Startup Investment Trends

This article was originally intended to be read by investors, but will also be interesting for those who want to create their own startup or are already in the process of creating it. The author describes well the trends in the world of startups, which will be useful for beginning businessmen. - Approx. translator

Work Y Combinator

The venture fund Y Combinator to date has funded 564 startups, including a current batch of 53 startups. The total estimated cost of 287 startups that were evaluated (as a result of attracting a round of financing, acquiring someone, or closing a startup as a result of which) is approximately $ 11.7 billion. The previous batch of 511 startups together amounted to approximately $ 1.7 billion. [one]

As a rule, these figures are formed due to the leaders of the list. Top 10 startups account for 8.6 of these 11.7 billion. However, they are followed by a group of younger startups. There are still about 40 who intend to become really large.
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The situation got a little out of control last summer, when there were 84 companies in the party that raised rating bars to reduce the size of this list. [2] Several journalists tried to interpret this as evidence of some macroprocess they had invented, but the reason had nothing to do with any external trend. We just realized that we used the n² algorithm, and we had to buy time to fix it. Fortunately, we came up with several Y Combinator distribution methods, and the problem now seems to be solved. Thanks to a new, more scalable model and a small number of companies, working with the current batch now seems easier than ever. I think we will be able to increase the number of startups by 2 or 3 times before we have to change something in our algorithm again. [3]

Startup World Trends

One consequence of funding so many startups is to see the trends at an early stage. Since fundraising is one of the main aspects with which we help start-ups, we are in a favorable position, which allows us to see the trends in investing.

Change of financing

I'm going to talk about where these trends are going. Let's start with the most basic question: will the future be better or worse than the present? Do investors as a whole earn more money or less?

I think more. Various forces operate, some of them will reduce profits, and some will increase. I can’t say with certainty which forces will prevail, so I’ll just describe them, and you can decide for yourself.

Changes in financing startups for two reasons (forces). The first is to reduce the cost of startup startup, the second is that start-ups are entering our life more and more, becoming commonplace.

When I graduated from college in 1986, I had only two choices: to get a job or go to graduate school. Now there is a third: start your own company. This is a big change. In principle, the company could be founded in 1986, but then it seemed unreal. It seemed possible to establish a consulting company or a company offering a niche product, but not a company that could become a major one. [four]

Such a change, when 3 appears instead of 2 options, represents a major social shift that happens once for several generations. I think this shift has just begun. It is difficult to imagine how large it will be. As big as the industrial revolution? Most likely no. But large enough to surprise everyone that major social shifts always make.

Change the number of startups

One thing is for sure: the number of startups will increase significantly. Monolithic companies with a weighty hierarchy of the mid-XX century are replacing the network of smaller companies. This process is now happening not only in Silicon Valley. It began several decades ago and even takes place in the automotive industry. He has a long way to go. [five]

Increased control of owners over companies

Another important reason for the change is to reduce the cost of starting a startup. In fact, two forces are connected: reducing the cost of launching is one of the reasons for the emergence of start-ups everyday.

The fact that start-ups require less money means that the founders will become more and more masters of the situation, unlike investors. You still need as much of their energy and imagination, but they no longer need that much third-party money. Therefore, the share of founders in their companies and control over them will increase.

Does this mean that investors will earn less money? Not necessarily, since the number of good startups will grow. The total amount of shares of run-ups that are in demand and accessible to investors is likely to increase, since the number of start-ups in demand will probably grow faster than the share sold to investors will decrease.

Change the percentage of successful startups

In the venture capital business, it is estimated that about 15 companies become truly successful annually. Despite the fact that many investors unconsciously view this number as a cosmological constant, I am sure that it is not. There are probably limitations on the speed with which technology can develop, but this is not the limiting factor now. If this were the case, every successful startup would be founded in the same month when it became possible. At the moment, the limiting factor of great success is the number of fairly good founders running companies, and this number can and will increase. There are still a lot of people from whom excellent founders would have come out, but who would never have taken it. This can be observed by the way in which some of the most successful startups came about. A lot of the largest startups have not been fully implemented, so there must be a lot of the same good start-ups that have not been implemented.

Perhaps there are 10 or even 50 times more good founders. As more of them move forward and establish startups, these 15 most successful ones per year can easily turn into 50 or even 100. [6]

And what about the profits? Are we moving towards a world in which profits will rise and rise? I think that top firms will actually make more money than in the past. High profits are not the result of investments in low-valued companies. They are the result of investments in companies that really work well. Therefore, if every year such companies will become more and more, those who learn to make the best choice will have increased success.

This means that the venture capital business will become more diverse. Companies that will be able to consider and attract the best startups will be even more successful, because the number of startups that you can consider and attract will increase. At the same time, bad companies will receive waste, as now, but will pay a higher price for it.

I also do not think that maintaining the founders control over their companies will remain a problem. The empirical evidence for this has already become clear: investors make more money by serving the founders than by commanding them. Somewhat humiliating, but in fact good news for investors, since it takes less time to serve the founders than to control their every move.

Business angels

And what about business angels ? I think there are many possibilities. As an angel investor, I was failing. It’s impossible to get access to the best deals if you aren’t as successful as Andy Bechtolsheim, and when you are already investing in a startup, venture capitalists, having come later, may try to take away your share. Now an angel can do something like Demo Day or AngelList and get access to the same deals as venture capitalists. The times when venture capitalists could push angels out of the capitalization table are long gone.

I believe that one of the biggest untapped opportunities for investing in startups today is fast angel-size investments. Few investors understand the costs incurred by startups in connection with attracting investments. If the company consists only of founders, at the time of raising funds all work stops, which can easily take 6 weeks. The current high costs of raising funds mean that there is room for low-cost investors who can get around the rest. In this context, low-cost means fast decision-making. If there was a reputable investor investing $ 100,000 on good terms and promising to decide “yes” or “no” within 24 hours, he would get access to almost all the best deals, since every good startup would first apply to it. Such an investor himself would be able to choose, since every bad startup would also turn to him first, but at least he would see the full picture. If the investor is known that he needs a lot of time to make a decision or to negotiate an assessment, the founders will leave him for later. And in the case of the most promising startups that easily attract funds, the queue may not reach the investor left for later.

Will the number of extremely successful startups grow in direct proportion to the number of new startups? Most likely not for two reasons. The first is that the fear of starting a startup in the old days was a fairly effective filter. Now, when the cost of failure decreases, we should expect that more and more startups will be launched. That's not bad. In the field of technology is a common practice, when innovation, reducing the cost of failure, increases the number of failures and at the same time leaves you ahead.

Idea conflicts

Another reason why the number of extremely successful startups will not grow in proportion to the number of new startups is the expected increase in the number of conflicts of ideas. Despite the fact that the limited amount of good ideas is not the reason that we have only 15 extremely successful startups per year, the number of good ideas is still limited, and the more startups there are, the more we will see a situation where several companies do one thing. and the same at the same time. It will be interesting, in a bad way, if conflicts of ideas become commonplace. [7]

Startup Pyramid

Mainly due to the increase in the number of early failures, the business of startups of the future will change its shape, it will increase its scale. What was an obelisk will become a pyramid. It will be slightly wider at the top, but much wider at the bottom.

What does this mean for investors? First, investors will get more opportunities at the earliest stage, because it is here that the volume of our imaginary array grows the fastest. Imagine an obelisk of investors that matches the obelisk of startups. As it expands into the pyramid to match the pyramid of startups, all content will tend upwards, leaving a vacuum down below.

This opportunity for investors basically means an increase in the number of opportunities for investors, since the degree of risk that an existing investor or company comfortably takes is one of the most difficult things to change for them. Different types of investors are adapted to different degrees of risk, with each of them taking a specific well-established degree of risk, and this applies not only to the procedures they follow, but also to people who work for such a company.

A series investment

I believe that the biggest danger for venture capitalists, as well as the greatest opportunity, lies in the investment stage of series A. Or rather, what was the stage of investment series A, until series A actually turned into rounds of series B.

Currently, venture capitalists often deliberately invest too much money at the stage of series A. They do this because they feel they have to snatch a large chunk of each company in series A to compensate for the cost of lost opportunity associated with obtaining a seat on the board. This means that where there is more competition for a transaction, the variable figure is the estimated value (and therefore the amount invested), and not the company's selling share. This means, especially in the case of more promising startups, that A-series investors often force companies to borrow more money than they want.

Some venture capitalists cheat and claim that companies really need so much. Others are more sincere and admit that their financial models require ownership of a certain percentage of each company. But we all know that the amounts that are raised in rounds of the A series are determined without asking what will be better for companies. They are determined by venture capitalists based on the share of the company they want to own and the market that determines the estimated value, and hence the amount invested.

Like a lot of bad, this situation has developed unintentionally. The venture capitalists business ran into it after the gradual obsolescence of their initial assumptions. The traditions and financial business models of venture capitalists began when the founders needed more investors. In those days, it was natural for the founders to sell most of their company in the round of series A. Now the founders prefer to sell a smaller share, and venture capitalists are balked because they are not sure that they can earn money by buying less than 20% of each company in series A.

I describe it as a danger, because A-series investors are increasingly in conflict with startups that they seem to be serving, and this trend will eventually turn against them. I describe this as an opportunity, since a lot of potential energy is accumulating now, as the market has moved away from the traditional business model of venture capitalists. This means that the first venture capitalist who “breaks the line” will start making A series investments for the share that the founders want to sell (and without the “option pool” only from the shares of the founders) will break a huge profit.

What will happen to the venture capitalists business when this happens? I do not know. But I bet that a particular firm will be ahead. If one of the leading venture capital companies starts making A series investments based on the amount that the company wants to attract, and leaves the acquired share at the discretion of the market, and not vice versa, it will instantly receive almost all the best startups. This is where the money lies.

You can not always resist the forces of the market. For the last ten years, we have seen that the proportion of companies sold in rounds of Serie A is uncontrollably reduced. Previously, 40% were common. Now venture capitalists are struggling to keep the bar at 20%. But every day I expect this strap to collapse. It will happen. Feel free to expect this.

Who knows, maybe venture capitalists will earn more by doing the right thing. This would not be the first such case. Venture capital is a business in which random big success gives you a hundred fold profit. How confident can you be in such financial models? Great strides should be only slightly less random to offset the halved share sold in series A.

Total

If you want to find new investment opportunities, pay attention to what the founders of startups complain about. They are your customers, and their complaints are unsatisfied demand. I gave two examples of what the founders are most complaining about: investors who make decisions for too long, and excessive capital increases in the rounds of series A. It is worth paying attention to this now. And a more universal recipe: do what the founders want.

Notes

[1] I understand that a true measure of a startup success is profit, and not attracted funds. We presented statistics on the funds raised, because these are the numbers that we have. We could not meaningfully talk about profits without including the numbers of the most successful startups, but we don’t have them either. We often discuss profit growth with startups at an earlier stage, because this is how we measure their progress, but when companies reach a certain size, such actions by the seed investor become arrogance.

In any case, the market capitalization of companies ultimately begins to functionally depend on profits, and post-investment estimates are at least the professionals' guesses as to what such capitalization will lead to.

The reason why only 287 startups have been evaluated is that the rest mainly attracted funds on convertible loans, and although convertible loans often have a rating limit, it represents only the upper limit of the estimated value. Back

[2] We did not try to take a certain amount. We could not do it, even if we wanted to. We just tried to be more selective. Back

[3] With bottlenecks, nothing is ever clear, I think the next one will be coordination of efforts between partners. Back

[4] I understand that starting a company does not necessarily mean starting a startup . Many people found ordinary companies. But this is not relevant for the audience of investors.

Geoff Ralston says it seemed possible to establish a startup in the mid-1980s in Silicon Valley. It would start there. But I know that East Coast students didn't think so. Back

[5] This trend is one of the main reasons for the increase in economic inequality in the United States since the middle of the twentieth century. The man who in 1950 would have been the general manager of unit x of Megacorporation, is now the founder of company x and owns a substantial share of it. Back

[6] If Congress adopts a startup visa in an unchanged form, then only this principle can give us an increase of up to 20 times, since 95% of the world's population lives outside the United States. Back

[7] If conflicts of ideas go far enough, this may change the very concept of a startup. At the moment, we, as a rule, advise startups to ignore competitors. We compare startups with running competitions rather than football: it is not required to take the ball away from the other team. But if conflicts of ideas become common enough, you may have to start doing this. That would be annoying. Back

Thanks to Sam Altman, Paul Buchgate, Dalton Caldwell, Patrick Collison, Jessica Livingston, Andrew Manson, Geoff Ralston, Harry Tan for reading the drafts of this article. (author's note)

The translation was made as part of the Tolstoy Summer Camp start-up summer school.