Startup Investing Trends

[Startup Investing Trends]

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| June 2013(This talk was written for an audience of investors.)Y Combinator has now funded 564 startups including the current
batch, which has 53. The total valuation of the 287 that have
valuations (either by raising an equity round, getting acquired,
or dying) is about $11.7 billion, and the 511 prior to the current
batch have collectively raised about $1.7 billion.
[1]As usual those numbers are dominated by a few big winners. The top
10 startups account for 8.6 of that 11.7 billion. But there is a
peloton of younger startups behind them. There are about 40 more
that have a shot at being really big.Things got a little out of hand last summer when we had 84 companies
in the batch, so we tightened up our filter to decrease the batch
size.
[2]
Several journalists have tried to interpret that as
evidence for some macro story they were telling, but the reason had
nothing to do with any external trend. The reason was that we
discovered we were using an n² algorithm, and we needed to buy
time to fix it. Fortunately we've come up with several techniques
for sharding YC, and the problem now seems to be fixed. With a new
more scaleable model and only 53 companies, the current batch feels
like a walk in the park. I'd guess we can grow another 2 or 3x
before hitting the next bottleneck.
[3]One consequence of funding such a large number of startups is that
we see trends early. And since fundraising is one of the main
things we help startups with, we're in a good position to notice
trends in investing.I'm going to take a shot at describing where these trends are
leading. Let's start with the most basic question: will the future
be better or worse than the past? Will investors, in the aggregate,
make more money or less?I think more. There are multiple forces at work, some of which
will decrease returns, and some of which will increase them. I
can't predict for sure which forces will prevail, but I'll describe
them and you can decide for yourself.There are two big forces driving change in startup funding: it's
becoming cheaper to start a startup, and startups are becoming a
more normal thing to do.When I graduated from college in 1986, there were essentially two
options: get a job or go to grad school. Now there's a third: start
your own company.
That's a big change. In principle it was possible to start your
own company in 1986 too, but it didn't seem like a real possibility.
It seemed possible to start a consulting company, or a niche product
company, but it didn't seem possible to start a company that would
become big.
[4]That kind of change, from 2 paths to 3, is the sort of big social
shift that only happens once every few generations. I think we're
still at the beginning of this one. It's hard to predict how big
a deal it will be. As big a deal as the Industrial Revolution?
Maybe. Probably not. But it will be a big enough deal that it
takes almost everyone by surprise, because those big social shifts
always do.One thing we can say for sure is that there will be a lot more
startups. The monolithic, hierarchical companies of the mid 20th
century are being replaced by networks
of smaller companies. This process is not just something happening
now in Silicon Valley. It started decades ago, and it's happening
as far afield as the car industry. It has a long way to run.
[5]
The other big driver of change is that startups are becoming cheaper
to start. And in fact the two forces are related: the decreasing
cost of starting a startup is one of the reasons startups are
becoming a more normal thing to do.The fact that startups need less money means founders will increasingly
have the upper hand over investors. You still need just as much
of their energy and imagination, but they don't need as much of
your money. Because founders have the upper hand, they'll retain
an increasingly large share of the stock in, and control of, their
companies. Which means investors will get less stock and less
control.Does that mean investors will make less money? Not necessarily,
because there will be more good startups. The total amount of
desirable startup stock available to investors will probably increase,
because the number of desirable startups will probably grow faster
than the percentage they sell to investors shrinks.There's a rule of thumb in the VC business that there are about 15
companies a year that will be really successful. Although a lot
of investors unconsciously treat this number as if it were some
sort of cosmological constant, I'm certain it isn't. There are
probably limits on the rate at which technology can develop, but
that's not the limiting factor now. If it were, each successful
startup would be founded the month it became possible, and that is
not the case. Right now the limiting factor on the number of big
hits is the number of sufficiently good founders starting companies,
and that number can and will increase. There are still a lot of
people who'd make great founders who never end up starting a company.
You can see that from how randomly some of the most successful
startups got started. So many of the biggest startups almost didn't
happen that there must be a lot of equally good startups that
actually didn't happen.There might be 10x or even 50x more good founders out there. As
more of them go ahead and start startups, those 15 big hits a year
could easily become 50 or even 100.
[6]What about returns, though? Are we heading for a world in which
returns will be pinched by increasingly high valuations? I think
the top firms will actually make more money than they have in the
past. High returns don't come from investing at low valuations.
They come from investing in the companies that do really well. So
if there are more of those to be had each year, the best pickers
should have more hits.This means there should be more variability in the VC business.
The firms that can recognize and attract the best startups will do
even better, because there will be more of them to recognize and
attract. Whereas the bad firms will get the leftovers, as they do
now, and yet pay a higher price for them.Nor do I think it will be a problem that founders keep control of
their companies for longer. The empirical evidence on that is
already clear: investors make more money as founders' bitches than
their bosses. Though somewhat humiliating, this is actually good
news for investors, because it takes less time to serve founders
than to micromanage them.What about angels? I think there is a lot of opportunity there.
It used to suck to be an angel investor. You couldn't get access
to the best deals, unless you got lucky like Andy Bechtolsheim, and
when you did invest in a startup, VCs might try to strip you of
your stock when they arrived later. Now an angel can go to something
like Demo Day or AngelList and have access to the same deals VCs
do. And the days when VCs could wash angels out of the cap table
are long gone.I think one of the biggest unexploited opportunities in startup
investing right now is angel-sized investments made quickly. Few
investors understand the cost that raising money from them imposes
on startups. When the company consists only of the founders,
everything grinds to a halt during fundraising, which can easily
take 6 weeks. The current high cost of fundraising means there is
room for low-cost investors to undercut the rest. And in this
context, low-cost means deciding quickly. If there were a reputable
investor who invested $100k on good terms and promised to decide
yes or no within 24 hours, they'd get access to almost all the best
deals, because every good startup would approach them first. It
would be up to them to pick, because every bad startup would approach
them first too, but at least they'd see everything. Whereas if an
investor is notorious for taking a long time to make up their mind

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