Is There a Y Combinator Valuation Bubble or Not?

Over the past 18 months, I've seen four of my friends "cash in". Most of these guys were at it for 7-10 years before the exit, and all but one of these was a sub-$30m deal.

In order to justify these "NEW" valuations, entrepreneurs & investors have to hold out for VERY high value exits, which will dramatically reduce the chances of success and statistically extend the exit time for the angels and entrepreneurs by over a decade.

For most entrepreneurs who are on their first business, $5m or $10m is a life changing amount of money - by declining exits at prices that could achieve that outcome, they are forced to keep rolling the dice, over and over again, hoping that growth continues, a new competitor doesn't emerge, someone doesn't undercut their pricing, and everything is going at 110%.

It doesn't seem to make sense on the surface of it.

(a) We're not in a bubble. We're in a revenue tsunami like nothing any of us have ever seen in our lifetimes.

Instagram didn't have a single dime of revenue. and the CEO basically waved away any thoughts of revenue when pointedly asked about it in an interview.

Facebook, who has 800M active, engaged users has only $4B in revenue. Is that what passes for a revenue tsunami these days? Guys, a revenue tsunami looks like double digit income growth quarter after quarter.

NB: Kudos to the CEO of instagram for making out like he did. But it's not an example to follow. Unless you like failure.

Bubble or no bubble it's a good time to make something happen.

I worked with an app co that stuck on millions of users and never earned a dime in revenue.

While the CEO was going manic about potentially running out of money, one of the advisors (who had recently sold for $100m+) emphatically insisted that we NOT generate revenue.

His reasoning?

The minute you turn on revenue you eliminate the "story" about the revenue potential.

The result?

A beautifully large exit to a entrenched and old school player.

Hook. Line. Sinker.

Not accurate. Out of ~45 companies in the W11 batch I think 4-8 have raised A rounds. There's still time for others, but I don't think there's any way that number will approach 20+.

We wouldn't be talking about a bubble if blue-collar workers had the same opportunity that white-collar workers do. (Yeah, I know, I can't find a better term for the groups.)

Also, the vast amount of economic activity is happening in SF/SV and in NY. Raising money outside of these two centres is much harder. This is one facet of structural mismatch between supply and demand. One part of the 500 Startups thesis is to find under-valued startups that don't happen to be in the major tech centres.

http://www.quora.com/the_edge/Long-wave-boom-and-bust-cycle-...

In it Steve Jurvetson (a Draper Fisher Jurvetson VC) shows the cyclical nature of capital, and how we seem to go from a PE boom and bust, to a VC boom and bust every ~7-10 years, with recessions interspersed in between.

YC appears to be near the centre of this new growth period, bubble or not, and is hence probably a beneficiary of the long term swings in global credit/capital.

Guess we'll just have to see how it plays out.

I hope it isn't that, and we have great companies, with solid business models (profit/revenue), without the mania that we had before.

But who knows, with the JOBS act passed (last week), and the consequent relaxation in securities regulations we may have sown the seeds of an unpleasant moment in the near future.

Talk:

http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2288

JOBS Source:

http://en.wikipedia.org/wiki/Jumpstart_Our_Business_Startups...

JOBS Act criticism:

The Consumer Federation of America characterized an earlier version of the legislation as "the dangerous and discredited notion that the way to create jobs is to weaken regulatory protections"

Criminologist William K. Black had said the bill would lead to a "regulatory race to the bottom" and said it was lobbied by Wall Street to weaken the Sarbanes–Oxley Act.

"gutting regulations designed to safeguard investors", legalizing boiler room operations, "reliev[ing] businesses that are preparing to go public from some of the most important auditing regulations that Congress passed after the Enron debacle" and "a terrible package of bills that would undo essential investor protections, reduce market transparency and distort the efficient allocation of capital".

  It assumes that you can a) get into the YC rounds
  (which 95% of angels can not) and b) there are
  other deals out there as good as the YC deals
  (80% of angel deals I see are not as refined as YC
  startups).

That's probably where YC derives most of its value.

OMGPOP is adding a significant amount to Zynga's topline revenue. Last reported, OMGPOP was bringing $250k per day.

Instagram? $0/day. Not harsh but just the truth.

OMGPOP doesn't scream bubble at all. Instagram's deal does. So are we in a bubble? The answer is in the eye of the beholder.

The author seems to be arguing that if you look at the actual and projected growth rate for both Instagram and OMGPOP (measured in number of account signups) as a percentage of the userbase of their suitors (i.e. Facebook and Zynga respectively), then the money paid for these companies represents "EXCELLENT" value.

To me that is an absolute fallacy. OMGPOP was going for 6 odd years and almost out of cash before they stumbled upon something that worked. Draw Something caught on like wildfire but the buzz will eventually die. What comes after it? i.e. how does past performance guarantee future performance (especially given the majority of past performance wasn't great)?

Similarly, Instagram has caught on like wildfire but even the CEO admitted that they have no way to monetize the user interest. So what we have is a freebie product that people love to use to send photos and an accompanying strap line of text. Yes it's cool but it isn't curing cancer and the users are using it as a fun throwaway service. They have no loyalty to Instagram and would drop it in a heartbeat if a charge was attached to using it.

So, where is the inherent "value" in all of these user accounts & signups? Having millions of user's doesn't automatically translate to a long term money printing machine like Apple or Google.

You can apply this argument to Zynga and Facebook themselves. Facebook has 800 million users but its total yearly revenue is half of Google's annual profits (according the wikipedia entries). Zynga IPO'd at $10 a share. Almost 6 months later and the share price hasn't moved. That doesn't look like explosive growth to me.

Given all of the above it really does feel like a bubble (at least to me). All the valuations seem to be based on a house of cards...

P.S. It's 1am where I am and I'm not an econ or finance guy so if my assumptions or arguments above are wrong , I'd love to have it explained to me rather than being flamed to death :)

4. The winner-take-all nature of network-effects businesses in which the dominant business can be an order of magnitude more valuable than other competitors.

So it is entirely rational given the Internet environment to see a dramatic stretching of the valuations for market leaders with network effects. It does, however, not bode well for aggregate returns for the venture capital asset class:

1. In a race to pick the winners ever earlier, valuations get stretched even for companies that have not yet proven that they really have strong network effects and that they will be the leader in their respective market.

2. These stretched early stage valuations will lead to depressed returns in a large number of companies and will also make many of these companies harder to fund. There will be more of these companies and more capital invested in them (in aggregate) than in the winners.

The fact is during this bubble, or non bubble, all of society is now online and connected and using the internet to make purchases for goods and services.

It wasn't the case during the last boom. If someone could enlighten me a little on how an exploration of things like this help move a startup forward, when we know there's plenty of profitable bootstrapped and funded startups that have become businesses.

how can relative valuations prove/disprove bubble valuations? poor point in my mind.

With all those people talking about bubbles, what happens if the bubble bubble burts? People get back to work and are actually productive? A horrifying thought indeed.