17 ms·

As Angel Investors Pull Back, Valuations Take a Hit

122 points by mgav 11y ago

dsacco 11y ago
As an angel investor, I can anecdotally confirm that I've become more cautious recently (in the last year, really). However, I'm not at all concerned about the stock market. That has never influenced my decision to fund a company. My belief is that a strong company can weather a bear market. I'm concerned with the current state of valuations - I enjoy giving investments to companies on the order of five figures or so each with the hope that they make something meaningfully impactful. I don't necessarily look for them to become moonshot successful; a win can be much smaller than that. Developing incrementally impressive technology that effects change is also a win. But valuations are so frothy right now that it's difficult to tell the strong companies from the ones that won't survive "when the tide goes out." It all seems very clear in hindsight, but it's hard to know right now, even moreso than usual. This is always very difficult, but the market for ideas has become somewhat "congested." There has been a flood of folks entering the "startup game" who seem to be planning for their IPO before they've even gotten a product off the ground. Again, anecdotally, I'm observing a noticeable increase in fraud among founders who are trying to raise money unscrupulously, especially with novice investors. I don't like to use the word bubble because I think it's lazy analysis, but I do strongly believe valuations are in the beginning of a market correction. At the very least, I think there will be a higher bar for invested money to indicate a legitimate valuation instead of a loan. I do think that there will still be plenty of capital ready to be given to companies, investors are just going to be more selective (read: cautious) about it, which may very well change the growth and success potential of certain more dubious business models in the valley.
- paulpauper 11y ago
  It's easy to separate the potential winners from the losers though. Start-ups that deal with hardware and other physical stuff tend to fare much worse than apps and software.
  - dsacco 11y ago
    I think that analysis is too one-dimensional - it's not meaningful enough for me to simply say "hardware startups are probably bad and software startups are probably good." That's not a complete picture, even if it's true that successful startups are not evenly distributed between hardware and software, because all the other factors of startup success are not evenly co-distributed between hardware and software. It is merely one dimension of risk analysis. In the United States, ~32,000 people die annually in car accidents. In New York, ~1200 people die annually in car accidents. I live in New York. Which statistic do I pay attention to? Does it influence my analysis of total vehicular accidents that New York has a much higher population density than most of the country? Am I more likely to die in New York or somewhere else? What is the startup building? What is the existing market the product? What experience and domain knowledge do the founders have? How far along are they? Who are their actual and potential customers? That's the first five minutes of a due diligence conversation. If it were so easy to divide potential winners from virtually certain losers, people would hedge so well they would lose almost nothing and most angel investors would become rich. The reality is very different.
  - bsder 11y ago
    > Start-ups that deal with hardware and other physical stuff tend to fare much worse than apps and software. I'm not sure I buy this. Maybe on Kickstarter, et al. I do, because most of the people trying to do hardware there are hobbyists who have never actually shipped a product and so have highly unrealistic expectations. My baseline for a hardware Kickstarter is "Take the Bill of Materials and Multiply by 3--if that isn't retail price they're in big trouble." Hardware startups take quite a bit more money to get running. However, once they do, you tend to have a very strong customer base and a less assailable position. They have hardware after all--3 guys and a dog can't just clone them.
- roymurdock 11y ago
  > However, I'm not at all concerned about the stock market. That has never influenced my decision to fund a company. It probably will as things start to slow down. During the growth phase of the business cycle, many companies do well. Even some with poor fundamentals that shouldn't. This is the danger of stimulus - it promotes an inefficient and wasteful allocation of resources. But it makes investing easier as a larger pool of companies are succeeding and finding exits for their founders and investors through IPOs and acquisitions, which are both very closely correlated with the health of the stock market. During the contraction phase, the companies with poor fundamentals are exposed. Ok, no loss there, they were struggling and nobody really believed in their potential anyways. But contractions can also bring down good, solid companies who were just caught unaware and were not holding enough liquid assets to pay their employees and the interest on their debts. Some non-negligible percentage will not make it through a rocky period while liquidity dries up and relatively cheap funding/investing slows down. I think it's smart to not read too much into the stock market as it can be distracting and noisy, but I think its trajectory and what it indicates about the phase and timing of the next business peak/trough cycle is extremely important and should not be discounted.
  - dsacco 11y ago
    You have a very good point, in that the stock market's current phase ultimately affects the health of all its constituent companies (in both a symbiotic and parasitic relationship). But like you said, I don't consider it helpful to pay attention on a day to day basis, and I find it to be a more useful indicator for macrotrends than microtrends. In other words, my understanding of the stock market will influence my opinions about the angel investing and startup market en masse, but it would not be anything more than one factor in my opinion about a single company I could invest in. While it's true that companies with strong fundamentals do fail in a downturn, companies with strong fundamentals can fail for any number of reasons. Just as I'm not all that concerned with my Vanguard funds going down for a while because they'll be back up in 10 years, I'm not too worried about a single company with strong fundamentals getting caught with its shorts down when the tide goes out. If it happens, it happens; in the absence of other poignant data, however, I find it much more important to focus on the company itself and pay attention to macrotrends more infrequently. Besides, a market downturn is an excellent time to hedge long bets with shorts :)
- CPLX 11y ago
  > However, I'm not at all concerned about the stock market. That has never influenced my decision to fund a company. You may be the exceptional person who has no assets whatsoever tied up in the stock market, but nearly every investor who has the resources to be an angel will have money in the market. When the market falls they have less money. They use money to invest in things. The correlation between the market and seed stage investing should be fairly direct and clear.
  - criddell 11y ago
    > The correlation between the market and seed stage investing should be fairly direct and clear. The money can only be in one place at a time though. If you pull money out of publicly traded stocks, wouldn't that mean you have more money for angel activities? Although, when the market is way down, that's a great buying opportunity, so is that when angel investors stop putting money into startups and instead go on a stock buying spree?
    - CPLX 11y ago
      You're arguing that they are substitute assets for each other that might move reciprocally, like stocks and bonds are. But equity at seed stage and public stage are the same asset class at different levels and move more in tandem. My argument was more about the wealth effect though, which is that a crash in stocks makes Angels poorer and thus less likely to invest in risky startups.
  - frandroid 11y ago
    It depends if the investor pulls their money out of the market when things start to shake down, or if they have some insights that would push them to do so ahead of a downturn. If they do, they might have _more_ money than usual to invest during a market downturn. Also, as a VC, your money is in a variety of startups that can crest even when the rest of the market goes sideways. Shopify had its IPO this year, others have been bought by the big guys, so their investors are now flush with new money. I mean if we have another big recession, there's going to be an investment chill so even an investor with cash to spare will have trouble finding partners to invest with. But we're not there yet.
- DenisM 11y ago
  An unrelated question, if I may... When evaluating a startup in a given area, how do you bridge the gap between your expertise in that area, and that which is required to assess the opportunity? Obviously the startup founders will always project the fields of gold ripe for the taking, so you can't blindly trust that. Do you only invest in the field you know well? Do you look for behavioral clues? Do you look for your or their peers' decision? Do you look for what's in trend, or counter trend? It seems like a super tough problem, yet it hardly ever gets discussed...
  - jacquesm 11y ago
    Hire an expert. This is routinely done during any kind of due-diligence, if you don't know the field find someone who does, get them to sign an NDA and start picking the proposition apart. Make sure there is absolutely no conflict of interest, make sure the expert will be told up front they will not be able to participate in any kind of deal and will only be paid an agreed-up-front hourly rate for their participation in the due-diligence process.
    - mbesto 11y ago
      Unfortunately angels rarely do due-diligence. The fees to do this for a portfolio approach (which VC's model is) are much too high.
      - jacquesm 11y ago
        The amount of money you spend on a due diligence should be related to the size of the investment. Under 100K investment 5 to 10% should be enough to keep you out of trouble. A couple of hours (or a full day) of an expert in the field that you're going for would amount to maybe $1K to $3K depending on the field. Easy money for the expert and a very cheap insurance for someone putting down 20 to 100K of their hard earned money. The funny thing is they don't bat an eye at spending that kind of money on a lawyer but to actually get a good look at the material it is suddenly 'a lot of money'.
        11y ago
- forgetsusername 11y ago
  >But valuations are so frothy right now that it's difficult to tell the strong companies from the ones that won't survive "when the tide goes out." There seems to be some contradiction here: you seem to say valuations don't matter, but also that you're worried about them. How do valuations prevent you from spotting a good company?
- cookiecaper 11y ago
  >I do think that there will still be plenty of capital ready to be given to companies, investors are just going to be more selective (read: cautious) about it, which may very well change the growth and success potential of certain more dubious business models in the valley. With so many SV companies that have hit it big without any real idea on how they're going to make money some day, it'd be interesting to hear what passes for a "dubious business model" out there.
- jacquesm 11y ago
  > There has been a flood of folks entering the "startup game" who seem to be planning for their IPO before they've even gotten a product off the ground. Again, anecdotally, I'm observing a noticeable increase in fraud among founders who are trying to raise money unscrupulously, especially with novice investors. FWIW I'll back you up on this, definitely a complicating factor for novice investors. Free tip to novice investors: If someone approaches you with a request for funding, if it is still 'just an idea' and if the idea will surely deliver billions and if the funding required is < $50K then you're being fed a line of bull-shit. Anything that will grow to turnovers that high will surely require a little bit of traction after implementation before any figures can be projected at all and anything that hasn't been implemented yet doesn't even qualify to be discussed in other terms than hypotheticals. Another free tip for novice investors: pair up with a more experienced investor to vastly reduce your chances of being ripped off on your first investment(s). This is also not a guarantee but it will increase your odds considerably, it also requires you to convince another, hopefully more skeptical party that what you've found is really worth an investment.
  - bsder 11y ago
    > anything that hasn't been implemented yet doesn't even qualify to be discussed in other terms than hypotheticals. Except that once you implement it, investors start anchoring to how small your numbers are. Catch 22. I work with an actual IoT startup. Hardware--implemented. Backend and frontend--up and running on Azure migration to AWS ongoing. Customers who pay? Yep--and they love it. So, investors? "Ick, haaaardwaaaaare? But ... but ... but ... that's going to take actual moooooney." (yeah--well, so did Nest, thanks) "Your numbers are too small to be meaningful" (no duh--does the word "startup" actually mean anything to you) "This isn't going to scale." (translation--it takes money and marketing to acquire customers--welcome to a business with actual value and customer lockin). "Big data is uninteresting to us now." (translation--"actuarials" and "business process" are only profitable--not wildly profitable and flippable) To a certain extent, I'm looking forward to these unicorns winding up on the butcher block and being discovered to have no meat. The lead VC's of these unicorns are going to give a bunch of the initial investors a huge haircut via preferences (don't get me started ranting on the stupidity of that). Suddenly, initial investors are going to have to start looking at "sustainable" rather than "flippable". Those of us with actual profit will be waiting.
- rdlecler1 11y ago
  The more money that flows to the sector the more of a magnet it is for sociopaths and I don't think many of us are very good at dealing with sociopaths. You mentioned fraud, care to give some examples (no need to name names of course).
  - api 11y ago
    I've seen some things I'd have to tone down to sell as believable fiction, and this was several years ago doing consulting for startups. Standard issue asshattery include things like: - Paper-thin mock up demos of a product being misrepresented as actual finished sale-able product. Sorry but the V in MVP stands for viable. - Impressive people are touted as employees, even co-founders, and when you go talk to them it's news to them. Maybe they had a conversation with said founder once and expressed some interest and suddenly to investors and others they are the CTO. Sometimes this arises from the founder(s) being so narcissistic that they simply assume that anyone would of course feel privileged to join them. Why wouldn't they? - Company/founder has sales/vendor relationship with other companies and misrepresents those products as "theirs," implying that they actually own them. In one case I saw rebranding without permission, which is flat out fraud. - Signups/trials/downloads misrepresented as active continuous users or free users counted together with paid users. - Lying about educational or work background. A skilled blowhard will do so in an ambiguous way, e.g. "went to MIT" means "attended one workshop there and read a lot of open courseware." - Products that would violate known laws of physics or proven mathematical theorems. (Or sometimes even grade school math...)
    - anon8418 11y ago
      > - Products that would violate known laws of physics or proven mathematical theorems. (Or sometimes even grade school math...) Drop-Kicker just covered one such startup: http://drop-kicker.com/2016/01/ampy-move-teardown-and-review/ http://drop-kicker.com/2016/01/ampy-move-teardown-and-review... This is from three PHD engineering students from Northwestern.... over $1.5MM raised via Kickstarter and investors. Hard to believe the founders (remember PHDs) are so naive to actually believe in their own advertising claims.
themartorana 11y ago
Valuations are fake, so who cares? I don't mean to be flip, but valuations are only important to other VCs. No surprise they created their own bubble. Valuations for the Uber-of-this or the AirBnB-for-that have been absurd. I'm not saying there aren't business opportunities there, but sometimes those opportunities are in the tens of millions of dollars, not billions, and hey, tens of millions is fantastic by the way. Edit: I'd like to say I think this is a good thing. I've seen a couple instances where growth was on the back of VCs and didn't have a foothold in reality, and friends ended up losing their businesses. I'm a fan of bootstrapping but I totally get where VC money can help - a lot, in fact. That said, keeping an eye on revenues and reality instead of funding slide decks and pie-in-the-sky "potential" revenues can only be good.
- deleted 11y ago
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- JonFish85 11y ago
  Valuations are fake from one perspective: that they don't reflect anything more than a handful of investors' decisions to pay for a slice of the company. They have very real meaning when it comes to things like employee options and ability to raise money to pay for employees. If a year ago a company raised $10m at a $50m valuation, but now they want another $50m to scale, they'll have to give up a much bigger percentage of stock to do that, which can essentially wipe out any employee stock (founders likely have a different class of stock that isn't as affected). And along the same lines, maybe the company can't raise as much cash as they want/need. In this case, they have to cut back on what they pay employees. In these cases, the money starts to tighten up, and people don't see the reason to stick around SV paying $4k/mo in rent if they're only being paid $8k (before taxes), so they start to look for other places to go. This can lead to a spiral where an otherwise good company can't retain or attract talent, and so the cycle continues (don't hit growth targets, can't raise money at good rates, etc)
- AndrewKemendo 11y ago
  >Valuations are fake, so who cares? Because they actually aren't fake. I mean I get what you are saying, but the reality is that real money changes hands based on those valuations, so they are priced the same way as any other security: Someone says they will pay a certain price per share. I think the issue is that investors setting the prices as market makers don't have a super strong track record of doing valuations with high accuracy.
paulpauper 11y ago
On AngelList, a crowdfunding site aimed at such investors, the average valuation for a company receiving funding reached $4.9 million for two quarters last year, its highest level in five years. But valuations dropped to $4.2 million in the fourth quarter, the lowest level since early 2012. Dow Jones VentureSource data shows that deals involving angel investors fell by 16% last year. It seems like a big deal until you realize there is a huge variance in prices and that 2012 isn't very long ago. The biggest and most successful ones seem to be doing just fine.
- jkaljundi 11y ago
  What makes it even more inaccurate is saying "median valuation" and not taking into account stages or quite often even geographies at all.
biggio 11y ago
Meanwhile http://www.bbc.co.uk/news/business-35339475 http://www.bbc.co.uk/news/business-35339475
- jkaljundi 11y ago
  A much better take to look at that data is this: http://www.vox.com/2015/1/22/7871947/oxfam-wealth-statistic http://www.vox.com/2015/1/22/7871947/oxfam-wealth-statistic It's the same as to compare someone on absolute salary of $100k in Silicon Valley vs $50k in Estonia, forgetting that the latter can provide a luxurious lifestyle with tons of money to spend, while former can mean being barely break-even.
  - aetherson 11y ago
    Median income in San Jose is $80k, so 50% of all households make less than that. $100k does not mean you're barely capable of breaking even. For any reasonable amount of income, it is possible to spend in such a way that you're barely breaking even, of course. But this whole meme of six figures is hard to keep afloat with is the worst kind of cringe-worthy "Oh poor well-paid me." My wife works at Habitat for Humanity in the East Bay. You don't want to consider what the low level employees there are making (and no, they aren't all living with their families or have spouses helping out).
    - tyingq 11y ago
      >>and no, they aren't all living with their families or have spouses helping out Honestly curious...what are they doing then? Isn't the typical rent cost higher than the entire salary of a low level employee at a charitable org?
      - djcapelis 11y ago
        For a luxury condo in downtown SF? Yes. That's not where the people who work for a living at charitable organizations live. HN is a weird bubble.
code4tee 11y ago
People are still willing to invest, but the issue is really that valuations got out of control and that's really hurting a lot of companies. For too many companies these days yesterday's glowing press release about being a 'unicorn' is today's oh $%#&! moment dealing with the ugly reality that sets in when valuations return to some resemblance of reality (e.g., employee stock options that become worthless, lots more tough questions about revenue and profitability and less awe over the hype). Companies that have a solid product, real revenue (i.e., their revenues aren't just coming from other companies on life support from VC cash) are profitable (or close to being so) and have a valuation based on reasonable multiples of their profit will get through the coming rough waters just fine with only a few bumps. Startups that can't tick those boxes are in for a really rough ride ahead. Somewhat ironically, the downfall of many of these startups will be that they ever allowed themselves to be valued so highly in the first place. A company that's reasonably valued at $20 million is going to be in a far better place than a unicorn once valued at $2 billion that's now valued at $500 million.
HashThis 11y ago
I know the Unicorn market is making a massive pull back, and about time. What is happening to the Valley valuations and number of deals completed? I'm curious on if this has any effect on seed companies with valuations at $4m to $6m pre in valuations or number of deals funded? Is this only impacting unicorns (which I don't care about)?
gmarx 11y ago
Whenever I see articles about how easily the investment money flows or had flowed all I can think of, from a purely self-centered point of view, is "what kind of loser am I that I have never been able to raise a single round?" Seriously, my ideas aren't objectively stupider than the ones I see funded. Even in this article, I mean, home eye exams? Did I read that right? How about a startup that will come to your house and groom your dog? These can be good businesses but are they on topic when we're talking about the angel investment environment? Apparently so. Not that I'm bitter (stop being bitter, dammit!)
- vonklaus 11y ago
  I think the point is, they are good businesses short term. They have a minimal terminal value, short lifespan, and there is virtually no barrier to enter the market. Sort of like when google launched. The only surviving niche of google X is travel. You just google pets, not petsearches.io. The equities market is so broken, and interest is so low, that there is an overspend into private markets. Value capture takes 20 years, company lifespan, i would baselessly guess, is 5 maybe. So this shit makes no sense. Best bet is still make something you like working on, to the extent you represent other people, is pretty much your product demand. But yeah mate, you could throw up a squarespace site and be the next cat bubble baths on demand startup. I realized as a super shitty developer, that I will probably totally fail at this side project, but at least when someone gets it done i can say i was years ahead of the curve, just didnt have the chops. ...not that im bitter
- czr80 11y ago
  Feel comfortable sharing one idea? Just curious, completely understand if you'd prefer not to.
  - vonklaus 11y ago
    Search. Turns out everyone was wrong. The next google is actually a google.
  - gmarx 11y ago
    Most of the ideas and products I attempted to get funded were around the idea of transforming the electronic medical record (in the broadest sense) from a mostly free text entity to a mostly well modeled discrete data entity. For more specific ideas I would be happy to discuss outside this board.
pierotofy 11y ago
As reality sets in, valuations start to reflect actual business value.
dannylandau 11y ago
I kinda side with Ron Conway on valuations. His take that valuations are not that important and company's success is mostly binary seems like common sense. Never understood the haggling that goes on over a few million when the exit could potentially be counted in the billions. Here is a link -- http://blogs.wsj.com/venturecapital/2010/10/18/ron-conways-big-deals-how-he-found-google-and-facebook/ http://blogs.wsj.com/venturecapital/2010/10/18/ron-conways-b...
- api 11y ago
  This is right to some extent. A valuation is not money-- it's basically a fictitious number that the company and its investors come up with to make the percentages work to everyone's satisfaction for a round. The problem is that it's also a minimum bar to be cleared later, and if that minimum bar is not cleared it means you're in down round territory. It also in many cases sets a bar for a minimum exit for anyone but the preferred shareholders to get much of anything. A down round is not necessarily death but it very negatively impacts founders, employees, and anyone else who holds common stock or options on common stock. This in turn can kill a company not through cash flow failure but by nuking morale and causing employees to leave (as well as demoralizing the founders). I've thought for quite some time that these really high valuations are actually a trap for founders. A lot of founders have sought them for IMHO ego-driven reasons, but in the end they'll be the ones getting diluted badly in a down round. I mean... I'm not a finance geek but it's always seemed to me that founder (and employee and also possibly seed investor) interests are maximized by maintaining a reasonable valuation. With a reasonable valuation the risk of a down-round is minimized and if there is a sale it's much more likely that the sale/exit amount will clear the liquidation preference bar and something will cascade down to the common shareholders. But what do I know. I just work here. :)
api 11y ago
As many have mentioned: the big wildcard here is how economically incestuous the startup world is. How many smaller startups are dependent on trickle-down from the unicorns? If the answer is "not too many" then it will not affect the other 99% of bootstrapped or less lavishly funded startups. If the answer is "a lot" it will be rough and have cascading follow-on effects. A major driver of the 2000 bubble was startups paying startups to advertise, market, or help build their startups. It was a classic bubble: an unintentional "emergent" pyramid scheme.
- kokey 11y ago
  That might actually be a problem at the moment, mobile and web content producers making good money off advertising from other well funded startups in the B2C space (e.g. mobile), and all of the ad tech industry in between. It hurt when the property bubble burst and property web development and ad revenue took a knock.
iamleppert 11y ago
Has something actually changed? I mean, appreciably in just a few months time? Just goes to show angel investors, while an essential component of the startup ecosystem, can be emotional, illogical, and volatile. If you're unable to accurately value what you invest in and prone to getting swept up in hype, you shouldn't be investing in startups (or maybe anything). The ones who suffer in all this aren't the investors -- they're already rich. It's the employees who get shitted on, forced to work harder for less, or loose their jobs because of the whims of the market and other people's faulty thinking.
pcmaffey 11y ago
This is why I'm conceptually attracted to convertible notes. Valuations always seemed like an illusion...but then caps became status quo as stand-in for valuation. I understand, buyers want to know the price they're paying... But it's still an illusion. That said, there seems to be a very functional solution: discounts. I don't understand why they are not used more. Why not develop industry models for expected value increase from seed > A > B, then invest with convertible notes discounted accordingly? Do this for each round... until there is a liquidation event. The notes themselves would have to offer slightly more protections with each round, but in general, it creates a model of relative value, while that value scale is still being determined... rather than fixating upon some arbitrary valuation.
- hkmurakami 11y ago
  A and B round investors need protection / investor rights / board seats, and you don't get many of these things with a convertible note. (Since you don't own the shares, you don't actually own the votes)
deleted 11y ago
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jorgecurio 11y ago
If these large startups with crazy valuations are now in danger of not being able to raise a bigger round to sustain their burn rate, and the crowd mentality of VCs sour, how realistic is it to expect any of these companies built on lack of due diligence in testing out the viability of their ideas to last? For example: startups delivering food. nobody done it before because everyone knew it was dumb unless you owned the entire delivery chain, and even then the margins were razor thin and they convinced bunch of VCs that an Android app was going to fix the broken business model.

122 points by mgav 11y ago

As an angel investor, I can anecdotally confirm that I've become more cautious recently (in the last year, really). However, I'm not at all concerned about the stock market. That has never influenced my decision to fund a company. My belief is that a strong company can weather a bear market. I'm concerned with the current state of valuations - I enjoy giving investments to companies on the order of five figures or so each with the hope that they make something meaningfully impactful. I don't necessarily look for them to become moonshot successful; a win can be much smaller than that. Developing incrementally impressive technology that effects change is also a win. But valuations are so frothy right now that it's difficult to tell the strong companies from the ones that won't survive "when the tide goes out." It all seems very clear in hindsight, but it's hard to know right now, even moreso than usual. This is always very difficult, but the market for ideas has become somewhat "congested." There has been a flood of folks entering the "startup game" who seem to be planning for their IPO before they've even gotten a product off the ground. Again, anecdotally, I'm observing a noticeable increase in fraud among founders who are trying to raise money unscrupulously, especially with novice investors. I don't like to use the word bubble because I think it's lazy analysis, but I do strongly believe valuations are in the beginning of a market correction. At the very least, I think there will be a higher bar for invested money to indicate a legitimate valuation instead of a loan. I do think that there will still be plenty of capital ready to be given to companies, investors are just going to be more selective (read: cautious) about it, which may very well change the growth and success potential of certain more dubious business models in the valley.

paulpauper 11y ago
It's easy to separate the potential winners from the losers though. Start-ups that deal with hardware and other physical stuff tend to fare much worse than apps and software.
- dsacco 11y ago
  I think that analysis is too one-dimensional - it's not meaningful enough for me to simply say "hardware startups are probably bad and software startups are probably good." That's not a complete picture, even if it's true that successful startups are not evenly distributed between hardware and software, because all the other factors of startup success are not evenly co-distributed between hardware and software. It is merely one dimension of risk analysis. In the United States, ~32,000 people die annually in car accidents. In New York, ~1200 people die annually in car accidents. I live in New York. Which statistic do I pay attention to? Does it influence my analysis of total vehicular accidents that New York has a much higher population density than most of the country? Am I more likely to die in New York or somewhere else? What is the startup building? What is the existing market the product? What experience and domain knowledge do the founders have? How far along are they? Who are their actual and potential customers? That's the first five minutes of a due diligence conversation. If it were so easy to divide potential winners from virtually certain losers, people would hedge so well they would lose almost nothing and most angel investors would become rich. The reality is very different.
- bsder 11y ago
  > Start-ups that deal with hardware and other physical stuff tend to fare much worse than apps and software. I'm not sure I buy this. Maybe on Kickstarter, et al. I do, because most of the people trying to do hardware there are hobbyists who have never actually shipped a product and so have highly unrealistic expectations. My baseline for a hardware Kickstarter is "Take the Bill of Materials and Multiply by 3--if that isn't retail price they're in big trouble." Hardware startups take quite a bit more money to get running. However, once they do, you tend to have a very strong customer base and a less assailable position. They have hardware after all--3 guys and a dog can't just clone them.
roymurdock 11y ago
> However, I'm not at all concerned about the stock market. That has never influenced my decision to fund a company. It probably will as things start to slow down. During the growth phase of the business cycle, many companies do well. Even some with poor fundamentals that shouldn't. This is the danger of stimulus - it promotes an inefficient and wasteful allocation of resources. But it makes investing easier as a larger pool of companies are succeeding and finding exits for their founders and investors through IPOs and acquisitions, which are both very closely correlated with the health of the stock market. During the contraction phase, the companies with poor fundamentals are exposed. Ok, no loss there, they were struggling and nobody really believed in their potential anyways. But contractions can also bring down good, solid companies who were just caught unaware and were not holding enough liquid assets to pay their employees and the interest on their debts. Some non-negligible percentage will not make it through a rocky period while liquidity dries up and relatively cheap funding/investing slows down. I think it's smart to not read too much into the stock market as it can be distracting and noisy, but I think its trajectory and what it indicates about the phase and timing of the next business peak/trough cycle is extremely important and should not be discounted.
- dsacco 11y ago
  You have a very good point, in that the stock market's current phase ultimately affects the health of all its constituent companies (in both a symbiotic and parasitic relationship). But like you said, I don't consider it helpful to pay attention on a day to day basis, and I find it to be a more useful indicator for macrotrends than microtrends. In other words, my understanding of the stock market will influence my opinions about the angel investing and startup market en masse, but it would not be anything more than one factor in my opinion about a single company I could invest in. While it's true that companies with strong fundamentals do fail in a downturn, companies with strong fundamentals can fail for any number of reasons. Just as I'm not all that concerned with my Vanguard funds going down for a while because they'll be back up in 10 years, I'm not too worried about a single company with strong fundamentals getting caught with its shorts down when the tide goes out. If it happens, it happens; in the absence of other poignant data, however, I find it much more important to focus on the company itself and pay attention to macrotrends more infrequently. Besides, a market downturn is an excellent time to hedge long bets with shorts :)
CPLX 11y ago
> However, I'm not at all concerned about the stock market. That has never influenced my decision to fund a company. You may be the exceptional person who has no assets whatsoever tied up in the stock market, but nearly every investor who has the resources to be an angel will have money in the market. When the market falls they have less money. They use money to invest in things. The correlation between the market and seed stage investing should be fairly direct and clear.
- criddell 11y ago
  > The correlation between the market and seed stage investing should be fairly direct and clear. The money can only be in one place at a time though. If you pull money out of publicly traded stocks, wouldn't that mean you have more money for angel activities? Although, when the market is way down, that's a great buying opportunity, so is that when angel investors stop putting money into startups and instead go on a stock buying spree?
  - CPLX 11y ago
    You're arguing that they are substitute assets for each other that might move reciprocally, like stocks and bonds are. But equity at seed stage and public stage are the same asset class at different levels and move more in tandem. My argument was more about the wealth effect though, which is that a crash in stocks makes Angels poorer and thus less likely to invest in risky startups.
- frandroid 11y ago
  It depends if the investor pulls their money out of the market when things start to shake down, or if they have some insights that would push them to do so ahead of a downturn. If they do, they might have _more_ money than usual to invest during a market downturn. Also, as a VC, your money is in a variety of startups that can crest even when the rest of the market goes sideways. Shopify had its IPO this year, others have been bought by the big guys, so their investors are now flush with new money. I mean if we have another big recession, there's going to be an investment chill so even an investor with cash to spare will have trouble finding partners to invest with. But we're not there yet.
DenisM 11y ago
An unrelated question, if I may... When evaluating a startup in a given area, how do you bridge the gap between your expertise in that area, and that which is required to assess the opportunity? Obviously the startup founders will always project the fields of gold ripe for the taking, so you can't blindly trust that. Do you only invest in the field you know well? Do you look for behavioral clues? Do you look for your or their peers' decision? Do you look for what's in trend, or counter trend? It seems like a super tough problem, yet it hardly ever gets discussed...
- jacquesm 11y ago
  Hire an expert. This is routinely done during any kind of due-diligence, if you don't know the field find someone who does, get them to sign an NDA and start picking the proposition apart. Make sure there is absolutely no conflict of interest, make sure the expert will be told up front they will not be able to participate in any kind of deal and will only be paid an agreed-up-front hourly rate for their participation in the due-diligence process.
  - mbesto 11y ago
    Unfortunately angels rarely do due-diligence. The fees to do this for a portfolio approach (which VC's model is) are much too high.
    - jacquesm 11y ago
      The amount of money you spend on a due diligence should be related to the size of the investment. Under 100K investment 5 to 10% should be enough to keep you out of trouble. A couple of hours (or a full day) of an expert in the field that you're going for would amount to maybe $1K to $3K depending on the field. Easy money for the expert and a very cheap insurance for someone putting down 20 to 100K of their hard earned money. The funny thing is they don't bat an eye at spending that kind of money on a lawyer but to actually get a good look at the material it is suddenly 'a lot of money'.
      - 11y ago
forgetsusername 11y ago
>But valuations are so frothy right now that it's difficult to tell the strong companies from the ones that won't survive "when the tide goes out." There seems to be some contradiction here: you seem to say valuations don't matter, but also that you're worried about them. How do valuations prevent you from spotting a good company?
cookiecaper 11y ago
>I do think that there will still be plenty of capital ready to be given to companies, investors are just going to be more selective (read: cautious) about it, which may very well change the growth and success potential of certain more dubious business models in the valley. With so many SV companies that have hit it big without any real idea on how they're going to make money some day, it'd be interesting to hear what passes for a "dubious business model" out there.
jacquesm 11y ago
> There has been a flood of folks entering the "startup game" who seem to be planning for their IPO before they've even gotten a product off the ground. Again, anecdotally, I'm observing a noticeable increase in fraud among founders who are trying to raise money unscrupulously, especially with novice investors. FWIW I'll back you up on this, definitely a complicating factor for novice investors. Free tip to novice investors: If someone approaches you with a request for funding, if it is still 'just an idea' and if the idea will surely deliver billions and if the funding required is < $50K then you're being fed a line of bull-shit. Anything that will grow to turnovers that high will surely require a little bit of traction after implementation before any figures can be projected at all and anything that hasn't been implemented yet doesn't even qualify to be discussed in other terms than hypotheticals. Another free tip for novice investors: pair up with a more experienced investor to vastly reduce your chances of being ripped off on your first investment(s). This is also not a guarantee but it will increase your odds considerably, it also requires you to convince another, hopefully more skeptical party that what you've found is really worth an investment.
- bsder 11y ago
  > anything that hasn't been implemented yet doesn't even qualify to be discussed in other terms than hypotheticals. Except that once you implement it, investors start anchoring to how small your numbers are. Catch 22. I work with an actual IoT startup. Hardware--implemented. Backend and frontend--up and running on Azure migration to AWS ongoing. Customers who pay? Yep--and they love it. So, investors? "Ick, haaaardwaaaaare? But ... but ... but ... that's going to take actual moooooney." (yeah--well, so did Nest, thanks) "Your numbers are too small to be meaningful" (no duh--does the word "startup" actually mean anything to you) "This isn't going to scale." (translation--it takes money and marketing to acquire customers--welcome to a business with actual value and customer lockin). "Big data is uninteresting to us now." (translation--"actuarials" and "business process" are only profitable--not wildly profitable and flippable) To a certain extent, I'm looking forward to these unicorns winding up on the butcher block and being discovered to have no meat. The lead VC's of these unicorns are going to give a bunch of the initial investors a huge haircut via preferences (don't get me started ranting on the stupidity of that). Suddenly, initial investors are going to have to start looking at "sustainable" rather than "flippable". Those of us with actual profit will be waiting.
rdlecler1 11y ago
The more money that flows to the sector the more of a magnet it is for sociopaths and I don't think many of us are very good at dealing with sociopaths. You mentioned fraud, care to give some examples (no need to name names of course).
- api 11y ago
  I've seen some things I'd have to tone down to sell as believable fiction, and this was several years ago doing consulting for startups. Standard issue asshattery include things like: - Paper-thin mock up demos of a product being misrepresented as actual finished sale-able product. Sorry but the V in MVP stands for viable. - Impressive people are touted as employees, even co-founders, and when you go talk to them it's news to them. Maybe they had a conversation with said founder once and expressed some interest and suddenly to investors and others they are the CTO. Sometimes this arises from the founder(s) being so narcissistic that they simply assume that anyone would of course feel privileged to join them. Why wouldn't they? - Company/founder has sales/vendor relationship with other companies and misrepresents those products as "theirs," implying that they actually own them. In one case I saw rebranding without permission, which is flat out fraud. - Signups/trials/downloads misrepresented as active continuous users or free users counted together with paid users. - Lying about educational or work background. A skilled blowhard will do so in an ambiguous way, e.g. "went to MIT" means "attended one workshop there and read a lot of open courseware." - Products that would violate known laws of physics or proven mathematical theorems. (Or sometimes even grade school math...)
  - anon8418 11y ago
    > - Products that would violate known laws of physics or proven mathematical theorems. (Or sometimes even grade school math...) Drop-Kicker just covered one such startup: http://drop-kicker.com/2016/01/ampy-move-teardown-and-review/ http://drop-kicker.com/2016/01/ampy-move-teardown-and-review... This is from three PHD engineering students from Northwestern.... over $1.5MM raised via Kickstarter and investors. Hard to believe the founders (remember PHDs) are so naive to actually believe in their own advertising claims.

themartorana 11y ago

Valuations are fake, so who cares? I don't mean to be flip, but valuations are only important to other VCs. No surprise they created their own bubble. Valuations for the Uber-of-this or the AirBnB-for-that have been absurd. I'm not saying there aren't business opportunities there, but sometimes those opportunities are in the tens of millions of dollars, not billions, and hey, tens of millions is fantastic by the way. Edit: I'd like to say I think this is a good thing. I've seen a couple instances where growth was on the back of VCs and didn't have a foothold in reality, and friends ended up losing their businesses. I'm a fan of bootstrapping but I totally get where VC money can help - a lot, in fact. That said, keeping an eye on revenues and reality instead of funding slide decks and pie-in-the-sky "potential" revenues can only be good.

deleted 11y ago
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JonFish85 11y ago
Valuations are fake from one perspective: that they don't reflect anything more than a handful of investors' decisions to pay for a slice of the company. They have very real meaning when it comes to things like employee options and ability to raise money to pay for employees. If a year ago a company raised $10m at a $50m valuation, but now they want another $50m to scale, they'll have to give up a much bigger percentage of stock to do that, which can essentially wipe out any employee stock (founders likely have a different class of stock that isn't as affected). And along the same lines, maybe the company can't raise as much cash as they want/need. In this case, they have to cut back on what they pay employees. In these cases, the money starts to tighten up, and people don't see the reason to stick around SV paying $4k/mo in rent if they're only being paid $8k (before taxes), so they start to look for other places to go. This can lead to a spiral where an otherwise good company can't retain or attract talent, and so the cycle continues (don't hit growth targets, can't raise money at good rates, etc)
AndrewKemendo 11y ago
>Valuations are fake, so who cares? Because they actually aren't fake. I mean I get what you are saying, but the reality is that real money changes hands based on those valuations, so they are priced the same way as any other security: Someone says they will pay a certain price per share. I think the issue is that investors setting the prices as market makers don't have a super strong track record of doing valuations with high accuracy.

paulpauper 11y ago

On AngelList, a crowdfunding site aimed at such investors, the average valuation for a company receiving funding reached $4.9 million for two quarters last year, its highest level in five years. But valuations dropped to $4.2 million in the fourth quarter, the lowest level since early 2012. Dow Jones VentureSource data shows that deals involving angel investors fell by 16% last year. It seems like a big deal until you realize there is a huge variance in prices and that 2012 isn't very long ago. The biggest and most successful ones seem to be doing just fine.

jkaljundi 11y ago
What makes it even more inaccurate is saying "median valuation" and not taking into account stages or quite often even geographies at all.

biggio 11y ago

Meanwhile http://www.bbc.co.uk/news/business-35339475 http://www.bbc.co.uk/news/business-35339475

jkaljundi 11y ago
A much better take to look at that data is this: http://www.vox.com/2015/1/22/7871947/oxfam-wealth-statistic http://www.vox.com/2015/1/22/7871947/oxfam-wealth-statistic It's the same as to compare someone on absolute salary of $100k in Silicon Valley vs $50k in Estonia, forgetting that the latter can provide a luxurious lifestyle with tons of money to spend, while former can mean being barely break-even.
- aetherson 11y ago
  Median income in San Jose is $80k, so 50% of all households make less than that. $100k does not mean you're barely capable of breaking even. For any reasonable amount of income, it is possible to spend in such a way that you're barely breaking even, of course. But this whole meme of six figures is hard to keep afloat with is the worst kind of cringe-worthy "Oh poor well-paid me." My wife works at Habitat for Humanity in the East Bay. You don't want to consider what the low level employees there are making (and no, they aren't all living with their families or have spouses helping out).
  - tyingq 11y ago
    >>and no, they aren't all living with their families or have spouses helping out Honestly curious...what are they doing then? Isn't the typical rent cost higher than the entire salary of a low level employee at a charitable org?
    - djcapelis 11y ago
      For a luxury condo in downtown SF? Yes. That's not where the people who work for a living at charitable organizations live. HN is a weird bubble.

code4tee 11y ago

People are still willing to invest, but the issue is really that valuations got out of control and that's really hurting a lot of companies. For too many companies these days yesterday's glowing press release about being a 'unicorn' is today's oh $%#&! moment dealing with the ugly reality that sets in when valuations return to some resemblance of reality (e.g., employee stock options that become worthless, lots more tough questions about revenue and profitability and less awe over the hype). Companies that have a solid product, real revenue (i.e., their revenues aren't just coming from other companies on life support from VC cash) are profitable (or close to being so) and have a valuation based on reasonable multiples of their profit will get through the coming rough waters just fine with only a few bumps. Startups that can't tick those boxes are in for a really rough ride ahead. Somewhat ironically, the downfall of many of these startups will be that they ever allowed themselves to be valued so highly in the first place. A company that's reasonably valued at $20 million is going to be in a far better place than a unicorn once valued at $2 billion that's now valued at $500 million.

HashThis 11y ago

I know the Unicorn market is making a massive pull back, and about time. What is happening to the Valley valuations and number of deals completed? I'm curious on if this has any effect on seed companies with valuations at $4m to $6m pre in valuations or number of deals funded? Is this only impacting unicorns (which I don't care about)?

gmarx 11y ago

Whenever I see articles about how easily the investment money flows or had flowed all I can think of, from a purely self-centered point of view, is "what kind of loser am I that I have never been able to raise a single round?" Seriously, my ideas aren't objectively stupider than the ones I see funded. Even in this article, I mean, home eye exams? Did I read that right? How about a startup that will come to your house and groom your dog? These can be good businesses but are they on topic when we're talking about the angel investment environment? Apparently so. Not that I'm bitter (stop being bitter, dammit!)

vonklaus 11y ago
I think the point is, they are good businesses short term. They have a minimal terminal value, short lifespan, and there is virtually no barrier to enter the market. Sort of like when google launched. The only surviving niche of google X is travel. You just google pets, not petsearches.io. The equities market is so broken, and interest is so low, that there is an overspend into private markets. Value capture takes 20 years, company lifespan, i would baselessly guess, is 5 maybe. So this shit makes no sense. Best bet is still make something you like working on, to the extent you represent other people, is pretty much your product demand. But yeah mate, you could throw up a squarespace site and be the next cat bubble baths on demand startup. I realized as a super shitty developer, that I will probably totally fail at this side project, but at least when someone gets it done i can say i was years ahead of the curve, just didnt have the chops. ...not that im bitter
czr80 11y ago
Feel comfortable sharing one idea? Just curious, completely understand if you'd prefer not to.
- vonklaus 11y ago
  Search. Turns out everyone was wrong. The next google is actually a google.
- gmarx 11y ago
  Most of the ideas and products I attempted to get funded were around the idea of transforming the electronic medical record (in the broadest sense) from a mostly free text entity to a mostly well modeled discrete data entity. For more specific ideas I would be happy to discuss outside this board.

pierotofy 11y ago

As reality sets in, valuations start to reflect actual business value.

dannylandau 11y ago

I kinda side with Ron Conway on valuations. His take that valuations are not that important and company's success is mostly binary seems like common sense. Never understood the haggling that goes on over a few million when the exit could potentially be counted in the billions. Here is a link -- http://blogs.wsj.com/venturecapital/2010/10/18/ron-conways-big-deals-how-he-found-google-and-facebook/ http://blogs.wsj.com/venturecapital/2010/10/18/ron-conways-b...

api 11y ago
This is right to some extent. A valuation is not money-- it's basically a fictitious number that the company and its investors come up with to make the percentages work to everyone's satisfaction for a round. The problem is that it's also a minimum bar to be cleared later, and if that minimum bar is not cleared it means you're in down round territory. It also in many cases sets a bar for a minimum exit for anyone but the preferred shareholders to get much of anything. A down round is not necessarily death but it very negatively impacts founders, employees, and anyone else who holds common stock or options on common stock. This in turn can kill a company not through cash flow failure but by nuking morale and causing employees to leave (as well as demoralizing the founders). I've thought for quite some time that these really high valuations are actually a trap for founders. A lot of founders have sought them for IMHO ego-driven reasons, but in the end they'll be the ones getting diluted badly in a down round. I mean... I'm not a finance geek but it's always seemed to me that founder (and employee and also possibly seed investor) interests are maximized by maintaining a reasonable valuation. With a reasonable valuation the risk of a down-round is minimized and if there is a sale it's much more likely that the sale/exit amount will clear the liquidation preference bar and something will cascade down to the common shareholders. But what do I know. I just work here. :)

api 11y ago

As many have mentioned: the big wildcard here is how economically incestuous the startup world is. How many smaller startups are dependent on trickle-down from the unicorns? If the answer is "not too many" then it will not affect the other 99% of bootstrapped or less lavishly funded startups. If the answer is "a lot" it will be rough and have cascading follow-on effects. A major driver of the 2000 bubble was startups paying startups to advertise, market, or help build their startups. It was a classic bubble: an unintentional "emergent" pyramid scheme.

kokey 11y ago
That might actually be a problem at the moment, mobile and web content producers making good money off advertising from other well funded startups in the B2C space (e.g. mobile), and all of the ad tech industry in between. It hurt when the property bubble burst and property web development and ad revenue took a knock.

iamleppert 11y ago

Has something actually changed? I mean, appreciably in just a few months time? Just goes to show angel investors, while an essential component of the startup ecosystem, can be emotional, illogical, and volatile. If you're unable to accurately value what you invest in and prone to getting swept up in hype, you shouldn't be investing in startups (or maybe anything). The ones who suffer in all this aren't the investors -- they're already rich. It's the employees who get shitted on, forced to work harder for less, or loose their jobs because of the whims of the market and other people's faulty thinking.

pcmaffey 11y ago

This is why I'm conceptually attracted to convertible notes. Valuations always seemed like an illusion...but then caps became status quo as stand-in for valuation. I understand, buyers want to know the price they're paying... But it's still an illusion. That said, there seems to be a very functional solution: discounts. I don't understand why they are not used more. Why not develop industry models for expected value increase from seed > A > B, then invest with convertible notes discounted accordingly? Do this for each round... until there is a liquidation event. The notes themselves would have to offer slightly more protections with each round, but in general, it creates a model of relative value, while that value scale is still being determined... rather than fixating upon some arbitrary valuation.

hkmurakami 11y ago
A and B round investors need protection / investor rights / board seats, and you don't get many of these things with a convertible note. (Since you don't own the shares, you don't actually own the votes)

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jorgecurio 11y ago

If these large startups with crazy valuations are now in danger of not being able to raise a bigger round to sustain their burn rate, and the crowd mentality of VCs sour, how realistic is it to expect any of these companies built on lack of due diligence in testing out the viability of their ideas to last? For example: startups delivering food. nobody done it before because everyone knew it was dumb unless you owned the entire delivery chain, and even then the margins were razor thin and they convinced bunch of VCs that an Android app was going to fix the broken business model.