Paul Graham: Some VCs Push For Large Rounds, Even When Startups Don't Need Them | Hacker News Reader

Paul Graham: Some VCs Push For Large Rounds, Even When Startups Don't Need Them

forbes.com

47 pointstomio31 comments

    "Graham suggests that if one reputable venture firm were 
    to break this non-spoken 20% Series A agreement, the best 
    startups would instantly flock to that firm. “It’s going 
    to happen,” Graham says. “You might as well anticipate it 
    and look bold.”"

pg,

Any plans on using the collective attractiveness of YC to help push that 20% stake down? e.g. would you talk to a lot of the startups in the current batch about collectively sticking to a lower percentage like 15% to get the ball rolling in the direction of the new funding landscape?

It seems like YC companies keep raising larger and larger rounds, oftentimes more money than they really need for 18 months of runway. With that in mind, the logical thing to do is to collectively help them give up less equity to get back to 18 months of runway.

Any plans on using the collective attractiveness of YC to help push that 20% stake down?

I think he just did.

> would you talk to a lot of the startups in the current batch about collectively sticking to a lower percentage like 15%

I'm not a lawyer or even a particularly skilled investor, but that smells like an SEC violation. Even if it wasn't, I think it'd be something akin to price fixing.

Would someone who knows more care to chime in? Am I wrong?

Isn't the current situation of 20% as a bottom limit the same?

The US has a history of cartel like behavior in finance. Just look at the percentage charged for IPOs [0]. I'm sure if you created a similar graph for venture capital financing that you'd see a black line on the graph just like the one created by Mark Abrahamson, Tim Jenkinson, and Howard Jones.

Trying to break that 20% barrier would seem acceptable. After all, the goal here isn't to get the VCs to take less equity for the same amount of money, but to provide more flexibility in the tradeoff between cash and equity.

[0] http://www.sbs.ox.ac.uk/research/people/Documents/Tim%20Jenk...

Some questions:

Do you believe that the 20% as a bottom limit is the result of a group colluding with intent, or is it just the result of a type of evolutionary convergence?

By chain rule, as long as the market has some modicum of elasticity, isn't fixing supply analogous to price fixing? Maybe I'm assuming that the supply of appealing early stage equity is much lower than it is? Or is something flying over my head and this has nothing to do with supply of said equity?

I definitely agree on the bigger point. The whole early stage equity market is weird as hell, and it seems like there are plenty of opportunities to manipulate/exploit it.

I would say culture and sometimes intentional and sometimes unintentional collusion.

Investments are made in other industries all the time and the percentage owned after an investment can vary dramatically, from fractions of a percent to majority ownership. What makes VC investments so special that its own nature would result in settling upon a nice conveniently round number like 20%?

Plus, the 20% isn't fixed in stone. It's an asymptote. It's not unusual for it to range as high as 30 to 35%. I'd love to see a graph like the one in the IPO study. I'm sure it would be very illustrative of collusion.

It would be overreaching of us to do something like that. We're not the VCs' adversaries. We need to cooperate with them, because they have expertise in later-stage problems that the startups need.

Founders Fund only took 16% during the Quantcast Series A, and they expressly said at the time that they didn't have a specific target for ownership percentage.

I remember this because other firms wanted 20% or more.

It doesn't work that way. The VCs have covenants and agreements with their investors that make them try to get to a certain target ownership.

More details please.

Which part was confusing?

Nothing was confusing. Just simple curiosity. I just want to know more about this.

Fred Wilson (Union Square Ventures) just wrote about something similar in his blog post today.

http://www.avc.com/a_vc/2013/06/valuation-vs-ownership.html

Edit: mentioned in the article - I should read more carefully!

'We are also very much focused on what is in the best interest of the entrepreneur. You might ask "how can taking $2mm for 20% be better than taking $5mm for 20%?" and you'd be right asking that question. The answer is you can get the other $3mm later at an even higher price. That has been the history of many of our investments.'

Can someone explain to me how this makes sense. I'm still going to have to give away x percent of the company to raise another $3mm. What am I missing here?

I agree, that didn't make much sense. It seems like the post was targeted more towards LPs than startups.

"... at an even higher price" is perhaps unclear; I presume he meant "... at an even higher valuation". That is, the total percentage of the stock you have to sell to the investor to raise the money is less if you raise in two stages than if you get it all up front.

There's an assumption here: that you actually manage to make demonstrable progress in the business between the first and second round. If you think it's going to take longer to show progress than the amount of time $2M will give you, then you should raise more to start with.

He's speaking as a buyer of equity. Later, equity will be worth more (i.e., have a higher price) so that same $3MM will be less dilutive. Conversely, from the entrepreneur's perspective, that same $3MM will be "cheaper" in the future.

Depending on the math, you could easily wind up with the same amount of cash raised but less dilution overall.

This is essentially a shallower version of "The New Funding Landscape" (http://www.paulgraham.com/superangels.html), which was published in 2010.

Yeah. It read like our beloved pg dumbed down to a Forbes puff piece level. Which kind of puts it at the business nerd equivalent of celebrity gossip for those not seriously interested in VC and startups. Such things can be a little painful to read if you're a startup nerd rather than a mainstream business nerd - not because it's wrong, but because it's shallow to us.

I wonder what impact it'll really have, though? Most people aren't in any position to ever deal with VC from either end, except at a far distance. And the VCs and startups are plenty aware of the situation already.

"Graham also released some metrics on Y Combinator: it has 564 startups total. Of the 285 that have valuations, the total valuation of the companies is $11.6 billion."

I wonder which companies are skewing that the most, anybody have a list of the top Y Combinator companies?

Obviously the average of $46 million doesn't provide a clear picture at all.

If memory serves, I believe that AirBnB and Dropbox represent about half of that.

Just taking out Dropbox and Airbnb, the average for the rest already drops quite a bit. With Dropbox at more than $4bil [1] and Airbnb at $2.5bil [2], that leaves the remaining 283 at about $5bil total, or $17.6mil each. Taking out others like Weebly would drop it further.

[1] - http://www.forbes.com/sites/quora/2013/02/07/why-is-dropbox-...

[2] - http://www.bloomberg.com/news/2012-10-19/airbnb-said-to-be-r...

So what you're saying is that if you take all of the successful companies out of an investor's portfolio, that portfolio will have a lower value.

Well I think more precisely, he's implying if you take out the few heavy hitters, then the value drops precipitously.

Or stated even more precisely, the mean and median are very different :)

No, he/she is saying that "average" is a poor metric to represent the totality of the samples. This is particularly true when you have such a high standard deviation.

By eliminating some of the biggest outliers, you're reducing the standard deviation, thus making the average metric more representative.

You'd also have to disregard the companies with very low or no value, but it seems this was already done in PG's original statement: "Of the 285 _that have_ valuations..."

Wasn't reddit sold quite cheaply, and not part of this list?

Yes, my mistake. Edited.

Measuring the "average" in any power-law distribution is mostly meaningless.

It would be interesting to know what the median valuation is. Half the startups will be above it, and half below it. This would provide additional interesting details.

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