The fundamental reason is that VCs do not have goals that are aligned with the goals of the company founders. This creates a built-in source of stress in the relationship. Specifically, founders would prefer reasonable success with high probability, while VCs are looking for fantastic hit-it-out-of-the-ballpark success with low probability.
...
Even though the second model has a lower expected return, it is vastly preferable to most founders, who can’t diversify away the risk, while VCs who invest in dozens of businesses would prefer the first model because it has a greater return. This is just Econ 101; it’s the same reason you buy car insurance and Hertz doesn’t.
Though to be fair, he also explained why he took VC for StackOverflow at Startup School 2012. Basically this:
A lot of points resonate with me, but here are some counterarguments to me that resonated quite well:
1. As a first-time founder, YC (the community + the program itself) is a great education. I've learned a ton about different growth channels at a "growth bootcamp", about different possible business models (through the companies that have come and done talks and those in our small group), and about the pitfalls of a startup (through the former founders who are both in the batch and presenting at the talk). All of these have compressed a lot of informal learning into formal/less-informal lessons
2. You still get to choose how to run your company, unless you give up majority voting shares of your company and/or board control. Even that decision is ultimately up to you. It's important to go into every conversation having a good idea of what is best for you and your company, and then to consider what is best for the investor. You will face pressure, but it's essential to have your own perspective in mind and be steadfast in crucial circumstances
3. The community and credentialing is amazing. YC has a reputation that helps to hire and partner with other important companies and people
4. I put this last, but to some founders, this is the most important part. If you are raising money, Demo Day is just a completely unique circumstance to do it
I definitely don't regret doing YC, but I seriously considered not doing it before. I'd bootstrapped all of my past companies, but points 1 and 2 here were the ones my friends mentioned that convinced me to do it
These days going through Y Combinator practically guarantees success for B2B/SaaS startups. Their network is so big now that you can hit growth targets that most VCs look for just by selling to other YC companies. Then you can throw the late stage logos on your landing page and use that to lure in enterprise customers.
Among many of YC's advantages, they do signal boost your company in a lot of important ways. But if you don't make something people want, no accelerator in the world will save your company from dying.
My statement was conditioned on getting into YC, which is really hard to do if your product sucks or has no traction.
Even with a weak product you'll be in a much better position because you'll able to meet with a lot of other founders/potential customers and get valuable feedback.
Oh, I don't think that's true. From what I can see and what I've heard from friends that have been through YC, they take a lot of flyers. That's part of the point.
Their filter process is based more on the founders. The product and idea is just part of evaluating the founders. It often happens that someone goes in with bad ideas and product. Some pivot their way out. Some can't.
I don't think other companies are going to buy into the new companies's products if those are not good. It's one thing to be able to reach to YC companies/founders, another to convince them to use your product.
That's true, but it's practically impossible to bootstrap a "bullshit" company and have it succeed.
If you get into YC you're guaranteed intros to anyone in their portfolio, press coverage from valley PR machines like techcrunch and will have a much easier time cold calling if you need to because you have the YC stamp of approval. You'll also have a much easier time raising on good terms because no VC is going to pass up a meeting with you.
"Venture capital gets so much attention in the media that it’s easy to forget that it’s not actually necessary."
I'm running a small bootstrapped company and am helping a friend's project with fundraising. Some of my friends are also VCs in London, so I see both sides of the table.
Very often I am part of discussions about fundraising with founders who barely have any traction with their products but are obsessed with fundraising.
I wish there are more stories about actual product building instead of people closing funding rounds.
I agree. To support it, my first company was bootstrapped and did around $10m in revenues but then was ultimately killed by competition and ecosystem issues.
I pocketed most this money (after taxes) ... had I raised money I'd be broke right now...
Kudos to you for building a company to $10mn revenues. I hope to achieve similar success in the coming years and honestly, I'd pat myself on the back of I just hit $1mn revenues with decent profits.
I believe ,,let's change the world'' was most of the time a way for employers/shareholders to make employees work insane hours.
Elon Musk is changing the world, works insane hours, but still lives the billionaire lifestyle by lending against his Tesla stock, while the other employees just get the insane hours part.
I don't view YC as a VC, am I wrong? This whole post is about VCs pushing you to the brink. YC doesn't push companies too hard, do they? Why not do YC and NOT raise VC money afterward but take advantage of the network?
YC is a non-traditional VC, but still a VC. VCs expect a certain growth rate (2-3x annually for the first five years) that almost always requires follow on funding.
You could do what you are describing, but if you are up-front with your plans to grow slowly, most VCs will pass on you.
1. Hundreds of pitch meetings with VCs. Plus they are pretty open about their expectations.
2. Fire you. Sue you for fraud. Talk badly about you in the media. Not saying they would, but there is a lot a deep pocketed VC could do to make your life miserable. It's generally a bad idea to lie to your investors. :)
VCs are useful in the longer scale of things. Sure you can build a $100M company or so bootstrapped, but by that time your competitor will be at $1B.
Whether or not you want this depends on the product you're doing. Several companies tried to make an operating system for touchphones. Out of them only Android was acquired and successful in the long run. Plenty of digital game distribution platforms tried to grow, but were choked out of the market by Steam.
The author is working on contracting specializing in American companies. The market for that is big enough. Or if you were, say, a community based baby stuff e-commerce, which can compete with Amazon, that works too.
The other thing to note is that YC partners say they go big to have the most impact on society.
I am currently analyzing how to launch robot affector business in Germany. With physical goods I must be present during sales pitch, video is not enough. It collides with my current corporate job, but it is doable. What kind of actuators do you sell?
But how are the chances of an exit with a company of that scale?
How big is the market for "niche" companies being acquired for USD 50m, if it was bootstrapped? It seems that there are a lot of acquisitions or acquihires in that range if you are VC funded and are working on innovative tech that makes sense for bigger companies to acquire. But if you are focusing on revenue/profits, and lets say you get to $6-$10m usd in revenue, who are gonna buy you? And an IPO doesn't seem factible since you are not big enough. And if you are outside USA its even a harder sell.
I guess it could happen that a lot of transactions of "niche" companies exists in that price range but they are not publicized by journalism because they lack relevance, and that would give you a biased perspective of lower sales of companies, but I wouldn't be that sure of that hypothesis.
So, what do you think about the odds of exits strategies for a $30-50m bootstrapped startup?
If you are profitable, there are a truckload of people that will want to buy you. Private equity, other companies, holding companies.
Look at it this way - say I'm super wealthy and I have $100M sitting in my bank account. It earns a tiny interest rate at the bank. Where can I put it to work for me so that it's growing? One option is to buy a company for $100M. For $100M I can buy a company that produces $10M/year in profit (roughly speaking). Now I'm earning a 10% annual return on my investment. I might even be able to grow the company, so when I sell it 5 years later, I sell it for $200M. So I've taken my $100M and turned it in to $250M.
That's the great thing about profitable companies. There is almost always a buyer.
It really depends on your business. My company is building a system for businesses and working with VCs (or YC, if accepted) would be valuable for us. It’s a sales tool, essentially.
In addition, there are cases such as building rockets or a factory or other regulated industries where you need capital. If you can bootstrap, do it. However, many people don’t have the upfront investment, connections, or education (in the case of YC).
I agree with the author if we were discussing standard “dumb money” VCs. But in this case, we are discussing YC, it’s community, reputation, and educational resources. You don’t technically need to take more money, just take the 7% hit and gain access to more resources. It may be worth it (it also may not), it depends on the situation.
I think the case for taking VC money is because some startups have hard and expensive products that require huge upfront capital to realize. This could mean hiring a team of engineers with significant expertise in the area as well as purchasing hardware that aren't entirely off-the-shelf. If you want to build flying motorcycles [1] or rockets, chances are you need some financial aid unless you're Elon Musk.
Aside from that, bootstrapping and not raising money could work for you.
>Venture backed companies only have about a 1% chance of reaching a $1B valuation. [...] I’m sorry, but you aren’t the 1. You are the 99 and your startup isn’t going to become a unicorn. [...] Why play a game that has such terrible odds of winning?
Because people have always liked to pursue things that interest them regardless of the odds.
(cue Han Solo's "Don't tell me the odds!")
Why do aspiring writers work on novels with long odds of it ever being a bestseller on NYTimes -- or even being published by a reputable publisher for that matter? Because, writing is what that person wants to do. Telling them it's a "waste of time" isn't going to change their mind if writing is what makes them happy.
Why does the high-school basketball player keep working on his jump shot even though the odds of NCAA players getting picked in one of the 60 slots of the NBA draft is ~1%? It's because playing basketball is what interests him.
Same for aspiring actors pursuing Hollywood fame that probably won't happen, researchers toiling away on scientific breakthoughs that may never materialize, startup founders building elusive unicorns, etc.
Yes, the similar DHH essays promoting "bootstrapping" and "slow growth" are always highly upvoted on HN because VCs are widely perceived as detrimental. However, both your and DHH's philosophy leaves out a crucial detail: What is the entrepreneur interested in working on?
If the interests happens to be a business that can be bootstrapped, then great. Pursue that option. However, if it's a business that requires millions to build out infrastructure (e.g. many consumer-facing websites), somebody with deep pockets (e.g. VCs) is the typical financing option since banks won't provide loans.
There are many ways to bootstrap consumer facing websites and other businesses that require a lot of early capital, you just have to be creative. I'm just trying to get people to think outside the "VC is the way" mindset because it burned me and because the experience wasn't what was promised.
>There are many ways to bootstrap consumer facing websites and other businesses that require a lot of early capital, you just have to be creative.
Yes but other financing options such as crowdsourcing (e.g. Kickstarter, or blockchain initial coin offerings), or charging consumers via subscription payments ... all have their disadvantages compared to VCs.
Another factor that may handicap your business is how your competition is financed. E.g. if your competition has $10 million in VC money but your business sticks to "bootstrapping" out of principle to stay anti-VC, you will be outspent in scaling out and may fail anyway.
Really, the critical advice is to be smart about analyzing the VCs and their financial terms before accepting their money. If VCs don't make sense for your particular business, don't do it.
I think the biggest difference between today and 20 years ago when I first go into Silicon Valley is that most founders are generally already planning their exit. There are a lot of startups whose mentality is "get big quick enough so that we can get bought out by Google/Facebook/Amazon/etc". And unfortunately this is a legitimate play because it leads to quick payouts so it motivates founders and VCs alike.
It's a fair mentality but it changes the nature of the game because most founders back in the 20th century wanted to helm their company until their last dying breath. So the fact that this person is already targeting a $50M exit makes it less interesting to me. I just don't think I would get excited working for someone I know with that short term of a mentality.
I've been working at startups since the mid-1990s and building-to-flip was as prevalent then as it is now.
I'd say the much bigger change is that randos have a real shot at getting funded today, due to YC and the syndicated convertible debt round. It's hard to overstate how much more open the funding market is now than it was even 15 years ago.
I think there was less money in the sector for the first 10 years or so of YC than there was during the dot-com era, so I don't know that it's true that the opening of funding markets to first-time founders is a consequence of too much VC funding.
YC exists because a dude made it big in the initial dot-com bubble. With every subsequent wave of windfalls, you get a larger pool of founders who struck gold and now want to play investor, and over a sustained length of time with no bust, that leads to a pretty founder-friendly ecosystem for funding. But the whole arrangement relies on there being ample institutional money available and no downturns sips from juicebro
I don't disagree with that diagnosis but think that's more a question of how money within the VC sector is allocated, not how much money is being allocated to VC in the first place. Like you, I see a lot of money going to people wearing cargo shorts and brightly colored sneakers and then getting plowed back into the startup casino. I'm just saying, that money used to go to country club investment bankers; it didn't --- at least until recently --- get diverted from the broader economy.
There are a lot of startups whose mentality is "get big quick enough so that we can get bought out by Google/Facebook/Amazon/etc"
Yep. I worked with a startup that, after a few months, obviously had this as its primary motive. They made an app similar to another big-name (at the time) app, with the intent of having that bigger app buy them out.
When the big fish didn't swallow their little fish they blew all of their remaining cash on a big party in New York and flew in all kinds of bold-faced names to bring attention to themselves. And it worked. A few months later they were eaten by another company, everyone lost their jobs, and the founders retired at 31.
The irony is that a few months after that, its only competitor "pivoted" and abandoned the space it was competing in. If the small fish had held on, it would have owned that market.
Basic human tact. If I was mad at the company, I would probably overcome decorum and dish. But I wasn't an employee, just someone involved with the company.
I gave them data from my company, and they gave me things in return. Through a bunch of sales that database ended up being the core of a large mobile app that's a household name, but you'd never know it from the outside.
I got 'stuck' at a similar place during the recession around '05. One of their projects was just demo-ware we were selling as finished product. When I wasn't on the project it wasn't so much my problem, but as time went on they consolidated all their work on that one, in part to improve their financial story for investors. So then I'm working on a slow trainwreck that I didn't get to set strategic direction on when the project was young and flexible. So many antipatterns repeated throughout that code. I learned to hate/fear caching on that project (ex: you can't cache a table scan, unless the entire table fits into memory, and then it's not a cache).
When we got bought the founders complained about how it wasn't enough to retire on. Aww, poor babies. We were too early (Apple introduced a similar product 6+ years after we started ours), so the payoff was only enough for them to live comfortably for the rest of their lives. Except they immediately got condos downtown with unobstructed water views so I doubt that lasted very long.
I think you had the same problem we did. Potential investors take competition in a space as validation. Legitimate competition just solidifies that validation. The moment you folded, the screws got tightened on the other company. Either they didn't get any offers at all, or with terms that were terrible. Founders don't want to be treated the same way they treat their employees.
(This thing where companies get bought out and discontinue their flagship product is, in my mind, a failure mode. That's not success if you make things for a living. Somebody, not us, got rich, while we have a project on our resume that was a failure by our standards, but makes us more attractive to the next guy who wants to pump and dump a company. An attractive little cog for their big wheel. And maybe, just maybe, enough from shares or bonuses to get a loan on a new car)
>> I think the biggest difference between today and 20 years ago when I first go into Silicon Valley is that most founders are generally already planning their exit. There are a lot of startups whose mentality is "get big quick enough so that we can get bought out by Google/Facebook/Amazon/etc".
Exactly the same mentality 20 years ago, except back then it was mostly about the IPO.
Fair point. IPO was the goal during the dot-com boom/bust (I saw this all first hand as well) but at least the founders weren't looking to ditch the company right after. The VCs were of course, they're always the snakes in the grass no matter what the backstory is.
My experience is that there was a fairly brief window in which founders believed an IPO was a plausible way to flip a company, and that before, during, and after that, the more common objective was to build a company to flip to some other firm that already had done an IPO. When we started our multicast company in early 1999, none of us believed for a second that an IPO was in our future, and our VC pitches (mostly guided by the VCs, some of whom ended up funding us) were almost entirely about who might end up buying us.
I think this is just an extreme boomtime mentality. Investors are cashed up, and so are the large tech companies buying these startups. Valuations are so high that building companies to flip is just too damned lucrative to do much else.
I think part of the difference between the late 90s and now (besides scale) is that small IPOs don't exist anymore. VCs need exits and once founders own n% of a $100m company, they need a way to realize those, unless they're willing to totally ignore their own financial interests.
The 1990s IPOs didn't work out well though. These companies were still longshots, and public markets lend better to lower risk-reward companies.
The second part of the problem is tech "monopolies," in the thiel sense. Google and FB's business models, for example, needs massive scale. A social network or search engine with 10% of the user's is not worth anywhere near 10% of what FB or google are worth.
So... the "highest value use" of a smaller startup is to help maintain a larger company's monopoly.
Finally, the tech space (especially consumer web stuff) just changes too fast to "build something lasting."
.. I'm not sure everything needs to be lasting. Do we even want dating apps or online loyalty programs that last a century? Maybe we just need classier ways of doing shorter horizon stuff.
> I just don't think I would get excited working for someone I know with that short term of a mentality.
This.
I was recently the first full-time hire at a seed funded company that was in the right place and the right time. They grew to 10 people over a few months, and I loved the people I was working with.
Knowing that the founders had a 10-40x equity stake larger than mine made it nearly impossible to feel invested in the company.
> Knowing that the founders had a 10-40x equity stake larger than mine made it nearly impossible to feel invested in the company.
Knowing that you don't have an equal stake in the company makes it almost impossible for the founders to view you as a peer. This is bad for everyone involved.
Until you become a founder yourself and know how hard it has been might change your mind. Otherwise we're all just employees. One big difference is that founders take bold moves and risks. I also consider this is capitalism at work.
It's not like the money's a gift... you have various metrics presumably that you have to hit once you raise money, especially once you're past the angel/seed stages.
> So the fact that this person is already targeting a $50M exit makes it less interesting to me. I just don't think I would get excited working for someone I know with that short term of a mentality.
But how do you know how much time will it take to reach that $50 million? If it was a VC backed company sure it might have taken couple of years ie short term. But for a bootstrap company focusing on a smaller pie or niche markets this could take years to happen.
For further context: It used to be that a technology company could go public and provide an exit to investors. After the dot com crash, Sarbanes-Oxley regulations made it much more difficult to IPO. It has many administrative requirements, greatly increases run rate to support and raises the finanical bar significantly to which companies can go IPO. The VC model however remains the same, they need 10X returns. Thus you see them pushing entrepreneurs to go IPO which post-SO means a longer runway to exit fraught with a lot of risk mostly placed on the entrepreneurs (compared to pre-SO). It became a rational choice for the founders to take smaller, faster exits since "the big one" (IPO) now looks less certain for all but the most successful startups.
That is a reasonable take but then you can also blame Sarbanes-Oxley on the likes of pets.com. SO is 2002 and while it was unquestionably a reaction to the dot com era and bust, it was also a reaction to Enron and others. Hell, it was passed and signed in the Bush administration.
Yeah, SO raised the bar to get into (and stay in) the public markets. Maybe regulation minded Congress had a point there. In any case, this correction didn't prevent private MA. Moreover, VCs still get their funds funded. So SO hasn't killed any golden gooses.
Maybe we should have corrected something in 2008. We certainly un-corrected Glass-Steagall in 1999.
Yup, the side effect is that customers of a given startup often get abandon with "it was great journey for us, you have one month to get your toys somewhere else" note.
No VC of any meaningful size is interested in a $50m exit.
Let's say as a VC you invested $3m and are holding 20% of the company at exit, that means you'll make $10m. A 3x return is nice but not going to be fund-maker.
If you're a $50m fund then you're expected to return >$150m, 10m will nudge you along to that target, but isn't going to be significant. Because a majority of your investments will go to zero or be small returners (1x-3x), it essentially means the good exits have to be >10x in order to be able to achieve reasonable returns for the fund.
It is my understanding that YC only funds companies that have a shot at being unicorns (I am happy to be corrected here). If you are aware of this fact, and a "lifestyle" business is your goal -- is it not dishonest to accept YC money?
If you look at the companies it funds that is obviously not even remotely the case. You don't have to lie. And even the most lifestyle business still wants to increase sales. I'm not sure the OP would even agree with the label lifestyle business.
If your funding arrangement allows a minority investor to veto future fundraising, subordinate liquidation preferences, etc etc, they can kill your company.
Of course, most deals aren't on such onerous terms - but they do happen.
The level of control depends on the term sheet. As far as I understand, there is always a degree of control/preference, even when VC's share is minor. I haven't heard of term sheets that would give total carte blanche to the founder.
I'm not an economist, but the SV economy (which has become a nontrivial chunk of the US economy) just doesn't seem like it can keep doing this forever. The driving ethos is to throw everything related to building a sustainable business out the window, in the interest of cashing-out as fast as possible. Slash-and-burn capitalism. That's not how you create jobs. That's not how you grow an economy. That's how a few people get very rich very quickly. "Move fast and break things", as it were.
Can someone elaborate on this? It makes no sense to me:
The risk profile of your company increases dramatically when you take VC funding. You start spending more money than you are earning, your focus shifts to raising your next round, and your VC now has veto authority over the sale of your company. Your company is now a ticking time-bomb.
You can literally NOT do those things. All the VC has is signaling. Theh can’t block your future raises, only have drag/tag along rights, first refusal or whatever.
VCs purchase a different class of stock than you have as a founder, called preferred shares. It is standard to require a majority of the preferred shares to authorize a sale of the company.
Approval of the Preferred Majority required to ... including a Company Sale.
However, that is a Series A term sheet. When you turned down YC, wasn't that at the seed stage? You would have still retained control until you converted later.
But are you saying that even only accepting a SAFE puts you on an inevitable path?
If you raise seed funding, the expectation is that you will continue to raise money to fuel your growth. Even if your SAFE or convertible note doesn't have those terms in it, your first priced round will and all previous investors will inherit those rights through their preferred stock.
Expectation is one thing and Term is another. Is it possible to raise seed funds with the expectation of early profitability? This is very much like your approach but still with a seed investment just without Series A handcuff terms.
Google did something like this. They wanted to avoid VC as much as possible and when they did get an A round it was on their terms.
Most companies that go through a program like YC are pretty early. Entering and accepting the funding means that often times companies have inflated valuations. Being accepted into a top tier program is not enough to pull in investors in many cases especially if it means that the valuation is inflated and the company is still working on product market fit or early revenue.
I think the amount of VC bashing in the post is unwarranted. It makes it sound like VCs make fat salaries on the backs of other people - either in form of investment or startup founder's hard work.
The fact is that some founders, including the author, feel that VC confirmation is a validation of their idea/business. So, while founders shouldn't raise huge amount of money for niche projects they do it anyways because that's how they see validation of their idea.
One of the requirement listed to apply via the author's company is native fluency in English. How do they evaluate that? If it's some test, I am not aware of any test which measures this. If it depends on where you are born? Is that kind of stratification legal?
Requiring "native fluency" could be interpreted as requiring the candidate to be a native English speaker, which would obviously be discriminatory. That's probably not the intent, but it's a bad choice of wording.
If they mean "as fluent in English as a native speaker", then that's arguably much too high a standard.
My university got a lot of international candidates whose first language wasn't English and who hadn't been educated in English up until that point. As a result, they established a process to assess your fluency so they could accommodate you with additional training on English to ensure you'd be successful.
Yes, I should have been more detailed in my response.
You're right that all of them give a quantative score, not a qualitative score like "native". There are qualitative scales where one of the labels is "native fluency". For example, the Interagency Language Roundtable has level 5 (native/bilingual fluency) which means the speaker has "complete fluency in the language, such that speech on all levels is fully accepted by educated native speakers in all of its features, including breadth of vocabulary and idiom, colloquialisms, and pertinent cultural references".
Other people have devised concordances that map the quantitative scores from things like TOEFL onto the ILR labels.
ILR level 5 is a very high bar, though, as you point out elsewhere. It is unlikely that Facet truly needs someone at that level, they'd most likely be fine with level 4 or level 3 speakers.
But reaaaaaaaallllly, I suspect we're all ironically missing the point of the communication. On the one hand, we can construe it narrowly and it may be technically flawed. On the other hand, it's marketing copy and I suspect most readers treat it informally, especially since their audience is entrepreneurial people who want to do contract work -- a pool who is likely to ignore the strict letter of the requirement and apply anyway.
I don't think it's correct to refer to a job ad as "marketing copy". A job ad should be clear, especially with regard to potentially discriminatory requirements.
https://www.joelonsoftware.com/2003/06/03/fixing-venture-cap...
The fundamental reason is that VCs do not have goals that are aligned with the goals of the company founders. This creates a built-in source of stress in the relationship. Specifically, founders would prefer reasonable success with high probability, while VCs are looking for fantastic hit-it-out-of-the-ballpark success with low probability.
...
Even though the second model has a lower expected return, it is vastly preferable to most founders, who can’t diversify away the risk, while VCs who invest in dozens of businesses would prefer the first model because it has a greater return. This is just Econ 101; it’s the same reason you buy car insurance and Hertz doesn’t.
Though to be fair, he also explained why he took VC for StackOverflow at Startup School 2012. Basically this:
https://www.joelonsoftware.com/2000/05/12/strategy-letter-i-...
tl;dr StackOverflow has a network effect and needed to scale fast.