How have things changed since 2001? My opinions only:
1. VCs don't sign nondisclosure agreements: yes you will be laughed out the door if you demand one.
2. VCs are sheep: yes, make sure your startup hits one of the hot buzzwords (metaverse, ai, etc) to maximize interest.
3. VCs aren't technical: diligence these days is even more of a joke than it was back then.
4. VCs don't take risks: second time founders can get funding just off their name, yes.
5. Venture funds are big: IMO, there's way too much capital chasing too little talent these days.
6. VCs collude: absolutely, make sure you don't tell VCs other firms you're talking to before the term sheet.
7. VCs don't say no: very annoying, they'll string you along forever.
8. Your idea, your work, their company: biggest change since 20 years ago. Founders have way way more leverage these days. You can negotiate insane valuations (and therefore tiny dilution) compared to even 5 years ago. You can also fight harder for provisions that maintain board control in favor of the founders. The risk of a VC being seen as "founder unfriendly" is way higher than fighting you, a single company out of 100s in their portfolio.
> They told me: "We think you should resign." I left; the problems didn't.
When there is a conflict between the engineering and money talent, the money is going to win. It doesn’t matter if you’re right, if you’re not rich and connected.
I wish I’d understood this, and done more to nurture a direct relationship with my VC instead of letting the angel handle that side of things.
> The engineers building the future deserve a fair equity share in the value they create; today they don't get one.
I understand that this is from 2001, but oh boy has this changed drastically.
For arguably the first time in history founders of businesses operate controlling interest of their stock on the public market. More billionaires have been minted from tech companies in the last 15 years. Not only have engineers gotten their fair share, their power is now being questioned (see Musk, Zuck, etc.).
You're right: funding is extremely founder-friendly right now.
From my perspective, though, the original article is talking about everyday engineers (the "technical team"). If you're an early, senior engineer at a startup, you might be offered 1% of the company. Over the early years of the company, you're often critical to the success and velocity of product development - usually just as critical as the technical cofounder. After four years, your company is acquired for $1B! Your 1% has been diluted to 0.75%, so you walk away with $7.5M. After long-term capital gains, you pocket a bit more than $6M. Objectively, you're now very wealthy - if you're still relatively young, this is enough money to buy a nice house, fund your retirement, and do some angel investing, even in the most expensive cities in the US.
Meanwhile, the technical cofounder walks away from the same story with $200M tax-free. That's dynastic wealth. Does the founder's additional year of work justify this difference? What about the partner from your primary VC, who's likely to personally take home tens of millions despite doing nothing more than investing other people's money and sitting in the occasional meeting?
This is the rosiest scenario - the engineer, founder, and VC all earn life-altering amounts of money. Things get much worse if you're a less senior engineer, you're hired after the first large round of funding, or (especially) the company's exit isn't as good. In all those situations, the founder and VC still get a life-altering windfall, while the senior engineer might barely get enough to retroactively bring their salary up to market rate.
> If you're an early, senior engineer at a startup, you might be offered 1% of the company.
The alternative for the senior engineer is to start a clone competitor with 25% ownership.
The reason an engineer accepts 1% is because: 1. they would be starting their horse after the race has started, 2. they don’t have the skills to be a CTO or found a team, 3. they don’t want to take the risk. Those 3 things are worth the real money, not just being an engineer.
If an engineer wants to own 25% at founding, they need to become a founder rather than bitch about the reality that your employer will pay you as little as possible to acheive what they want. Oh, and mathematically a founder clearly can’t give 25% to more than 4 senior engineers that join subsequently ,and why should they?
You can continue that line of reasoning: there is surely an equally competent and hard working engineer in some large company, or Europe, that for the same 4 years got $0 extra on top of inflationary increases. You got $6M - how much should you redistribute among those competent developers to make it fair?
Maybe you took some risks, maybe you didn’t. Maybe the founders took more, maybe they didn’t. But at some level, if neither engineer showed up for work, the world would be largely the same. If the founders didn’t act as prime movers at a critical inflection point, there would’ve been one fewer IPO and a lot less value creation for everyone to try to split up.
It's worse than that, the VC gets millions in management fees and a 20-30% carry on a diversified portfolio so they take on no risk. There's literally no downside for them and they push companies to take on a ton of risk because they're looking for 1% of their investments to return the whole fund, which makes no sense for an employee who only has a tiny fraction of shares in one of the companies.
You forgot that the engineer got paid from day 0, plus 1% equity. While the cofounder got the idea, filtered it among all bad ideas, pitched and mounted it, and was on 100% risk. I have the same discussion with my employees, they want 100k$ per year from day one with guarantees of permanent employment, then they want equity.
More likely you got options, and they are taxed as income at a liquidity event (acquisition, IPO)... unless you were confident enough in the startup to execute those options & immediately pay the resulting taxes out of pocket. And you have to have that confidence before the valuation is too high & the taxes are unaffordable to absorb.
It's a good article but some parts of it don't ring true, or perhaps things have changed since it was written (in 2001).
For example, the investor director a VC appoints to a board does not generally get any stock options - just a fee for attending board meetings (generally paid to the VC firm, not the individual). It also feels unlikely that a VC today would appoint their own CEO - it does happen, but it is far more likely that they would either back the existing management team or not invest at all, such is their view of how critical the team's quality is to the company's prospects.
The author also describes the VC and its appointed CEO taking ~75% of the company. I've never seen anything like that happen - investors usually end up with about ~30% stake, regardless of what funding phase you are at.
The paragraph about the 'down round' scenario is bizarre. There would need to have been serious failures in the company's/founder's legal work to allow this type of retrospective revaluation to occur. I've never heard of anything like this.
I guess the reason for these oddities is because the landscape was very different in 2001, when we were just emerging from the dot com boom, but I'm not sure. Can anyone else comment?
Anyway, overall it's a really good article, and the final parts ('Fixing the problem') was pretty insightful, since things like this have actually happened since then.
The down round situation was probably the result of anti-dilution protection, meaning it was baked into the previous rounds documents, not something that was renegotiated. Anti-dilution protection basically says that if the company closes a Series B financing at a price lower than the price of the Series A, the Series A investors get an adjustment to their fully-diluted ownership (ie get additional ownership). In the worst case, the Series A shares are effectively repriced to the Series B price, but most often the adjustment is much less. These terms would be part of the Series A term sheet and deal documents, not something that is raised when the Series B occurs.
> The VC connects wealthy investors to nerds. There are few alternatives. You can self-fund by consulting and by setting aside money for your venture. That doesn't work.
It would've been great if an explanation was given for this opinion. Why wouldn't this work? From my limited experience it works fairly well.
Time and misalignment. It's distracting and hard to scale.
Seed money buys time for small team to find product/market fit, and growth money for customer acquisition with a delayed payback period... and the ceiling is how reality-distorting your CEO is.
Consulting is limited by your hours, and likely takes away from your experimentation, product refinement, customer success, and marketing $ + hours. In addition, it biases the product/processes towards the service as consulting immediately makes serious money and saas takes months/years to make even $100/mo. The only exception we did was limited consulting around customer success and co-design of features already on our roadmap. Super painful decision, revenue-wise!
Despite strong interest, we resisted consulting services for our GPU visual graph intelligence platform for years to avoid the misalignment. Due to the recent demand for graph AI for analyzing problems like security /fraud / customer behavior / digital twins, and our interest in bundling those capabilities into our platform yet realizing we need to learn alongside our users, we flipped that decision. However, we have a base product, are being super picky on projects aligned with graph AI, and our clients also want that product goal realized long-term (vs more consulting.)
This is a bit circular, but...it doesn't work because others will use VC. Those using VC will make more progress because they wont be hindered by side gigs to bootstrap the company. If they have good metrics, they will also have access to growth capital which can either out-fund or flat out smother unfunded competitors.
How do I know? I raised some funding for our startup (3yrs full-time) but bootstrapping further was unsustainable vs competitors who were fundraising. VC funded competitors could hire more, sell more, compensate more. The market becomes skewed.
Is it good for the VC-backed competitors? Sort of. They survive. They have longer stories. But they get diluted. Many die as they try to swing for the fences (as VCs want, power law and all...) Some get fired by VC-dominated boards. Some are sent on wild goose chases by outsider funders. This probably happens less-so with better VCs.
You have to remember this article was written in 2001, when most "big" ventures were hardware and therefore very capital intensive. Google shattered that idea: Larry and Sergei retained an extraordinary percentage up through the IPO because they didn't "need" the VC money, and they were doing quite well without it. Many of us from the period looked at that result, took it to an extreme, and proceeded to self-bootstrap our next endeavors.
>Larry and Sergei retained an extraordinary percentage up through the IPO because they didn't "need" the VC money, and they were doing quite well without it.
Fyi... Google got VCs Sequoia Capital & KPCB $25 million around June 1999 which was about ~9 months after they started in Sept 1998. Before the VC funding, they also got a group of seed investments from Stanford professors and other individuals (Andy Bechtolsheim, Jeff Bezos, NBA star Shaq, etc.)
Hard to focus on two things. Get cash today usually outweighs the long term building. On a macro level this is why so little software innovation comes from Accenture. All their focus is on billable hours.
This was written in a pre-SAAS era. The writer was talking about capital intensive startups. It would and it it does work now. Competition with a VC funded adversary is done by developing in stealth.
For founders, a lot has changed about VC funding since this article was written - much of the VC criticism still rings true, but founders often end up with much larger ownership shares and better funding terms.
IMO, YC catalyzed a lot of that change. I don't always agree with every partner's latest think piece, but I appreciate the changes they've brought to startup funding.
At least two of my friends have had their ideas stolen and funded separately.
The first startup I ever worked for, one of the founders had done diligence for a VC and stole the idea. The founder, knowing the VC, was by definition a bankable exec.
... The VCs running a $1 billion fund don't have the time to manage one thousand $1 million investments.
VCs collude:
...
I attended a recent talk by a VC luminary, who gloated over the state of the venture industry, after money for technology start-ups was scarce. Here's my summary of the VC's view:
"A year ago there was too much money available, so there was too much competition to fund good ideas. ... Valuations are reasonable and, with few rivals in each sector, new markets will develop--as they might not have with many rivals."
This is nonsense. ... I'm not talking about market size or market opportunity...; I'm talking about rates of innovation."
--
What's this called? What do economists call it?
Why isn't it obvious?
--
Attempt to restate problem:
Large investors prefer fewer, larger deals. Because of attention scarcity and transaction costs.
Today, we have excess idle capital under performing AND zillions of unfunded ideas, unending needful work not being done.
This applies to all investors. VCs, governments, megacorps, etc.
The genius of Y Combinator is reducing transaction costs, enabling more ideas to get funded efficiently.
How do we (society) do A LOT more of that? How do we make broad portfolios the norm?
--
Policy platform statement:
Lacking other ideas for how to connect capital with small to modest investments, I support wealth redistribution.
Radical repeated cashectomies and stifling regulations for the current 0.1%.
Radical laissez faire and near free capital (zero interest loans, grants, government largess) to seed small, young business development.
Ridiculous, audacious, ambitious moon shot programs. X-Prizes, stipulate that all funds must allocate some fraction to high risk high reward efforts, genius grants, a firehose of funding for academia, arts, culture, community building, whatever. Basically recreate the New Deal's CCC. Set some benchmark, like target funding of say 1% of GDP.
Naturally, I support UBI, universal health care, free childcare, jubilee style bankruptcy protections, and so forth. For the very pragmatic reason of unlocking human potential by reducing (removing) individual risk.
>> Large investors prefer fewer, larger deals. Because of attention scarcity and transaction costs.
>> Today, we have excess idle capital under performing AND zillions of unfunded ideas, unending needful work not being done.
That might be a consequence of the concentration of wealth that's been happening. Not only does a VC have limited attention, but there aren't many ideas that need billions of dollars to fund. It might be better for startups to have twice as many rich guys with half as much money. OTOH maybe there's a way for them to spread it around more with a layer of oversite? But they'd need trusted oversite, and I'm guessing that's hard for them to find.
Readit News
1. VCs don't sign nondisclosure agreements: yes you will be laughed out the door if you demand one.
2. VCs are sheep: yes, make sure your startup hits one of the hot buzzwords (metaverse, ai, etc) to maximize interest.
3. VCs aren't technical: diligence these days is even more of a joke than it was back then.
4. VCs don't take risks: second time founders can get funding just off their name, yes.
5. Venture funds are big: IMO, there's way too much capital chasing too little talent these days.
6. VCs collude: absolutely, make sure you don't tell VCs other firms you're talking to before the term sheet.
7. VCs don't say no: very annoying, they'll string you along forever.
8. Your idea, your work, their company: biggest change since 20 years ago. Founders have way way more leverage these days. You can negotiate insane valuations (and therefore tiny dilution) compared to even 5 years ago. You can also fight harder for provisions that maintain board control in favor of the founders. The risk of a VC being seen as "founder unfriendly" is way higher than fighting you, a single company out of 100s in their portfolio.
> They told me: "We think you should resign." I left; the problems didn't.
When there is a conflict between the engineering and money talent, the money is going to win. It doesn’t matter if you’re right, if you’re not rich and connected.
I wish I’d understood this, and done more to nurture a direct relationship with my VC instead of letting the angel handle that side of things.
I understand that this is from 2001, but oh boy has this changed drastically.
For arguably the first time in history founders of businesses operate controlling interest of their stock on the public market. More billionaires have been minted from tech companies in the last 15 years. Not only have engineers gotten their fair share, their power is now being questioned (see Musk, Zuck, etc.).
From my perspective, though, the original article is talking about everyday engineers (the "technical team"). If you're an early, senior engineer at a startup, you might be offered 1% of the company. Over the early years of the company, you're often critical to the success and velocity of product development - usually just as critical as the technical cofounder. After four years, your company is acquired for $1B! Your 1% has been diluted to 0.75%, so you walk away with $7.5M. After long-term capital gains, you pocket a bit more than $6M. Objectively, you're now very wealthy - if you're still relatively young, this is enough money to buy a nice house, fund your retirement, and do some angel investing, even in the most expensive cities in the US.
Meanwhile, the technical cofounder walks away from the same story with $200M tax-free. That's dynastic wealth. Does the founder's additional year of work justify this difference? What about the partner from your primary VC, who's likely to personally take home tens of millions despite doing nothing more than investing other people's money and sitting in the occasional meeting?
This is the rosiest scenario - the engineer, founder, and VC all earn life-altering amounts of money. Things get much worse if you're a less senior engineer, you're hired after the first large round of funding, or (especially) the company's exit isn't as good. In all those situations, the founder and VC still get a life-altering windfall, while the senior engineer might barely get enough to retroactively bring their salary up to market rate.
The alternative for the senior engineer is to start a clone competitor with 25% ownership.
The reason an engineer accepts 1% is because: 1. they would be starting their horse after the race has started, 2. they don’t have the skills to be a CTO or found a team, 3. they don’t want to take the risk. Those 3 things are worth the real money, not just being an engineer.
If an engineer wants to own 25% at founding, they need to become a founder rather than bitch about the reality that your employer will pay you as little as possible to acheive what they want. Oh, and mathematically a founder clearly can’t give 25% to more than 4 senior engineers that join subsequently ,and why should they?
Maybe you took some risks, maybe you didn’t. Maybe the founders took more, maybe they didn’t. But at some level, if neither engineer showed up for work, the world would be largely the same. If the founders didn’t act as prime movers at a critical inflection point, there would’ve been one fewer IPO and a lot less value creation for everyone to try to split up.
https://en.wikipedia.org/wiki/Mean_reversion_(finance)
Like most things, the gray area in the middle with checks and balances is probably best.
Dead Comment
For example, the investor director a VC appoints to a board does not generally get any stock options - just a fee for attending board meetings (generally paid to the VC firm, not the individual). It also feels unlikely that a VC today would appoint their own CEO - it does happen, but it is far more likely that they would either back the existing management team or not invest at all, such is their view of how critical the team's quality is to the company's prospects.
The author also describes the VC and its appointed CEO taking ~75% of the company. I've never seen anything like that happen - investors usually end up with about ~30% stake, regardless of what funding phase you are at.
The paragraph about the 'down round' scenario is bizarre. There would need to have been serious failures in the company's/founder's legal work to allow this type of retrospective revaluation to occur. I've never heard of anything like this.
I guess the reason for these oddities is because the landscape was very different in 2001, when we were just emerging from the dot com boom, but I'm not sure. Can anyone else comment?
Anyway, overall it's a really good article, and the final parts ('Fixing the problem') was pretty insightful, since things like this have actually happened since then.
I think things are a lot better now from what I see.
It would've been great if an explanation was given for this opinion. Why wouldn't this work? From my limited experience it works fairly well.
Seed money buys time for small team to find product/market fit, and growth money for customer acquisition with a delayed payback period... and the ceiling is how reality-distorting your CEO is.
Consulting is limited by your hours, and likely takes away from your experimentation, product refinement, customer success, and marketing $ + hours. In addition, it biases the product/processes towards the service as consulting immediately makes serious money and saas takes months/years to make even $100/mo. The only exception we did was limited consulting around customer success and co-design of features already on our roadmap. Super painful decision, revenue-wise!
Despite strong interest, we resisted consulting services for our GPU visual graph intelligence platform for years to avoid the misalignment. Due to the recent demand for graph AI for analyzing problems like security /fraud / customer behavior / digital twins, and our interest in bundling those capabilities into our platform yet realizing we need to learn alongside our users, we flipped that decision. However, we have a base product, are being super picky on projects aligned with graph AI, and our clients also want that product goal realized long-term (vs more consulting.)
How do I know? I raised some funding for our startup (3yrs full-time) but bootstrapping further was unsustainable vs competitors who were fundraising. VC funded competitors could hire more, sell more, compensate more. The market becomes skewed.
Is it good for the VC-backed competitors? Sort of. They survive. They have longer stories. But they get diluted. Many die as they try to swing for the fences (as VCs want, power law and all...) Some get fired by VC-dominated boards. Some are sent on wild goose chases by outsider funders. This probably happens less-so with better VCs.
Fyi... Google got VCs Sequoia Capital & KPCB $25 million around June 1999 which was about ~9 months after they started in Sept 1998. Before the VC funding, they also got a group of seed investments from Stanford professors and other individuals (Andy Bechtolsheim, Jeff Bezos, NBA star Shaq, etc.)
Deleted Comment
Hard to focus on two things. Get cash today usually outweighs the long term building. On a macro level this is why so little software innovation comes from Accenture. All their focus is on billable hours.
It’s possible, just hard.
Wasn't it Reid Hoffman who wrote a long article or a book about this?
IMO, YC catalyzed a lot of that change. I don't always agree with every partner's latest think piece, but I appreciate the changes they've brought to startup funding.
http://archive.boston.com/business/technology/articles/2009/...
... The VCs running a $1 billion fund don't have the time to manage one thousand $1 million investments.
VCs collude:
...
I attended a recent talk by a VC luminary, who gloated over the state of the venture industry, after money for technology start-ups was scarce. Here's my summary of the VC's view:
"A year ago there was too much money available, so there was too much competition to fund good ideas. ... Valuations are reasonable and, with few rivals in each sector, new markets will develop--as they might not have with many rivals."
This is nonsense. ... I'm not talking about market size or market opportunity...; I'm talking about rates of innovation."
--
What's this called? What do economists call it?
Why isn't it obvious?
--
Attempt to restate problem:
Large investors prefer fewer, larger deals. Because of attention scarcity and transaction costs.
Today, we have excess idle capital under performing AND zillions of unfunded ideas, unending needful work not being done.
This applies to all investors. VCs, governments, megacorps, etc.
The genius of Y Combinator is reducing transaction costs, enabling more ideas to get funded efficiently.
How do we (society) do A LOT more of that? How do we make broad portfolios the norm?
--
Policy platform statement:
Lacking other ideas for how to connect capital with small to modest investments, I support wealth redistribution.
Radical repeated cashectomies and stifling regulations for the current 0.1%.
Radical laissez faire and near free capital (zero interest loans, grants, government largess) to seed small, young business development.
Ridiculous, audacious, ambitious moon shot programs. X-Prizes, stipulate that all funds must allocate some fraction to high risk high reward efforts, genius grants, a firehose of funding for academia, arts, culture, community building, whatever. Basically recreate the New Deal's CCC. Set some benchmark, like target funding of say 1% of GDP.
Naturally, I support UBI, universal health care, free childcare, jubilee style bankruptcy protections, and so forth. For the very pragmatic reason of unlocking human potential by reducing (removing) individual risk.
>> Today, we have excess idle capital under performing AND zillions of unfunded ideas, unending needful work not being done.
That might be a consequence of the concentration of wealth that's been happening. Not only does a VC have limited attention, but there aren't many ideas that need billions of dollars to fund. It might be better for startups to have twice as many rich guys with half as much money. OTOH maybe there's a way for them to spread it around more with a layer of oversite? But they'd need trusted oversite, and I'm guessing that's hard for them to find.