Y Combinator & TechStars - Not a good deal for Entrepreneurs?

So I've heard about YCombinator for a while and just read about Techstars on TechCrunch.

What I didn't know is that they take a substantial equity stake in your company for the money that they give you. From Techcrunch - the Y Combinator folks take basically 1% of your company for $1000 and TechStars takes the equivalent of $1% of your company for $3000.

I think that this is a bum deal for entrepreneurs. Here's my logic:

According to the National Venture Capital Association the average post money valuation for a early to seed stage company is a little over 12 million dollars (see page 3). Let's say that VCs take an average of 50% of the company so that is a 6 million dollar pre money valuation.

In the Y Combinator model seed companies that they fund are worth $100k. In the TechStars model the seed companies are worth $300k. I'll grant these seed funders the benefit of rounding in their favor.

This means that companies that Y Combinator is funding are at a 60x discount to what a VC is funding companies at. Techstars isn't so bad at only about 20x.

Granted that seed stage startups are a lot riskier than A round startups are, but are they really 60x as risky?

I know that not everyone has this option but I'd rather go beg/borrow the money and take a shot at growing the business that way instead of giving up that kind of equity position.

Comments

[Paul Brown]

Your interpretation of funding stage (and thus of post-money valuation) is off. Take a look at the definitions on the PWC Money Tree site (http://www.pwcmoneytree.com/moneytree/nav.jsp?page=definitions#stage); an "Early Stage" company could even conceivably be raising a Series A round. YCombinator and Techstars are looking to serve companies that are off the end of the spectrum for the PWC report, i.e., pre-"Seed/Start-Up".

[Chris Law]

Paul I think that you misread my post. Yes Early stage companies raise A rounds at a worth of typically 6 M pre-money.

YCombinator and Techstars are investing in an earlier stage company and there should be a discount for risk there. I just don't think that the discount should be 60x. I don't understand why an entrepreneur would do that unless they didn't have other sources of funding.

I do think a more reasonable discount would be 5-10x at a very early stage.

[Paul Brown]

Even having been an entrepreneur, I think that Y-C and TS are being reasonable; I wouldn't take them up on their offer, as I'd spend my own money on it...

The thing that makes the discount reasonable is that you're looking at a company that doesn't exist: pre-product, pre-team, pre-customers, even looking at founders without entrepreneurial experience. If you start tinkering with those variables, e.g., you have no product but you have a strong team or a proven entrepreneur, then the 40-60x discount should quickly slide down to a more reasonable level if not even 1-5x.

[David Cohen]

Our products are certainly not a fit for everyone.

A few points to consider:
1) You compare the seed funding to venture funding. I think this misses the point that it's a very rare company that is venture funded in the first place. They're typically being funded becuase they have a very high intrinsic value (founders with past success, products with paying cusotmers, etc). So to compare seed funding to venture funding is fine - assuming venture funding is even an option. Given that it's not in almost every case, why draw the comparison at all?
2) The discussion of funding misses the point of this sort of program. Most entrpreneurs who are accepted report at the end of the program that they would have done it with no funding. The point is the connections, access to future capital, and advice and mentorship. This is the central value provided by these programs, not the seed funding. The question really should be what's that worth for a company that could never hope of accessing such resources without such a program?
3) Finally, remember that often the goal is to obtain larger financing at the end of the program. Since the shares (at least in the case of TechStars) have no controlling rights, dilution protection, or other special provisions, raising a $500k or $1M round will dilute TechStars down to 1 or 2 percent. If you consider that the company would not have been likely to raise that round - is it now worth that small percentage to have made that happen, meet all these serial entrepreurs, investors, etc, or is it not?

Again, it's not for everyone. But it can sure help the right sort of company.

[mike simonsen]

Remember too, Chris, that YC is basically giving these guys an immediate shot at legitimacy. These are not established entrepreneurs who can go out and get valued at $12M.

For a couple of kids right out of school with nothing but some coding chops and an inkling of an idea, the YC experience legitimizes them as a company. Giving 10% to a partner who is highly optimized to take care of all the business stuff so you can build your product and get to market could be a bargain for these kids.

I bet if you asked the Redditt guys, they'd tell you the experience was entirely worth it.

The rest of us have to use our accumulated money and experience to bootstrap the company. Their $6k for 3 months per person wouldn't even cover my mortgage ;-)