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Comment by einarvollset | Hacker News Reader

Skipping over the comment about how we don't understand startup investing.. :)

On pt 2: there is no mandatory monthly payments, and we don't really control founder comp. What we're trying to do (which relates to the point I skipped over above) is attempting to come up with a structure where a founder can build a profitable business doing 7 or 8 figures while the investors get "suitably" risk adjusted compensated for that success.

Whether you think our valuations "suck" or not, we have spent a lot of time thinking about what we can do to build out a novel ecosystem that can provide fertile ground for these kinds of businesses. What we don't think works is simply say "hey, you know what this is a hits business, so forget about valuations and just give them a SAFE".

If you had a business that wanted to raise financing but was honest about the fact that the founder did not thing they were going to become GitHub you'd know what I meant :)

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As someone who applied, and is producing hardware, everything is stacked against me from the beginning it feels. I have a business that need pretty much exactly what tinyseed offers, but beyond that it would only need external funding to stay running in a scorched-earth situation. We could crank out a few million in profit a year without burning ourselves out in the process, but a few million a year is "chump change" these days. As it stands, I am running the risk of personally running out of money before the product is at risk, as our operating costs are essentially zero, but the operating costs of my kids are not. The combination of these things somehow makes a matured, tested, and in-use life safety platform not as exciting to investors as it would seem to people outside the startup world. I mean hey, I'm trying to keep people from losing their lives, if I were making the next business-class notepad replacement I'd have 2 million dollars and a 300k monthly cloud burn-rate.

Thanks for the reply. I hope you appreciate some critical feedback that comes from a good place. Helping early stage startups is a great thing.

But the entire point of startups being hit-based is that not even the founders themselves know how big they could get. The founders of Atlassian and GitHub could not possibly have known. Their opinion at the beginning was totally useless. They very well might've said "We'll never be as big as X" with total honesty.

So it's not a matter of "honesty" at all. Businesses and people evolve. Ambitions grow. Even Mark Zuckerberg had absolutely no idea how big Facebook would become.

This is a counter-intuitive fact of startups that seems hard to internalize, but it's the very nature of such highly scalable companies.

It doesn't require that you "forget about valuations". You can absolutely try to get returns on your average outcomes, in total they should be significant. But it just takes a single 1000x return to dwarf them all, and now your big hit is all that really mattered financially.

I think the 15% valuation sucks and the 8% valuation is high but reasonable. As a founder I would not want to give up more than 8% but I wouldn't want to come across as a hardass either, which is an awkward spot to be placed.

Good luck!

Thank you, but I think your assumption that the only thing that matters is finding 1000x returns is wrong. If you look at VC returns at scale and over time, what's considered acceptable returns are lower than you might expect (12% IRR).

If you're funding people at $2m valuation without customers and with a SAFE, then yes the only way to get there is with the hits. We are betting that's not the only way, but it does mean we cannot compete in the valuation olympics.

(I find this topic interesting to talk about and I don't mean to make this a huge criticism of what you're doing. I think it's great any time someone in a position to help early stage startups does so.)

I'm definitely not saying that 1000x returns are all that matters, just that they're an inescapable reality.

My understanding is based on what I believe are three facts:

1. A given startup's financial returns can range from 0x to 1000x or more due to the uniquely-high scalability of tech startups.

2. It's impossible to predict how big any particular startup's returns will be (i.e. not even the founders or investors can know).

3. Some very small percentage of any (sufficiently large) startup portfolio will return huge multiples unless you do something incredibly backwards.

I'd imagine that YC generates much more than 12% IRR even excluding their hits. But what makes them so incredibly profitable is their hits. And because of their understanding that the hits are what makes them so profitable, they can rationally afford to be very generous towards all of their startups, which makes great startups want to apply, creating a virtuous cycle.

Creating a firm that tries to be YC-without-the-hits seems totally fine, except if you still end up with huge hits, because then you're just YC with much less founder-friendly terms. It may feel like the conservative and safe approach but it could also be the riskiest possible path, by serving to filter out the best startups.

There's a huge market opportunity for YC competitors that are remote but operate on the same terms. And when someone does this, they'll be first choice for all of the best startups, just like YC is. And it seems smart to compete with what's possible rather than with what currently exists.

"I'd imagine that YC generates much more than 12% IRR even excluding their hits. "

What makes you think so? 12% IRR is 3x capital in 10 years. YC terms are $120k for a SAFE * 256 companies/year = $30m/year. 10x is $300m return per cohort.

Assuming we remove the unicorns, and that 50% die, that's 127 companies (half dead, one unicorn). Assuming again that the non-dead raise subsequent funding over various rounds, diluting YC's original stake down to (say) 4%, then all the 127 remaining companies would need to sell for an average $60m to beat a 12% IRR. Given how many exits are actually zero investor return acqui-hires then I think that's unlikely.

" then you're just YC with much less founder-friendly terms."

I don't think so, because nobody who applies to YC is going to be able to get any funding what so ever if they argue that they want to become a $20m ARR vertical SaaS business. So I guess it boils down to whether you think it's more founder friendly to say "no" than it is to offer our terms.

YC has pro rata rights, so maybe that 4% is low? Regardless, I concede that it's entirely possible many (or all) of the YC batches are unprofitable without the hits. It's an interesting question.

I just think the entire concept of asking founders how big their companies could be doesn't make much sense. If Drew Houston predicted that he would be willing to sell Dropbox for $1 million in six months, and the Google Guys wanted to sell Google for a few million to Yahoo, YC had zero idea how big Airbnb would be, etc. what exactly is the point?

My understanding is that YC asks the question "How big could your company become?" but discounts the answer very heavily because of how hard it is to predict at the earliest stages. Almost any startup can give an answer about how they could conceivably be huge. Anyone trying to build a $20 million ARR SaaS company has a very easy answer.

It seems obvious that a founder with nothing would love to have a nice $20 million ARR business. It also seems obvious that when they achieve that level of success their ambitions will often grow, as happened with Dropbox, Facebook, Google, Stripe, and virtually every other hit startup ever.

I do think there's a good point about focusing on sustainable growth, and "not growth at all costs" but this just seems like what all the best founders and VCs actually practice, so it boils down to "don't be stupid".

So if I may - your assertions are:

A) There is nothing wrong with how funding currently operates in the tech space. It allocates resources optimally in terms of risk adjusted returns for investors and there is no room to try alternate approaches.

B) There is no way to assertain what the potential size of a business is, anything could become Dropbox (including - I dunno, a SaaS focused on kitchen countertop installers)

C) The only way to provide suitable risk adjusted returns for investors is the current approach (focusing on finding unicorn outliers that can scale to 1000x)

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