Is Y Combinator worth it by numbers? | Hacker News Reader

Is Y Combinator worth it by numbers?

michaelbabich.medium.com

3 pointsMikho8 comments

YC also has a 4% participation right https://www.ycombinator.com/deal/

Include that and founder ownership drops by 4 percentage points in scenario A.

Also AFAIK the option pool is usually 10% post-money, so the founder would get a few percent less than calculated in the examples (10% pre-money).

The 4% participation right in the priced round—if YC decides to exercise it—doesn't change anything since it will be a normal equity investment along with a new investor. It means that this new investor gets 96% share of the round and YC gets the remaining 4% of the round. This doesn't influence the founders' ownership in any way—the main number the scenarios compare. In other words, if the priced round results in a 10% share of a start-up given to new investors and YC exercises the 4% participation right, YC gets additional 0,4% and new investor gets 9,6% of this start-up. It doesn't matter for the founders' share what the split of the 10% be.

I'll update the option pool numbers. Thanks.

Ahhhh, right, thank you for the correction.

Note there is a good article on the previous two types of YC SAFE which makes some other points: https://siliconhillslawyer.com/2019/05/01/startups-shouldnt-... Does the YC 7% SAFE get more than $125k liquidation preference when converted?

Also, does it help to add in the legal fees which are usually paid by the company e.g. $30000 is 1% of your example cash, and I don’t think YC charges for legal?

YC definitely sell a good story that being founder friendly is their long-term strategy; however: https://siliconhillslawyer.com/2019/02/18/relationships-and-...

Disclaimer: I am a newbie investor and still trying to understand some of the nuances.

Thanks. Good read. I'd say legal fees don't influence the cap table and, hence, founders' share unless founders pay them with equity. So, it's a matter of the way the investments are spent, not the cap table structure. But definitely spending relatively big chunk of money on legal at an early stage leaves less money to use for the primary purpose and later dilutes founders' share with inevitable new financing.

I really like your point. Okay, this is fun, I’ll try another hypothetical.

Start with the fact the company will be worth a billion (all the gains are outliers and you have to play to win), and then inductively work out costs backwards.

Objective function: Let’s assume every productive hour in the first year linearly increases your returns, so spending 5 weeks chasing investors reduces returns by $100 million. Every angel dollar returns 30x, so the marginal cost of $30k legal fees is actually $9 million (ignoring other non-trivial factors!)

Constraints: you must have certain things (money, employees, legal documents, advice) so the outcomes are extremely sensitive to the constraints. We talk about a constraint like legal fees, but removing that constraint should theoretically have a massive impact on viability, IPO price, and founder returns. It isn’t linearly a few percent ($x kilodollars of a $x megadollar investment).

Startup economics for founders are highly unintuitive and non-linear, with exponentials over time causing thought failures. You have made me realise I don’t have a good feel for this AT ALL.

Addendum: one of the sentences on siliconhillslawyer.com talks about smart VCs counter-intuitively forcing money to be wasted in early rounds. It gives the VCs more leverage with founder negotiations about equity ownership when the money runs out and another round is needed.

In general, any decision in the early days has a long tail and consequences. Hire the wrong person—and start-up wastes not only a semi-annual or an annual salary (more than $30K) but also a lot of valuable time. Sometimes wrong hire could kill a start-up just by wasting all the money early.

It's good to optimize in the early days but it's also important to not be penny wise and pound-foolish. In general, today there are a lot of standard deals, documents, and lawyers who specialize in start-up deals. Properly speaking, for a law firm it is usually worth making its services inexpensive and accessible for fresh start-ups since it's the firm's investment in keeping these start-ups as clients should they grow and become big. It's not worth it for a lawyer to rip off a start-up for pennies and lose this start-up as a client when it becomes big. Not to mention losing reputation among other startups. So, for a start-up, it's worth finding the right lawyer who works mostly with start-ups and not rely on "general practices" pushed by a VC or VC's own loyal lawyer that surprisingly serves only this VC's pocket.

Taking money at the early stage is a tough game. When founders take an investor's money, the investor's business model becomes the business model of their start-up: only outlier growth and outsized returns. The longer start-ups bootstrap the better it is for founders and for business. Preferably, to bootstrap till the product-market/fit and take money only as a fuel for growth. This way a start-up has a lot of leverage in fundraising since it doesn't need money to survive—just to have more fuel to make the fire bigger.

Calculations in my post make it obvious that any pre-seed round (including Y Combinator's deal) results in founders losing a very big chunk (30%+) of their start-up by the time they close the next Seed round or priced round in YC'S deal case.

Nevertheless, if there are no other options and the only one is to take money early, then so be it. It's better like this than nothing at all.

For those who want to crunch numbers here is the Excel file I created for the comparison with all the scenarios and valuations:

https://link.babich.me/ycdeal

I crunched some numbers to model different scenarios and different start-up valuations to compare whether the YC deal is any good and what the other options are. In general, thinking about the 7% of the Safe and whether it's worth it is the wrong mental model to start with. It’s like announcing winners and losers in a race immediately after the start and before anybody even runs half a distance. The thing is 7% Safe is just Step 1 in a priced round when YC’s shares convert — and there are 3 steps that depend on the priced round valuation and share a new VC gets. Anyway, I modeled 3 scenarios with 7 different start-up valuations of the priced round for each to compare founders' shares as a result.

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