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Jun 5, 2012    |       7 comments

RIP Good Times, Part II? The popping of the bubble that never was.

It was almost 4 years ago that Sequoia famously prepared a deck for their portfolio companies, stating “RIP Good Time“. Benchmark and Ron Conway also jumped on board. It turned out that the situation for startups wasn’t that bad. VC funds still had money to invest and even if capital supply softened a bit and valuations got lower, some pretty awesome companies got funded and grew in those years, including Dropbox and AirBnb.

But we’re at it again my friends. After Facebook’s disappointing market performance, yesterday Paul Graham (PG) sent an email to Y Combinator (YC) potfolio companies stating that times are going to get harder, amounts are going to get lower and valuations are going to deflate. PG warns that some companies might even have to face down rounds.

But, are we really doomed? Are all capital sources going to dry up?

I’m going to make the very hard bet and disagree with Paul Graham (and Chris Dixon). I’m not really sure why but everyone keeps on dismissing fund mechanics and vc competition in this type of situations. First Round Capital, A16Z, NEA, KPCB, Sequoia and Khosla all raised new funds very recently for a total of several billion dollars. Early seed stage doesn’t look bad either with 500 Startups, Lowercase Capital, etc. all raising new capital.

All of these funds will be deploying their capital in the next 2-5 years. In this period of time top startups will keep on getting funded and will keep on commanding high valuations, because they will be able to raise capital from anyone, and those funds know that internet companies are still valuable, there is no tech bubble and by building a long-lasting company that creates value well-timing its IPO, you can make incredible returns.

I’m not worried for Stripe, Gumroad or even Scribd. But I am worried for most of the other YC portfolio companies. This probably deserves a post of its own, but YC has been growing too much. There is a fixed amount of high winners that YC can produce every batch, and while growing the batch size might make sense to lower risk and get that occasional additional winner, it can also have dangerous consequences for itself and the ecosystem.

YC has been diluting its brand and its average company quality by growing this fast and this big. YC still produced some truly outstanding companies and the average quality of its companies is way higher than those at the same stage that didn’t go trough it BUT, pushing out 80 companies a batch “demanding” that each of those raises a seed round at 10m pre is just wrong and unsustainable. Often it may have been investors’ fault for just blindly investing at crazy valuations because of YC’s brand name. But that just can’t go on forever. Other accelerators, even with huge batches and great quality, never tried to command such crazy valuations (500 Startups, AngelPad, TechStars, etc.)

I hope that with PG’s email, YC’s bubble popped.

What PG is calling here, mostly applies to his portfolio companies in the short term. In the long term instead, things might be harder for everyone, but that’s just too hard to predict.

Even if capital would dry up a bit, I think that there could be some pretty good upsides to it:

  • Lower tier funds that are trying to raise new funds and didn’t return good results to their LPs, will face seriously bad times. This process has already started and has been documented endless times.
  • Less VC competition will mean slightly lower and more sane and sustainable valuations in seed deals.
  • Less entrepreneurs starting small, copycat startups.
  • Less competition for talent.

 

  • http://dockyard.com Brian Cardarella

    If people spent as much time over-analyzing and second guessing this junk as they did putting energy into building something imagine where we would be.

    • http://bernardi.me/ Stefano Bernardi

      Agree to a certain extent. There’s certainly huge bullshit talks from journalists to make pageviews but then there are also considerations by people who are building shit and are trying to figure out the environment they live in.
      Blindly building may be a good strategy, I prefer to understand macro (both large-scale international, and small-scale VC ecosystem) events as well. So that’s the reason of the post.

      I spend time thinking about it, might as well share it.

      • http://dockyard.com Brian Cardarella

        I think one side effect we could see, if investment does in fact drop, will be a higher quality number of startups. When the $$ is being thrown around like it is there is a lot of bullshit getting through. Eventually that bullshit fails and the nay-sayers point and say “see?!”. So perhaps this is a good thing.

  • http://twitter.com/vail130 Vail

    I’m very curious about this statement:

    “There is a fixed amount of high winners that YC can produce every batch”

    Can you elaborate on that?

    • http://bernardi.me/ Stefano Bernardi

      Market dynamics.
      Imho it’s fundamentally, as well as probably statistically, impossible to just that many successful companies in the market at the same time. It’s like building a town where you can only get out via a tunnel. You can work on the tunnel and expand it, but you can’t grow exponentially, nor linearly for the matter, the town and number of cars jamming the tunnel :)

      Town = YC
      Cars = startups
      Tunnel = Market
      End of tunnel = Exit event

      Hope this makes sense.

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