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.
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.
In my opinion, this is precisely what makes the business so frothy. I don't really believe that YC backed companies are significantly (certainly not twice) more likely to succeed.
The whole incubator thing could be the best or worst thing to happen to to Valley; we just don't know yet.
Investors are not just counting on the fact that YC makes a company more successful- they also know YC filters for startups that are already more likely to succeed.
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.
Obviously they try to select the top startups, but as smart as they are, it's hard to believe that there is zero error in their selections.
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.
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.
I wish we could claim that. But YC's brand is not that powerful. There are still startups that present at Demo Day and aren't able to raise money.
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.
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.
"OMERS Ventures, a $180-million fund established by the Ontario Municipal Employees Retirement System last fall, said Thursday it has picked HootSuite Media Inc. as its first major funding recipient."
Disclaimer - I work for one of OMERS other (earlier) investments. I guess we're just not "major" :P
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.
every asset class has a benchmark asset, and you measure the return against it.
the issue is that i don't know what asset class funds would place VC investments in. they could (but i doubt) benchmark against treasuries or whatever.
iirc a sufficiently good vc return is 3x over the life of the fund, which translates to an IRR of maybe 20%.
What do you mean by "high beta"? LPs are looking for uncorrelated returns. If you want high beta you could just make leveraged investments in an index.
For the rest: beta is defined as correlation to the market. Sigma is standard deviation of returns and also called risk.
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 still remember laughing in the year before the dot com bubble burst when I'd hear all the "this time is different" talk about how Internet companies didn't need to make a profit.
- 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.
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.
I'm still waiting for salaries to catch up tho.
A CEO with net profits of 10 mil/year is going to be a lot less stingy than a founder with 15 mil in funding.
I hear that at this stage, the way to make money is to do hourly consulting at a high rate. That comes with its own issues, but if cash is your motivation, it is your best bet.
There is a wide area in between "good" and "bad". And those startups would no question have an easier time in a frothy market and a harder pitch in bad times.
This isn't an observation on how startups get funded. It is an observation based on years of selling things to people and the ease of doing so when things are on the way up as opposed to the way down.
(As an example, right now, domain name valuations are up and I"m closing as many deals (on behalf of clients and others) that I can knowing it can change.)
I'm also curious to know if a startup's burn rate would be lower in Canada than in the bay area.
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.
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.
After a friends and family or Angel round, is their any connection between the investment and the people who stand to lose money?
Sequoia sometimes uses that most of their LPs are charitable foundations, schools, etc. as a marketing tactic, but it's Sequoia, so people probably make their decision based on it being Sequoia.
Some of the super-angel type funds do -- I know Founder Collective emphasizes that their partners are mainly entrepreneurs. It's a Boston/NYC fund -- Chris Dixon and some other people.
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.
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.
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.
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.
VC will think twice about investing in copy-cat startups that are on legally shaky ground.
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.
I read this last month and it also resonated with me: http://bryce.vc/post/17396972172/rise-of-the-independents
I know what company I run: it's an indie company, currently ramen profitable after a few months full-time and probably with an unconventional path in front of us.
"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.