Abundant Capital
blog.aaronkharris.com
blog.aaronkharris.com
I wonder if the abundance of capital is not evenly distributed through the startup lifecycle, but more heavily-weighted towards later stages.
Anecdotally, I've heard from founders that SEED rounds are getting harder despite all the frothiness. Even back when we did our seed rounds ~2015, we already heard "today's seed round is yesterday's Series A" in terms of $ size but also minimum bar of progress. And these days it seems that is EVEN MORE true. It's also true it's easier to start a SaaS company than ever before. But it's ALSO ALSO true that there is less and less SaaS greenspace. Hmmmm.
That said, it is also uncommon for me to see startup employees which previously worked for FAANGs (you do see founders).
unsuccessful or not yet successful startup | working at a big company | successful startup
(I'd rather not work for a startup because the middle bracket looks fine to me).
If people are working for that startup lottery ticket and then not getting the full reward when it comes up a winner, they are just getting screwed. Which is a possibility but not very mysterious, right?
As a faang employee, it just looks like the startup space is completely uninterested in trying to hire me.
Paid by who and in what case? If the company IPOs or buys back a sizeable chunk of stock as part of fundraising or acquisition, employees with options do just fine. Employees are paid when they choose to sell.
If the company liquidates that's obviously a bad deal for employees, but it's a bad deal for everyone involved.
In some sense, working for a tech startup is like working for FAANG and spending part of your salary on buying 10 year call options on random other private tech companies (if that were possible without having VC-tier wealth). Lost sleep is a founder issue.
You need to read up on preferred stock vs. common stock, and the shenanigans that startups can do in order to reduce employee payouts, e.g. stock dilution.
Dilution can happen regardless of any preferred stock agreement. The biggest sources are when top leadership exercise huge options packages or when the company issues new stock for sale. If you buy stock or call options you are subject to dilution on the public market too. Under dilution, any investors that negotiated an anti-dilution clause on their preferred stock are the winners, everyone else loses. It's stacked but it doesn't break the game completely.
There's a pretty good chance of failure of this strategy. I've stuck around my company for almost 10 years to hit my FI target, and the first 2 years I didn't get equity by default as an intern. The opportunity cost is potentially huge. However, as an individual there's no way I would have been able to invest at this company at the time I got options. The job has been pretty nice in the mean time. FAANG also would have returned extremely well in that time, but more like 10x not 100x.
Is this an efficient strategy on the risk-reward frontier? I don't know. But sometimes the outcome works out very well. Unfairness in the system is there but not so different than owning any random stock. Fiduciary duty exists.
Diversification is also important, though, and is really the biggest problem with startup employee equity: your job is also your lottery ticket, and you lose both at once if/when the company fails. Dilution and preferred stock deals just make it worse.
There are, of course, other reasons to do work than money. But what charity would you give $50k/year to?
Yes, some blind luck is needed to win at this game. However, the job market has been such that a solid programmer can get something lined up pretty quickly if their current job fails. I don't think the risk is as bad as people portray. Again, picture buying long term call options for a single stock with a proportion of income each year. Somewhat risky, but risk is capped and the payoff could be quite big. More diversification is almost definitely more efficient but carries less tail upside.
By "unfairness" I don't mean risk, I just mean unfairness.
I agree that job loss probably isn't all that bad... (Unless it lines up with a wave of companies closing, which is known to happen from time to time.)
I can also just save + diversify /more/ with faang salary and equity than I could at a startup. The $50k/year is a lower bound on what I expect the pay cut to be in moving to a startup. So from where I sit, there's really no financial argument for moving to a startup. The startup has rather lower pay, some probability of payout multiplied by a value that I just kinda expect will be chipped away by the suits, and some probability of a bad outcome (with some bounded range of potential badness). I look at it and just think it's not interesting unless I get really, really bored.
Joining a company that's relatively close to IPO is an interesting middle area.
If you’ve got e.g. $300M to deploy, you really don’t want to be doing less than $5-10M a pop. Seed rounds (even these new big ones) are too small. If you do put $5M in, now you’ve now got to lead. Ugh, more work.
Easier to just plow $50M a pop into a few series Ds led by others.
Let's say you invest $300mil into 30 seed bets, with each bet having a 10% chance of returning a 10x, 15% returning a 3x, and 85% of going to zero. But when you invest that same amount into 6 series D bets, each bet might have a 50% chance of returning 2x, 30% chance of going to zero, and 20% chance of going 3-4x. If you do the math to calculate the average expected payout using these numbers, you will get an expected average payout higher for the latter scenario. And assuming each bet is completely independent from another, it seems like a pretty solid hedge.
Numbers are obviously made-up for illustrative purposes and are not the source of truth, but it shows a pretty good hypothetical situation when doing 6 bets is safer than 30 bets (given you have the same amount of money to spend on those bets). But, I think, it is fairly commonly agreed on that a Series D startup is way less likely to go to zero than a seed stage one, thus making a singular bet on a Series D startup much safer (but also less profitable in case of a success). Given many enough of those bets, the risk becomes pretty manageable and, imo, less risky than seed stage investing. I am not trying to say that what I am describing is the case, I am trying to say that it is a realistically possible case.
Saying this as someone with no experience with that model whatsoever, so anyone is welcome to correct me if there is something glaringly wrong or missing in my assessment of this.
My estimate, admittedly not looking at data right now, would be that a Series D company is roughly 100x more likely to succeed than a seed stage company.
But then again your returns could easily be less than 100%, whereas with seed you can literally get a 100x ROI (this actually happened for Uber).
The most important thing here though is, that it's very likely that some of those investments will eventually yield big returns that you would like to share with your team. As that becomes a reality, your investment becomes your team's. You could then use those returns on another team as a way to further leverage their collective capital (e.g. to fund their employee hiring efforts by paying them) and they could then use their own capital as their own way to increase their employee morale (e.g. by creating a startup, selling it to a VC), without being obligated to be on the team's side.
This sort of model will likely be extremely attractive to founders to use, but it's still likely a very conservative way of approaching building a team in these types of models. This is something you can see in a lot of other sectors of the industry and it's something I have not witnessed here with the exception of maybe the big VC's. Also, as a company grows and its employees get larger, you may simply become an important part of the team and have less room to invest in your own capital as they grow. This is a fairly common phenomenon in tech circles right now in general but it's not something you might see in the tech industry with a lot of companies in general.
Not only are their preferential shares (which people should know about), but in some cases the investment seems to have been ways of moving and/or washing money.
Things like Chinese investment via investment funds and Saudi money via the vision fund and others can be seen as ways to move from illiquid assets to liquid holdings and these investors are prepared to lose money in that transaction.
Note that while interest rates are fairly low (especially for short term <5 yr debt), the yield on a 10 year US treasury, which is often used as a benchmark, has been consistently increasing for about 6 months and is ~50% higher than it was at the beginning of the year: https://fred.stlouisfed.org/series/DGS10/
This path to success is becoming the norm, but it happens quietly because “guy leaves director-level role at a global bank to build a billion dollar fintech startup” isn’t as appealing of a story to the media. This kind of founder is much less of a risk in many ways than a younger one, but while the founder may be willing to live off savings for a year or two, the talent they would need to surround themselves with is also more experienced, with domain knowledge themselves. So why bother with a $500k seed round when it’s going to take $5M at a minimum to take a real crack at it? Now that we’re out of the “SaaS all the things” phase of this economy, you can’t just throw a bunch of overachieving 20 year olds at every problem.
The issue is how a speculative cash-flow is priced relative to the risk free cash-flow - what is the discount demanded of a speculative venture?
This discount, which is not the risk discount, but rather a measure of how risk is estimated, goes through secular swings:
As investments are seen to pay off, investors update their priors and view similar investments as less risky relative to the previous pricing. In a bust, people are convinced many of the same investments wont pay off and become more skeptical of ventures.
So I don't see this as a function of low rates so much as higher levels of confidence and optimism. That's all this is -- confidence and optimism, not scarcity or abundance of capital.
If this analysis is true, then the current climate will flip back once there is a high profile series of busts, rather than once rates are raised. But as raising rates tends to slow down the economy, rising rates may be the trigger that creates the busts, but it's not the only possible trigger.
Therefore, although I believe we are in a secular period of low rates, I don't believe we are in secular period of easy venture funding or "abundant capital". Note that one example would be Japan, where venture funding is historically hard to obtain as investors are much more conservative even though they have had a period of low rates for quite a while. This is because a risk free rate change from 1% to 2% isn't going to make a whole lot of difference to the discount demanded for a bet that has maybe a 50% chance to pay off. Updates of your assessment of risk are going to dominate the pricing of the venture's cashflow.
So probably something long lived.
If you invest 10 million in my business and I use it to buy 10 million worth of 30-year treasury bonds, how exactly is this capital “seeking new investments”?
Σ(capital available) > Σ(investment opportunities)
You can see it in rising angel valuations, rising early-stage VC valuations, rising later-stage VC valuations, rising growth-equity valuations, rising leveraged buyout valuations, rising stock market valuations, rising cryptocurrency prices, rising home prices, etc. Feeding frenzies and bidding wars for high quality assets have become more and more common. Asset prices keep going up and up and up...
The multi-trillion-dollar question:
Is this sustainable?
In this case, the imbalance has existed for years and is getting more pronounced. My thoughts here are based on that dynamic. If this changes, then I'd likely change the advice.
It's not entirely unlike mortgage rates, tbh; when you refi matters, due to the rates being variable. When you raise also matters, but sometimes raising is the important part, and the terms are the terms.
Right now all three of those are true, to varying degrees. If you correctly called the top in 2007 and got out of the market, it wouldn't matter unless you got back in before 2012. As someone who lived through those years - at every point during that period, there was a loud chorus of voices saying that we were about to have a double-dip, prices didn't really correct far enough, and fair value indicated they should've gone back to where they were in 2002-2004.
Remember that if you're in cash, you've chosen to put your wealth in an asset class whose controlling authority's stated policy is to make it worth consistently less every year.
a) "epistemic arrogance" -- you believe you're smarter and know more than everyone else;
b) "heads, you might win, tails, everyone loses anyway" -- so you might as well gamble on heads;
c) "f*ck it, load up!"
And there's also d):
d) "wait it out" -- if you're already rich and infinitely patient, like Mr. Buffett. Maybe find a hobby to occupy your brain -- e.g., play Bridge online.
No, more like you decide to be less greedy than everyone else. You choose to leave money on the table in favor of getting out early.
If you think things are overvalued, there are two ways for it to go:
- the value of equities crashes in nominal terms and consumer prices are stable
- the value of the dollar itself declines, so that the nominal values of equities stay the same but consumer prices inflate to make the real value of equities revert to the norm
It’s probably a mix of a and b, but outcomes that tilt more heavily towards the latter would hurt people holding cash more. And right now b is closer to official Fed policy, since it would prefer that to getting into a Japanese deflation trap.
We might as well consider VTI to be better than FDIC insured on a 5+ year timeframe. FDIC only protects nominal values. The Fed can protect real values.
a) They were getting out before the top, they'd sell to some other poor fool when it was time
b) The world had changed completely and it was a new paradigm (it's different this time!)
It's wise to avoid cash in the long term, but it's unwise to avoid it completely, and certainly when you sense things are getting a little crazy, it is not at all unwise to shift some of your holdings to cash, though you'll be mocked for it by many, for whom risk is a distant prospect which happens to some other poor sucker.
So depending on what the central bank will do, cash might be good or not.
An asset that isn't used as a medium of exchange does not have the characteristic of inflation. An asset can have an inflated price (in a currency) but the asset itself (in this case copper) cannot have inflation if its not used as a medium of exchange. The distinction is important.
https://www.cnn.com/business/markets/commodities/
Crude oil, natural gas, silver, corn, wheat, lumber, all up 2-3x since the bottom in April. In many cases (i.e. everything not oil-related), this is not just recovery from a dip: prices are significantly higher than 2017-2020 levels.
That said, I don't buy the conventional Wall Street narrative that this means the Fed'll raise rates and we'll get a stock market crash. Or rather, I believe that'll happen, but it'll be too late and the currency will have devalued 10x or more by then. The Fed has pledged to keep rates low through 2023, and to allow inflation to overshoot the 2% target to make up for the last decade of ~1.5% inflation rates, and that any rate movements will be "well telegraphed" for a long period of time beforehand. They still have tens of millions of people out of work. I doubt they'll act until it shows up in headline CPIs for a year or two.
Once inflation rates really get going, it's hard to tamp them down. The Fed has a pretty fun (and quite educational) game where you get to play the Fed chair:
https://www.sffed-education.org/chairthefed/default
Try playing one of the inflationary scenarios (they're random, but just keep playing till you get one with a tight labor market rather than a housing crash or recession). If you don't raise rates early and often, you quickly get into a situation where inflation is 7-8% and you have to hike rates to 15% or more to tamp it down. Why? Because inflationary expectations are subtracted from the nominal interest rate to get to the real interest rate. If inflation is high, you have to hike nominal rates even higher to get real rates to go up at all, and you have to hike real rates pretty high to make a meaningful dent in the money supply.
Im curious why you think inflation in the US is going to go from <2%, not to 3, or 5, or 10%, but to 1000%?
The basic money equation from macro-econ 101 is MV = PQ: money supply * velocity of money = average price level * quantity of goods sold. Under normal conditions, V is assumed to be constant, and so you either increase the money supply to keep up with greater economic output (M ∝ Q) or if you increase it too fast, you get inflation (M ∝ P). This is "ordinary" inflation: it's predictable, controllable by the central bank, and follows roughly linear equations.
When people notice and then start to assume inflation, their behavior changes. If you know that your dollars are going to be worth 20% less next year, you have an incentive to get rid of your dollars as quickly as possible. You'll spend them as soon as you get them, because they'll quickly become worthless otherwise. This shows up as an increase in V, and it means that even holding the money supply constant, you still get inflation (V ∝ P). Moreover, because the cause of the increased price level was increased velocity of money, this feedback loop becomes self-reinforcing: the higher prices go, the quicker people want to get rid of their money and turn them into hard goods. At this point the central bank has lost control of the economy, and you have hyperinflation.
Looking at data on a few dozen instances of hyperinflation, the threshold seems to be ~20% inflation annually. Below this, consumers write off inflation as annoying but don't change their behavior significantly. Above it, hyperinflation seems inevitable: there are very few instances of sustained inflation above 20%/year where the government has later managed to bring it down, and it usually ends with hyperinflation, a currency crisis, and the replacement of the currency (and usually government) with a new one.
We've observed price increases > 20% in a number of industries this year: commodities (listed above), housing, food, and labor is getting up there. It hasn't filtered down into CPI numbers because those are averages, and inflation is flat or even negative among some demographics. But prices in fundamental industries tend to bubble up eventually, and if the Fed is focused on bringing back the stagnant parts of the economy while other areas are raising prices at 50-100%/year, inflation will cross that threshold throughout the economy before they can react.
(Incidentally, historical incidents of hyperinflation usually happen in the transition between a command to a market economy, the two most common examples being when wartime gives way to peacetime, and when communism gives way to capitalism. The transition from a pandemic economy to a normal economy has many elements in common with that: there's a large shift in consumer demand while the economy has been optimizing for pandemic production for the last year.)
>(Incidentally, historical incidents of hyperinflation usually happen in the transition between a command to a market economy,
Most command economies simply didn't provide enough production capacity to meet the demand of all citizens.
>the two most common examples being when wartime gives way to peacetime, and when communism gives way to capitalism.
China had massive food shortages that were papered over by price controls. Just because someone fakes the numbers doesn't mean there was food for everyone. By introducing a free market you are merely revealing an existing collapse in production
The Weimar Republik is a classic example of a collapse in production capacity. Germany lost the war, winners destroy factories and there is a lack of working age men because they died in the war. People don't have fond memories of there being food everywhere and some speculating capitalist driving up prices because of greed. No, there were many days where they got three slices of bread per day and a hand sized lump of coal to heat their home.
>The transition from a pandemic economy to a normal economy has many elements in common with that: there's a large shift in consumer demand while the economy has been optimizing for pandemic production for the last year.)
How exactly is that going to result in a food shortage?
It's also interesting to plot all these commodities (as well as cryptocurrencies) in terms of the S&P 500, which is rapidly becoming the true store of value. I think you'll find that their price is relatively constant in those terms, and it's the dollar that's been falling.
IMHO, we're at Greenspan's "irrational exuberance" speech of 1996. If you pulled out of the NASDAQ in 1996, you never made it back. (The nadir of the dot-com bust had the NASDAQ at 1139 in Sept 2002; it was at 1133 in July 1996.) In the meantime you would've missed out on 4x gains in the NASDAQ itself, and up to 100x in certain specific assets.
My indicator for when we're near the top of the bubble and it's time to pull out is that folks like you will drop out of the discussion and start keeping their opinions to themselves. That's when it's time to sell; when you're ridiculed for it.
Perhaps you're right though, and this has a long way to run... I'm afraid I just can't bring myself to invest in things which are overvalued due to FOMO rather than actually making money or having a prospect of making money. Old-fashioned I know.
Re pulling out of NASDAQ, I'm not sure that's a good example. You never made it back implies you lost something. You might have had indifferent returns in other assets, but not a loss. If you invested in 1999 on the other hand, you made a loss till 2013, over 10 years later, after another bubble burst. To me it is more important to avoid risk of extreme loss than attempt to chase extreme gains.
The Shiller book on Irrational Exuberance is better than the Greenspan movie IMO ;)
I am guessing we will see cash devalue roughly 2x in the next five years. As a result, there's a scramble where to put money safely.
If the alternative -- cash -- loses half of its value once COVID19 financial measures start unwinding, all of a sudden, investments just need a 50% ROI to be profitable. If I dump a million dollars into a startup, and it sells for the equivalent of $500k in five years ($1M after inflation), I've come out neutral.
I wrote that badly, didn't I? Let me rephrase that more clearly: Let's say I expect 100% inflation over the next 5 years.
I can buy an investment which will lose 50% of its real value over that time. I come out neutral compared to holding cash.
In dollars: I buy today at a nominal value of $1 million, and sell at $1 million. Same as cash.
In value: I buy today at a real value of $1 million. I sell at a real value of $500k in 2020 dollars.
I can buy into investments whose real value is falling, and still come out ahead in inflationary times. Value-losing startups suddenly become okay investments since they lose less value than dollars.
Both due to COVID19 and government debt generally, I think we're heading for high inflation.... People are looking for assets to put money into. Real values can go going down, while nominal (dollar) values can be going up.
https://en.wikipedia.org/wiki/Real_versus_nominal_value_(eco...
Selling at $2 million would mean I didn't lose value, but I'm not sure people are finding alternative investments which won't lose value; it's why people are grabbing bitcoin, and stocks are hot.
How can money which can't be spent hold value?
Think about it. The fed gives a bank money, the bank gives money to you so you can build a house and then the city denies you the construction permit. You decide to just buy an existing house instead.
No but society has basically locked us all into it. I made a previous comment on why devaluing the currency causes a worldwide game theory of economic actors protecting their purchasing power to counteract it: https://news.ycombinator.com/item?id=15728480
Can we reconfigure society? It doesn't seem like it. Some critics today think that Bitcoin's limit of 21 million to support its philosophy against inflation is wrong.
Hey, maybe it isn't society that wants inflation but it's the US Govt and/or The Fed Reserve forcing it on us. Well, surveys say the majority of Americans want $2000 stimulus checks so that money has to come from somewhere. It's easier for politicians to print new money rather than sell Yellowstone Park to China for a few trillion dollars.
printing money out of thin air, vs borrowing money (via gov't bonds) are different things. I believe the US borrowed this money for the stimulus cheques.
Borrowed from taxpayers. The instrument is an AOT tax deduction/rebate for the 2021 tax year. "We know you are going to pay your taxes, you can have some of it back right now".
I'm not saying I'm against government regulation. I certainly am not. At all. I'd like to see some way to control inflation and the monetary system for good. But I'm against it getting too out of control in the first place. That's in my own interests. Maybe I'm wrong on that. I don't mind inflation. When it's controlled I want it to decrease, because, as I've said in other posts, more economic growth creates less government interference and I think that's what we want for Bitcoin. But I don't want anything that gets too out of control to stop the currency from appreciating. When it's artificially forced onto the market I'd like to see it to decline and be replaced with something, maybe a currency with a higher cap or something.
It's all up to us, the Bitcoin community. You choose to participate in the process or you don't.
It also may take a longer time frame for the improved productivity to manifest than it does for the economic metrics to reflect it. Meaning that one thing to watch out for is that the capital abundance may recede before the investments are able to return the productivity - and that would be tragic because there are an abundance of neglected investment areas which we as a society and an economy can realize benefits. To the extent that our capital investment allocation paths don't match societal needs is the real challenge with this bubble.
https://www.investopedia.com/ask/answers/072815/what-margina...
The net effect is that consumption (and associated demand) is suppressed at the lower to middle end of the income scale, where individuals' income isn't enough to sustain their needs + wants. When these individuals spend, the demand for labor + raw materials per $ spent is high, because they are often buying consumables or durables (food, washing machines, etc).
At the high end of the income/wealth distribution, there are few needs that aren't met or exceeded, so their wealth ends up chasing assets and investments that induce far less demand for labor per $ invested. A the extreme end of this are private equity funds (billions managed by a small number of people).
which is how new jobs are created - from this mechanism of investment (and acceptable returns from it). The problem is whether these jobs produce value in the future, at a greater rate than the returns being expected by the owners. If the excess returns are all captured by the owners, society wouldn't have progressed forward. But if these jobs brought more value than just the ROI, then it's a good outcome.
So anyway, you have this massive influx of savings flowing into the system, buying up investable assets to save for retirement, and thus bidding up prices. They call this the "global savings glut." There are OLG (overlapping generation) models that show how this behavior works in a simplified setting; you can easily get over-saving, dynamic inefficiency, and "rational bubbles" as an outcome in an OLG model with different demographic curves.
Like - if you think there's too much capital compared to X - couldn't capital just be worth less or X be worth more?
I know Aaron isn't saying that the investors don't matter.
But when I think about why VCs hate going through an auction-like process, at least part of it is human nature. Like, we're about to work together for a long time. Let's not start off by commoditizing what we each bring to the table. I understand the POV that 99.999% of what VCs bring to the table is the literal commodity of cash... but if you have good ones, they really can help.
In our case, we had multiple term sheets for our Series A so I was able to optimize terms and get the partner/fund who I thought would add the most value but at "market" on the other terms. "Market" being what was on the other term sheets. That seemed to work OK as a softer way of actually doing the auction.
The real point in all of this is that if the VC's value-add is true, then you shouldn't NEED to discount things because of that. If it's real, then they should be happy to pay 'market rate' to invest in you, and the impact of their other value will be that together you build a better business, which is more valuable to them too.
Also, that you had multiple term sheets means you... ran an auction. It's wonderful that most of the terms were similar, but getting multiple term sheets is effectively generating a bidding war. You don't have to pick the one that is monetarily best (we didn't, because we preferred the partners), but that's why you're doing. :)
My process had elements of an auction - using competing options to determine "a market price" for various terms. BTW - the VCs also had that, in that they could have put that same capital to work in other companies vs mine.
But that's not a pure auction. i.e. there's still room for qualitative choice and optimization on both sides. This should be most obvious to you in the non-monetary terms and how difficult it would be to translate into $ terms (for instance - how many seats on the board? How much lower/higher of price makes sense for more/fewer board seats? Well, for starters, it would depend on which VC is asking and what stage the biz is in). Clearly these aren't pure auctions.
Because (back to my original point) this is possibly a 10+ year partnership you're getting into (longer than many marriages).
A good process is more equivalent to (1) speed dating, which leads to (2) a handful of non-exclusive longer dates, (3) a period of exclusivity (no-shop) and 'meeting the family' (diligence), and then possibly, finally, (4) marriage.
The startup ecosystem in Brazil is probably in a time lag and perhaps this is why my experience might not be as insightful here. Still, I agree with your comment 100%. The majority of our early investors held some relevant experience in our field or offered tangibly valuable networking opportunities.
In fact, I think that the abundance of venture capital has the effect of flooding the ecosystem with "regular-value investors" (those that only have cash to contribute with), so these "extra-value investors" that actually partner with you are harder to find. And taking the authors suggestion of intentionally starting a bidding war further exacerbates the problem.
Instead of finding someone with experience and maturity in the field you're going to venture into, it increases the odds of picking investors that don't really know much exactly because they won't realize the bid was getting too high. By design you're trading knowledge for higher expectations.
It would seem that all this "easy money" is simply flowing to the places where it has always flowed before, but in larger quantities. The same big money chasing a small number of deals, just with deeper pockets and more gusto to participate in an auction if need be.
Honestly, has it really gotten any easier for the typical startup?
If something about your seed-stage startup is stopping you from getting into YC, then I would ask myself if I might be doing something wrong. This is coming from someone who went through YC with one startup and also got rejected in another instance. While YC does make mistakes, in my case they were spot on.
Please know that I am not discouraging you from pursuing whatever it is that you're working on - every early-stage founder has a special place in my heart. Just realize that your time on this planet is limited, and there truly is so much opportunity out there. Spend your time wisely.
That means the signal isn’t there, even though the company is just as good as one that did enter YC.
That was never up for debate. The real question is would those great teams have raised at better terms and from higher quality investors if they went through YC (obviously also accounting for the 7% YC tax)? From what I can tell by looking at the YC valuations, the answer is a no with one caveat: if they had a previous exit, their previous investors will give them a sweet deal with or without YC.
> It’s kinda known for pumping out low quality startups anyway. Most YC companies are not Dropbox.
It would be nice to see how you arrived at this conclusion. The YC portfolio is valued at over $300B [0], so I would say the investment community certainly disagrees with you (with or without Dropbox). In fact, that 300B figure was published before Stripe and Coinbase announced their IPO pricing, which has now likely added another $50B or so to the bottom line.
> It would be nice to see how you arrived at this conclusion.
Demo days.
If a great team is skipping YC, it's safe to assume they know what they are doing.
You said "just like every other VC." So, if it's a global phenomenon that's true in every segment of the VC landscape, why bring it up as an argument against YC? This entire thread is about venture capital, so I doubt you're trying to make a point about bootstrapping or something along those lines.
I think what you're trying to say is that getting into YC is not a guarantee for success, but nobody ever claimed that. The odds are stacked against you either way, but the YC cohort's odds are way better than those of comparable startups that either didn't get admitted or never even applied to YC. If you want to debate this point, then let's see a substantive argument. Here's mine: YC's estimated IRR is 155% [0] (and this is an outdated number that doesn't include the recent IPOs). In comparison, the top ‘quartile’ of funds since Web 1.0 have returned about 20% IRR [1].
> Demo days.
I can't really do much with this response, but thank you nonetheless.
For everyone else, if you're contemplating applying to YC, I would refer you to one of the many discussions on HN where people presented actual math on when YC pays off and when it doesn't. For example, in this thread [2], the top comment links to a spreadsheet [3] that says if you want to raise $1m without YC, you should be able to get a seed valuation of $6.5m or higher, otherwise it's less dilutive to go through YC. Naturally, if you want to raise a higher amount, the threshold gets higher (eg: for $3m, the crossover valuation is $9m). Not to mention other value-added benefits, such as access to the Series A program, thousands of potential customers, etc.
[0] https://www.quora.com/What-is-Y-Combinators-IRR-or-estimated...
[1] https://www.quora.com/What-is-the-average-IRR-achieved-by-ve...
[2] https://news.ycombinator.com/item?id=24616649
[3] https://docs.google.com/spreadsheets/d/1kxOBF0CPhcktmgFvAZtY...
If you can get into YC then you can raise from any number of firms on equal footing.
Edit: for context, the comment I responded to was originally linking to the S20 batch and implied that the companies are weak.
We take all companies indexed on AngelList and isolate for those started in 2021. Then we separate them into YC and non-YC cohorts. In January of 2026, we will see which cohort has a higher rate of shut downs.
Deal?
Let's compare the experience of YC vs non-YC.
YC: you submit an application with about 30 inputs. One of them has to deal with traction, and it's clearly a very important one. If that's not looking good, you have 29 ways to make up for it. It's not easy, but every batch has startups that had 0 traction when they were admitted, so clearly it's possible. At the end of the day, you're guaranteed that a group of people will read your application and will discuss it internally.
Non-YC: to make an apples-to-apples comparison, I'll assume you have no prior relationship with the VC you're trying to reach. So you'll need an intro, which is nothing else but someone else taking on the burden of vouching for you. So someone at some point needs to believe that you're onto something. But if you don't know anyone, how do you get to that point, especially if you have no traction? Good luck with cold emails in that case!
> If you don’t already ... know a bunch of VCs, you won’t be raising money.
True for VCs, not true for YC. Just look at all the startups from India and Africa that got into YC and are killing it. You think they were super well-connected with the YC network when they applied?
If you have great relationships with VCs, YC or any other VC will invest in you.
You seem to be trying to make the case that YC offers some sort of unique lift to that of other firms and I don't agree, they gate on the same criteria as everyone else.
I find it comical that the VC community thinks it is diverisifying its entrepreneurship base by backing the same network of people that moved from San Francisco to Austin or New York.
The truth of the matter is that capital might indeed be abundant, but it is going into much the same places it always has. The concentration of wealth and opportunity continues unabated.
I challenge VCs with all this extra money sloshing around to rethink the path to sustainable entrepreneurship. If this was the late 1800s, the money would all be flowing into steel mills in Pittsburgh and the emerging oil barons and tycoons in those cities that are very much ignored today.
Are your parents potential LPs? Have a $5M seed! No? Sorry we couldn’t get to conviction.
There's just more money sloshing around and these funds have to deploy it somewhere.
Imho the outsized benefit to being from central casting is probably a sign of the end times for western civilization etc but that's the pattern I've seen from scattered anecdotes.
There is an unreal amount of capital sloshing around right now, that part is true, but there is a hurdle in knowing how to raise it and that knowledge is not evenly distributed even if you otherwise have a solid startup. I learned how to do this the hard way. There is a “fish don’t notice the water” aspect to it.
(Currently raising a large Series B outside of the west coast.)
This is how investment decisions are made. Few investors care about your three year financial projections. You still need to seriously know your stuff, but that is not enough ipso facto. The first cut will be your ability to spin an engrossing narrative.
I can go deep into the financials but no one asks me to if the story is exceptional.
Storytelling is a critical part of fundraising. You can generate wildly different outcomes from the same set of facts.
Imagine you have a good story. But you have no connections. And you're in a region with a dearth of VCs. So you can't just randomly walk into (or email) a VC to get any sort of reception.
Without access to a side door, which is how the VCs currently connect with their chosen few, and with the front door basically bolted shut (very few VCs take inbound cold emails or respond to contact forms), it is impossible to just tell your amazing story to a receptive VC.
This is the issue. It's not that people don't know how to handle VC conversations. It's that they can't even get that conversation started. The VCs continue to turn to their existing networks, pools, or preferred mode of "discovering" startups. This results in the same few getting the attention.
Tell me how you solve the introduction problem.
That's the narrative people who raise large rounds are spinning. It has nothing to do with the tech, product... only how desirable it is to other VCs. The only way you craft that narrative is to be close to many VCs and pitch them all at the same time to create FOMO. Only those with strong existing connections make this happen.
Yes, if you built something that millions of people use the VCs will take a bet on your sure thing. That's super rare though. Most funding is going to their friends as it always has.
Who are the VCs listening to in Nashville, Columbus, Latvia, and Bogota? Or if they aren't listening regionally, then where and who are they listening to?
My understanding is that VCs, like most people, are fundamentally lazy. They won't go out of their way to listen to people they aren't already listening to. This means the same networks, inbound deal feeds, and communities.
There is roughly 2.5T dollars in dry powder (uncalled capital). In laymen's terms this means there is currently 2.5T dollars sitting there not being deployed and $830B of this for PE Buyouts alone. It looks like VC is ~$300B. In other words, investors can't spend allocated money (from LPs) fast enough.
https://www.bain.com/globalassets/noindex/2020/bain_report_p... -> Figure 1.12
A startup founder visa will more than take care of this 'dry powder' and get it working to increase the US GDP. Said visa needs to have a realistic "minimum savings requirement" to come live in the US & start a company (not the $1MM or even $500k required by EB-5 that put it out of reach for most founders especially on the younger side).
Said visa is a necessity because of the way human society works & the way the global order has formed. All this Capital is in the US (reserve currency). People who control it and decide how to allocate it are in the US (history). People do not like to give capital to other people who will live and use it thousands of kilometres away (oversight becomes hard).
Wishing for more tech startup founders to spring from the general US population alone is not going to solve it, and pumping all the available money into the same companies may be quite risky from a diversification perspective for the US economy.
Has anyone already curated a list of quality resources? I would be greatly appreciative!
I echo your sentiment, by the way: thus far, fundraising on good terms is turning out to be far easier than we expected - is it possible that low interest rates from the fed are making it easier for investors to get money? If so, we may expect this trend to continue for a few years, as the fed has committed to keeping rates low for some time.
[edit] It's a bit dated, but the points and lessons are timeless. The 'norm' has changed (SAFEs are more common over convertible notes now, for example), but the rest is still accurate.
Capital is abundant, but it's also pretty easy to dilute yourself into single digit ownership.
I expected your link to take me to a page that contained a simple list.
I also assumed that trypaper.io was the domain for a note-taking app called Paper, and that you were intending to link to one of your pages on that service. :)
...
Please forgive me for leveraging my confusion, for which I take full responsiblity, into a critique of your page design, but in the hopes that something here might be constructive...
I would have been less confused if the page headline was static instead of rotating/frequently incomplete due to animation/"difficult" to read. Something like "Financing your SaaS" would seem to cover all cases, maybe with a rotating subtitle without the backspacing animation so that the full content of each entry could be read in a glance?
Also the background of white with a pattern of pale blue dots made me think "note paper/note-taking app". The domain name makes sense for this also, but it was the background that forced the idea to front of mind.
Again, I'm sure this is a me thing and not a you thing -- but if others exhibit similar confusion, that's my best guess as to the cause.
...Now I will read the content on the site. Thanks for humoring me.
However, if you need to make a bet, you make a bet, because for a VC fund, the small chance of an outsized return (that can return your fund) is better than a more likely chance of a 'decent' return, so you often make a bet and double down while it still seems viable.
There's a reason Lyft kept getting funded even when Uber raised significantly more.
I agree. So what's the auction marketplace of startup fundraising - a place where every deal can be posted publicly, or as close to that as possible?
Other than that, it doesn't exist. Got some thoughts on this part of the dynamic in the works.
That said, 'auctions' for accredited investors already exist, if the company choose to take advantage of it. There are seed funding sites as well as AngelList, etc., to publicize deals.
Some founders also choose not to publicize a raise (except among the VC/angel networks) so as to remain under the radar until they are ready to launch.
You mean their second or third homes, right? There's a minimum net-worth requirement before you're able to invest in a startup so a failed investment is not going to bankrupt any investors. The founders are much more likely to end up in the poorhouse if things don't work out than investors are.
I agree with you; it is a good thing that there are accreditation requirements to invest in as risky an investment as a startup. Getting rid of that would be an awful idea. That was the point of my comment.
https://henrysward.medium.com/finally-a-private-stock-exchan...
Once we have a liquid and active market for our shares, (in our case we have enough liquidity to support ~ $100M of volume per quarter), when we want to raise primary capital we simply sell common shares out of treasury.
This is powerful for a couple of reasons. First, we get better price discovery on CartaX than going door-to-door on Sand Hill Road. Second, all shares bought on CartaX are common stock. There is no preferred stock, board seat, or covenants to deal with in a primary.
But perhaps most importantly, CEOs and CFOs don’t have to spend months raising money, doing roadshows, meeting with investors, and negotiating termsheets.
We live in a world where a software start-up needs basically $0 in cap ex.
If the founders don't have existing financial obligations and can live in a place that isn't the BA or NYC or Seattle then they can make a lot of progress for peanuts.
Venture Capital is essentially paying for 1. The founders existing financial obligations, and 2. The ability for them to live in an extremely expensive part of the world.
The only other thing that a VC provides is a financial reason not to work for a large tech company that's going to pay the founder hundreds of thousands of dollars a year.
And therein lies the fundamental problem of Silicon Valley today. Most of what matters in early stage startups is not anything remotely objective about the startup's prospects. What matters most at this stage is connections and perceived pedigree.
All that should matter, in an efficient market, is the real potential of the startup itself.
"YC demo day slot" = someone spent 10 minutes interviewing some people and decided they were a good culture fit.
"High quality angel" = Someone's friend knows a well known rich person and hooked them up.
"Pedigreed founders" = Someone's rich parents bought them credentials by gaming the system.
It's not reasonable to expect every early stage startup to have "strong growth" because big successes most did not have this attribute.
But what could be improved is the process of finding startups with high potential. YC was, when it launched, an innovative attempt at solving this. But it hasn't evolved or scaled enough to address the market.
Some kind of early stage crowdfunding solution seems the most likely answer, but no one has managed to crack this nut yet. And so the Silicon Valley investors continue to feed in the same small pond.
The most likely outcome is that a new system will develop that totally bypasses traditional Silicon Valley investors. They may have an abundance of capital compared to the small number of startups they care to look at, but they have nowhere near the money (or intelligence) that the public at large has.
I thought this note was important, this is precisely what investors signalled when startups started being able to crowdfund equity under Regulation CF.
It's been a year we're trying to close our round, missing 350k from the $1M round and yet still growing 30% MoM. Yes covid fucked our business in a sense, and we got hit since March - but we remain ever so bullish esp given our sustaining growth.
There are interesting things happening in that space, but they are still at the fringe.
Hard data on aggregate seed funding through the years would be interesting.
Also - hang in there! 30% MoM is no joke, sounds like you’ve done one the hardest things (made something people want).
So people who actually make successful products get valued more and more. The unfortunate part is you actually have to work for a living, but luckily you keep getting more of the lazy people’s money.
I don't think capital is your problem.
Some of them were also helpful just as the equivalent of 'executive coaches.' Being in the weeds constantly means it's hard to be objective sometimes. Good VCs and good angels are usually experienced and helpful, even if the incentives aren't perfectly aligned. They mostly are though; growth helps both the VC and the founder, so in that sense they're aligned.
But when deciding how big your option pool should be, your incentives are no longer directly aligned. :)
It's nice that you'd prefer a longer runway to more coaches. I prefer a longer runway and more coaches I trust to help me execute; they are not mutually exclusive and you've presented a false choice, particularly in this market which is so founder-driven.
However, let's stop and ponder, how much more will this capital buy? Will it buy more actual assets? Will salaries go up? Then you will get the same amount of engineers for the capital. This is quite a decaying state, not that different to how despite, more food being produced, and salaries "going upz and increasing" the average person in the US can afford, worse quality food and housing despite having "muh iphones".
Long term this trend will further bitcoin's position as a more useful nominal quantity. When will the salaries in fixed BTC begin? Right now it is a bit unstable, sure "muh transaction costs". But imagine schemes where pay is paid out yearly, reducing the number of transactions, or where it is held in escrow.
1. why are there no startups building VC investing as a platform akin to what carta has done for equity.
2. are there any ways to shore up the cost of the transaction such that they benefit both parties as a service (eg. shore up lawyer fees which are currently passed onto the fundraiser)
Wefunder, Republic, Startengine, etc...? They'll be able to run non-accredited investor crowdfunding rounds up to $5MM per year soon.
this is a dangerous assumption. The feds are poised to raise interest rates this year and it will have ripple effects, in particular the abundance period of capital is slowly being reigned in to avoid a loss of faith in the dollar and slow down inflation.
What inflation? CPI has been absurdly flat for years, despite all the QE and pandemic relief funds. Inflation is only showing up in property and securities.
I guess this is why its so easy to control the markets. People don't even practice critical thinking and check for real world data.
Whatever we are told is what we hold!
Founders: If you want to ONLY optimize for max price + max check size, the “partners” you bring into your business are bankers.