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Paul Graham is one of the more interesting personalities in the American startup scene today.

Recognizing some of the flaws inherent in the venture capital model as it relates to consumer internet startups, he launched YCombinator.

YCombinator bills itself as a "new kind of venture firm specializing in funding early stage startups."

The model is quite simple - let young entrepreneurs with ideas for web startups apply for funding and, after a review process far less intensive than traditional venture capitalists apply, fund the ones that are appealing.

Entrepreneurs that receive funding from YCombinator get just about enough money to live a Top Ramen lifestyle for a few months ($5,000 per founder) as well as 'valued-added' services such as mentoring and legal assistance. In exchange, YCombinator gets 2-10% of the new company (the median is reported as being 6%).

The purpose of YCombinator's funding is to enable entrepreneurs to take their ideas from concept to some sort of reality (i.e. a working prototype) typically so that the next steps can be taken (i.e. follow-on funding from traditional angels or venture capitalists).

Frankly, as an entrepreneur myself, I'm not a fan of YCombinator's model. Equity is the most expensive form of financing in the early stages of a company's existence and giving up 2-10% of it for an amount under $20,000 makes no sense. In my opinion, any entrepreneur who does not have that amount of money to invest in himself and who is unable to raise it from family and friends probably should think twice about starting a new business.

Additionally, from an investor standpoint, I think the YCombinator model is weak. Not only does the amount of funding lend itself to feature-as-a-business 'startups' with no real competitive barriers, it mostly appeals to young techies who may be talented and hungry but who lack the real world skills and experience that is usually conducive to success.

Again, my feeling is that any entrepreneur who can't come up with a small amount of money on his own has already demonstrated that he's less resourceful than he'll need to be to run a bootstrapped businesses.

All of this aside, I sometimes read Paul Graham's 'essays' because they provide an interesting perspective that's different from mine and a recent 'essay' caught my attention. It's entitled “The Other Half of Artists Ship” and in it, Graham talks about the cost of 'checks.'

Graham is, of course, discussing checks as in 'checks and balances' - the measures companies take to ensure that mistakes made in the past aren’t made in the future.

His primary thesis: checks are costly and harmful - usually far more costly and harmful than companies recognize. He provides multiple examples of how checks and balances can harm companies (and even entire economies).

In Graham's opinion, companies that require their suppliers to validate their solvency, corporations that implement flawed purchase limits and associated approval processes and governments that over-restrict and over-regulate often find themselves paying more for their checks than those checks are designed to save.

He then goes on to argue that "the cost of checks may actually be increasing" because "software plays an increasingly important role in companies, and the people who write software are particularly harmed by checks."

According to Graham, "programmers are unlike many types of workers in that the best ones actually prefer to work hard" and that this dynamic leads programmers to want to write more code. This is a naive generalization in my opinion (I've met my fair share of lazy programmers too).

In Graham's estimation, the software development cycle is harmful to the best programmers.

He refers specifically to the formal release cycle - the process that governs the testing and 'launch' of new code in any software development environment and argues that it's a check that is far too costly.

Unfortunately, not having some sort of formal release cycle in which code is tested before being made public makes about as much sense as adding new parts to a commercial plane and flying it with passengers before you’ve thoroughly tested that everything is working properly.

A detailed discussion of why formal release cycles are an important part of running a legitimate technology company (especially when one actually provides software that people rely on and - gasp - pay for) is beyond the scope of the post. Hopefully it's obvious.

What I do think is worth discussing is that in his 'essay' on checks, Graham forgets to mention the most important checks of all - the ones you take to the bank and deposit.

Graham's thesis is one-sided and places programmers at the center of the universe. To be sure, your programmers are extremely important. But technology is about solutions, not the people who implement them.

Good software (including web applications) is designed to be of value to its users in some fashion. This value is (hopefully) eventually translated into revenue.

Good software is not designed to be art in application form. Obviously, some applications look like they're an attempt at abstract impressionist software, but the genesis for the best software is usually an answer to a simple question - wouldn't it be useful if there was an application that could do x?

The best software is written not by self-fashioned programming Picassos but by programmers who are passionate about coming up with solutions to tough problems.

In Graham's world, however, that's not the case. He cites a Steve Jobs quote, "real artists ship" and states:

"For good programmers, one of the best things about working for a startup is that there are few checks on releases. In true startups, there are no external checks at all. If you have an idea for a new feature in the morning, you can write it and push it to the production servers before lunch. And when you can do that, you have more ideas."

Graham argues that this is the closer to the way it should be at all companies.

I say - forget 'new features.' Forget 'more ideas.'

I’d argue that more than half of the bloated, crappy software that once worked decently became bloated and crappy because some programmer got an 'idea' for a 'new feature.' And then he got 'more ideas' for 'more new features.' By the time you knew it, your accounting software was capable of navigating a satellite to the moon through an option in the Tools menu.

The bottom line is that if you have a piece of software that somebody actually uses is, getting an idea over dinner, writing the code in the morning and releasing it by lunch the next day is not a good idea. The best ideas are usually sourced from stakeholders and/or developed with their assistance (feedback, testing, etc.) - the user-centered design process. Worthwhile ideas are validated and implemented thoughtfully, not hashed out over a pizza-fueled 24-hour coding marathon.

The best features provide real value to users (not the programmers who are tasked with implementing them) and the result of providing value to users is as simple as it is appealing - earn more checks to deposit.

Given that YCombinator has probably funded more lightweight, feature-as-a-startups than anyone else, I’d venture a guess that Paul Graham knows more about writing checks than cashing them, more about creating features than developing solutions.

The bottom line is that, in a day in age where more and more of the startups you're likely to hear about seem to be driven by hipster techies instead of profit-driven entrepreneurs out to trade solutions for cash, it's easy to forget that the most successful software companies still are solutions-oriented, not programmer-oriented.

As such, I'd argue that Graham's advice should be ignored. Focus on providing better solutions, not on producing more source code.

Drama 2.0

Published 8 December, 2008 by Drama 2.0

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Jason

very interesting counter argument to Paul's model

almost 8 years ago

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TomH

Ugh, where to start...

- If you understood the content of the YC program, including the speakers they present, industry introductions they make, the effort they put into helping founders understand the industry, you'd be aware that the value YC offers is well beyond the money. They're quite frank about this; the money is about the least important part of what they offer. And, as PG explains (http://www.paulgraham.com/equity.html), to justify taking a 6% stake, they only need to increase the value of the startup by 6.4%. To the growing number of YC-funded startups that have been acquired at huge valuations, or received large VC-injections at good valuations, or that remain in business when they otherwise would not have, this is a pretty sweet deal. The last point here is probably the most important; compared with startups generally, there are very few YC-startups that have failed completely, and the rate is diminishing as they get better at picking promising founders and learning how to keep them going. And as they say, those startups that don't die, win eventually: http://www.paulgraham.com/die.html.

The rest of your piece is a lot of babble that completely misinterprets Graham's message. No-one is a more enthusiastic advocate of succinctness (http://paulgraham.com/power.html) and "user-centered design", or more disparaging of software bloated with useless features. The "checks" he criticises are the ones that result in companies spend excessive sums on poorly designed, bloated applications, and those that get in the way and prevent good programmers from providing better solutions.

almost 8 years ago

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Drama 2.0

TomH: First, I understand the YCombinator program very well. We're going ot have to agree to disagree here - I don't believe $5,000 per founder plus "connections" plus "mentoring" plus "speakers" is worth 2-10% of a company. There's a reason you don't see "veteran" entrepreneurs lining up to apply for YCombinator. I'll leave it at that.

Second, I think your definition of "success" and "failure" is distorted. Raising VC funding is *not* "success." A startup is "successful" when it gets acquired (at a valuation above initial investment), goes public or becomes self-sustaining. Conversely, not immediately going out of business does not mean you're not going to fail. Most new businesses don't open one day and fail the next.

Per YCombinator's website, I count 60 startups that have been funded. The number that have been acquired (from the information I was able to locate) can be counted on both hands. To be sure, that's certainly not a bad batting average but I also think you need to look at the environment in which these acquisitions occurred.

The past several years have been "Bubble Times." That has meant easy access to capital and more acquisitions. Both have distorted how well the type of startups YCombinator funds will do over the long haul.

There's no doubt that Paul Graham has his connections and an introduction Graham makes on behalf of a YCombinator startup to a VC he has a personal relationship with is likely to go somewhere. There has always been a lot of back-scratching in Silicon Valley and I give Graham kudos for the model he’s developed to take advantage of it. It's quite attractive: invest $15,000 in a startup founded by three young guys, get a VC buddy to invest in them at a significantly higher valuation three months later and watch the paper value of your investments increase substantially.

When it comes to acquisitions, larger companies over the past several years have been quite aggressive in making smaller acquisitions, oftentimes of companies that are extremely young.

This frothy environment is, as you probably know, ending. VCs, by necessity, are changing their tune and being more selective about their investments. Their industry, thanks to a drought of IPOs and blockbuster acquisitions, is in real trouble and they’re likely to get squeezed by limited partners who have themselves been hurt by the financial meltdown. Many VCs are focusing on other markets (like cleantech) that make more sense when one considers the economics of their business. This means capital is not going to be as easily available to the type of consumer internet startups YCombinator has funded.

As for acquisitions, large companies are also being more selective and I think you'll see a lot fewer acquisitions of feature-as-startup businesses. Instead, companies with strong cash positions have much more incentive to put that cash to use buying undervalued, established companies that can measurably benefit them (if they decide to make acquisitions in the first place, of course).

So let me put it this way: YCombinator's overall "success" will not be judged by the performance of its portfolio companies during a period when the most ridiculous of copycat startups could raise money in the VC feeding frenzy. Rather, it will be judged by the performance of its startups during a period when the price of wheat is greater than the price of chaff.

Third, I don't care how "enthusiastic" Paul Graham is about user-centered design. The essay discussed here smacks of the programmer-centric nonsense that promotes source code over solutions.

A programmer who gets an idea in the morning and releases it by lunch is not practicing user-centered design. It's one guy getting an idea, throwing it into production and seeing if it sticks with little regard for the user.

almost 8 years ago

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Märt Ridala

What heated discussion! :-)
Working in an IT hosting service provider, totally agree with the problems of launching new features. In my experience Mr Murphy steps in during more than 50% of system upgrades.

On the other hand I think that Paul Graham is right regarding the big costs and slowness of decision making and "checks" in big companies. And startups do have the benefit of being flexible and fast with their decision making.

almost 8 years ago

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TomH

> "There's a reason you don't see "veteran" entrepreneurs lining up to apply for YCombinator."

YC is not for "veteran entrepreneurs"; it's for young/inexperienced/unpolished founders with nothing more than energy, raw talent and (often initially bad) ideas, and who wouldn't ordinarily get a look in by good VCs or angels or other investors at such an early stage. The 2%-10% they take is hardly of a company, they're taking a share in a rough idea and the perceived potential of a couple of guys to make something people want. They're taking a small share of a concept and a bit of enthusiasm, and offering in return, all the support they can offer to help turn that into something real.

When you say you "don't believe" $15K-$20K is worth (on average) 6%, are you saying you can statistically demonstrate that YC does not usually increase the value of their startups by 6.4%?

I have no dispute with you on "success"; YC's model is completely focused on helping founders achieve profitability and ultimately a "significant exit" - acquisition or IPO. And your cynical description of YC's motives and modus operandi is an absurd distortion, not supported by any evidence. Your subsequent paragraphs on this point are consistent with everything that YC stands for.

These two sites give a reasonable insight to the levels of success so far achieved by YC startups.
http://pulse2.com/2008/11/05/the-15-most-successful-y-combinator-companies/
http://rankedindex.com/yc

What they show is:
- A handful that have been acquired at huge valuations within months of launch;
- Several that have secured multiple funding rounds, from experienced, sophisticated VCs and angels, not generally the types to be swindled by bubble hype;
- A handful of *very* highly ranked sites, almost 50% within the serious traffic territory of 100,000, and many more close to this level, only months after launch. No, not an indicator of "success", but at least passing the "make something people want" test.

Others have reportedly turned down acquisition offers and opted to continue building the value of their startup.

As for measuring success by how many have been acquired or IPO'd by now; the oldest YC startups are about 3 years old. With the exception of the *real* bubble (to which the past couple of years bears no resemblance), few startups IPO within such a short time. And the number who have been acquired within such a short time is impressive by any standard.

The most significant point here is that were it not for YC, many of these startups would not exist at all. It is not a matter of whether YC is a good deal compared with the alternatives. No doubt, for most businesses, including yours, YC is an unattractive deal. But where businesses that would otherwise not have existed at all have been able to grow substantial audiences and in some stand-out cases achieve multi-million dollar exits, it's a huge win for the world and for the founders.

Sure, the world's changed a lot and like everyone else, YC will have to adapt, and long-term success for their startups will be increasingly challenging. It will be particularly interesting to see how YC startups fare in this environment compared with those that conform to more traditional models.

And finally:
> "A programmer who gets an idea in the morning and releases it by lunch is not practicing user-centered design."

He is if the idea is in response to a user requirement, and if he's a good hacker it will be. You're getting fixated on a single sentence, taking it out of context and using that to distort the message of that essay of PG's entire philosophy.

almost 8 years ago

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Drama 2.0

Mart: yes, it's amazing how Mr. Murphy always manages to find a front row seat at new releases. That guy is everywhere!

In regards to your comment, I'd generally agree that some companies have a process that is slower than desirable. That's to be expected at large companies and it isn't going to change.

I would point out that Graham doesn't consider the "costs" that are often created for users/customers when new software releases are made.

Hypothetical Example #1: you offer a web-based CRM application. You release a bunch of new "features", some that change the user experience. If some of your corporate users have staff members that become confused by the new features and the changes in the user experience, they may require assistance or training. Additionally, some of the changes may disrupt their workflow, resulting in a reduction of productivity. The costs of all these things may not be insignificant.

Hypothetical Example #2: you sell an industry-specific desktop-based accounting suite and release an upgrade. Your customers' system administrators may need to handle the upgrade. There are costs here. More frequent releases are obviously likely to increase these costs.

In both examples, customers are impacted by the releases and their frequency. If the value provided by those releases is greater than the costs to the customer in dealing with them, everybody wins. You don't know that this is likely to be the case, however, unless your development process and release process have been focused on the customer.

If you are simply releasing upgrades containing new features dreamt up by your programmers because they think they have something "cool" or want to write more code, you are likely to impose costs on your customers that are unjustified. Over the long haul, this could very well result in problems with customer retention and lower uptake of new releases.

Bottom line: letting Primadonna programmers run wild is about as good an idea as letting Primadonna CEOs run wild.

TomH: good discussion here.

You ask:

"When you say you 'don't believe' $15K-$20K is worth (on average) 6%, are you saying you can statistically demonstrate that YC does not usually increase the value of their startups by 6.4%?"

That's not what I'm saying but we can take this approach.

The problem with valuation at the "idea stage" (which is really where most YCombinator startups are at) is that there is no good way to come up with a valuation. Asking whether or not YCombinator increases the value of these startups by 6% belies the fact that placing any value on them at all is guesswork.

The valuations for startup businesses at the idea stage varies wildly - $100,000 to $1 million is typical for angel rounds and obviously varies based on a number of factors (who you're raising money from and what they’re willing to give you being the most important). Of course, just because you raise $50,000 from friends and family, for instance, at a $500,000 valuation doesn't mean that you really have a company worth $500,000 because it’s unlikely every other investor out there is going to be willing to go along with that valuation.

So does funding from YCombinator increase the value of a startup? We don't know.

Let's say you have 3 founders who take $15,000 from YCombinator in exchange for 6% of the company. Paul Graham values it, on paper, at a post-money valuation of $265,000. Is that company worth 6% more ($280,900) the minute that Graham's money is the bank and it announces that it has raised money from YCombinator? Probably not (if that’s what you’re asking).

Looking it from another perspective: consider that those same founders may have been able to negotiate a better deal from another funding source.

A couple of years ago, a good friend of mine sold a small stake in his startup to a friend/mentor for a mid-5-figure sum at a $1 million valuation. He and the other founders personally invested around $30,000 in the business up to that point. Coincidentally, the percentage this angel owns in the company is pretty close to the median amount YCombinator takes (6%). Yet the $30,000 my friend and his other founders had invested to get the business going put them in a better position than a team of founders who would give up 6% for $15,000 right at the outset. The $30,000 investment they made to get the business off the ground resulted in their ability to create $750,000 more in equity than Graham would have given them when they first came up with their idea.

Obviously that equity really isn't worth anything (except on paper) until they are able to exit (and there is no guarantee of an exit or an exit at a desirable price) or the company is generating enough cash to pay out dividends.

But let me ask you a few questions:

1. Would you rather sell 6% of your company for $65,000 or would you rather sell 6% of your company for $15,000?

2. Would you rather own 94% of a business that is valued at $250,000 pre-money and has $15,000 in the bank or would you rather own 93.5% of a business that is valued at $1 million pre-money and that not only has $65,000 in the bank but also has a developed product and its first paying client?

3. If you answered logically (that you'd rather own 93.5% of a company that is worth $1 million), would you agree that investing $30,000 of your own money to create a company that an investor is willing to value at $750,000 more than you may have otherwise received is a worthwhile investment of $30,000?

I'll answer the last question for you: of course (assuming that you really believe in what you're doing).

Moving on to "success", I suppose we have different definitions.

You provided this link:

http://rankedindex.com/yc

This tells me nothing about how well these companies are doing where it counts (revenue, cash flow, etc.). How much traffic a website receives doesn't tell me if the company is going to survive the next week, next month or next year.

For what it's worth, I was involved with two websites that both would have been in the top 10 of this list based on their Alexa scores. They were sold for a combined low six-figure amount over a year ago.

Obviously, valuation is about more than traffic so I would not infer anything meaningful from my anecdote but it does highlight the fact that holding up traffic as some measure of "success" in a discussion like this is quite pointless. Just because you have a website that's in the top 15,000 on Alexa, for instance, doesn't mean you have an asset worth millions. For what it’s worth, the websites we sold probably had more in annual revenue than most of the startups on that list and we never raised a cent of money.

On VCs, you wrote:

"Several that have secured multiple funding rounds, from experienced, sophisticated VCs and angels, not generally the types to be swindled by bubble hype;"

If you look at the hurt VCs are experiencing right now and how many are moving away from consumer internet startups, I think you'd understand why you're going to have a hard time convincing me that there are "experienced, sophisticated VCs and angels, not generally the types to be swindled by bubble hype."

Notwithstanding the fact that I disagree with you, for argument's sake I'll suspend my disagreement and consider that the best VCs are immune to herd mentality.

The problem you still have, however, is that no matter how sophisticated and experienced, an honest VC will admit to you that he doesn't know which startups are going to succeed and which will fail. He's in the business of money management: his limited partners give him money to invest and his job is to allocate that money so as to try to produce the best return.

Since he isn't quite sure about which companies will help him achieve this, the technique he employs is "spray and pray." He tries to, taking into account his investment criteria, a) identify the markets with the greatest perceived opportunity and b) identify the most promising young companies within it. He then "sprays" his money around hoping some of it ends up with a winner.

If you delve into the statistics on VC returns over the past decade, you'll see very clearly how spray and pray works in the real world. The vast majority of VC returns have been driven by a very small number of massive exits (think companies like Google, eBay, Yahoo, etc.). In fact, some funds have been made by a single investment. Most VC-backed companies "fail" return-wise.

Paul Graham employs the same "spray and pray" model on a much smaller scale dollar amount wise. He's invested in 60 companies during these recent boom times. Several have been acquired, some have raised follow-on funding.

That's all to be expected.

Unfortunately, I'd suggest that his model is especially vulnerable in tough times. Follow-on funding is going to be more difficult for many startups to obtain now that capital is harder for even VCs to access and the thirst for acquisitions will be far more limited as companies look to conserve cash and spend it more prudently.

When you have a bunch of inexperienced founders trying to build a new company with $5,000 apiece in today's economy and they can't quickly access more capital (or get acquired) by the time their Top Ramen money is gone (assuming they’re still pre-revenue), it's logical that things will eventually fall apart for many, if not most, of them.

Consider that there are more and more voices out there suggesting that we're entering a deep global recession. There are a handful of voices even suggesting that we're possibly headed for a depression or secular bear market. Robert Prechter, who, to a chorus of laughter, predicted the bull market of the 1980s in the 1970s, has even suggested that we could be headed into a 100 year bear market.

Even if the most mild scenario (a painful recession) is what we end up with, one might logically predict that a "firm" investing $15,000 in young, inexperienced founders who only have the resources to build simple web applications is going to find it difficult to produce winners.

We'll see if, 5 years from now, history has been logical.

As for your suggestion that I'm distorting Paul Graham's philosophy, I'm only commenting on what he wrote. There's no mention of user-centered design in his essay that I noticed.

As for your comment about a programmer waking up one morning with an idea that is based on a "user requirement", how exactly does he know that it's a user requirement? How does he know that his idea is the best way to implement a solution to the user requirement? What you speak of is not user-centered design. It's assumption. User-centered design doesn't go from start to finish between breakfast and lunch.

And as they say, assumption is the mother of all...

That’s more than enough comment for an entire week. :)

almost 8 years ago

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TomH

"Let's say you have 3 founders who take $15,000 from YCombinator in exchange for 6% of the company. Paul Graham values it, on paper, at a post-money valuation of $265,000. Is that company worth 6% more ($280,900) the minute that Graham's money is the bank and it announces that it has raised money from YCombinator? Probably not (if that’s what you’re asking)."

This is where you show you don't understand the YC model. Earlier, you make the obvious point that making a valuation on a mere idea is difficult. Indeed it's impossible, given the value is in the successful implementation, not the idea itself. This is why YC don't bother trying to guess valuations. They say "we'll give you this standardised amount of money to cover the founders' living expenses, and mentor you for 3 months to get your idea implemented to a level where you can take the next step, whatever that may be". The 6.4% valuation increase happens not when YC deposits the money, but over the 3 months as the concept materialises, at which point a somewhat more realistic valuation may be established by external investors, or ideally, sustainable revenue. So, on the basis that most YC startups are initially worth nothing, if after 3 months they end up being worth *anything*, YC's value-add is infinite. If you'd rather argue that the idea itself is worth something, then the help that YC offers to get the idea implemented at all would surely be worth somewhat more than 6.4% - if evidenced only by the fact that after the 3 months they have angels and VCs willing to fund them who wouldn't have beforehand. This is unless of course you insist that all angels and VCs who invest in YC startups are brain-dead dupes (which, I'll grant, does seem to be your view to some degree).

Your suggested post-money valuation of $265,000 hinges on the idea that all YC offers is money, when in fact the opposite is true. They quite clearly state the most important part of their offering is mentorship and a supportive, fertile environment, and this is what they are constantly working to improve. If you can provide evidence that this mentorship is in fact worth nothing (or perhaps closer to 3-5%), and indeed cannot ever be worth anything no matter how good a job they do, you're entitled to your point, but you need to do better than "I don't believe $5,000 per founder plus "connections" plus "mentoring" plus "speakers" is worth 2-10% of a company.".

To your questions:

> 1. Would you rather sell 6% of your company for $65,000 or would you rather sell 6% of your company for $15,000?

If the latter option was likely to help achieve a far greater valuation in the longer term, then I might take that one. That's assuming I even had a choice. Perhaps most people who were offered the first option would reasonably take it; for many or most YC founders, it's not a choice they have the luxury of being asked to make.

> 2. Would you rather own 94% of a business that is valued at $250,000 pre-money and has $15,000 in the bank or would you rather own 93.5% of a business that is valued at $1 million pre-money and that not only has $65,000 in the bank but also has a developed product and its first paying client?

Again, this assumes the choice were available to be made. Indeed, the latter option you present here is the very scenario that YC is trying to make possible through their involvement. If YC gives people the opportunity to accept such a deal who would not otherwise have had it, would you still claim their contribution is worthless?

> 3. If you answered logically (that you'd rather own 93.5% of a company that is worth $1 million), would you agree that investing $30,000 of your own money to create a company that an investor is willing to value at $750,000 more than you may have otherwise received is a worthwhile investment of $30,000?

> I'll answer the last question for you: of course (assuming that you really believe in what you're doing).

In fact the answer is "of course" only if:

(a) you have $30,000 of your own to invest (or are willing to spend time - possibly years - saving it or raising it - or indeed learning how to raise it - rather than just working on your startup)

(b) you cannot add any value to your business by being exposed to the mentorship, advice, moral support, industry introductions, discount legal advice, increased industry profile, attention from potential investors & acquirers, frequent interaction with other promising & talented startup founders, that YC offers.

For any startup where these 2 points hold true, you are absolutely correct.

The next lengthy section of your response doesn't need me to counter it in detail. You're right to argue that success is a lot more complex than Alexa rankings. That's why I conceded it from the start. But thanks for going to the trouble anyway.

Fortunately, if only because it saves me more typing, we have a free market economy that does a rather good job of determining business success.

There's no doubt that the VC market is deeply flawed. It's why YC is in business, and Graham does a far better job of articulating this than you ever could:
http://www.paulgraham.com/divergence.html
http://www.paulgraham.com/fundraising.html
http://www.paulgraham.com/venturecapital.html

In the spirit of trying to remedy what is broken in the VC world, what YC does is not remotely a "spray and pray" approach. They operate a continually evolving process for identifying promising founders, and put tremendous effort into helping them focus their energies and implement their ideas, and continue helping them for as long as it takes to keep them in business long enough to get things right and make a significant exit. It couldn't be more different than the "spray and pray" approach you describe, and you again expose yourself as having no real understanding of what YC actually does.

You're right to point out, again, that difficult economic times are here and likely to get worse. You're pretty keen to predict especially tough times for YC; Graham, whose financial future and reputation relies on getting these sorts of things right, seems to think he can steer his business and his startups through it, but is under no illusion that it's going to be easy.

Whether you are smarter than PG remains to be proven, at least somewhat.

And on your final point, you're still fixated on the "feature idea in the morning/deployed by lunch" comment, which is a demonstrative point not a practical recommendation. (And, BTW, prima donna programmers are not good programmers.)

His essay is about how to get good programmers to do good work. You keep trying to refute it by talking about bad programmers doing bad work.

The essay may not be specifically about user-centred design, but if you've picked up any recommendation remotely contrary to the idea of user-centered design, you've read between the lines and got it wrong.

PG's mantra is "make something people want". You'll not find a stronger advocate of user-centered design than Graham.

almost 8 years ago

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Drama 2.0

TomH: it's clear that we have different philosophies on funding. That's fine. Different strokes for different folks.

I personally don't place much value on YCombinator's mentorship and the "fertile environment" it offers. Perhaps I've simply spent too much time bootstrapping my own businesses and associating with people who have done the same. At the end of the day, I'd rather be writing code, working on SEO, hitting the phones to sell and filling in the gaps I have in my skill set on my own.

I don't want to wait for approval from an investor to get moving and I don't need to give up equity for mentorship (if you look, it’s not difficult to find mentors who love helping younger people and who ask for nothing in return). My home office is as fertile an environment as I need.

Discussion of private company valuations is a tricky one, especially when one is dealing with companies that have no revenue, and thus no profits. To argue that a YCombinator startup that goes from concept to prototype, for instance, on Paul Graham's $15,000 is worth 6.4% more than it was when Graham invested 3 months earlier is a highly subjective argument. Just because somebody gives you $15,000 for an “idea” at a $250,000 valuation does not mean that you’ve created enough value to increase that valuation by 6.4% when you have a prototype/alpha/beta product.

You suggest that external investors validate valuation if follow-on funding is raised but I would point out that the valuations angels and VCs place on companies are not necessarily good ones. They too are based on guesswork and are oriented more to the economics of the investor than they are to the economics of the company (which still probably has nothing other than “projections”).

Many VC-backed companies eventually have to raise down rounds and many eventually fail (bringing their value to somewhere close to $0 excluding any assets that may be sold and cash on hand that is returned to investors and debt holders).

There are a lot of VC-backed companies out there right now with 9 and 10-figure valuations that are unlikely to - anytime soon (if ever) - receive those valuations from the public markets or from an acquirer. In the absence of profits supporting such valuations, their valuations are worthless.

I'll leave a discussion of valuation at this: a company isn't money until a) its stock becomes liquid or b) profits provide a basis for an intrinsic value.

On how VCs operate, you write:

"...what YC does is not remotely a 'spray and pray' approach. They operate a continually evolving process for identifying promising founders, and put tremendous effort into helping them focus their energies and implement their ideas, and continue helping them for as long as it takes to keep them in business long enough to get things right and make a significant exit."

No offense but I think you're being naive.

*Every* VC firm will tell you that they have an extensive process to identify the most promising startups and entrepreneurs. In fact, because they’re investing substantially more money than Graham, most apply and even more grueling standard. And *all* VCs claim to make a considerable effort to help the founders of their portfolio companies succeed.

On a side note, your claim that Graham will continue helping his companies for as long as it takes to “make a significant exit” is a ridiculous one, not in the least because 99% of the startups out there *never* “make a significant exit.” Are you seriously suggesting that he’ll continue to write checks ad infinitum if one of his startups doesn’t gain traction and can’t raise institutional money?

This aside, there's nothing new with what Graham is doing - he's just catering his approach to idea-stage "startups” and the type of assistance he provides is tailored to founders who are generally far less experienced than the founders most VC firms fund.

At the end of the day, no investor (including Graham) knows which startups will succeed and which will fail. By investing in enough of them, they increase your odds of picking a few winners and if they're lucky, those winners will be big enough to offset all your losses. If Graham wasn't spraying and praying, he'd have 5 balls-in investments instead of 60 investments that each represent the same amount of money a guy with bad luck and a gambling habit might lose in Vegas on a crappy weekend.

For what it's worth, I've discussed the problems VCs face before:

http://www.drama20show.com/2008/05/01/ross-levinsohn-from-big-rounds-to-down-rounds/
http://www.e-consultancy.com/news-blog/365547/the-greater-fool-theory-and-web-2-0.html
http://www.drama20show.com/2008/07/03/vcs-respond-to-the-venture-capital-crisis/
http://www.e-consultancy.com/news-blog/366009/why-vcs-invest-in-stupid-companies.html
http://www.drama20show.com/2008/10/28/why-vc-infatuation-with-cleantech-will-hurt-silicon-valley/
More musings: http://www.drama20show.com/category/vc-insanity/

Perhaps my words aren't as soothing as Graham's but I can live with that. That said, just because Graham recognizes that the VC model is flawed and articulates it well doesn’t mean that his model is any better.

I would point out that Graham's essay on fundraising (which you linked to) shows a real lack of knowledge in certain areas. Specifically, he points out a number of problems with bootstrapping a startup. I don't disagree with the argument that bootstrapping is difficult but I find this statement quite surprising:

"If you factor out the 'bootstrapped' companies that were actually funded by their founders through savings or a day job, the remainder either (a) got really lucky, which is hard to do on demand, or (b) began life as consulting companies and gradually transformed themselves into product companies."

I don't know what sort of bootstrapped startups Graham has interacted with but I'd point out that by definition, bootstrapped startups are always funded by their founders (either through savings, personal debt or other sources of income). That's the point! If you don't have any capital and are doing consulting, you aren't bootstrapping. You're consulting. To put it another way, if you factor out the "bootstrapped" companies that were actually funded by their founders through savings or a day job, you're left with companies that aren't bootstrapped!

Fact: most new businesses are bootstrapped. Some of the most successful technology companies in the world - Microsoft, HP, Dell, Cisco, Oracle, eBay - were all bootstrapped to start. Yes, that's right - the founders of these companies didn't get an idea, write a business plan and make the rounds on Sand Hill Road. Before they ever raised a cent from anyone, they bootstrapped.

I'm sure Graham knows all this although I'd point out that the nature of YCombinator gives him good reason to argue against bootstrapping. The amount he invests ($5,000 per founder) is far less than many bootstrappers invest in themselves. In other words, if there weren't inexperienced entrepreneurs out there who seem incapable of saving $10,000 or starting a new business while keeping a day job, Graham would have no market for YCombinator.

In any case, Graham loses a lot of credibility when he can't even describe bootstrapping accurately.

Finally, as for your comment "Whether you are smarter than PG remains to be proven, at least somewhat," I'd point out that life isn't an intelligence contest.

I don't care who the "smarter man" is. I care only about my own business. I don't invest in internet startups and will likely never have any interest in doing so. As such, this is little more than a philosophical debate for me.

That said, if you want to play this game, I'd simply suggest that you perform a survey of 100 people and ask a single question: at the present time would you find it desirable to have equity in ~60 internet startups, most of which are pre-revenue and completely illiquid?

If you don’t have the time to do a survey, you could look up how many technology IPOs and M&A deals there have been over the past year (especially in the consumer internet space) or how many VC firms are having trouble getting investors to meet their capital calls.

In any case, while I think Graham’s model is flawed, I wish him success. If he proves that the YCombinator model can thrive (and thrive in the toughest of economic environments), more power to him.

I'll leave it at that. Thanks for the “conversation.”

almost 8 years ago

Drama 2.0

Drama 2.0, Chief Connoisseur at The Drama 2.0 Show

Update: Mixwit, which was funded by YCombinator, is closing up shop.

http://blog.mixwit.com/2008/12/10/all-good-things/

Nothing wrong with trying and failing (happens to everyone) but just a reminder that there isn't a single investor in the world who will stick by their investments in perpetuity until they reach a large exit as had been claimed above.

almost 8 years ago

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