2 February

The Founder’s Choice: Paul Graham For President

If you have anything to do with startup funding, the Yuri Milner/SV Angel announcement over the weekend to invest $150K on spec in every current YCombinator startup (43 in all) was a neutron bomb – and perhaps the biggest endorsement of YC founder Paul Graham to-date. The no-strings-attached convertible note was quickly snapped up by virtually every participating startup as fast as the analysis started rolling in from the blogosphere.

To begin with, the variance of reaction across the startup ecosystem has been fun to watch. Some think it’s a masterstroke of genius, while others rumble about ‘dumb money’ following ‘dumb money’.  If you haven’t read Jason Calacanis’ Top 10 anonymous survey (and associated commentary) of angel reactions, it’s worth checking out right now. It delivers some great insider, nuanced points on the topic but also illuminates some haters.

My theory is an individual (or firm) reaction is directly inverse to two things: 1) how much opportunity those money-slingin’ bastards just yanked out from underneath you, and 2) how much you wish you’d thought of that idea. So if that no-strings-attached $150K just froze you out of deals in your comfort zone, you’re mighty pissed. But if you’re an entrepreneur this really does feel like things are starting to break your way in the funding world. Over the summer, I wrote an article on the Golden Age of Startups, and much of my vision has been wildly exceeded.

In my previous post, I focused a lot on the newly announced 500 Startups, who you would think should be in the Top 5 of those scared silly by the Milner/SV Angel deal. But as my man Dave McClure proves yet again in Jason’s article, you’re always better to have a smart public opinion than a ‘who-stole-my-lunch-money’ private bitching session. I’m confident he’ll continue to draw the best and brightest entrepreneurs to his pirate ship because of who he is personally and the resources 500 Startups provides. News flash: it’s not all about the money!

So let’s look at what this money means to a startup business – keeping in mind that we’re talking YC companies exclusively. For the 2-3 person founder teams that make it through the YC gauntlet (thousands applied, 43 were selected), this is a huge deal. It clears the deck of any fundraising distractions, and should propel virtually every business further down the track. Here’s a short list of why that $150K rocks:

  • No money-raising worries during the final weeks of YC class
  • Time saved equals a better product and tighter market focus
  • Enables 1-2 post-YC pivots if necessary
  • Provides enough capital to secure 5-10x more users (or customers or partners, depending on the business)
  • Gives founders real runway to fine-tune their product for market (not 30 days)
  • Opens up 1-2 additional hires to drive market traction (again, depending on your business that might be an engineer, a bizdev resource or a PR agency)
  • Delivers the potential to just flat skip an angel round and go straight for a VC-led $5-10M Series A with founder ownership beautifully intact
  • Creates the founders’ option to choose a Dave McClure-sized exit in the $20-40M range, hang on the majority for a billion-dollar run like Zuck, or take some money off the table during a later round like Groupon.

Of all the critics, I found the most interesting argument to be that it’s too safe. One of the anonymous founders in Jason’s survey described it as: “Betting on YC right now is like betting on Michael Jordan or Mike Tyson to win in their prime -- not difficult and almost safe.”

While it’s difficult to call spending $6M in the dark “safe,” the point is YC is rockstar central. Perhaps the clearest winner here is Paul Graham and YCombinator itself. Beyond the market validation for YC, this cements Paul’s role as a bona fide game changer in the startup world. (Lest we forget that Paul almost singlehandedly brought sexy back with convertible notes.) If you run all the numbers, it’s most likely that YC’s ~5% equity chunk could be the largest non-founder ownership going into a Series A. The smartest entrepreneurs will drive their valuations hard (growing 500K-750K users) before closing the next round.

All these dynamics are incredibly pro-entrepreneur, and lead to a whole new degree of founder control (Paul Graham’s term) that the most visionary investors are now embracing. It’s no mistake that guys like Paul Graham and Ron Conway are booming based on a policy of giving smart people the freedom to invent and iterate. And if Paul’s right, there are emerging VCs who are ready to continue that into and beyond Series A level deals. Think of the examples that whet everyone’s appetites for what could be: Zuckerberg at Facebook, Pincus at Zynga, Mason at Groupon. And make no mistake, altering the first-level terms of an ecosystem creates cascading change that eventually can be defined as a self-fulfilling prophecy. And who really wants to argue with him when he says:

“Founders retaining control after a series A is clearly heard-of. And barring financial catastrophe, I think in the coming year it will become the norm.”

So will this fundamentally change the economics of angel funding? Yes, in the sense this is now a blueprint for big investors coming into the seed space – although I’d expect only a few have the tolerance for blind investing. For the rest of the angel ecosystem, time will tell based on how successful this effort is. Remember, this a one-time bet on 43 companies for a total of $6M, which is about like pocket lint if you’re sitting with billions of Facebook stock in front of you. One thing’s for certain: the competition for investing in the best entrepreneurs has just ratcheted up again.

And let’s close with what this means to those cashing the checks. The second most important benefactors in this deal are YC companies number 11-43. If you assume the Top 10 get funded almost instantly, this $150K could easily be the difference between three hits out of 43 (7% batting average) and eight hits out of 43 (19% batting average). And yes, the next Facebook or Zynga could come from this second-chance group.

So yeah, I think the Milner/SV Angel/YC deal is pure genius and I hope it drives a few big hits to ensure something like it continues to be an influence across the startup world. Now where’s my 2012 polling place again?

comments 

 
0 # Mike Schinkel 2011-02-03 09:23
I've always wondered why VC investors didn't spread more seed money around. This is a good day. It will be interesting to see if this is successful for them as I hope it will be. If so, it might validate the idea among more investors although I'm not sure that it will ever penetrate the security-obsessed south.

And speaking of POTUS, I'd love to take (from a red state) on this: http://www.avc.com/a_vc/2011/02/startup-america.html
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0 # GFRRTDEFF 2011-02-03 22:56
Mike: Can't give you the "red-state take" as I'm solidly purple – a 25-year registered independent. I started out to cover both topics in the vein of a huge week for startups, but the YC topic got to 1,100 words pretty quick.

My short take on Startup America is the team they've put in place gives it a much better crack at success versus your typical moronic government program. With the leadership of Steve Case; the backing of the Kaufmann Foundation (who's probably among the most important forces in favor of startups to begin with); the weight of TechStars (I've got huge respect for Brad Feld); and a 15-city hackathon commitment from Facebook I can see the potential for a real grassroots movement.

I truly hope they can rise above the mediocrity of most government-sponsored initiatives!
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0 # Mike Schinkel 2011-02-04 14:55
Yes. With all of the criticism of Obama (and I'm by no means one who thinks he is perfect) I wonder what those who criticize him have to say about Startup America and if anything like that would have ever come from the other side of the aisle? Above all, me hates hypocrisy.

BTW, ya know purple is the color of bruises; I wonder if there is a hidden metaphor there? But I digress...

(P.S. I never get an email to follow-up on comments. If that's broken I think you're loosing lots of potential activity on the site.)
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0 # GFRRTDEFF 2011-02-04 20:21
I'll probably wait to see a few tangible things happen with Startup America before weighing in on their effectiveness. Great promise though.

Let me do a tech check on the follow-up comment piece, and I'll let you know.
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0 # Mike Schinkel 2011-02-03 09:24
Ugh... that was supposed to be "I'd love to read your take..."
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0 # Rams 2011-02-03 16:05
Beg to disagree. Paul Graham and people like him can achieve what they have because they bring on ONLY passionate and commited team members. Other useless folks are given the boot. However, this is near impossible in politics. So can Mr. Graham play politics?
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