Paul Graham recently interviewed with TechCrunch’s Ryan Lawler at the PreMoney Conference. The discussion focused on the current inefficiency in Series A fundraising, including a possible solution. Mr. Graham also mentioned the current state of Y Combinator and provided updated amounts regarding its portfolio.
The issues with Series A fundraising are both the hassle and amounts imposed by venture capital firms, according to Paul Graham. The hassle is based on the time and effort required to engage with VC’s. Smaller startups usually consist of just the founding team, none of whom has much experience communicating with investors. Venture capital firms each have their own process of investing. Therefore, fundraising by startups means a loss of valuable time otherwise spent actually running the business.
Mr. Graham claims the amounts demanded by venture capitalists also burden startups. Venture capital firms insist on investing more money than the company needs in exchange for more equity than founders like to sell. VC’s typically want 20% of the company in exchange for a Series A. From one perspective, the reasoning by VC’s for that model is economic: by investing early, venture capital firms often don’t know about the return on their investments for 6-8 years. From another perspective, however, competition by potential investors complicates matters. Competition to get in on a round results in much greater risk to investors as they over-invest simply to obtain the same share of ownership. That competition burdens the startup with incredibly high expectations and an inflated valuation.
The solution proposed by Paul Graham is for Series A investors to embrace the model Y Combinator invented for seed-money fundraising: automate the process, including the terms and dollar amounts. Hypothetically, a reputable investor willing to invest $100,000 on market terms with a one day turn-around time could obtain equity in every startup based entirely on ease-of-use. Standardizing the process means that every company seeks money from this investor because of the negligible cost of applying for funds. The investor likewise has a greater pool of applicants from which to select investments. Fixed terms eliminates all of the complications associated with competing for a round. Using this approach would result in this hypothetical investor having a greater return than other investors based on a better portfolio.
Ryan Lawler asked Mr. Graham about what it takes to make an incredibly valuable success like Dropbox or Airbnb. He responds that becoming a huge success is really a matter of becoming a “break-out hit,” a quality that must come from within the startup itself. Y Combinator’s contribution to their success is primarily preventing the company from dying early through common and preventable mistakes.
Asked about the infamous YC S12, Paul Graham says the issues there were the result of an N Squared algorithm, “where the number of interconnections grows as the square of the number of inputs”. The problem was that every Y Combinator partner had to understand what every startup was doing. The solution was to “shard YC,” with every startup picking a YC partner that is their assigned interface to Y Combinator. This new approach is much more effective and scalable than the previous strategy. “We are now order n… with room for maybe 3X growth before we have problems with this number of partners”.
Finally, the interview provided some updated stats on Y Combinator itself. Here they are:
|Y Combinator Fast Facts|
|564||Companies funded by Y Combinator|
|511||Companies funded through YC W13|
|53||Companies in current batch of YC S13|
|$ 11.6 billion dollars||Total post-money valuations of the 511 companies funded through YC W13.
Based on the 285 of those 511 companies that have post-money valuations.
|$ 8.6 billion dollars||Total post-money valuations of the 10 most valuable companies|
|$ 3 billion dollars||Total post-money valuations of remaining 501 companies|