid to criticize any alternative valuation that fixed the problem you're addressing. For example, it would be conservative to value all of YC's startups in terms of their cash and receivables, plus the liquidation value of their furniture and servers. But then it would be trivial to say "Hey! AirBNB isn't an asset play. It's valued based on growth. The asset value is a worst-case scenario, but most of the other scenarios involve a lot of revenue growth and free cash flow."
Basically, is there any valuation method you have that would make you indifferent to a bet on the portfolio's valuation going up or down? (i.e. anything you think would produce a "fair" market price?)
Actually, more directly: how much of your net worth would you invest in shorting YC's portfolio at this inflated $4.7bn valuation?
No, there isn't. Angel investing is an inherently speculative game. What I would say is this: a YC investor could reasonably claim to have seen a return on any shares he sold, or any shares he holds of a company that has gone public. That's it. Beyond that, all investments are good only in theory. Were I to buy a house, I would decide what was affordable based on the former, not the latter. The same is true for my contributions to my children's college fund or my retirement fund. In short, all of the things that actually matter in life would be based off of what I had sold and what shares I held of public companies. To make any long term financial decisions based on the projected worth of companies that had, at best, gone through a successful series A or B would be foolish. They're nice numbers to think about, but they don't mean a damned thing until they're putting food in my kids' mouths.
Let's illustrate my point like this: Suppose you are given the chance to pay 1MM for some good that has a 20% chance of being worth 1BB in 5 years. If you can spare the million, then this is a fantastic investment by any measure. Having bought into this investment, however, how would you describe your net worth? Your investment is valued at 1BB. The fact that it will likely never be worth that much doesn't change its value. Heading off the foreseen criticism, let's say that savvy investors would only say it is worth 200MM, the ultimate value times the expectation of realizing it. Still, that 200MM is fairy money. It doesn't exist, and you can't do a damned thing with it until you somehow manage to convince someone to give it to you. To claim that you're "worth" 200MM is silly, as you can't spend a dime of it.
This is the problem I have with pg's numbers: They sound great until you ask what the cash-out is. Saying "I've invested in companies that are worth 4.7BB" is great, but it doesn't say anything useful about how well your money has been used. Remember, prior to investment it was real money that could buy apples and tuitions. Now it's theoretical money that could buy a whole lot of apples, but only under a specific set of favorable circumstances.
A final reduction: There is a claimed ROI of ~13:1. Being generous, I would ask this: how many people who invested 1MM into YC have pulled 5MM out?
A market price is a price at which someone with good information is indifferent between going long and short. If you're applying some discount to the $200mm based on the possibility of a $0 outcome, you'd have to put your money where your mouth is and sell short at that level.
If you'd made $200mm through some other means, and bought that 20% chance for a billion dollars at the market rate, would you treat that as a loss? At what market value would buying that constitute a good deal?
The whole reason we have valuation is to answer questions like that. The question of "What is this worth?" is very different from the question "How much cash can I extract from this now? "What is this worth?" means "What is the net present value of all the cash I can extract from this asset, assuming I extract at the optimal time?" It's the difference between the value of a couple scraps of gold in a creek and the value of a massive gold mine.
A final reduction: There is a claimed ROI of ~13:1. Being generous, I would ask this: how many people who invested 1MM into YC have pulled 5MM out?
That's not the point, though. Startups are illiquid, so it doesn't make sense to sell. Plus, the YC people just don't seem to need that much money. Some people get rich in order to buy jets and vacation homes--the impression I get is that the YCers got rich enough to spend their time working on cool stuff, e.g. YC.
In YC's case, it's portfolio is entirely made up of high-risk startups, so to the best of my knowledge, it's not classic portfolio theory.
So, it's not really a diverse portfolio, but it's definitely a portfolio play, which is substantially less risky than having all your assets tied up in the stock of a single startup.
Think about it this way, if 2001 hit again and all tech stocks plummeted, all the companies in the YC portfolio would be substantially negatively impacted, so there isn't a portfolio effect to protect against this correlation in YC's assets.
As a industry, probably/maybe. Was certainly the case in the dotcom crash.
Performance-wise, not really. Most startups fail, some make it big. Why? Low investment costs and high possible leverage with internet technology (to little marginal cost). This could change in the future.
In this case the second way is probably more fruitful to think about, since one big winner will even out all the losers. I'm sure this is possible to "prove" by some Black-Swan-ish statistic model theory.
NOTE: I could be wrong.
EDIT: I agree that web startups today aren't one industry. Social web startups is a candidate though.
Even though we (CarWoo! YCS09) are a web startup, we see ourselves primarily as a company that plays in the automotive industry. All of our key metrics are highly-correlated with the automotive industry, not with what Techcrunch writes on any given day.
While a lot of YC startups' metrics ebb and flow with the goings on of the echo chamber, many do not.
So I think you should have ended up with 1240%.
E.g turning $1 to $1.50 is a 50% return and $1 to $2 is 100% so $1 to $13.4 is a 1240% return. Still a spectacular return given the short time period.
Otherwise I agree with your numbers. The cost doubling sounds high at first but YC is by definition very hands on.
I understand we are really just disagreeing about the semantics of the word "return", but I'm just including how I see it most commonly used in my line of work.
In a few years when there are 1000 YC companies it will start to mean a lot less to all those people who have been helping YC companies succeed to date. It probably already means a lot less to a VC to hear you're a YC company, because they've met 300 of them.
If it's the YC halo effect that's driving high returns it will be a big problem if it starts to wear off.
Harvard, Yale, MIT, Stanford, etc. seem to be doing rather well, as far as higher education goes.
And I would imagine those that have partnered with them are doing okay too.
>It probably already means a lot less to a VC to hear you're a YC company, because they've met 300 of them.
I doubt that. A VC is just trying to pick the next Google. Or the next Google founder(s).
Startup incubators may in some ways be easier to replace than universities (Harvard, Brown, etc. are still going strong after 200+ years), but they are subject to similar dynamics, insofar as there is team loyalty and networking benefits (as there obviously are). Personally, I would accept 10% dilution of my company simply to be an YCombinator alumnus since I think the benefits are and will remain that high.
Not a good example. These schools increase their enrollment very slowly, while other schools have grown massively. As a percentage of total college grads, these schools are more exclusive than they used to be.
But the general idea is correct: the value of the YC brand is getting diluted, of course (imagine what it would mean if YC funded just one company per cycle!), but the total value of the brand keeps going up.
For, as in the case of YC, the success is first and foremost attributable to the participants - and whatever other value there may be is easily confounded and exaggerated. The only fair way to establish a comparison is to consider those who were accepted to YC, but chose not to enroll, for whatever reason. This is reasonably clear when X is 1300 students a year, harder when it's less than 100 startups.
Anyway, a rather belabored way of saying that the higher education comparison may be accurate... but not necessarily in the way that you think!
Another way to look at it is that the total number of YC startups over the least six years is less than the number of deals the typical VC sees each week.
Personally, I'd think the opposite is possible. (And likely if YC companies continue to be considered "successful".) A stronger YC network and a large portfolio of successful companies should only strengthen the brand.
A better question would be:
With all the 'me too' incubators out there, how much can YC scale horizontally? YC has been eating the Angel's lunch, but there will be more people at the table every year. How much of the market can YC grab without growth hurting their per-startup performance?
In many ways, it also makes me comfortable saying that the "Harvard of startups" description is appropriate. Sprinkle in a bit of elitism based on merit, give people some general framework, a bit of advice, and a lot of free reign, and brilliant and hardworking people will make things happen. Much better to be a bit hands-off and cultivate excellence then micro-managing the actions of the less focused or ambitious.
This, even more than recent acquisitions, is the best news I've seen out of YC in awhile, and truly excellent. Congratulations!
btw, to pg or anyone else, would be a little bit interesting to see more about the power law distribution as it applies to investing. I'm assuming this is true across the field, but don't know for sure (do all vcs get the same distribution, or is it simply true of software startups, or is it simply true of software startups that manage to include big hits? Moreover, do you simply get big hits by funding enough decent sluggers, or are there other strategies to make sure you have a decent shot at the next Dropbox, Twitter, Google, etc.)
* expectancy = (probability of win * average win) – (probability of loss * average loss)
You mention the concern that would be inherent if funding was at 100% prior to yuri with regards to an overly conservative stance. With, as you have stated, the real goal being finding the next google or facebook isn't a 90+% level almost as worrying ??? Wouldn't something closer to 70 make a better balance in terms of maximizing coverage to increase the chance of landing the outliers ?
So to be clear. I'm most interested in how many of the 208 considered as part of the $22.4 million calculation are self-sustaining and making a profit today.
It's a small assumption, but I think one that could be made.
It makes more of a success/failure comparison than a return percentage calculation, but it would still be really interesting to know.
"We're looking for companies with high beta. E.g. we're
ok funding groups for whom the likelihood of failure is
high but for whom success, if it happens, will be big."
Am I using the wrong definition of beta? Is there another term that better expresses this characteristic of investments?
But in terms of asset allocation, you're right: PG is actually looking for alpha. You can get all the beta you want with leverage: just buy short-term out-of-the-money calls if you want extremely high beta.
(There's actually a lot to think about, here. Startups are pure "alpha" since the beta component is an expected return of zero.)
PG means alpha here.
"Beta" has two popular definitions. One is "market beta," i.e. the return you've gotten from the market you're in versus the particular trades you make in that market. I have only heard professional investors refer to this. The other kind is the one defined by investopedia. I only hear this mentioned by retail brokers.
If PG said he wanted high alpha, it wouldn't make sense to increase the probability of failure. All else being equal, higher alpha means a lower chance of failure (at any given volatility level, the higher-alpha portfolio has a lower chance of going to zero, since e.g. if beta is -99% and the lower-alpha portfolio generates -1% alpha, that takes it to zero. Right?
Rs = BRm + A
It doesn't speak to general volatility at all. The definition linked is inane; Beta of 2 only twice as volatile as the market if the security is highly correlated to the market.
Beta is literally cov(Rs, Rm) / var(Rm).
In this particular case, if he wanted returns highly correlated to beta he would just invest in VCs. To get a beta of 2 he'd leverage the funds somehow and invest that.
He thinks he has an edge, which is contained in alpha (return not captured by market performance.)
People do cite betas. e.g. here's a quote page for Yahoo, on a big personal finance site, that cites the "beta" as defined earlier: http://www.dailyfinance.com/quotes/yahoo-inc/yhoo/nas It's entirely possible for a typical investor to only encounter that version.
Colloquially, if someone says "I like high-beta stocks," they mean "I like really volatile stocks," not "I like stocks that have some combination of high volatility and high correlation to some index." So the statement makes sense colloquially.
A more accurate version would be "YC looks for a moderately negative beta and expects a very high alpha." Since that describes companies that fundamentally alter their target industries--e.g. by harming all the established players, but still making money.
But what do I know, I only spent a decade on wall street.
Avg. value (22.4M) * Avg. equity (6%) = Value of average stake (1.34M)
Compare this to an investment of $20k, wow.
I am sure there is some sort of dilution that occurs, but anywhere in this order of magnitude is remarkable.
For example, the majority of the total value comes from the few outliers (AirBnb, Heroku, DropBox) and the other 80/90/95% of companies contribute relatively little to the total valuation.
So let's say they still own 6% of these outliers. Great! That's still worth a lot. But how much do they still own? Have their shares been diluted? Did they have to issue new shares due to further financing? Has that 6% turned into 3% or 1.5%?
I'm not an expert but it's quite possible that their initial 6% has been diluted.
I think the picture looks good, overall, for YC from an investment standpoint. I think avg. value is not a great metric by which to value the "average" YC company since my guess is that the majority of the value is on the top end.
Measuring the value of companies that have grown dramatically since the last round if pretty arbitrary. If this estimate were done on the same companies in the same states but in 2009, wouldn't it be off by 50%?
Wow - I didn't know this. Does anyone have any more detailed examples of this happening they can share?
Most of this seems like it should be public information, since fundings that large are usually announced by press release. Has anyone compiled a list?
Actually, I'm surprised how many of the acquisitions were talent acquisitions for ~$2M/founder. Decent sized chunk of change, but you can get that much by going to work for Google, kicking ass, and then getting a FaceBook offer.
Interesting to note that there are probably a few Wufoos in the total YC universe that reached meaningful profitability without having to raise more money.
Those are the ones worth emulating even though they don't get nearly the amount of attention as ones raising mega vc rounds.
"All this also helps explain why a “batting average” or “track record” figure is useless regarding general purpose grant writers, as we describe in this FAQ question: http://seliger.com/faq.html#anchor5 . We don’t know if our clients are going to come from Beverly Hills or from places where most residents haven’t graduated from high school. From a grant writing perspective, a client from the latter place might be more likely to be funded than someone from Beverly Hills."
I can imagine many reasons, but I'd be interested to hear from you why you chose to share these numbers at this time?
I was present, and a two things were clear from the interview:
1. Charlie Rose had a few wildly incorrect assumptions about YC. (e.g. "so, to date, you've invested, what, $100M?")
2. Paul Graham had not given a lot of thought to aggregate numbers. When asked, he about total the total value of the YC portfolio, he could only guess.
Edit: interview link http://www.ustream.tv/recorded/14928956
I hadn't realized how nice you are. Your real-life persona completely contradicts the caricature I had developed in my mind after years of reading your essays.
I was expecting Vulcan (hyper-smart, non-sentimental), but instead got Camp Counselor (humble, encouraging).
You should do more on-stage stuff.
Of course that could be cut in half tomorrow. Startup valuations are even more volatile than ordinary equities.
Couldn't one argue that startup valuations are sticky in a downward direction? The 21 largest companies are highly valued because they're generating tons of revenue (or even profits). Nothing short of a market collapse would hault that revenue generation, and it's hard to imagine such a collapse in the market of, say, peer-to-peer vacation rentals or cloud-based multi-platform storage.
It's entirely possible, though, that by "cut in half tomorrow" PG meant that Winter 2012 will include 210 companies. :P
I don't think valuation of startups are strongly based on revenue and profit. At least not in a way where their revenue/profits force a certain valuation, rather than simply suggest that the potential and growth is there. (if that makes sense).
Companies are highly valued b/c they (a) generate income or (b) have the potential to generate income. (a) companies are trivial cases, since they already make money. Let's move on.
Looking at (b) companies: they're highly valued because market conditions + company fundamentals suggest they CAN generate income soon. Let's assume company fundamentals (leadership, labor) are constant and solid (trivial, since they're being advised by PG and other VCs).
Therefore, highly-valued companies that do no yet generate income can only be negatively disrupted by market forces. Based on the initial assumption about (b) companies' potential, I argue that (b) have been selected such that they are not particularly vulnerable to negative shocks.
Therefore, their valuations have a very, very high floor and are sticky in the downward direction.
No less of a company, but a slight change (yet reasonable change) could drastically effect their value (as it would with most startups at a similar phase).
By taking the average value in this case, it's likely giving an inaccurate picture of what the average YC funded company is actually worth.
Just a thought. I could be wrong assuming most of the total value does not come from outliers but my sense is that I'm right based on the news I've seen around YC companies.
Note to self: if you're succeeding in everything you're doing, you're probably failing to attempt awesome things in which you could succeed.
There is market feedback in this thought (and in the footnote where you cite 'beta'). Really what you are saying is that you are aiming for a level of conservatism/risk relative to the market.
I'm curious what the funding rates were in 2006 and how they changed. How much of the increase on funding percentages were due to being better at doing YC and how much of the increase was due to their being much more risk capital in the market?
I wonder if pg and YC partners would be able to give enough time and attention to 62 startups.
YC brand and alumni network is stronger than ever. YC is great at scouting great entrepreneurs at early stage. At this point YC may be acting as a filter for investors.
The big question is, Will YC still the advisory role to create great products? or Is it now a funding school that provides a brand and access to Angels and VCs?
Would love pg, YC partners or alumni to chime in on this.
Or perhaps the lower tier VCs just can't compete with the "better" firms.
I find it interesting that you so readily equate "lower-tier" VCs with "lower quality" VCs. Is this a reliable rule?
If you were a low-tier good-quality VC, surely you'd become known as a top-tier VC pretty soon?
- the average YC investment is $20K for 5% (400K valuation),
- YC's share get's diluted in each company by a round giving up 30% of the company
- the average YC company is worth $22.4M
...then that translates to a 43X return for YC. Woah.
But YC is clearly going to do spectacularly well. They deserve big congrats for what they've accomplished.
You also have to assume dilution since almost everyone raises money. So they might have started with 6%, but they probably have more like 3% in a mature company (assuming 50% dilution for no particular reason).
So if you wanted to estimate returns at this point you could say (3% * 4.7 billion) / (212 * 17k) which is 39x (or 3900%). Not half bad!
The 9/10 startups thing was always a myth, though, especially if you're talking about startups which get to the stage of getting any funding at all. It's more like 1/2.
No... this is incorrect. Power laws looks like this (imagine the "top 10%" in green): http://en.wikipedia.org/wiki/Power_law so the median value, or even showing a histogram of all values, would be WAY more informative. My hunch is that the "22.4m" average valuation is way higher than most YC grads.
What about the control group though? You know, the 50% that were deemed fit for YC after the interview but lost at the coin toss backstage. How did those compare?
Let's say you ranked startups during admission on a 1 to 100 scale, and took the top 20 scoring startups. (I don't know if this is the metric you used, but I imagine the following protocol could be adapted regardless; as long as you kept the data.)
Take the bottom 5 scoring startups that you funded - i.e. the ones that just made it. Now compare their outcomes to the next 5 --- i.e. the top 5 scoring startups that didn't get funded.
If you see a significant difference, that could show that being a part of YC adds tremendous value to a company. On the other hand, this sort of analysis is really hard because the data points are so few, and the noise in the data so high (the volatility is just too much to make meaningful conclusions).
It's still an interesting experiment to run, because there is a chance that being a part of YC adds just such a large amount of value that it still comes out in the data.
This sounds like a good instrumental-variable exercise for finding out whether the YC branding adds a significant amount of value to investors.
EDIT: gabrielroth got it.
/Insert Einsteins's quote about god being dicey