Uncrunched

I have a few thoughts on this Y Combinator/Google Ventures mess.

Background:

The original post is at Business Insider and includes a leaked email from Y Combinator founder Paul Graham. The email:

If you’re talking to Google Ventures you may be part of a pattern. The pattern is: you’ve already raised some money at a cap of $x. Then GV says they’re interested and wants to invest at a cap of $x/2.

If this happens to you in isolation, you worry “Oh dear, maybe my cap is too high.” But in fact for some bizarre reason this is just their standard m.o.

What do you do in response? Just focus on other investors instead. Maybe you’ll find enough from other sources that you can blow off GV. Or maybe you won’t, and you’ll need that offer to fall back upon. Either way it’s better to wait.

Graham commented and clarified on this on a Hacker News thread:

Just so everyone understands, I was not saying that Google Ventures is a bad investor and should be avoided. If we thought that, the email would have been a lot shorter. I was just talking about a structural problem that happens when you’ve already raised some money on a convertible note with a valuation cap, and an investor offers to invest at a lower cap.

That sort of offer puts founders in a bind, because if you take it (a) it can anger the earlier investors, and (b) perhaps worse, it can, like a “down round” give investors the impression that your prospects are getting worse.

My overall advice about fundraising is to do breadth-first search weighted by expected value. I.e. talk to every investor who’s interested but focus on the most promising ones. This is one of many situations whose solution follows from that rule. An investor offering you money on worse terms is at least offering you money, which is better than nothing. But all other things being equal, the expected value of such an investor is lower than that of one willing to invest on the same terms as your existing investors, so you have any of the latter you should focus on them.

My thoughts:

1. My first reaction to the message is that Google has done absolutely nothing wrong. It is absolutely fine for a venture firm to offer whatever they want to a startup, and it’s absolutely fine for the startup to not accept that offer and move on. It’s easy to read Graham’s message as bullying. A sort of “don’t piss us off or we’ll blackball you” type thing.

2. However, the actual message in the email isn’t all that bad (more on that below). What’s awful is that it looks like a public takedown with the leak. Most people don’t really parse the language or read Graham’s clarification. They just see “Y Combinator Is Publicly Trashing Google Ventures.”

3. I think Graham’s choice of language in a couple of sentences is way too strong. Like suggesting Google Ventures has a “standard m.o” of lowball offers. I’ve seen no evidence of this from Google Ventures.

4. To sum up the first three points above, the only real problem with this email is that it became public and looks like bullying. You have to remember, though, that Graham is probably horrified this was made public.

5. An aside – Most stuff like this from Y Combinator doesn’t leak. The fact that this did leak is the most interesting part of all this for me. It may be because there are so many companies coming out of YC now that there isn’t the same sense of loyalty to the program. Or it may be a sign of stress because some of the startups may be finding it much more difficult to raise funding than previous classes.

6. Another aside – Most of these YC companies are being started by extremely green entrepreneurs who have never raised money from investors, or even had any real business experience. They’ve also seen an extremely loose venture capital world over the last few years and may have unrealistic expectations on just how hard it is to do all this stuff. A “setback” like a low offer may make them feel like they’re being mistreated and it’s natural that they’d complain to their support group (YC and their fellow startups) about it. Graham has a big job mentoring these entrepreneurs and he’s shown over time to be pretty balanced with his advice.

7. Graham has sent us (CrunchFund) private feedback at least twice in the past. We appreciated the feedback (he didn’t have to take the time to communicate), we responded, and everyone moves on.

8. I don’t fully agree with Graham that it is a disaster for startups to accept money at one valuation cap and then accept money at a lower cap. But he’s right that investors can get extremely pissed off about it.

The two times we’ve seen this happen (where we offered less than the previous cap and our offer was accepted) the company amended the previous agreements to give those investors the same deal we got.

9. The VentureBeat article today that suggests the reason Graham wrote this email is because Google Ventures is now a full on competitor to Y Combinator (“Google Ventures has perhaps become more of a competitor to Y Combinator than an asset”) is just pure nonsense.

The email is clearly nothing more than Graham trying to mentor and advise his startups. I know him well, and like most successful people he doesn’t worry much at all about his competitors (even if Google Ventures was a competitor, which it really isn’t).

That article also shows a fundamental misunderstanding of how these financings work on a mechanical level. For example, the statement “In debt financing, most rounds have multiple caps” is just wrong. Many startups raise multiple “financings” over time with different, usually increasing, valuation caps. But in a single financing? No, that’s quite rare.

There are other errors in the article as well but I won’t take the time to list them here. Just imagine if I wrote an article on fashion or particle physics or something that I know nothing about and my research consisted entirely of reading Wikipedia for a few minutes. There’s be a lot of words there maybe, but anyone with real knowledge of the subject would know I was full of shit.

I also think VentureBeat should fully disclose any other issues they have that might be affecting their judgement about Y Combinator, but I’ll leave it at that.

10. In the end the startups are the ones who will take a hit on all this. If a venture fund has to make a choice between walking away from a deal or making a lower offer than other investors, they’ll almost certainly walk away rather than take the risk of a public lashing like this. I’m sorry about that. I’m certain it’s the absolute last thing Graham wanted to happen.