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.
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.
Every entrepreneur I've talked to, including many outside Silicon Valley that are not part of any accelerator has said that it's easier to raise money than ever before. If you have an idea and team that's fundamentally fundable, you'll get money fairly easily. The size of the round might be smaller, the valuations might be lower, and it might take longer, but I know several people in the middle of Wisconsin who have raised seed rounds between $500K-750K easily. Being part of the Silicon Valley scene or an incubator is by no means a prerequisite for a seed round. Series A would be a different story.
While the market for seed rounds has been generally frothy, I believe these wild valuations are very specific to YC. Maybe they are indeed adding real value to investors by attracting the very best founders, or maybe investors are creating an YC bubble by overestimating their odds based on some recent homeruns. Probably the truth is somewhere in between.
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.
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.
Incubators were around before YC though, and pg et al seemed to want to avoid being identified as an incubator. At any rate though, YC certainly redefined what an incubator is, and my impression is that the track record already shows better returns than any previous incubator. But as with any good idea, the cargo cults are quick to follow, and I think it's inevitable that a froth would be raised following this kind of success.
It's true that a YC company is more likely to succeed, but it still seems wrong to use someone else's filter instead of your own. Maybe this is just a result of the high competition to fund YC companies- they simply don't have time to use their own filters for this prefiltered subset. I'd argue that it probably won't be in their best interest to do this in the long run, but then again I'm not an investor.
I think it is still hard for companies to raise money. While the article is excellent, it doesn't really note that there were several companies that applied to Y, but only 60 got in. (Disclaimer: No, I did not apply). It may have been easier for those 60 companies to raise more money now, but I doubt it was ever that easy and it will ever be to raise money.
There should be a high bar for competence and business value to raise (large amounts of) money, but a lot of the ways the investment process is hard have nothing to do with that -- and things like YC, angels, angellist, etc. are addressing those inefficiencies.
If I were an angel in Montana, having access to the best deals globally would be a lot more attractive than trying to get into all 3 tech startups in Montana in a given decade. It's a lot easier to interact with businesses and founders online, and then to make an investment, than it used to be.
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.
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?
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.
I'm not sure that's the right metric for "dumb" money. Say, as a gedankenexperiment, that you're a very bright, very successful person interested for whatever reason in investing in a tech startup. But you don't know technology. Do you (A) spend hours trying to understand the technology before carefully investing your cash or (B) hop on the coat tails of a proven winner?
That said: this has all the smell of Yet Another F'ing Bubble. PG and company should be very careful not to let this get out of hand. A big high profile wreck or two (YC-funded startup that takes 20M and bombs inside two years, say) would destroy the brand they've created.
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.
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.
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.
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.
Good point. Though I think the top VCs hardly ever lose money on a fund, they just make lower profit margins. In fact Doug Leone of Sequoia once said that they never had a fund that lost money, although in 2002 they almost did . But even if they did, if their investors had consistently invested in their funds over the years, they would have been ahead of the game. So in the long term I believe that top VCs and their investors are going to do well.
Since VC investing is supposed to be higher beta, I think an index fund of U.S. small cap stocks would probably be fairly appropriate, possibly with some investments from emerging markets (e.g. Brazil) thrown in. The person who would know exactly the right benchmark would be Paul Kedrosky, I'm sure it's appeared on his blog at some point or another.
People outside the finance world seem to think beta is the same thing as standard deviation, and forget about the market correlation factor. I think the natural conclusion goes like: beta ~= risk ~= potential reward. It's hard to remember the bit where the ups/downs correlate with the market.
The most common way I've heard the term used is to mean correlation to "the market", meaning "the set of things that you can invest in".
A high beta asset goes up more than everything else when "markets" do well, and a low beta asset less so.
It is common in a multi-asset-class trading environment to make a grab for beta when the belief is that the short term trend for markets is good. Like when there is unexpected positive news flow about the global economy. "Buy some beta!"
My guess is that VC returns are dominated by IPO exits, and IPO exits need institutional and retail demand for equities, which tends to happen in up markets. To the extent that VC returns are directional with the state of capital markets broadly, it seems like calling it a high-beta strategy is reasonable.
I probably used the wrong term. What I meant is that for small cap stocks, there is a very high rate of return over a 20+ year timespan, but in any given year there is a lot of uncertainty. Venture capital strikes me as being similar in that sense.
I agree - it seems true (albeit strange) that only a handful of VCs are making returns that justify the risk. But those top VCs are consistently ahead of the game. I don't think those index funds did very well during the tech bubble burst, when Sequoia almost lost.
"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."
Doesn't matter whether coming from wealthy individuals or institutional investors or the public.
Both are susceptible to the halo, follow the bandwagon, and hype. The decision are ultimately made from people. It's what drives any tulip craze.
I don't think you can compare what we see now to the bubble days. Let's look at some key differences:
- In the 90s there were 50 million internet users, now there are over 2 billion. The internet economy is huge.
- It's becoming easier to get seed funding, but it hasn't become any easier to raise series A (some claim it's becoming harder due to the increased number of seed companies chasing those series A dollars). In the bubble days the madness went all the way to the IPO.
- When the bubble burst, people lost faith in the future of technology, or at least in the rate at which it would advance. Now that phones have become computers, books have been digitized, and people rely on technology for every aspects of their lives (even to socialize!), it's pretty obvious that technology is here to stay.
For sure we may see a down-swing. If macro economics go in shambles due a new war or an economic meltdown in Europe, then technology investment will suffer as well. But as opposed to the bubble days, I don't think technology investment will be the cause for such a down-swing. I think we have matured since the bubble and the fact that it was so traumatic (we're still discussing it aren't we?) also helps preventing it from re-occurring.
One of the reasons it is different this time, but still a bubble, is that there is tons of cheap money flowing around the globe, and sophisticated investors are desperately looking for returns. Hedge funds have had big outflows in the last 3 years. That (risk-seeking)money has to slosh somewhere. The total size of the hedge fund world is larger than in 1999-2000.
Also, the concentration of advertising dollars that flows through a few key companies - Facebook, Google, Microsoft, etc., is significant. Ad spending basically drives this whole thing from the revenue side. In 1999 there was less of this money in absolute terms and also the ad and marketing folks had not yet learned how to target ads to users online.
So ads + Quantitative Easing (hope I am not getting too fast and loose here but this is shorthand) means that worthless companies like Instagram can seem strategic to ad delivery platforms like Facebook. And there is so much extra risk capital chasing deals that $1B is nothing to throw away.
PG has been in the right place at the right time, but just because he and his partners do things differently in their business does not mean that the macro picture is not the most important factor.
edit - we have not matured we have just gotten better at online advertising and marketing. But that is arguably a great efficiency for the post-industrial service economy.
it's not entirely the same. while there are echoes, the few companies that are hitting the open market via IPO are not getting massively inflated stock prices. it'll be interesting to see how this little bubble bursts.
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? ;)
Don't base your plans on the funding market. Good startups can raise money in bad times (Airbnb raised its first round at the low point of the stock market in 2009) and bad startups can't raise money even in good times. So start a good company when you're ready to, and treat fundraising as a matter of secondary importance.
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.
I've never hired anyone, so I can't offer much insight here. It sounds like Canada has less immigration issues than the US, but I imagine most startups aren't going to be paying for employees to relocate internationally so that's probably a moot point.
Yes, Tarsnap is bootstrapped. Yes, I would have considered staying in Vancouver even if I needed to take funding; obviously I can't offer a subjunctive forecast for how that would have gone, but I've had no shortage of angel investors and seed-round VCs emailing to ask if I'm looking for funding.
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.
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".
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.
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.
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.
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.
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.
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.
Assuming you're right, presumably if the person you were replying to knew about companies in the storage market, they wouldn't be asking that question. So it might be more helpful to list some of the companies you're thinking of: EMC? Basho? Dropbox?
That resonates deeply with me, and I've been struggling to put across all of that when all I hear from peers is the intention to flip or IPO and on the importance of grabbing as much money as possible whenever possible.
Not to say YC isn't the answer. There's certainly many good reasons to do YC or something similar (the two biggest being the people/network and the atmosphere/environment - from what YC alumni have said), but I would say that unless your business needs the money... try and do without it.
Sure, but it's not either/or. My last company was very profitable but is not going to IPO any time soon or get bought for a crazy valuation. However, I cashed out enough to fund my current company. I don't have millions in the bank, but I have enough to give me a 2 year runway and still live a comfortable lifestyle.
"Go for broke" companies usually end up just broke. But if you can build a profitable business that finances future endeavors. Last year I had an epiphany that I'll be working in small tech startups for the rest of my life, and that I will enjoy it very much so long as the bills are paid.
If I could repeat the last five years 4-5 more times I'll be very happy, even if not a jillionaire.