When offering convertible debt, the investor accepts the valuation at the next round of investments (in this case series A).
The risk for the convertible debt investor is that this valuation will be very high and the series A can take a long time.
To limit this risk convertible debt investors negotiate valuation caps and discounts.
Cap: The convertible debt gets converted at min=[series A valuation, cap].
Discount: The convertible debt gets converted at series A valuation * (1- discount)
(Obviously, when both cap and discount apply, the valuation for conversion becomes min = [series A valuation * (1 - discount), cap].)
Quick answer - he does get equity at the next funding round. What he gets is the amount of equity that $150,000 would buy at that valuation.
So if someone else invests $250,000 for 25%, that's a valuation of $1m. Yuri would get 15% at that valuation. He'd get 7.5% at a $2m valuation and so forth.
The $150k offer reminds me of a rumor about the way in which Subway selected franchise locations back in the 1980's.
Subway wouldn't do extensive market research or study traffic counts. Instead, they would see where there was a McDonalds franchise and then open a franchise in the same catchment area. At least that was the rumor (not to compare YC to McDonalds or Hamburger University).
I heard the rumor about Burger King (combined with the idea that McDonalds would do the extensive market research and study traffic counts and so forth.)
Does anyone else see that this offer will drastically change the tone and success rate of YC startups?
Constraints (in the form of funding and time) were a large part of YC. Entrants got a low (but livable) amount of money and 3 months to come up with something great. That something would either sink or swim on demo day.(for more on how constraints help creativity: http://ecorner.stanford.edu/authorMaterialInfo.html?mid=1530) Within those constraints, past YC classes did pretty well, and came up with amazing companies. Those that didn't failed quickly, and could go on to bigger and better things. But YC is now throwing those constraints away.
Because the $150k offer is guaranteed runway, it fundamentally changes the behavioral economics behind startups participating in YC. Products no longer have to be demoable by demo day, and startups won't have to think about profitability/funding, in the short term. This means that we should expect YC startups to dream -and fail- bigger in the future.
I was thinking this as well, but for a different reason. I, for one, would never enter the YC program. $15,000 (especially for that much equity) just doesn't work for most people. The only demographic that can really make that work are 20ish year olds coming right out of school. They haven't started real life yet, and have minimal obligations. Anyone else competent/qualified is probably quitting a job and has various bills and debts, and if they made the decision to do a startup, they already have some bootstrap money or a bit of revenue from a side gig, so that $15k isn't going to make or break them. For 150k however, this changes things entirely. YC can now attract a far more diverse pool of aspiring startups.
I was curious about the potential for returns so I considered a scenario: the successful YC companies take series A investment at an average $10 mm pre-money valuation (which is reasonable for a YC company starting off with $150k), and no series B is ever needed before exit. This gives the original investors a 1.5% stake at the time of exit.
In order to return the $6 mm there needs to be $400 mm of exits.
But I don't think it's reasonable to assume that the successful companies wouldn't take additional funding past series A. More likely, any successful company would also take series B funding. Then we'd need to see ~$500 mm - $800 mm to break even.
My guess is that these investments aren't really intended to be profitable. I would guess that they're instead a gateway into future deals that will be profitable.
I think your logic is generally right, but I'd say in addition to being a gateway into future deals, it's also a guarantee that they'll be in for any truly huge wins.
There's a solid chance that the next Google or Facebook-level company will come through YC, and this deal means they'll get a piece of it.
Going off on a tangent, one of the comments on the TC article seemed really odd - even by TC's standards for terrible comments.
Am I the only one who finds Y combinator predatory? It preys on 20 year old kids who think they're building the next google. Am I crazy?
On the actual subject of the article - if any of the four startups that haven't (yet) signed the paperwork don't end up accepting the offer, I hope they share their reasonings (either now or sometime in the future).
And on a pedantic note: 39/43 rounds to 91% rather than 90%.
Some people believe that in every economic transaction, at least one party must be exploited, no matter how wildly beneficial the deal is to both sides. It's actually a natural implication of the idea that wealth is never created, only reallocated. Unfortunate to see that view among TechCrunch readers, who have evidence to the contrary presented to them every day.
Maybe that commenter is being a bit harsh, but I certainly also get that vibe. At the very least the whole thing has a "dotcom bubble, version 2.0" feel.
And on a pedantic note: 39/43 rounds to 91% rather than 90%
Maybe they were going for one sigfig. This comment doesn't really add anything, so next time you find yourself typing "And on a pedantic note" press delete 22 times.
Na i'd take that money any day. First it's good to have Yuri Milner and Ron Conway on your team.
43 startups @ 150k is only 6.45million, which is typical funding for one venture capital company. Except it's diversified into 43 of them, so that if one of them advances to a series C, they can probably get it all back.
I guess the only problem would be if you try to get a Series A from DST, then you might possibly not get an ultra high valuation, but then again, DST seems to be throwing money at startups after their lustful experiences with Zynga/Groupon/Facebook
This just toughens up the next round of YC applications, which is a bummer. But i'm really interested to see how this will work out.
150K x 43 = 6,450,000.
I'm guessing that there is a fair chance that at least one of the 43 companies alone will allow them to break even on their investment. They should end up doing extremely well on the deal.
Numbers missing: what is the typical valuation at Series A for a company coming out of YC? If it's $2 million then he'll wind up with (on average) 7.5% of each company (similar to what YC itself gets for about eight times less money), so to break even on one exit it'll have to be a $100+ million exit, which would be bigger than any YC exit so far as far as I know.
They'd be crazy not to, it basically boosts whatever runway they had by a considerably amount. What's more interesting than those that took it is those who didn't and if in the end there will be any that won't take it at all and what their reasons are. Likely the number will be '0'.
I would assume the conversion is calculated at the value of the acquisition or IPO (which is really just a type of investment round). [edit: as it says, no discount so forget this part] Typically there's a conversion percentage kicker, so it might be 110% of the value (ie the early investor gets more for the risk)
Seriously? I don't think you grok quite how disruptive this is. This is a better deal than any YC company has gotten... probably ever. The only way someone could top it is to pay founders to let them invest. Add to that the fact that YC almost certainly had piles of legal analysis done to protect the founders' interests.
Convertible debt paperwork is really only a few pages... Heck, they might've used YC's boilerplate docs to simplify things.
[+] [-] pkrumins|15 years ago|reply
I understand what a debt is, so how is "no cap and no discount debt" different from a regular debt?
Also why would you as a startup would want to take a debt?
Another question - what's the point of Yuri giving the debt, it seems he's not even asking for equity in return?
[+] [-] ebaysucks|15 years ago|reply
The risk for the convertible debt investor is that this valuation will be very high and the series A can take a long time.
To limit this risk convertible debt investors negotiate valuation caps and discounts.
Cap: The convertible debt gets converted at min=[series A valuation, cap]. Discount: The convertible debt gets converted at series A valuation * (1- discount)
(Obviously, when both cap and discount apply, the valuation for conversion becomes min = [series A valuation * (1 - discount), cap].)
[+] [-] ladon86|15 years ago|reply
So if someone else invests $250,000 for 25%, that's a valuation of $1m. Yuri would get 15% at that valuation. He'd get 7.5% at a $2m valuation and so forth.
[+] [-] yokumtaku|15 years ago|reply
and http://www.startupcompanylawyer.com/2010/01/11/what-is-a-con...
[+] [-] brudgers|15 years ago|reply
Subway wouldn't do extensive market research or study traffic counts. Instead, they would see where there was a McDonalds franchise and then open a franchise in the same catchment area. At least that was the rumor (not to compare YC to McDonalds or Hamburger University).
[+] [-] rmorrison|15 years ago|reply
[+] [-] philwelch|15 years ago|reply
[+] [-] zacharycohn|15 years ago|reply
[+] [-] CamperBob|15 years ago|reply
Very common tactic.
[+] [-] ssebro|15 years ago|reply
Constraints (in the form of funding and time) were a large part of YC. Entrants got a low (but livable) amount of money and 3 months to come up with something great. That something would either sink or swim on demo day.(for more on how constraints help creativity: http://ecorner.stanford.edu/authorMaterialInfo.html?mid=1530) Within those constraints, past YC classes did pretty well, and came up with amazing companies. Those that didn't failed quickly, and could go on to bigger and better things. But YC is now throwing those constraints away.
Because the $150k offer is guaranteed runway, it fundamentally changes the behavioral economics behind startups participating in YC. Products no longer have to be demoable by demo day, and startups won't have to think about profitability/funding, in the short term. This means that we should expect YC startups to dream -and fail- bigger in the future.
[+] [-] updog|15 years ago|reply
[+] [-] mcmc|15 years ago|reply
In order to return the $6 mm there needs to be $400 mm of exits.
But I don't think it's reasonable to assume that the successful companies wouldn't take additional funding past series A. More likely, any successful company would also take series B funding. Then we'd need to see ~$500 mm - $800 mm to break even.
My guess is that these investments aren't really intended to be profitable. I would guess that they're instead a gateway into future deals that will be profitable.
[+] [-] pg|15 years ago|reply
[+] [-] ekanes|15 years ago|reply
There's a solid chance that the next Google or Facebook-level company will come through YC, and this deal means they'll get a piece of it.
[+] [-] corin_|15 years ago|reply
And on a pedantic note: 39/43 rounds to 91% rather than 90%.
[+] [-] mlinsey|15 years ago|reply
[+] [-] burgerbrain|15 years ago|reply
[+] [-] jodrellblank|15 years ago|reply
Which should be cleared up by reading http://lesswrong.com/lw/qs/einsteins_superpowers/
[+] [-] jpwagner|15 years ago|reply
Maybe they were going for one sigfig. This comment doesn't really add anything, so next time you find yourself typing "And on a pedantic note" press delete 22 times.
[+] [-] imkevingao|15 years ago|reply
43 startups @ 150k is only 6.45million, which is typical funding for one venture capital company. Except it's diversified into 43 of them, so that if one of them advances to a series C, they can probably get it all back.
I guess the only problem would be if you try to get a Series A from DST, then you might possibly not get an ultra high valuation, but then again, DST seems to be throwing money at startups after their lustful experiences with Zynga/Groupon/Facebook
This just toughens up the next round of YC applications, which is a bummer. But i'm really interested to see how this will work out.
[+] [-] liamk|15 years ago|reply
[+] [-] hugh3|15 years ago|reply
[+] [-] jacquesm|15 years ago|reply
[+] [-] rams|15 years ago|reply
[+] [-] paraschopra|15 years ago|reply
[+] [-] danbmil99|15 years ago|reply
[+] [-] 6ren|15 years ago|reply
[+] [-] what-to-do|15 years ago|reply
[+] [-] webwright|15 years ago|reply
Convertible debt paperwork is really only a few pages... Heck, they might've used YC's boilerplate docs to simplify things.
[+] [-] cperciva|15 years ago|reply
[+] [-] unknown|15 years ago|reply
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[+] [-] shub|15 years ago|reply
[+] [-] bigwally|15 years ago|reply