Disclosure: I have no financial interest in Ycombinator or any of its companies.
In July of this year, Yaron Samid and I started planning to build an academy for Israeli entrepreneurs The Academy was loosely modeled on Ycombinator, my intellectual hero Paul Graham’s investment company.
The TechAviv mission: Help Israeli entrepreneurs build great companies and promote Israeli ingenuity. Yaron and I went to Israel in late September as the global economy began to unravel. Everybody loved TechAviv and wanted to help, but two months later the entire investing landscape has changed. During the summer the angel market was as vital as it’s ever been. Today the angel market appears to be on life support.
Huge wealth has been eviscerated this fall. Wealthy people are less affluent and feel much less wealthy. I can relate to that. Gloomy prognostications about the economy and rumors of defaults in the venture community make this an even darker moment for new startups.
But Israelis, particularly venture investors, will not support TechAviv. They claim that they are legally forbidden to do fund of fund investing. It’s a hollow truth that surely could have avoided through a myriad of legal structures. I suspect they either did not believe we would succeed or they cannot get the returns they typically seek and they did not understand the model. Both reasons would be reasonable, but for the Venture industry to scale the entire ecosystem needs to be functioning. Sequoia cannot invest in what has not been created.
Yaron and I saw 10 Israeli venture firms. None of them had heard of Ycombinator. No wonder Paul’s firm, to my knowledge, has never had an Israeli company in the portfolio. While Israeli venture firms would benefit enormously from an academy like TechAviv, they were unwilling to support it financially. Ok, we expected that. Paul’s startups have usually been funded by angels anyway.
The Ycombinator and TechAviv models depend upon angel investors supporting nascent companies until they are ready to raise institutional capital. Angels have become a vital component of the private company ecosystem because they add more value than “friends and family” investors. Angels network, give dispassionate advice, and prepare companies for institutional investment.
Unfortunately, the word on the street is that angels are hibernating.
Neither TechAviv nor YCombinator, can give birth to 15 companies a year if they have no prospects of finding capital. That’s the conventional wisdom and in venture investing the “conventional wisdom” is the only wisdom.
Enter Paul Revere Graham, who writes a typically contrarian essay called “Why to Startup in a Bad Economy.”
The economic situation is apparently so grim that some experts fear we may be in for a stretch as bad as the mid seventies.
When Microsoft and Apple were founded.
As those examples suggest, a recession may not be such a bad time to start a startup. I’m not claiming it’s a particularly good time either. The truth is more boring: the state of the economy doesn’t matter much either way.
If we’ve learned one thing from funding so many startups, it’s that they succeed or fail based on the qualities of the founders. The economy has some effect, certainly, but as a predictor of success it’s rounding error compared to the founders.
I might argue that tough times are an advantage:
1. Team stability because people don’t leave.
2. A penurious culture is formed from inception
3. Less capital is raised, making entrepreneurs more efficient and less distracted by all the peripheral opportunities.
4. Companies are asked to think about revenue earlier and create a culture of generating revenues.
The converse to all these points may also be true and that’s really my argument. There is no “right way to invest.” There are only right entrepreneurs to back. Great entrepreneurs succeed in any market.
Venture investors sometimes preach that recessionary environments are the best time to invest Here’s their script, “Recessions are great times to invest because there is less competition, valuations are lower, and talent is less expensive.” If this were true, institutional investment would rise in 2009 and nobody believes this will be the case.
Why not? Because venture investors are paid very well to manage committed capital. They can proceed very cautiously for a year and earn the same frothy salary they did in 2006. To be sure, they would rather invest and look forward to carried interest, but they will only invest if others also invest and if nobody invests, well, why should they?
I remember 2001 and 2002. It was very hard to get a hold of your board members because they were on vacation more than they had been during all of the 1990s. When your VCs were working, they were closing companies. Understandably they hate that since its terrible for their limited partners and even worse for the firm’s Internal Rate of Return. All this negative energy creates a very bad startup environment and then nobody takes advantage of the downturn in the economy. Capital is reserved for the winners and losers that already exist. As a result, a whole class of entrepreneurs stays out of the market. And this leads to less innovation, fewer jobs created, and less enthusiasm about startups. It’s a vicious cycle. And this time it makes even less sense than it did 7 years ago, since it is so much less expensive to seed a company than it was in 2001.
Nevertheless, the conventional wisdom is that concept and seed-stage investing are going into hibernation for at least a year. Even the optimistic Chris Sacca think there is angel shakeout underway. I’ve been in countless meetings with investors with significantly less vision and experience than Paul who think Ycombinator will fail miserably over the next two years.
But of course they don’t understand that Paul and his partners could for 0 for the next 8 quarters and their model would still be better than sitting around collecting management fees waiting for the lure of “the sure thing.” Paul gains institutional knowledge and the Ycombinator brand continues to stand for true innovation and differentiation. The irony is that vc micro-economic investors are highly seduced by the macroeconomic conditions. They would rather invest in mediocre companies in an strong economy than stellar companies in a poor market.
If I were an investor I’d beg to get into YCOMBO demo days. Paul will have many more applications and his portfolio will be hungrier for capital. You could probably get a good deal.
As for TechAviv, well I’ve always relished a challenge. We’ll have to see.