As an angel investor, I can anecdotally confirm that I've become more cautious recently (in the last year, really). However, I'm not at all concerned about the stock market. That has never influenced my decision to fund a company. My belief is that a strong company can weather a bear market.
I'm concerned with the current state of valuations - I enjoy giving investments to companies on the order of five figures or so each with the hope that they make something meaningfully impactful. I don't necessarily look for them to become moonshot successful; a win can be much smaller than that. Developing incrementally impressive technology that effects change is also a win.
But valuations are so frothy right now that it's difficult to tell the strong companies from the ones that won't survive "when the tide goes out." It all seems very clear in hindsight, but it's hard to know right now, even moreso than usual. This is always very difficult, but the market for ideas has become somewhat "congested."
There has been a flood of folks entering the "startup game" who seem to be planning for their IPO before they've even gotten a product off the ground. Again, anecdotally, I'm observing a noticeable increase in fraud among founders who are trying to raise money unscrupulously, especially with novice investors.
I don't like to use the word bubble because I think it's lazy analysis, but I do strongly believe valuations are in the beginning of a market correction. At the very least, I think there will be a higher bar for invested money to indicate a legitimate valuation instead of a loan.
I do think that there will still be plenty of capital ready to be given to companies, investors are just going to be more selective (read: cautious) about it, which may very well change the growth and success potential of certain more dubious business models in the valley.
It's easy to separate the potential winners from the losers though. Start-ups that deal with hardware and other physical stuff tend to fare much worse than apps and software.
I think that analysis is too one-dimensional - it's not meaningful enough for me to simply say "hardware startups are probably bad and software startups are probably good." That's not a complete picture, even if it's true that successful startups are not evenly distributed between hardware and software, because all the other factors of startup success are not evenly co-distributed between hardware and software. It is merely one dimension of risk analysis.
In the United States, ~32,000 people die annually in car accidents. In New York, ~1200 people die annually in car accidents. I live in New York. Which statistic do I pay attention to? Does it influence my analysis of total vehicular accidents that New York has a much higher population density than most of the country? Am I more likely to die in New York or somewhere else?
What is the startup building? What is the existing market the product? What experience and domain knowledge do the founders have? How far along are they? Who are their actual and potential customers?
That's the first five minutes of a due diligence conversation. If it were so easy to divide potential winners from virtually certain losers, people would hedge so well they would lose almost nothing and most angel investors would become rich. The reality is very different.
> Start-ups that deal with hardware and other physical stuff tend to fare much worse than apps and software.
I'm not sure I buy this.
Maybe on Kickstarter, et al. I do, because most of the people trying to do hardware there are hobbyists who have never actually shipped a product and so have highly unrealistic expectations. My baseline for a hardware Kickstarter is "Take the Bill of Materials and Multiply by 3--if that isn't retail price they're in big trouble."
Hardware startups take quite a bit more money to get running. However, once they do, you tend to have a very strong customer base and a less assailable position. They have hardware after all--3 guys and a dog can't just clone them.
> However, I'm not at all concerned about the stock market. That has never influenced my decision to fund a company.
It probably will as things start to slow down.
During the growth phase of the business cycle, many companies do well. Even some with poor fundamentals that shouldn't. This is the danger of stimulus - it promotes an inefficient and wasteful allocation of resources. But it makes investing easier as a larger pool of companies are succeeding and finding exits for their founders and investors through IPOs and acquisitions, which are both very closely correlated with the health of the stock market.
During the contraction phase, the companies with poor fundamentals are exposed. Ok, no loss there, they were struggling and nobody really believed in their potential anyways. But contractions can also bring down good, solid companies who were just caught unaware and were not holding enough liquid assets to pay their employees and the interest on their debts. Some non-negligible percentage will not make it through a rocky period while liquidity dries up and relatively cheap funding/investing slows down.
I think it's smart to not read too much into the stock market as it can be distracting and noisy, but I think its trajectory and what it indicates about the phase and timing of the next business peak/trough cycle is extremely important and should not be discounted.
You have a very good point, in that the stock market's current phase ultimately affects the health of all its constituent companies (in both a symbiotic and parasitic relationship).
But like you said, I don't consider it helpful to pay attention on a day to day basis, and I find it to be a more useful indicator for macrotrends than microtrends. In other words, my understanding of the stock market will influence my opinions about the angel investing and startup market en masse, but it would not be anything more than one factor in my opinion about a single company I could invest in.
While it's true that companies with strong fundamentals do fail in a downturn, companies with strong fundamentals can fail for any number of reasons. Just as I'm not all that concerned with my Vanguard funds going down for a while because they'll be back up in 10 years, I'm not too worried about a single company with strong fundamentals getting caught with its shorts down when the tide goes out. If it happens, it happens; in the absence of other poignant data, however, I find it much more important to focus on the company itself and pay attention to macrotrends more infrequently.
Besides, a market downturn is an excellent time to hedge long bets with shorts :)
> hedge long bets with shorts
I am curious, without sharing details obviously, have you actually been able to successfully pull it off or do you expect to see some hits due to changes in direction?
> However, I'm not at all concerned about the stock market. That has never influenced my decision to fund a company.
You may be the exceptional person who has no assets whatsoever tied up in the stock market, but nearly every investor who has the resources to be an angel will have money in the market.
When the market falls they have less money. They use money to invest in things. The correlation between the market and seed stage investing should be fairly direct and clear.
> The correlation between the market and seed stage investing should be fairly direct and clear.
The money can only be in one place at a time though. If you pull money out of publicly traded stocks, wouldn't that mean you have more money for angel activities? Although, when the market is way down, that's a great buying opportunity, so is that when angel investors stop putting money into startups and instead go on a stock buying spree?
You're arguing that they are substitute assets for each other that might move reciprocally, like stocks and bonds are. But equity at seed stage and public stage are the same asset class at different levels and move more in tandem.
My argument was more about the wealth effect though, which is that a crash in stocks makes Angels poorer and thus less likely to invest in risky startups.
It depends if the investor pulls their money out of the market when things start to shake down, or if they have some insights that would push them to do so ahead of a downturn. If they do, they might have _more_ money than usual to invest during a market downturn. Also, as a VC, your money is in a variety of startups that can crest even when the rest of the market goes sideways. Shopify had its IPO this year, others have been bought by the big guys, so their investors are now flush with new money. I mean if we have another big recession, there's going to be an investment chill so even an investor with cash to spare will have trouble finding partners to invest with. But we're not there yet.
When evaluating a startup in a given area, how do you bridge the gap between your expertise in that area, and that which is required to assess the opportunity?
Obviously the startup founders will always project the fields of gold ripe for the taking, so you can't blindly trust that. Do you only invest in the field you know well? Do you look for behavioral clues? Do you look for your or their peers' decision? Do you look for what's in trend, or counter trend?
It seems like a super tough problem, yet it hardly ever gets discussed...
Hire an expert. This is routinely done during any kind of due-diligence, if you don't know the field find someone who does, get them to sign an NDA and start picking the proposition apart.
Make sure there is absolutely no conflict of interest, make sure the expert will be told up front they will not be able to participate in any kind of deal and will only be paid an agreed-up-front hourly rate for their participation in the due-diligence process.
The amount of money you spend on a due diligence should be related to the size of the investment. Under 100K investment 5 to 10% should be enough to keep you out of trouble. A couple of hours (or a full day) of an expert in the field that you're going for would amount to maybe $1K to $3K depending on the field. Easy money for the expert and a very cheap insurance for someone putting down 20 to 100K of their hard earned money.
The funny thing is they don't bat an eye at spending that kind of money on a lawyer but to actually get a good look at the material it is suddenly 'a lot of money'.
I don't disagree, but there aren't enough "experts in the field" to supply your proposed demand. In a typical diligence round, you usually have financial/accounting, legal, commercial and ops/tech diligence. Are you suggesting they find a finance expert, a ops/tech, and commercial expert and pay them $1-3k each and on each investment?
Assuming the angel has at least one of those skills will save some money and assuming that it's not a single person funding the round yes, that's precisely it, whatever skills the group of angels does not bring to the table they'll have to farm out.
Otherwise you might as well go to the casino and put all your money on 'black'. Better odds that way.
I used to work quite a bit for angels (I'm priced out of their range now I guess) and contrary to A rounds the number of bad deals proposed to angel investors is substantially higher. By the time you get to an A round there has already been a significant shake-out, all of which means some angel or group of them have lost a bunch of money.
Contrary to what people believe angel investments are a lot harder to get right than later rounds. There are many more start-ups that die prior to receiving an A round than afterwards and the amounts are low enough that doing proper due diligence is not in the cards. But an abbreviated dd is (much) better than none at all.
I'm also an actual investor (but on a very small scale, I'm pretty careful) and that's how it is actually happening.
Except when it isn't and there will be blood (investor blood).
I make a living like doing tech dd, and when a due-diligence needs other expertise I'll be the first to point it out. This works pretty good for investors and technology people alike.
Investors that don't do due diligence at all end up losing their shirt, so that's a pretty good starting point. Just abbreviate the process relative to the amount of money involved, after all, it is a risk mitigation strategy, not a risk erasure strategy (if you don't want risk: don't invest anything just sit on your money and watch it evaporate, every other kind of investment strategy will carry risk to some degree).
So due diligence is happening after they decided to invest, right?
What about before? There is a number of startups that are pitching you (the generalized investor you), and for most of them you wouldn't know enough about target market to judge one way or another. Like, you don't know about wholesale distribution of manufactured goods from mid sized companies, how can you assess if the founders are onto something?
> So due diligence is happening after they decided to invest, right?
Yes, usually this happens after the terms sheet is signed (and for smaller investments after a letter of intent is signed or a handshake deal is agreed upon). Up to that point it is read as true that everything the founder says will check out.
The due-diligence process is there for two reasons: to fulfill the 'duty to research' for a VC to cover their backs in case a deal goes bad after investment and LPs wonder how the hell they got suckered in like that as well as to simply protect the funds.
For angels the situation is worse here because they don't have the funds or the organization to do this properly.
> What about before?
Typically a VC has a number of analyists that assess the companies that pitch them to see how solid the various commercial claims are. The accent there is usually on the numbers and the commercial side of things, which is reflected in the education of the associates (typically: finance, accounting and/or a bit of legal and commercial).
Angels tend to do this part by themselves.
Angels and VCs do roughly the same thing, only angels do it earlier on (when the risk is higher, companies are cheaper and the deals are much smaller so they can still participate), the biggest difference is dictated by the size of the deals, it limits the amount of money you can spend in order to determine if you spend it wisely.
To make an extreme example: a full legal/commercial/technical/financial dd would cost approximately 100K or so. The bulk of that will be eaten up by the legal portion, the remainder is roughly equally split between the other parts.
If you're looking to plunk down 100K as an angel if you actually did a full DD you'd be out 200K if the deal goes through or 100K if it doesn't, so then there is no point in doing DD at all. Hence my advice to do an abbreviated one scaled down to a portion of the size of the investment, but to definitely look at all these aspects of the company, if possible through the eyes of an outsider.
The other important thing to remember is that doing DD puts a strain on the company you invest in, and if every angel would do a full DD on a company before investing then the company would grind to a halt during their seed round.
Yet another note: for seed investments there usually isn't a whole lot to verify anyway, the company is still tiny, probably has no turnover (so financial dd becomes: look at the model), has very little technology (so tech becomes: look at the proof of concept) and so on. So everything becomes a lot simpler anyway, it wouldn't be possible to do a full process DD on a start-up that has only just become real enough to look for seed funding.
Thank you for taking the time to answer my question!
The reason I'm asking is that I keep imagining this picture: suppose there are 20 areas of economy(there are more but bear with me), and each angel knows one area well. Startups come at random from all 20 areas, so for 1 in 20 pitches the investor hears about something he understands deeply, can ask good questions and question assumptions. And so he can make an educated decision. What about the other 19? He can't judge the financials because it's too early. He has to rely on various proxies, such as interest from others (not necessarily any more qualified), the quality of the deck, the looks or pedigree of the founders (PhDs and professors are like really sexy as I found out), and so on. The likely rejection reason then comes out arbitrary, and obfuscated. Few people just say "not my area" before you even start. The startup founders are now wasting their time in 95% of the cases, unless they come with a sexy background and then investors are just piling up.
Wouldn't that be a lot more efficient if investors just referred unknown companies to a buddy who knows the domain area? I don't see it happening. Am I looking in the wrong place?
> Wouldn't that be a lot more efficient if investors just referred unknown companies to a buddy who knows the domain area?
That definitely happens. Most angels or VCs have a domain they are interested in and outside of that they will simply not participate or refer. Happened to me less than a week ago so definitely this occurs and fairly frequently.
> I don't see it happening.
It depends on how close to the fire you're sitting and who you are talking to I guess. In my 'backyard' it happens, frequently and the number of times that a deal is not even looked at is high enough that I never even thought this might somehow be special.
Another thing that will happen is that the party that did the referral will still take part in the round but at a much lower level.
This is a very fluid world you're trying to capture, local customers, connections and cliques will make up a lot of the background for such deals and you'd have to take all of those into account when you try to factor something like this into your worldview.
Personally I'd rather not see angels lose their shirt in areas that are not their domain,better if that money gets spent a bit wiser and on things that they understand.
My hunch is that most angels have random deals come to them, and most of those not being the specialty of this person, get tossed aside.
Then there is a group of angels who tag-team, and if one finds a deal he can't grasp, he would redirect to another member of the team. 12 people cold cover an area of expertise that's 12 times larger.
At least that's what I think should be happening... Does it?
Yes, pretty much. A single angel investing without a network is in dangerous territory, but that's the exception, not the rule. Most angels do have a network, that's also how you find them in the first place.
Perhaps the world is different, more optimal, in your neck of the woods. We've seen our share of angels coming up with all kinds of reasons to bail out, and never seen one saying "oh jeez, supply chain management is not my thing, let me ask Bob - he likes this stuff". I doubt they all knew the supply chain well enough to judge, but judge they did.
I hear what you're saying, it all makes sense. I just don't see it unfolding before my eyes.
>But valuations are so frothy right now that it's difficult to tell the strong companies from the ones that won't survive "when the tide goes out."
There seems to be some contradiction here: you seem to say valuations don't matter, but also that you're worried about them. How do valuations prevent you from spotting a good company?
>I do think that there will still be plenty of capital ready to be given to companies, investors are just going to be more selective (read: cautious) about it, which may very well change the growth and success potential of certain more dubious business models in the valley.
With so many SV companies that have hit it big without any real idea on how they're going to make money some day, it'd be interesting to hear what passes for a "dubious business model" out there.
> There has been a flood of folks entering the "startup game" who seem to be planning for their IPO before they've even gotten a product off the ground. Again, anecdotally, I'm observing a noticeable increase in fraud among founders who are trying to raise money unscrupulously, especially with novice investors.
FWIW I'll back you up on this, definitely a complicating factor for novice investors.
Free tip to novice investors: If someone approaches you with a request for funding, if it is still 'just an idea' and if the idea will surely deliver billions and if the funding required is < $50K then you're being fed a line of bull-shit.
Anything that will grow to turnovers that high will surely require a little bit of traction after implementation before any figures can be projected at all and anything that hasn't been implemented yet doesn't even qualify to be discussed in other terms than hypotheticals.
Another free tip for novice investors: pair up with a more experienced investor to vastly reduce your chances of being ripped off on your first investment(s).
This is also not a guarantee but it will increase your odds considerably, it also requires you to convince another, hopefully more skeptical party that what you've found is really worth an investment.
> anything that hasn't been implemented yet doesn't even qualify to be discussed in other terms than hypotheticals.
Except that once you implement it, investors start anchoring to how small your numbers are. Catch 22.
I work with an actual IoT startup. Hardware--implemented. Backend and frontend--up and running on Azure migration to AWS ongoing. Customers who pay? Yep--and they love it.
So, investors?
"Ick, haaaardwaaaaare? But ... but ... but ... that's going to take actual moooooney." (yeah--well, so did Nest, thanks)
"Your numbers are too small to be meaningful" (no duh--does the word "startup" actually mean anything to you)
"This isn't going to scale." (translation--it takes money and marketing to acquire customers--welcome to a business with actual value and customer lockin).
"Big data is uninteresting to us now." (translation--"actuarials" and "business process" are only profitable--not wildly profitable and flippable)
To a certain extent, I'm looking forward to these unicorns winding up on the butcher block and being discovered to have no meat. The lead VC's of these unicorns are going to give a bunch of the initial investors a huge haircut via preferences (don't get me started ranting on the stupidity of that). Suddenly, initial investors are going to have to start looking at "sustainable" rather than "flippable".
Yes. I may not be apart of that highly rigged game personally, but holy goddamned yes a thousand times. The front page of HN almost always has at least one story during the day about how irrational they are.
Some are. The rest aren't irrational so much as impatient. They tend to believe -- correctly or not -- that the winners and losers among their portfolio can be identified quickly, and prioritized accordingly.
They are not just thinking about your company in isolation. They are thinking about it in terms of stack-ranked IRR on a spreadsheet with other investments.
Now that I stopped laughing, I can give you a reasonable answer.
Yes, they are. But, then, handing someone a couple million dollars in the hope that it will turn into 50 or 100 million is an irrational act, too. So, it's hard to get too upset over them being purely irrational.
There are two problems:
1) VCs/Investors are sheep.
This is the infuriating one as it makes most of the VCs/investors you deal with effectively useless. To the point that when pitching to them the goal is to trigger that behavior (the term is FOMO-"Fear of Missing Out" aka: acting like sheep). So, if everybody is investing in something, everybody will invest in something. Until it blows apart. If you just want funding, try to pitch something which runs downwind of this tendency.
2) It's really all after the fact rationalization of "I don't like/trust you."
This doesn't make me mad--I just would rather a VC/investor just say this. But they won't turn you down definitively for lots of social reasons (mostly hoping they don't turn down the next AirBnB/Uber/etc. and get laughed at at the country club). I would actually respect someone more who simply said "My astrologer says the signs aren't right. KTHXBYE." Or, even, flat out "I don't like you." I'm cool with that--my personality is straightforward--most people like it, a few call it tactless and arrogant. If you're one of those I rub the wrong way, fine, we need to find different dance partners.
The problem is that too many investors want you to jump through hoops when they're looking for reasons to turn you down. Generally, you should simply read this as "No" and move on. It's like trying to date a pretty girl--when she gives you some excuse multiple times, she's probably telling you "No" but trying to keep you in her list of options just in case.
Upshot: raising money is hard work. If you want to sit in the big chair, you had better be prepared for the slog.
At the risk of upsetting those that pay my bread & butter, yes, for the most part. And then there are tons of buts.
The first one: but they're usually good at judging people.
The second: some of them do hire tech people to help improve the odds (because that's all this is, playing the odds, improve them enough and you can do very well at this).
The third: they're past masters at the other end of it, protecting the exit. This is important because without an exit there is no return worth measuring (dividends don't really count as a rule, but an IPO would be nice if the company survives the lock-up period or if the VCs get to float their shares or a large chunk of them).
Obligatory lame VC joke: Q: Why does a venture capitalist walk into the negotiation room backwards? A: So they keep sight of the exit.
The fourth: there are at least as many irrational founders as there are irrational VCs, if not many many more.
Finally: Trust is everything. Break the trust at any point and you can kiss any investment goodbye. Have broken tech, a broken business model, a good attitude and team willing to put in the time and the effort to fix the tech and the model (or even an outright pivot) and I wouldn't rule out that you get funded.
Fun fact: the one thing that keeps on being repeated back to me whenever we (one of my clients and me) go to do tech dd on any one of the companies they've signed a terms sheet with is that no matter how many other investors have already been in that position and no matter how many times that company has already seen due diligence teams it will be the very first time that they actually get to really show their tech, both the good and the bad. This never ceases to amaze me, the amount of sloppy homework on the part of VCs and the usual suspects of companies that do dd (usually the big legal and accounting firms get hired and they then farm out the bits to various parties) is scary and this costs quite a few of them many millions of dollars annually. Even so, it's good advertising for me so I really shouldn't complain.
Have you looked at more conventional forms of funding? If you already have meaningful revenues, why not just get a small business loan from a commercial bank? I've never done it, but I expect the interest rates are laughably low at the moment if you have decent credit and some assets (hardware, so yes) to back the loan. Plus, you wouldn't have to give up any equity.
> Have you looked at more conventional forms of funding?
We have, but hardware doesn't lend itself to small amounts of money. And there are different trajectories depending upon whether you can get 500 thousand, 2 million, or 5 million.
The folks I work with are religious about maintaining a low burn rate. Hardware has a LOT of NRE, and you can get in deep trouble very quickly.
We actually had to be very hard-nosed with customer which we expected to be profitable with about 100K volume (actually kind of the Valley of Death in electronics volume--100K has all the NRE of huge volume without the profitability) because we simply couldn't take the risk with cash we had in reserve. If the customer didn't follow through, the NRE would have killed the company. This is a very different discussion if you have 5 million in the bank.
In addition, while I can't prove it, I suspect that we lost some funding because we're religious about burn rate management. VC's want "Go big or go home" and someone who is managing burn rate well is anathema to this.
I can see how hardware would benefit from someone taking a risk with investment. It's better to sell hardware at the price point it would be at if you are doing it large scale to test the market, even if you are selling it at a loss. However, it sounds like you are almost beyond that point and know there is a demand and at what price, but it was probably hard to compete for investment (and talent) when investors were willing to throw money at zany schemes with hopes of unicorns. I hope for you, once investors become more careful again, that a business with something more proven and where the cash was managed sensibly will be exactly the type of company that most investors will be keen on. This was roughly the situation after the dotcom boom, except investors were poorer and less confident (well, I hope). I also think investors will have to increase their appetite for hardware, because IoT and autonomous vehicles are showing a lot of promise. I also think money that would normally go to unconventional oil and gas projects would be seeking something new. Good luck!
Pairing up with a more experienced investor is a great idea. The easiest way for an outsider to do this is to join an angel group. When I first started angel investing, I joined the Seattle Angel Conference [1], and I learned a lot from the more experienced members.
I'd counter that free tip with a dose of the real world. That less then $50,000 is rent and payroll.
If I'm a software start-up with a < 10 person team and I'm six months into a six month development cycle, and oh shit we miscalculated the significance of feature X, which has now revealed itself to be our greatest value proposition and requires 2 months more development time to be fleshed out (mini-pivot I suppose) in order to be sold to customers.. I need that 10k, 20k, 50k just to push the product out the door.
Sure I'm going to tell you all about our sales projections, remember when you asked to hear them in the meeting, and yes the projections will be optimistic (but still fundamentally sound). No I will not go into too much depth about all the reasons we pushed launch back two months (the meeting would go past the ~30 minutes allotted and you would likely feel bored towards the end of the meeting.. not good).
I think both investors and founders are products of our current environment. We both ride the roller coaster, yet I feel like founders often get portrayed as the dishonest ones (I'm guessing it's because we don't hold the money). Maybe I would just like to feel more representation in this thread.
10 to 250k is what a single angel will invest. Usually these team up for a larger seed round depending on their ability to fund.
Sure, $50K is peanuts, but then again, compare it to what YC offers and it's actually not all that weird. Usually seed funds do not get you enough money to go on a hiring spree and collect your favorite list of valley talent. But it might just be enough to get you to the point where you can demo your stuff and get a larger round. Essentially that's all that seed funding is, a way to get in front of a group of larger investors after doing some more product development.
There are dishonest people both on the founders side and on the investors side, no exclusivity there for either group.
Rare to see a career based on dishonesty last very long, word definitely gets around.
The more money that flows to the sector the more of a magnet it is for sociopaths and I don't think many of us are very good at dealing with sociopaths. You mentioned fraud, care to give some examples (no need to name names of course).
I've seen some things I'd have to tone down to sell as believable fiction, and this was several years ago doing consulting for startups.
Standard issue asshattery include things like:
- Paper-thin mock up demos of a product being misrepresented as actual finished sale-able product. Sorry but the V in MVP stands for viable.
- Impressive people are touted as employees, even co-founders, and when you go talk to them it's news to them. Maybe they had a conversation with said founder once and expressed some interest and suddenly to investors and others they are the CTO. Sometimes this arises from the founder(s) being so narcissistic that they simply assume that anyone would of course feel privileged to join them. Why wouldn't they?
- Company/founder has sales/vendor relationship with other companies and misrepresents those products as "theirs," implying that they actually own them. In one case I saw rebranding without permission, which is flat out fraud.
- Signups/trials/downloads misrepresented as active continuous users or free users counted together with paid users.
- Lying about educational or work background. A skilled blowhard will do so in an ambiguous way, e.g. "went to MIT" means "attended one workshop there and read a lot of open courseware."
- Products that would violate known laws of physics or proven mathematical theorems. (Or sometimes even grade school math...)
Wow. After reading that I personally call fraud. Even if there is any real tech behind the scenes, these people obviously didn't ship it to their Kickstarter backers. They hoodwinked Kickstarter as a source of easy money and then immediately turned that into VC backing.
Using people that way is textbook sociopathy. People are rungs on a ladder to be stomped on. Unfortunately it works. People fall for it again and again because they don't scratch the surface enough to see what's actually there.
Anyone interested in investing should take note of a few things here: highfalutin college degrees, patents (you can patent a cheese sandwich) or "patent pending" (which is trivial and meaningless), and unsupported claims of novelty are not reliable indicators of anything.
Valuations are fake, so who cares? I don't mean to be flip, but valuations are only important to other VCs. No surprise they created their own bubble. Valuations for the Uber-of-this or the AirBnB-for-that have been absurd. I'm not saying there aren't business opportunities there, but sometimes those opportunities are in the tens of millions of dollars, not billions, and hey, tens of millions is fantastic by the way.
Edit: I'd like to say I think this is a good thing. I've seen a couple instances where growth was on the back of VCs and didn't have a foothold in reality, and friends ended up losing their businesses. I'm a fan of bootstrapping but I totally get where VC money can help - a lot, in fact. That said, keeping an eye on revenues and reality instead of funding slide decks and pie-in-the-sky "potential" revenues can only be good.
Valuations are fake from one perspective: that they don't reflect anything more than a handful of investors' decisions to pay for a slice of the company.
They have very real meaning when it comes to things like employee options and ability to raise money to pay for employees. If a year ago a company raised $10m at a $50m valuation, but now they want another $50m to scale, they'll have to give up a much bigger percentage of stock to do that, which can essentially wipe out any employee stock (founders likely have a different class of stock that isn't as affected).
And along the same lines, maybe the company can't raise as much cash as they want/need. In this case, they have to cut back on what they pay employees. In these cases, the money starts to tighten up, and people don't see the reason to stick around SV paying $4k/mo in rent if they're only being paid $8k (before taxes), so they start to look for other places to go. This can lead to a spiral where an otherwise good company can't retain or attract talent, and so the cycle continues (don't hit growth targets, can't raise money at good rates, etc)
Because they actually aren't fake. I mean I get what you are saying, but the reality is that real money changes hands based on those valuations, so they are priced the same way as any other security: Someone says they will pay a certain price per share.
I think the issue is that investors setting the prices as market makers don't have a super strong track record of doing valuations with high accuracy.
On AngelList, a crowdfunding site aimed at such investors, the average valuation for a company receiving funding reached $4.9 million for two quarters last year, its highest level in five years. But valuations dropped to $4.2 million in the fourth quarter, the lowest level since early 2012. Dow Jones VentureSource data shows that deals involving angel investors fell by 16% last year.
It seems like a big deal until you realize there is a huge variance in prices and that 2012 isn't very long ago. The biggest and most successful ones seem to be doing just fine.
It's the same as to compare someone on absolute salary of $100k in Silicon Valley vs $50k in Estonia, forgetting that the latter can provide a luxurious lifestyle with tons of money to spend, while former can mean being barely break-even.
Median income in San Jose is $80k, so 50% of all households make less than that. $100k does not mean you're barely capable of breaking even. For any reasonable amount of income, it is possible to spend in such a way that you're barely breaking even, of course.
But this whole meme of six figures is hard to keep afloat with is the worst kind of cringe-worthy "Oh poor well-paid me." My wife works at Habitat for Humanity in the East Bay. You don't want to consider what the low level employees there are making (and no, they aren't all living with their families or have spouses helping out).
Heh. No, I looked up the average rent for Oakland, which I assumed would be less expensive than downtown SF. I saw $3k, which would likely be higher than the take home pay for a low-level employee.
Averages aren't really representative - even in SF there is a very, very wide variance between a crappy run-down studio in an undesirable neighborhood vs. a luxury condo in the hottest neighborhoods. The average is really just tossing those two in a blender and hitting the "puree" button.
Likewise, there are still cheap places to live in Oakland, even if the average is high (and rising). Also, there are places further out of Oakland that are still relatively inexpensive.
In any case, the "typical rent" on a SF/Oakland apartment already affords a lifestyle more luxurious than most people in this country ever experience, which is why IMO aetherson is right in calling it "Oh poor well-paid me". This meme that 6-figure incomes in the Bay Area is "break even" is a special kind of myopic: "Oh dearie me, I'm making 6-figures, enjoying quality of life way higher than is typical for my country, but I'm just breaking even!"
I live in the Bay Area and I don't know anyone who pays $3k for something in Oakland by themself. I think the averages you're looking at probably show a bunch of places multiple people live in together and split.
Well, when I met my wife (this was a few years back, but also her pre-tax salary was about $45k at the time), she lived in a very small one-bed apartment in a bad part of Oakland. Prior to being able to afford that, she rented a room in a house (not with relatives) in Berkeley.
I haven't been to the living places of my wife's coworkers, but I would expect that the ones who live alone tend to live in small apartments in undesirable areas of relatively inexpensive cities.
Median income does not mean what you think it means.
There are basically 4 socioeconomic classes in modern society: the disposessed, the working poor, the middle class and the wealthy class. You can split hairs and make different cuts, but if you follow this model.
* The disposessed is the people that fell through the cracks. They are struggling to survive usually for multiple issues that are holding them back, even if they have incomes. In a healthy society they should be a small minority.
* The working poor is the people that manage to make ends meet, but are one unexpected big expense away from financial disaster. Unlike the dispossesed their main problem is that the jobs they are qualified to hold do not pay enough, so they may do everything right and still land in trouble.
* The middle class is people that is financially relaxed, even if not rich. They can afford luxuries, and are the prefered target market for many business both because there are many of them and because they have disposable incomes.
* The wealthy run the show. They are not relevant to this dicussion.
The point about "median income" rethoric is that Americans assume the middle class is always 50% or more of the population. So, by definition, median income == middle class. This is not the standard way of things around the world or through American history. Instead, there was an historic anomaly after WWII, when all the other industrial economies were blown up during the war and Americans enjoyed the advantage of being isolated enough to keep their infrastructure mostly intact. Every Risk player knows how this go.
This allowed the American economy to grow faster than population during the second half of 20th century, so most people could aspire to join the middle class, and the upper tiers of middle class could aspire to join the whealty class.
Arguably, the oversupply of money in the Bay Area is reverting this trend. This is what happened to Spain in the 17th and 18th century. The country itself got rich because of all the resources they extracted from their colonies in the Americas, but the rest of their economy did not grow as fast.
The result is that everyone that was not connected to the gravy train from overseas was, in effect, poor... even if they had enough money on their pockets to qualify as well to do in places like Central Europe that did not have colonies of their own. The well-off German farmer had access to cheap food, shelter, craft goods and the occasional specialized service that were simply not available to the average Spaniard lackey, because those last were priced out of the market by the soldiers and the customs officers.
Now the colonies are in the cloud, and software developers are the workers that help bring the value produced there into the realm of physical reality.
I think these points are only radicalized by things like Bitcoin which will have an effect like the silver coming in from the "New World" . . . except more eerie . . . or ethereal: Ethereum's currency is called "ether"
Was going to say that in Baltics 50k a year is not a salary that an average engineer can aspire to. It is more than the premier makes..
Additional data point: UBNT is paying 36k in Riga which is an outlier at the top. I think most positions with a few years of experience are around 25k in Riga and starting salaries are around 12k.
$50k gross is <€3k net monthly. There are quite many who make that, probably over 2% of the tech workforce (more than 2-300 people in Estonia). But even with €2k net your consumable income is bigger than for someone making $100k in the Valley.
People are still willing to invest, but the issue is really that valuations got out of control and that's really hurting a lot of companies. For too many companies these days yesterday's glowing press release about being a 'unicorn' is today's oh $%#&! moment dealing with the ugly reality that sets in when valuations return to some resemblance of reality (e.g., employee stock options that become worthless, lots more tough questions about revenue and profitability and less awe over the hype).
Companies that have a solid product, real revenue (i.e., their revenues aren't just coming from other companies on life support from VC cash) are profitable (or close to being so) and have a valuation based on reasonable multiples of their profit will get through the coming rough waters just fine with only a few bumps. Startups that can't tick those boxes are in for a really rough ride ahead.
Somewhat ironically, the downfall of many of these startups will be that they ever allowed themselves to be valued so highly in the first place. A company that's reasonably valued at $20 million is going to be in a far better place than a unicorn once valued at $2 billion that's now valued at $500 million.
Whenever I see articles about how easily the investment money flows or had flowed all I can think of, from a purely self-centered point of view, is "what kind of loser am I that I have never been able to raise a single round?" Seriously, my ideas aren't objectively stupider than the ones I see funded. Even in this article, I mean, home eye exams? Did I read that right? How about a startup that will come to your house and groom your dog? These can be good businesses but are they on topic when we're talking about the angel investment environment? Apparently so. Not that I'm bitter (stop being bitter, dammit!)
I think the point is, they are good businesses short term. They have a minimal terminal value, short lifespan, and there is virtually no barrier to enter the market.
Sort of like when google launched. The only surviving niche of google X is travel. You just google pets, not petsearches.io.
The equities market is so broken, and interest is so low, that there is an overspend into private markets. Value capture takes 20 years, company lifespan, i would baselessly guess, is 5 maybe. So this shit makes no sense.
Best bet is still make something you like working on, to the extent you represent other people, is pretty much your product demand.
But yeah mate, you could throw up a squarespace site and be the next cat bubble baths on demand startup.
I realized as a super shitty developer, that I will probably totally fail at this side project, but at least when someone gets it done i can say i was years ahead of the curve, just didnt have the chops.
Most of the ideas and products I attempted to get funded were around the idea of transforming the electronic medical record (in the broadest sense) from a mostly free text entity to a mostly well modeled discrete data entity. For more specific ideas I would be happy to discuss outside this board.
Thanks! It's a good idea, but I can see why it was hard getting funding - it's a difficult market to enter: a lot of people are trying to do this, including large well entrenched competitors, there's a high regulatory burden, and you're selling to a conservative customer base (doctors who need to change their working habits + hospital admin who need to make a significant investment).
(I'm sure you know all of that, by the way, just reflecting on how difficult it would be to convince an investor).
Yep. I'm currently trying to figure out a "back door" to sneak in. I had a meeting with a VC yesterday (not to raise money) and she added an idea to one of my ideas and the result has me pretty excited. Of course, I've been here before ;)
While I agree with much of the sentiment (esp in today's Silicon Valley), there are a bunch of caveats:
- A lot of ideas sound dumb when they first come out
- A lot of signals are used to decide which companies to invest in (I don't agree that this is right, but it's easier to get cash when you're in a prestigious incubator, or graduated from a top eng school)
- Many successful companies are a good idea, a good market, and good execution - so an idea is just a (limited) starting point
They're some really (what I consider) dumb ideas out there (esp in the seed part of the space), but I wonder to what degree the unicorns are actually good ideas that raised way too much - and tried to grow way too rapidly.
I disagree. Judgments are difficult in the vast formless middle but some things are objectively good business ideas and some are objectively bad. Unless we are having a philosophical discussion about the possibility of anything being "objective", I submit it is possible to define some criteria for a good business idea, then assign by consensus a probability with which each idea meets these criteria.
As a founder who has raised both angel and institutional $$, these articles can have the same effect on me. For nearly everyone, raising money is hard, especially in the beginning. Uber had trouble closing its first money. There's a lot of luck, hard work and network involved in getting $$ in. The first money is less about idea and more about reputation and hustle.
It took me a long time to figure this out, because no one tells you, but it's actually very simple. There are two ways people raise money in Silicon Valley:
It's very easy to get some initial traction for these local services businesses, so investors fall for them easily. They lose money on every transaction but will make it up in volume ala Kozmo.com, Pink Dot, etc.
Despite the fairytales, no one actually invests in technology startups based on their products in Silicon Valley. Really, no one.
Oculus VR is a great example of the kind of business that investors had no interest in. They reluctantly jumped on the bandwagon very late, and only after it had lots of traction. Very few investors were interested in SpaceX or Tesla. That's how bad Silicon valley investors are at what they do. It's an industry ripe for disruption (see: YC).
The false narrative told in Silicon Valley is that VCs are in a constant search to fund new innovative technology products. That they consider it their job to actively seek out great new products to fund.
In reality, they sit around waiting for winners to emerge and then try to pounce (traction). Or they back people that have such prestigious credentials no one will blame them if it fails (reputation).
Palmer Luckey could have gone door-to-door with the Oculus Rift prototype and not a single investor in Silicon Valley would've been interested (product). Without reputation or traction, he had nothing they valued.
It's actually a very exciting situation because it means there's huge untapped potential waiting to be unlocked. YC has tapped into this just a little bit.
this has been my suspicion that it's a game of hot potatoes where the goal is to pass it to the next sucker for profit. Almost like a Ponzi scheme where the last guy to buy the company bears all the risks, often the public IPO market, while the train of VC and underwriters have already made their money.
The guys who work for VC has to make number of investments and it's not like investing in the stock market, it's far far riskier and uncertain (hence the huge returns). So it makes sense that they would gravitate towards low risk bets by betting on momentum to piggyback on.
This explains why there's crowding towards 'hot & flashy' startups on techcrunch and not as much to individuals focused on technological innovation. This crowding naturally leads to unicorns with unsound valuations that I've been qustioning.
The comments on HN after some hiatus is starkly different than those of 2014 or 2015. In 2014 I said the bubble will pop and I was ridiculed and downvoted to hell. In 2015 more people agreed and now majority of the comments are people ringing alarm bells now.
I think the coming years where unicorns drop left & right, we will also witness the beginning of the end for Twitter & Facebook and towards a decentralized, peer to peer, cryptographic replacement.
>It's actually a very exciting situation because it means there's huge untapped potential waiting to be unlocked. YC has tapped into this just a little bit.
Very much agree. The root problem stems from people's inability to independently measure value. They rely on external signals (traction, reputation, etc), because believing in a team and product independently is hard work. It's a leap of faith, where you have to believe in yourself first. Most people would rather run with the herd.
That said, there are more and more people who don't follow that pattern. As they become successful and turn to investing and supporting the next generation, I think we'll see a lot more daring ventures come to light.
I had (and have) a similar reaction. It was strongest when I was raising money back in 2000 for my first startup.
My co-founders and I were pretty dismayed by the anecdotes of "20 year-olds raising millions with just an idea!" because we were, well, 20-year-olds with a great idea, and the millions were NOT being thrown at us. (And not to sound too arrogant, but we were pretty much in the target demographic for that easy capital -- Harvard & MIT guys with a great idea and great demo.)
In the end, we did end up raising money -- after a LONG slog and MANY disappointing meetings. So we proved it was doable, but certainly not easy.
We came to a pretty simple conclusion back then: The anecdotes were either exaggerations, extrapolations from a tiny number of actual examples, or outright falsehoods. Remember, this was the first dot-com boom, and the story about kids with big ideas and tons of investor cash was a new one and played well in the press, so it's easy to understand why it got play.
These days, the story is different - and to staunch's point above, the "easy money" stories today are either coming from inexperienced/naive investors who think that's how things are done in Silicon Valley, or experienced investors throwing money at folks who have made money for them before (and why not? If your investee made you 10X on your last investment, it's understandable why in some cases, simply as a thank-you, you'd throw one of those Xs back at the new idea.
One thing to really internalize is that a business is not a product.
If you just look at some product that's gotten investment and think "why would they invest in that?", you're thinking about it wrong.
The entrepreneur that's been out raising that round has been out pitching a vision for a large billion dollar business, with that product as just one of the initial steps on the road to getting there.
To raise money from investors, you'll need to on the one hand present a vision for a large business like that, a clear road-map to getting there and sufficient proof to convince them that you and your co-founders are capable of executing on that vision and that road map.
Sometimes you prove this with a working product and traction around it, sometimes you can prove it because of a stellar background (having done it before) and sometimes you prove it because you're pitching to people who already know you very well and believe in you.
I kinda side with Ron Conway on valuations. His take that valuations are not that important and company's success is mostly binary seems like common sense. Never understood the haggling that goes on over a few million when the exit could potentially be counted in the billions.
This is right to some extent. A valuation is not money-- it's basically a fictitious number that the company and its investors come up with to make the percentages work to everyone's satisfaction for a round.
The problem is that it's also a minimum bar to be cleared later, and if that minimum bar is not cleared it means you're in down round territory. It also in many cases sets a bar for a minimum exit for anyone but the preferred shareholders to get much of anything.
A down round is not necessarily death but it very negatively impacts founders, employees, and anyone else who holds common stock or options on common stock. This in turn can kill a company not through cash flow failure but by nuking morale and causing employees to leave (as well as demoralizing the founders).
I've thought for quite some time that these really high valuations are actually a trap for founders. A lot of founders have sought them for IMHO ego-driven reasons, but in the end they'll be the ones getting diluted badly in a down round.
I mean... I'm not a finance geek but it's always seemed to me that founder (and employee and also possibly seed investor) interests are maximized by maintaining a reasonable valuation. With a reasonable valuation the risk of a down-round is minimized and if there is a sale it's much more likely that the sale/exit amount will clear the liquidation preference bar and something will cascade down to the common shareholders. But what do I know. I just work here. :)
As many have mentioned: the big wildcard here is how economically incestuous the startup world is. How many smaller startups are dependent on trickle-down from the unicorns?
If the answer is "not too many" then it will not affect the other 99% of bootstrapped or less lavishly funded startups. If the answer is "a lot" it will be rough and have cascading follow-on effects.
A major driver of the 2000 bubble was startups paying startups to advertise, market, or help build their startups. It was a classic bubble: an unintentional "emergent" pyramid scheme.
That might actually be a problem at the moment, mobile and web content producers making good money off advertising from other well funded startups in the B2C space (e.g. mobile), and all of the ad tech industry in between. It hurt when the property bubble burst and property web development and ad revenue took a knock.
Has something actually changed? I mean, appreciably in just a few months time?
Just goes to show angel investors, while an essential component of the startup ecosystem, can be emotional, illogical, and volatile.
If you're unable to accurately value what you invest in and prone to getting swept up in hype, you shouldn't be investing in startups (or maybe anything).
The ones who suffer in all this aren't the investors -- they're already rich. It's the employees who get shitted on, forced to work harder for less, or loose their jobs because of the whims of the market and other people's faulty thinking.
This is why I'm conceptually attracted to convertible notes. Valuations always seemed like an illusion...but then caps became status quo as stand-in for valuation. I understand, buyers want to know the price they're paying...
But it's still an illusion. That said, there seems to be a very functional solution: discounts.
I don't understand why they are not used more. Why not develop industry models for expected value increase from seed > A > B, then invest with convertible notes discounted accordingly? Do this for each round... until there is a liquidation event.
The notes themselves would have to offer slightly more protections with each round, but in general, it creates a model of relative value, while that value scale is still being determined... rather than fixating upon some arbitrary valuation.
If these large startups with crazy valuations are now in danger of not being able to raise a bigger round to sustain their burn rate, and the crowd mentality of VCs sour, how realistic is it to expect any of these companies built on lack of due diligence in testing out the viability of their ideas to last? For example: startups delivering food. nobody done it before because everyone knew it was dumb unless you owned the entire delivery chain, and even then the margins were razor thin and they convinced bunch of VCs that an Android app was going to fix the broken business model.
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[ 2.9 ms ] story [ 161 ms ] threadI'm concerned with the current state of valuations - I enjoy giving investments to companies on the order of five figures or so each with the hope that they make something meaningfully impactful. I don't necessarily look for them to become moonshot successful; a win can be much smaller than that. Developing incrementally impressive technology that effects change is also a win.
But valuations are so frothy right now that it's difficult to tell the strong companies from the ones that won't survive "when the tide goes out." It all seems very clear in hindsight, but it's hard to know right now, even moreso than usual. This is always very difficult, but the market for ideas has become somewhat "congested."
There has been a flood of folks entering the "startup game" who seem to be planning for their IPO before they've even gotten a product off the ground. Again, anecdotally, I'm observing a noticeable increase in fraud among founders who are trying to raise money unscrupulously, especially with novice investors.
I don't like to use the word bubble because I think it's lazy analysis, but I do strongly believe valuations are in the beginning of a market correction. At the very least, I think there will be a higher bar for invested money to indicate a legitimate valuation instead of a loan.
I do think that there will still be plenty of capital ready to be given to companies, investors are just going to be more selective (read: cautious) about it, which may very well change the growth and success potential of certain more dubious business models in the valley.
In the United States, ~32,000 people die annually in car accidents. In New York, ~1200 people die annually in car accidents. I live in New York. Which statistic do I pay attention to? Does it influence my analysis of total vehicular accidents that New York has a much higher population density than most of the country? Am I more likely to die in New York or somewhere else?
What is the startup building? What is the existing market the product? What experience and domain knowledge do the founders have? How far along are they? Who are their actual and potential customers?
That's the first five minutes of a due diligence conversation. If it were so easy to divide potential winners from virtually certain losers, people would hedge so well they would lose almost nothing and most angel investors would become rich. The reality is very different.
I'm not sure I buy this.
Maybe on Kickstarter, et al. I do, because most of the people trying to do hardware there are hobbyists who have never actually shipped a product and so have highly unrealistic expectations. My baseline for a hardware Kickstarter is "Take the Bill of Materials and Multiply by 3--if that isn't retail price they're in big trouble."
Hardware startups take quite a bit more money to get running. However, once they do, you tend to have a very strong customer base and a less assailable position. They have hardware after all--3 guys and a dog can't just clone them.
It probably will as things start to slow down.
During the growth phase of the business cycle, many companies do well. Even some with poor fundamentals that shouldn't. This is the danger of stimulus - it promotes an inefficient and wasteful allocation of resources. But it makes investing easier as a larger pool of companies are succeeding and finding exits for their founders and investors through IPOs and acquisitions, which are both very closely correlated with the health of the stock market.
During the contraction phase, the companies with poor fundamentals are exposed. Ok, no loss there, they were struggling and nobody really believed in their potential anyways. But contractions can also bring down good, solid companies who were just caught unaware and were not holding enough liquid assets to pay their employees and the interest on their debts. Some non-negligible percentage will not make it through a rocky period while liquidity dries up and relatively cheap funding/investing slows down.
I think it's smart to not read too much into the stock market as it can be distracting and noisy, but I think its trajectory and what it indicates about the phase and timing of the next business peak/trough cycle is extremely important and should not be discounted.
But like you said, I don't consider it helpful to pay attention on a day to day basis, and I find it to be a more useful indicator for macrotrends than microtrends. In other words, my understanding of the stock market will influence my opinions about the angel investing and startup market en masse, but it would not be anything more than one factor in my opinion about a single company I could invest in.
While it's true that companies with strong fundamentals do fail in a downturn, companies with strong fundamentals can fail for any number of reasons. Just as I'm not all that concerned with my Vanguard funds going down for a while because they'll be back up in 10 years, I'm not too worried about a single company with strong fundamentals getting caught with its shorts down when the tide goes out. If it happens, it happens; in the absence of other poignant data, however, I find it much more important to focus on the company itself and pay attention to macrotrends more infrequently.
Besides, a market downturn is an excellent time to hedge long bets with shorts :)
You may be the exceptional person who has no assets whatsoever tied up in the stock market, but nearly every investor who has the resources to be an angel will have money in the market.
When the market falls they have less money. They use money to invest in things. The correlation between the market and seed stage investing should be fairly direct and clear.
The money can only be in one place at a time though. If you pull money out of publicly traded stocks, wouldn't that mean you have more money for angel activities? Although, when the market is way down, that's a great buying opportunity, so is that when angel investors stop putting money into startups and instead go on a stock buying spree?
My argument was more about the wealth effect though, which is that a crash in stocks makes Angels poorer and thus less likely to invest in risky startups.
When evaluating a startup in a given area, how do you bridge the gap between your expertise in that area, and that which is required to assess the opportunity?
Obviously the startup founders will always project the fields of gold ripe for the taking, so you can't blindly trust that. Do you only invest in the field you know well? Do you look for behavioral clues? Do you look for your or their peers' decision? Do you look for what's in trend, or counter trend?
It seems like a super tough problem, yet it hardly ever gets discussed...
Make sure there is absolutely no conflict of interest, make sure the expert will be told up front they will not be able to participate in any kind of deal and will only be paid an agreed-up-front hourly rate for their participation in the due-diligence process.
The funny thing is they don't bat an eye at spending that kind of money on a lawyer but to actually get a good look at the material it is suddenly 'a lot of money'.
Otherwise you might as well go to the casino and put all your money on 'black'. Better odds that way.
I used to work quite a bit for angels (I'm priced out of their range now I guess) and contrary to A rounds the number of bad deals proposed to angel investors is substantially higher. By the time you get to an A round there has already been a significant shake-out, all of which means some angel or group of them have lost a bunch of money.
Contrary to what people believe angel investments are a lot harder to get right than later rounds. There are many more start-ups that die prior to receiving an A round than afterwards and the amounts are low enough that doing proper due diligence is not in the cards. But an abbreviated dd is (much) better than none at all.
Except when it isn't and there will be blood (investor blood).
I make a living like doing tech dd, and when a due-diligence needs other expertise I'll be the first to point it out. This works pretty good for investors and technology people alike.
Investors that don't do due diligence at all end up losing their shirt, so that's a pretty good starting point. Just abbreviate the process relative to the amount of money involved, after all, it is a risk mitigation strategy, not a risk erasure strategy (if you don't want risk: don't invest anything just sit on your money and watch it evaporate, every other kind of investment strategy will carry risk to some degree).
What about before? There is a number of startups that are pitching you (the generalized investor you), and for most of them you wouldn't know enough about target market to judge one way or another. Like, you don't know about wholesale distribution of manufactured goods from mid sized companies, how can you assess if the founders are onto something?
Yes, usually this happens after the terms sheet is signed (and for smaller investments after a letter of intent is signed or a handshake deal is agreed upon). Up to that point it is read as true that everything the founder says will check out.
The due-diligence process is there for two reasons: to fulfill the 'duty to research' for a VC to cover their backs in case a deal goes bad after investment and LPs wonder how the hell they got suckered in like that as well as to simply protect the funds.
For angels the situation is worse here because they don't have the funds or the organization to do this properly.
> What about before?
Typically a VC has a number of analyists that assess the companies that pitch them to see how solid the various commercial claims are. The accent there is usually on the numbers and the commercial side of things, which is reflected in the education of the associates (typically: finance, accounting and/or a bit of legal and commercial).
Angels tend to do this part by themselves.
Angels and VCs do roughly the same thing, only angels do it earlier on (when the risk is higher, companies are cheaper and the deals are much smaller so they can still participate), the biggest difference is dictated by the size of the deals, it limits the amount of money you can spend in order to determine if you spend it wisely.
To make an extreme example: a full legal/commercial/technical/financial dd would cost approximately 100K or so. The bulk of that will be eaten up by the legal portion, the remainder is roughly equally split between the other parts.
If you're looking to plunk down 100K as an angel if you actually did a full DD you'd be out 200K if the deal goes through or 100K if it doesn't, so then there is no point in doing DD at all. Hence my advice to do an abbreviated one scaled down to a portion of the size of the investment, but to definitely look at all these aspects of the company, if possible through the eyes of an outsider.
The other important thing to remember is that doing DD puts a strain on the company you invest in, and if every angel would do a full DD on a company before investing then the company would grind to a halt during their seed round.
Yet another note: for seed investments there usually isn't a whole lot to verify anyway, the company is still tiny, probably has no turnover (so financial dd becomes: look at the model), has very little technology (so tech becomes: look at the proof of concept) and so on. So everything becomes a lot simpler anyway, it wouldn't be possible to do a full process DD on a start-up that has only just become real enough to look for seed funding.
The reason I'm asking is that I keep imagining this picture: suppose there are 20 areas of economy(there are more but bear with me), and each angel knows one area well. Startups come at random from all 20 areas, so for 1 in 20 pitches the investor hears about something he understands deeply, can ask good questions and question assumptions. And so he can make an educated decision. What about the other 19? He can't judge the financials because it's too early. He has to rely on various proxies, such as interest from others (not necessarily any more qualified), the quality of the deck, the looks or pedigree of the founders (PhDs and professors are like really sexy as I found out), and so on. The likely rejection reason then comes out arbitrary, and obfuscated. Few people just say "not my area" before you even start. The startup founders are now wasting their time in 95% of the cases, unless they come with a sexy background and then investors are just piling up.
Wouldn't that be a lot more efficient if investors just referred unknown companies to a buddy who knows the domain area? I don't see it happening. Am I looking in the wrong place?
That definitely happens. Most angels or VCs have a domain they are interested in and outside of that they will simply not participate or refer. Happened to me less than a week ago so definitely this occurs and fairly frequently.
> I don't see it happening.
It depends on how close to the fire you're sitting and who you are talking to I guess. In my 'backyard' it happens, frequently and the number of times that a deal is not even looked at is high enough that I never even thought this might somehow be special.
Another thing that will happen is that the party that did the referral will still take part in the round but at a much lower level.
This is a very fluid world you're trying to capture, local customers, connections and cliques will make up a lot of the background for such deals and you'd have to take all of those into account when you try to factor something like this into your worldview.
Personally I'd rather not see angels lose their shirt in areas that are not their domain,better if that money gets spent a bit wiser and on things that they understand.
Then there is a group of angels who tag-team, and if one finds a deal he can't grasp, he would redirect to another member of the team. 12 people cold cover an area of expertise that's 12 times larger.
At least that's what I think should be happening... Does it?
I hear what you're saying, it all makes sense. I just don't see it unfolding before my eyes.
There seems to be some contradiction here: you seem to say valuations don't matter, but also that you're worried about them. How do valuations prevent you from spotting a good company?
With so many SV companies that have hit it big without any real idea on how they're going to make money some day, it'd be interesting to hear what passes for a "dubious business model" out there.
FWIW I'll back you up on this, definitely a complicating factor for novice investors.
Free tip to novice investors: If someone approaches you with a request for funding, if it is still 'just an idea' and if the idea will surely deliver billions and if the funding required is < $50K then you're being fed a line of bull-shit.
Anything that will grow to turnovers that high will surely require a little bit of traction after implementation before any figures can be projected at all and anything that hasn't been implemented yet doesn't even qualify to be discussed in other terms than hypotheticals.
Another free tip for novice investors: pair up with a more experienced investor to vastly reduce your chances of being ripped off on your first investment(s).
This is also not a guarantee but it will increase your odds considerably, it also requires you to convince another, hopefully more skeptical party that what you've found is really worth an investment.
Except that once you implement it, investors start anchoring to how small your numbers are. Catch 22.
I work with an actual IoT startup. Hardware--implemented. Backend and frontend--up and running on Azure migration to AWS ongoing. Customers who pay? Yep--and they love it.
So, investors?
"Ick, haaaardwaaaaare? But ... but ... but ... that's going to take actual moooooney." (yeah--well, so did Nest, thanks)
"Your numbers are too small to be meaningful" (no duh--does the word "startup" actually mean anything to you)
"This isn't going to scale." (translation--it takes money and marketing to acquire customers--welcome to a business with actual value and customer lockin).
"Big data is uninteresting to us now." (translation--"actuarials" and "business process" are only profitable--not wildly profitable and flippable)
To a certain extent, I'm looking forward to these unicorns winding up on the butcher block and being discovered to have no meat. The lead VC's of these unicorns are going to give a bunch of the initial investors a huge haircut via preferences (don't get me started ranting on the stupidity of that). Suddenly, initial investors are going to have to start looking at "sustainable" rather than "flippable".
Those of us with actual profit will be waiting.
Are investors really that irrational?
They are not just thinking about your company in isolation. They are thinking about it in terms of stack-ranked IRR on a spreadsheet with other investments.
Yes, they are. But, then, handing someone a couple million dollars in the hope that it will turn into 50 or 100 million is an irrational act, too. So, it's hard to get too upset over them being purely irrational.
There are two problems:
1) VCs/Investors are sheep.
This is the infuriating one as it makes most of the VCs/investors you deal with effectively useless. To the point that when pitching to them the goal is to trigger that behavior (the term is FOMO-"Fear of Missing Out" aka: acting like sheep). So, if everybody is investing in something, everybody will invest in something. Until it blows apart. If you just want funding, try to pitch something which runs downwind of this tendency.
2) It's really all after the fact rationalization of "I don't like/trust you."
This doesn't make me mad--I just would rather a VC/investor just say this. But they won't turn you down definitively for lots of social reasons (mostly hoping they don't turn down the next AirBnB/Uber/etc. and get laughed at at the country club). I would actually respect someone more who simply said "My astrologer says the signs aren't right. KTHXBYE." Or, even, flat out "I don't like you." I'm cool with that--my personality is straightforward--most people like it, a few call it tactless and arrogant. If you're one of those I rub the wrong way, fine, we need to find different dance partners.
The problem is that too many investors want you to jump through hoops when they're looking for reasons to turn you down. Generally, you should simply read this as "No" and move on. It's like trying to date a pretty girl--when she gives you some excuse multiple times, she's probably telling you "No" but trying to keep you in her list of options just in case.
Upshot: raising money is hard work. If you want to sit in the big chair, you had better be prepared for the slog.
The first one: but they're usually good at judging people.
The second: some of them do hire tech people to help improve the odds (because that's all this is, playing the odds, improve them enough and you can do very well at this).
The third: they're past masters at the other end of it, protecting the exit. This is important because without an exit there is no return worth measuring (dividends don't really count as a rule, but an IPO would be nice if the company survives the lock-up period or if the VCs get to float their shares or a large chunk of them).
Obligatory lame VC joke: Q: Why does a venture capitalist walk into the negotiation room backwards? A: So they keep sight of the exit.
The fourth: there are at least as many irrational founders as there are irrational VCs, if not many many more.
Finally: Trust is everything. Break the trust at any point and you can kiss any investment goodbye. Have broken tech, a broken business model, a good attitude and team willing to put in the time and the effort to fix the tech and the model (or even an outright pivot) and I wouldn't rule out that you get funded.
Fun fact: the one thing that keeps on being repeated back to me whenever we (one of my clients and me) go to do tech dd on any one of the companies they've signed a terms sheet with is that no matter how many other investors have already been in that position and no matter how many times that company has already seen due diligence teams it will be the very first time that they actually get to really show their tech, both the good and the bad. This never ceases to amaze me, the amount of sloppy homework on the part of VCs and the usual suspects of companies that do dd (usually the big legal and accounting firms get hired and they then farm out the bits to various parties) is scary and this costs quite a few of them many millions of dollars annually. Even so, it's good advertising for me so I really shouldn't complain.
http://amzn.com/B00EWZCTD0
Thanks.
We have, but hardware doesn't lend itself to small amounts of money. And there are different trajectories depending upon whether you can get 500 thousand, 2 million, or 5 million.
The folks I work with are religious about maintaining a low burn rate. Hardware has a LOT of NRE, and you can get in deep trouble very quickly.
We actually had to be very hard-nosed with customer which we expected to be profitable with about 100K volume (actually kind of the Valley of Death in electronics volume--100K has all the NRE of huge volume without the profitability) because we simply couldn't take the risk with cash we had in reserve. If the customer didn't follow through, the NRE would have killed the company. This is a very different discussion if you have 5 million in the bank.
In addition, while I can't prove it, I suspect that we lost some funding because we're religious about burn rate management. VC's want "Go big or go home" and someone who is managing burn rate well is anathema to this.
Yeah, not right now, thanks. I'll share the name when I'm ready for a stress test. <grin>
[1] http://www.seattleangelconference.com/
If I'm a software start-up with a < 10 person team and I'm six months into a six month development cycle, and oh shit we miscalculated the significance of feature X, which has now revealed itself to be our greatest value proposition and requires 2 months more development time to be fleshed out (mini-pivot I suppose) in order to be sold to customers.. I need that 10k, 20k, 50k just to push the product out the door.
Sure I'm going to tell you all about our sales projections, remember when you asked to hear them in the meeting, and yes the projections will be optimistic (but still fundamentally sound). No I will not go into too much depth about all the reasons we pushed launch back two months (the meeting would go past the ~30 minutes allotted and you would likely feel bored towards the end of the meeting.. not good).
I think both investors and founders are products of our current environment. We both ride the roller coaster, yet I feel like founders often get portrayed as the dishonest ones (I'm guessing it's because we don't hold the money). Maybe I would just like to feel more representation in this thread.
Sure, $50K is peanuts, but then again, compare it to what YC offers and it's actually not all that weird. Usually seed funds do not get you enough money to go on a hiring spree and collect your favorite list of valley talent. But it might just be enough to get you to the point where you can demo your stuff and get a larger round. Essentially that's all that seed funding is, a way to get in front of a group of larger investors after doing some more product development.
There are dishonest people both on the founders side and on the investors side, no exclusivity there for either group.
Rare to see a career based on dishonesty last very long, word definitely gets around.
Standard issue asshattery include things like:
- Paper-thin mock up demos of a product being misrepresented as actual finished sale-able product. Sorry but the V in MVP stands for viable.
- Impressive people are touted as employees, even co-founders, and when you go talk to them it's news to them. Maybe they had a conversation with said founder once and expressed some interest and suddenly to investors and others they are the CTO. Sometimes this arises from the founder(s) being so narcissistic that they simply assume that anyone would of course feel privileged to join them. Why wouldn't they?
- Company/founder has sales/vendor relationship with other companies and misrepresents those products as "theirs," implying that they actually own them. In one case I saw rebranding without permission, which is flat out fraud.
- Signups/trials/downloads misrepresented as active continuous users or free users counted together with paid users.
- Lying about educational or work background. A skilled blowhard will do so in an ambiguous way, e.g. "went to MIT" means "attended one workshop there and read a lot of open courseware."
- Products that would violate known laws of physics or proven mathematical theorems. (Or sometimes even grade school math...)
Drop-Kicker just covered one such startup: http://drop-kicker.com/2016/01/ampy-move-teardown-and-review...
This is from three PHD engineering students from Northwestern.... over $1.5MM raised via Kickstarter and investors.
Hard to believe the founders (remember PHDs) are so naive to actually believe in their own advertising claims.
Using people that way is textbook sociopathy. People are rungs on a ladder to be stomped on. Unfortunately it works. People fall for it again and again because they don't scratch the surface enough to see what's actually there.
Anyone interested in investing should take note of a few things here: highfalutin college degrees, patents (you can patent a cheese sandwich) or "patent pending" (which is trivial and meaningless), and unsupported claims of novelty are not reliable indicators of anything.
Edit: I'd like to say I think this is a good thing. I've seen a couple instances where growth was on the back of VCs and didn't have a foothold in reality, and friends ended up losing their businesses. I'm a fan of bootstrapping but I totally get where VC money can help - a lot, in fact. That said, keeping an eye on revenues and reality instead of funding slide decks and pie-in-the-sky "potential" revenues can only be good.
They have very real meaning when it comes to things like employee options and ability to raise money to pay for employees. If a year ago a company raised $10m at a $50m valuation, but now they want another $50m to scale, they'll have to give up a much bigger percentage of stock to do that, which can essentially wipe out any employee stock (founders likely have a different class of stock that isn't as affected).
And along the same lines, maybe the company can't raise as much cash as they want/need. In this case, they have to cut back on what they pay employees. In these cases, the money starts to tighten up, and people don't see the reason to stick around SV paying $4k/mo in rent if they're only being paid $8k (before taxes), so they start to look for other places to go. This can lead to a spiral where an otherwise good company can't retain or attract talent, and so the cycle continues (don't hit growth targets, can't raise money at good rates, etc)
Because they actually aren't fake. I mean I get what you are saying, but the reality is that real money changes hands based on those valuations, so they are priced the same way as any other security: Someone says they will pay a certain price per share.
I think the issue is that investors setting the prices as market makers don't have a super strong track record of doing valuations with high accuracy.
One of the most important clauses is the liquidation preference. There are many others.
When a company decides they want to go public it becomes very important.
It seems like a big deal until you realize there is a huge variance in prices and that 2012 isn't very long ago. The biggest and most successful ones seem to be doing just fine.
It's the same as to compare someone on absolute salary of $100k in Silicon Valley vs $50k in Estonia, forgetting that the latter can provide a luxurious lifestyle with tons of money to spend, while former can mean being barely break-even.
But this whole meme of six figures is hard to keep afloat with is the worst kind of cringe-worthy "Oh poor well-paid me." My wife works at Habitat for Humanity in the East Bay. You don't want to consider what the low level employees there are making (and no, they aren't all living with their families or have spouses helping out).
Honestly curious...what are they doing then? Isn't the typical rent cost higher than the entire salary of a low level employee at a charitable org?
That's not where the people who work for a living at charitable organizations live.
HN is a weird bubble.
Likewise, there are still cheap places to live in Oakland, even if the average is high (and rising). Also, there are places further out of Oakland that are still relatively inexpensive.
In any case, the "typical rent" on a SF/Oakland apartment already affords a lifestyle more luxurious than most people in this country ever experience, which is why IMO aetherson is right in calling it "Oh poor well-paid me". This meme that 6-figure incomes in the Bay Area is "break even" is a special kind of myopic: "Oh dearie me, I'm making 6-figures, enjoying quality of life way higher than is typical for my country, but I'm just breaking even!"
I haven't been to the living places of my wife's coworkers, but I would expect that the ones who live alone tend to live in small apartments in undesirable areas of relatively inexpensive cities.
There are basically 4 socioeconomic classes in modern society: the disposessed, the working poor, the middle class and the wealthy class. You can split hairs and make different cuts, but if you follow this model.
* The disposessed is the people that fell through the cracks. They are struggling to survive usually for multiple issues that are holding them back, even if they have incomes. In a healthy society they should be a small minority.
* The working poor is the people that manage to make ends meet, but are one unexpected big expense away from financial disaster. Unlike the dispossesed their main problem is that the jobs they are qualified to hold do not pay enough, so they may do everything right and still land in trouble.
* The middle class is people that is financially relaxed, even if not rich. They can afford luxuries, and are the prefered target market for many business both because there are many of them and because they have disposable incomes.
* The wealthy run the show. They are not relevant to this dicussion.
The point about "median income" rethoric is that Americans assume the middle class is always 50% or more of the population. So, by definition, median income == middle class. This is not the standard way of things around the world or through American history. Instead, there was an historic anomaly after WWII, when all the other industrial economies were blown up during the war and Americans enjoyed the advantage of being isolated enough to keep their infrastructure mostly intact. Every Risk player knows how this go.
This allowed the American economy to grow faster than population during the second half of 20th century, so most people could aspire to join the middle class, and the upper tiers of middle class could aspire to join the whealty class.
Arguably, the oversupply of money in the Bay Area is reverting this trend. This is what happened to Spain in the 17th and 18th century. The country itself got rich because of all the resources they extracted from their colonies in the Americas, but the rest of their economy did not grow as fast.
The result is that everyone that was not connected to the gravy train from overseas was, in effect, poor... even if they had enough money on their pockets to qualify as well to do in places like Central Europe that did not have colonies of their own. The well-off German farmer had access to cheap food, shelter, craft goods and the occasional specialized service that were simply not available to the average Spaniard lackey, because those last were priced out of the market by the soldiers and the customs officers.
Now the colonies are in the cloud, and software developers are the workers that help bring the value produced there into the realm of physical reality.
Here in Tallinn, not so much.
Additional data point: UBNT is paying 36k in Riga which is an outlier at the top. I think most positions with a few years of experience are around 25k in Riga and starting salaries are around 12k.
But yes, once you reach EUR 2000 net, you can have a very comfortable lifestyle.
Companies that have a solid product, real revenue (i.e., their revenues aren't just coming from other companies on life support from VC cash) are profitable (or close to being so) and have a valuation based on reasonable multiples of their profit will get through the coming rough waters just fine with only a few bumps. Startups that can't tick those boxes are in for a really rough ride ahead.
Somewhat ironically, the downfall of many of these startups will be that they ever allowed themselves to be valued so highly in the first place. A company that's reasonably valued at $20 million is going to be in a far better place than a unicorn once valued at $2 billion that's now valued at $500 million.
I'm curious on if this has any effect on seed companies with valuations at $4m to $6m pre in valuations or number of deals funded?
Is this only impacting unicorns (which I don't care about)?
Sort of like when google launched. The only surviving niche of google X is travel. You just google pets, not petsearches.io.
The equities market is so broken, and interest is so low, that there is an overspend into private markets. Value capture takes 20 years, company lifespan, i would baselessly guess, is 5 maybe. So this shit makes no sense.
Best bet is still make something you like working on, to the extent you represent other people, is pretty much your product demand.
But yeah mate, you could throw up a squarespace site and be the next cat bubble baths on demand startup.
I realized as a super shitty developer, that I will probably totally fail at this side project, but at least when someone gets it done i can say i was years ahead of the curve, just didnt have the chops.
...not that im bitter
(I'm sure you know all of that, by the way, just reflecting on how difficult it would be to convince an investor).
- A lot of ideas sound dumb when they first come out
- A lot of signals are used to decide which companies to invest in (I don't agree that this is right, but it's easier to get cash when you're in a prestigious incubator, or graduated from a top eng school)
- Many successful companies are a good idea, a good market, and good execution - so an idea is just a (limited) starting point
They're some really (what I consider) dumb ideas out there (esp in the seed part of the space), but I wonder to what degree the unicorns are actually good ideas that raised way too much - and tried to grow way too rapidly.
The obvious things: traction, good business plan, viable market, reputation/track record, team, etc. help. But luck and hustle are required, too.
1. Traction (rapid week-over-week growth, significant press)
2. Reputation (elite background, connections)
It's very easy to get some initial traction for these local services businesses, so investors fall for them easily. They lose money on every transaction but will make it up in volume ala Kozmo.com, Pink Dot, etc.
Despite the fairytales, no one actually invests in technology startups based on their products in Silicon Valley. Really, no one.
Oculus VR is a great example of the kind of business that investors had no interest in. They reluctantly jumped on the bandwagon very late, and only after it had lots of traction. Very few investors were interested in SpaceX or Tesla. That's how bad Silicon valley investors are at what they do. It's an industry ripe for disruption (see: YC).
In reality, they sit around waiting for winners to emerge and then try to pounce (traction). Or they back people that have such prestigious credentials no one will blame them if it fails (reputation).
Palmer Luckey could have gone door-to-door with the Oculus Rift prototype and not a single investor in Silicon Valley would've been interested (product). Without reputation or traction, he had nothing they valued.
It's actually a very exciting situation because it means there's huge untapped potential waiting to be unlocked. YC has tapped into this just a little bit.
The guys who work for VC has to make number of investments and it's not like investing in the stock market, it's far far riskier and uncertain (hence the huge returns). So it makes sense that they would gravitate towards low risk bets by betting on momentum to piggyback on.
This explains why there's crowding towards 'hot & flashy' startups on techcrunch and not as much to individuals focused on technological innovation. This crowding naturally leads to unicorns with unsound valuations that I've been qustioning.
The comments on HN after some hiatus is starkly different than those of 2014 or 2015. In 2014 I said the bubble will pop and I was ridiculed and downvoted to hell. In 2015 more people agreed and now majority of the comments are people ringing alarm bells now.
I think the coming years where unicorns drop left & right, we will also witness the beginning of the end for Twitter & Facebook and towards a decentralized, peer to peer, cryptographic replacement.
Very much agree. The root problem stems from people's inability to independently measure value. They rely on external signals (traction, reputation, etc), because believing in a team and product independently is hard work. It's a leap of faith, where you have to believe in yourself first. Most people would rather run with the herd.
That said, there are more and more people who don't follow that pattern. As they become successful and turn to investing and supporting the next generation, I think we'll see a lot more daring ventures come to light.
My co-founders and I were pretty dismayed by the anecdotes of "20 year-olds raising millions with just an idea!" because we were, well, 20-year-olds with a great idea, and the millions were NOT being thrown at us. (And not to sound too arrogant, but we were pretty much in the target demographic for that easy capital -- Harvard & MIT guys with a great idea and great demo.)
In the end, we did end up raising money -- after a LONG slog and MANY disappointing meetings. So we proved it was doable, but certainly not easy.
We came to a pretty simple conclusion back then: The anecdotes were either exaggerations, extrapolations from a tiny number of actual examples, or outright falsehoods. Remember, this was the first dot-com boom, and the story about kids with big ideas and tons of investor cash was a new one and played well in the press, so it's easy to understand why it got play.
These days, the story is different - and to staunch's point above, the "easy money" stories today are either coming from inexperienced/naive investors who think that's how things are done in Silicon Valley, or experienced investors throwing money at folks who have made money for them before (and why not? If your investee made you 10X on your last investment, it's understandable why in some cases, simply as a thank-you, you'd throw one of those Xs back at the new idea.
If you just look at some product that's gotten investment and think "why would they invest in that?", you're thinking about it wrong.
The entrepreneur that's been out raising that round has been out pitching a vision for a large billion dollar business, with that product as just one of the initial steps on the road to getting there.
To raise money from investors, you'll need to on the one hand present a vision for a large business like that, a clear road-map to getting there and sufficient proof to convince them that you and your co-founders are capable of executing on that vision and that road map.
Sometimes you prove this with a working product and traction around it, sometimes you can prove it because of a stellar background (having done it before) and sometimes you prove it because you're pitching to people who already know you very well and believe in you.
Here is a link -- http://blogs.wsj.com/venturecapital/2010/10/18/ron-conways-b...
The problem is that it's also a minimum bar to be cleared later, and if that minimum bar is not cleared it means you're in down round territory. It also in many cases sets a bar for a minimum exit for anyone but the preferred shareholders to get much of anything.
A down round is not necessarily death but it very negatively impacts founders, employees, and anyone else who holds common stock or options on common stock. This in turn can kill a company not through cash flow failure but by nuking morale and causing employees to leave (as well as demoralizing the founders).
I've thought for quite some time that these really high valuations are actually a trap for founders. A lot of founders have sought them for IMHO ego-driven reasons, but in the end they'll be the ones getting diluted badly in a down round.
I mean... I'm not a finance geek but it's always seemed to me that founder (and employee and also possibly seed investor) interests are maximized by maintaining a reasonable valuation. With a reasonable valuation the risk of a down-round is minimized and if there is a sale it's much more likely that the sale/exit amount will clear the liquidation preference bar and something will cascade down to the common shareholders. But what do I know. I just work here. :)
If the answer is "not too many" then it will not affect the other 99% of bootstrapped or less lavishly funded startups. If the answer is "a lot" it will be rough and have cascading follow-on effects.
A major driver of the 2000 bubble was startups paying startups to advertise, market, or help build their startups. It was a classic bubble: an unintentional "emergent" pyramid scheme.
Just goes to show angel investors, while an essential component of the startup ecosystem, can be emotional, illogical, and volatile.
If you're unable to accurately value what you invest in and prone to getting swept up in hype, you shouldn't be investing in startups (or maybe anything).
The ones who suffer in all this aren't the investors -- they're already rich. It's the employees who get shitted on, forced to work harder for less, or loose their jobs because of the whims of the market and other people's faulty thinking.
But it's still an illusion. That said, there seems to be a very functional solution: discounts.
I don't understand why they are not used more. Why not develop industry models for expected value increase from seed > A > B, then invest with convertible notes discounted accordingly? Do this for each round... until there is a liquidation event.
The notes themselves would have to offer slightly more protections with each round, but in general, it creates a model of relative value, while that value scale is still being determined... rather than fixating upon some arbitrary valuation.
(Since you don't own the shares, you don't actually own the votes)