Archive for the 'Silicon Valley' Category

Series Seed and Series A

Back in the ‘ol days, the first money that went into a technology startup was called  “Series A”. This not only marked the first money coming in but also set the valuation not to mention the terms of equity which impacts all other types of investment.

However, those were the days where you had to raise $5-10m to get servers up, which you can now do for $10 with companies like Amazon, Rackspace, and Digital Ocean.  It’s a very different world now with the change in cost from marketing to hiring and beyond. During the last half decade, we have also seen an “accelerator” boom and an Angel investor boom where startups can get $20-100k in “seed” financing which accomplishes the same thing as the original Series A but without the traditional terms.

Actually, it’s even crazier than that: entrepreneur friends of mine are raising “seed” rounds now of $1-3m which was what you would raise as Series A. What the hell is going on?

Series Seed

It’s been remarked Series Seed is the new Series A.  Why bother calling something an A-round? Well, for one good reason: there’s a valuation.  A distinguishing difference between raising seed money and Series A money is you price the equity you are selling verses deferring it.  In Silicon Valley, “convertible notes” have become the standard now. You raise the funds from an accelerator or angel investor, but don’t discuss the valuation (as you have no idea about revenues yet which is what you really need for a valuation).   The investment is presented as “short-term” debt that converts into equity.  The option, which always happens, is that the investor will receive shares instead of the principal based on the agreed terms. Another reason: If you’re raising Series A from VC that means you’ve graduated into a different type of startup.  You’re more of a growth business.  No longer testing the market but building to scale.  For a VC to participate as a Series A, it’s a partnership decision that thinks you can be a billion dollar company and not just an idea.  Not more worried about cash in the bank, but that you’ll need enough people to grow quickly (or more commonly, that you can’t grow exponentially without the cash)

Language matters
I know of a lot of people who are forced to price their seed round. So, if the first money you receive is “seed” and the first priced money you receive is “Series A” then this definition doesn’t work.

That’s why I would define Series A as having two of the three following characteristics:

  • Done by a multi-partner venture capital firm, not individuals. Your first real institutional money that also has the potential to lead your Series A round.
    • Important to distinguish is this is not an accelerator or a micro-VC (the latter could be $5-25m with one partner, which for all intents and purposes, is  a VC fund). These are new breeds of investors that aren’t the traditional, and have very different motivations as well as likely not being able to participate in Series A rounds, let along lead it.
  • Done with a price. Your valuation is now defined.
  • Done for the purposes of growth, not “startup”

This isn’t just semantics, language matters for millions (of dollars) of reasons.  Entrepreneurs ask me on a daily basis how to fundraise and this same advice applies.  Understanding these differences could save you from wasting 12 months of your life.  Raising seed money is a whole different ball game to raising a Series A, with entrepreneurs not realising this until they have three months of cash left, a payroll, and a lot of users/customers.

My advice is be sure to know the importance of the bar between Series Seed and Series A:  vision is 60% of how you raise money with Series A (don’t confuse vision for plans.)  Even if you raised $3m seed it doesn’t mean you’re Series A worthy.  More cash in the bank doesn’t mean you’re a growth company and you’ll run out of money before you know it, which is the main reason small businesses fail.

Web 3.0 will not be on the web

It’s Saturday 7pm. A pretty airline hostess friend of mine was in San Francisco for the night, wanting to do drinks. What to do?

I was knocking on the door of a home in Palo Alto that had a Guy Fawkes mask on a Christmas reef. As for why, it was to attend the first ever Decentralized Autonomous Society Meetup, an event with a minimal description other than a title “Let the revolution begin”. The event reads:

In the early 90s the cypherpunk movement held its meetup in Palo Alto, working through many ways in which cryptographic technology could be used to promote human freedom. Eventually Bitcoin was born.

Today we discuss how the second wave of blockchain innovation can enhance human freedom.

The house was packed. Hours earlier, TechCrunch had posted  Decentralise All The Things! and mentions Ethereum and Maidsafe who are leaders in the movement. In my search to find a solution to a business challenge I have, I inadvertently was now at a meetup where one of the speakers was a representative from Maidsafe and another speaker representing Ethereum. But not just that: I found myself after the talks talking to the globe trotting Vitalik Buterin, the inventor and chief scientist of Ethereum.

Although I had been tracking Bitcoin for a few years now and evangelising it behind closed doors to influential politicians, business executives and my network, a frustration I had was that no one understands the true impact.  This is something that has been on my mind every since I become aware of after a talk by former Googler Mike Hearn in 2012.

That changed a few months ago, when I stumbled on Ethereum’s white paper and found it the single best document describing the state of cryptocurrency and its potential beyond being simply a means of exchange as Bitcoin is known. Ethereum’s creator might only be 20, but with his former project being the Bitcoin magazine which has been an invaluable resource to understand Bitcoin, he comes across to me as probably having one of the deepest understandings of cryptocurrencies, their potential — and weaknesses.

Both Vitalik and I hold a mutual view that we don’t know what the future of Bitcoin is and if it will last. But after talking to him, I had in no doubt that I had met a genius that one day may be regarded like Tim Berners-lee who created the world wide web.

Separately, I was talking with one of the organisers, and he was excited I understood the potential of DAO (Decentralised Autonomous Organisations) and similarly remarked at his frustration that most investors in Silicon Valley don’t seem to get it. Given silicon valley investors are beating the drum roll of Bitcoin’s world domination despite the rest of the world not getting it, you can take that to be a sign this is pretty early days of the Decentralised Autonomous movement.

But let me get to the point of why I’m even writing this — both due to something Vitalik said to me and that I separately read yesterday that he pointed me too. He referred me to a recent blog post on secret sharing and where he writes a money quote in the conclusion of the article explaining DAO’s as follows:

If the blockchain is a decentralized computer, a secret sharing DAO is a decentralized computer with privacy

In a world where no one can really explain it yet, that explains DAO’s beautifully. But let’s back it up: blockchain, one of the four technologies underpinning Bitcoin (the others being PGP, Proof-of-work (such as mining which includes hash functions and Merkle trees ), and peer-to-peer)…is a computer? When I prodded Vitalik about what use-cases he was prioritising ahead the Ethereum 1.0 release later this year (March), he eventually responded: “It’s hard to prioritise one use case when you’re building a computer!”.

And that’s exactly what’s going on. This is all software, architecture and philosophical vision for a decentralised world, bringing the Internet back to its roots. In the process, this will enable a weak form of artificial intelligence. If hypertext is what underpins the web and has transformed the world of communications, then cryptography is what underpins the blockchain and will be transforming our world starting with payments but beyond that such as any system where “trust” is needed like elections, contracts and more. The power being the computers manage the “trust” (no humans tampering with it) and can automate the enforcement.

3D printing and Dones are two long term technologies that I regard as inevitable and game changing. It just might take 20 years for us to fully realise it. Well, Bitcoin, blockchain and crypto-currencies is my other main trend — but the externalities of that trend such as the Ethereum project and the ecosytem building around it, is something I think everyone should have on their radar that I think is akin to the web starting.

This year will see Ethereum 1.0 released (roadmap) with a chat application, a browser, as well as the ability for people to build their own applications with javascript — and we’ll also see the Bitcoin foundation be transitioning to a block-chain based voting system for its 2000 members which if it happens will become the highest profile example of DAO principles in action, beyond the Bitcoin network itself and the blockchain voting by the Danish political party.

Don’t get me wrong, this is not something that I’m early to identify rather it’s been in my face: at my business StartupHouse, we host events for Bitcoin developers and its intrigued me in their grass roots support. Combined with my reading, once you begin to understand the value of a blockchain, the power of cryptography, and what you can do outside of currency — then maybe, just like me and thousands of grass roots community support in silicon valley and around the world, you’ll begin see the emergence of something. A something driven by a frustration to emerge from the world post the credit crunch induced recession, government abuse of power with people’s money, and inequality where the few are owning more of our society’s capital.

A vision that, maybe, just might be a revolution in how the world operates that is as dramatic as what the world was like before the web. Stay tuned.

A great result for Alakaboo!

Markus Moonie, the Swiss founder of Alakaboo (a vegetable photo sharing site), has announced that Facebook will be acquiring the startup he founded for an undisclosed amount. The two time entrepreneur who previously sold his first startup to the Non-profit Creative Commons, says he found Facebook to have a unique view and aligned passion for what he was building.

 “Starting a business is hard. Creating a website with a ‘to be launched’ page, pivoting three times, feeling importance in being able to hire and fire people, and talking to investors who have no idea in picking the next big star but backed me because I’ve got good SEO on my blog and look like a good bet along with my Berkeley, D-Combinator, Creative Commons branding — means I have the right to talk like I know what I’m doing”. Moonie says that the decision to sell was based on what he thought was best for him, a refreshing change as most entrepreneurs are working to make their investors money and represents a nascent trend in how the power has shifted to entrepreneurs in today’s market.
Moonie considered the funding environment, which is going gangbusters — and what it would take to execute on his vision like an actual product that people want. He believes that it would make much more sense if he was to sell as a talent acquisition so that he can get name brand recognition of Facebook, the 2X tag that puts him on par with other entrepreneurs as successful, as well as stock options in a company that actually has a future. The fact he had no cash left in the bank and couldn’t raise additional money was a secondary consideration, according to Moonie.
We reached out for comment and Facebook declined to comment other than saying they will be shutting down Alakaboo, firing all the non-engineers in the team, and putting Moonie in a Operations manager role for a role that requires relationships with the Creative Commons and nothing to do with vegetable photo sharing. Once again, yet another win for Switzerland and D-Combinator, who produce title-but-not-substance ‘founder’ engineers and inspire the next generation of snake oil producers.
All names, entity’s, and events in this post are fictional.

Snake oil role models and silicon valley’s ponzi scheme

Several years ago, I considered someone “successful” because he had sold a business to a brand name technology company. Recently, I discovered he practically made no money from it. He’s still successful in my eyes, but when it comes to giving people advice on building a successful business I hold his opinion just as high as any other reasonably intelligent person — but no more.

????????  elevator floor illusion

This is a common issue for people living in Silicon Valley that they can relate to: Smart people that “sell” their company and become celebrated entrepreneurs. As a case in point Facebook has quite openly said they only acquire companies for the talent and not for the business itself. What this means is that the products the startup built isn’t the reason they exited; instead the value of the people in the business are what was acquired. If I was to start a solar company and buy expensive furniture — only to be “acquired” for the value of that furniture and nothing more, that’s not success; that’s just money being shuffled around.

I’ve been observing a trend where smart engineers think they are founders. They start a company, but they lack essential skills that makes the startup gradate to a sustainable business: which is what the entire point is for a startup (the search of a business model, which it can then execute on). These smart engineers are smart engineers — but they are not founders. And because there is a talent crunch, these companies will get “acquired” and be considered a success, distorting the story that will inspire and help future entrepreneurs.

A ponzi scheme built on snake oil
If a company is acquired before it generates positive cash flow or even revenue, it means what they build wasn’t a success in the context of “let’s copy that model”. As to why they were acquired, there could be multiple reasons: talent acquisitions are just one example, but there could be strategic value in acquiring a company as it complements the acquiring company’s existing product line. A product is a solution to a problem, and often people build great technology that is better classed as a feature. An acquisition gives these feature driven technologies a fake sense of validation. It’s a ponzi scheme.

Snake oil, Sapa

Economically, this ponzi scheme doesn’t hurt so there is no need to regulate it: these founders cash out something and the company that acquires them can likely absorb the losses. In fact, the maturity of the information technology industry now has allowed for outsourced innovation which I think is a great thing. (Innovating in a big company is practically impossible if you ever meet someone who has lived to tell the tale, and now Silicon Valley giants can acquire disruptive innovation rather than solely relying on it to be generated internally.) But it also creates a fake understanding of what success is. An externality of this are small ideas and nothing game changing, the higher calling for those that can change our world.

A true measure of success
I’ve come to realise that the only metric that matters in business is cash. Not revenues, not number of employees — but cash that sits in the bank and the inflow of it that will grow it. I get nervous when I see companies hire ahead of their revenue growth and skeptical of companies that boast about revenue but sugar coat their margins. Cash is king, and any evaluation of a business is useless without understanding its cash position.

Start -> All Programs -> Cash Machine!

Which leads to why the ultimate goal of a startup is to be able to generate enough cash from customers so that it can fund its operations. You may want to change the world and that’s an honourable goal for a startup — but if you are not sustainable, you’re not going to last long enough to have that impact.

When we hear about smart people selling their companies, stop to ask are they really successful? Technology allows us to automate processes, but this simply allows us to scale operations due to reduced cost. But scalability is irrelevant in the same way revenue is irrelevant for a professional services firm that relies on the hourly input of its staff. If you’ve built something that improves society, while at the same time return increasing profits despite a constant investment — you’re a success and you should be ranked according to the fundamental value of the asset you build. And if you sell your company for whatever reason, you’re still a success: just don’t go around rubbing that snake oil in people eyes, because that’s not the medicine we need to foster the next generation of great businesses.

The backstory on Silicon Beach and an Aussie Entourage

When a newspaper a year ago interviewed me, I matter-of-factly talk about an “Aussie Mafia” in Silicon Valley and how we regularly talk to our friends in Australia. More recently The Next Web rather cheekily said I regarded myself as part of an “Aussie mafia” in the commentary to the video interview. The interview caused a bit of a stir with emails and additional blog posts about the project.

Voyeur : July 2011, Page 114

But it wasn’t until this last week when an article surfaced from the  July 2011 Virgin Australia inflight magazine “Voyeur” that some noise really affected me. Back in April 2011,  the journalist asked for my help on people to speak to and to give him insight in tech which he readily admitted was not his normal beat; but as a consequence of that discussion, I think the article made some presumptions which make it look like I created the Australian tech community and this “Aussie Mafia”.

Well, not quite. Given both the drinks mentioned in that article, the brand “Silicon Beach” and the “Aussie Mafia” are mentioned, it was suggested by someone I clear up the real history. So here it goes.

“Silicon Beach”
The Australian newspaper media popularised the term “Silicon Beach” from a front page article in January 2007 to describe Sydney in Australia that had a growing tech scene. Six month’s later, I wrote a post saying we should call all of Australia “Silicon Beach” as “we’re one island continent anyway”. A year later, I registered the domain name siliconbeachaustralia.org (and later, negotiated siliconbeach.org) with a placeholder website and launched a mailing list which set the brand on fire. I then went onto build the brand further by launching a podcast series with Bronwen Clune, writing a letter to the Australian Senate on behalf the community that had formed around the mailing list (and a subsequent proposal on request of some Australian senators that formally had them refer to the industry as “Silicon Beach”).

Now those infamous drinks.

Back in May 2008 along with Mick Liubinskas and Lachlan Hardy we made a decision by the Shelbourne  Hotel‘s Pool table to do a weekly drinks that was ‘same time same place’ to avoid confusion — the goal was this consistency would build community in Sydney’s fragmented technology industry. That afternoon Bart Jellema, Kim Chen, Mike Cannon-Brookes and others in attendance agreed — with Bart and Kim being instrumental in making them what its become (they would often be the only people there!). The drinks initially were called “FITSBAD” based off a public Twitter discussion Mick and I subsequently had, which stood for “Friday Information Technology Silicon Beach Drinks” and separately over alcohol at one of the drinks with Bart we called it “Official Friday” because, well, it gave it more status (Bart pushed passionately, I kept drinking). Months later, I convened Mick and Bart and asked them to call it one or the other as they started competing with each other, and so “Official Friday” it became. But then, it slowly turned into “Silicon Beach drinks” (no doubt influenced by Mick and Bart who are the biggest supporters of the brand, but also because Melbourne hosted a monthly drinks under that brand). These drinks further entrenched the brand I didn’t invent but made and now unfairly get credit for doing everything.

Silicon Beach is a brand that I built but so has everyone else in Australia. Just because I first popularised the term though doesn’t mean I did anything special.

“Aussie Mafia”
I first heard about this term from drunk Facebook posts by my Aussie friends in Silicon Valley when I lived in Sydney (people like Martin Wells, Chris Saad, Mike Cannon-Brookes). It would later turn out my future room mate Marty Wells actually invented the brand and replicated in Silicon Valley what he did in Sydney, which was organise the tech entrepreneurs socially. Which is ironic, because the “Silicon Beach” drinks filled the void when Marty left Australia with the events he ran like the semi-exclusive Dinner2.0 (where I met Marty) and Stirr. Dean McEvoy (an Aussie that formally lived in Silicon Valley and that went on to do something amazing in Australia) even registered aussiemafia.com. Kind of funny, as it was a jovial term to describe Aussie entrepreneurs in Silicon Valley. No one took it seriously, until other people did.

In the months I lived with Marty between September 2009 and January 2010 (I moved to America in August 2009), we called our wifi network “Aussie Mafia HQ” and I tapped into a semi-regular catchup Marty would have with his friends Alisdair FaulknerStephen Weir (a Kiwi), Chris Saad and Bardia Housman. It actually started when Stephen and his girlfriend would eat once a week at a venue, and invited other couples like Alisdair, and sometimes Bardia  (who was in the near end of an exhaustive year long process in selling his company to Adobe and starting to come up for air again) and their partners hanging out — but when the talk of the boys constantly turned to business the girls decided to let them do their own thing. I arrived in America around the time these drinks became a boys catchup driven by Steve, Marty and Al.

Over the next few months, it became a routine and then a ritual. And when visiting Australian’s wanted to meet us individually (as individually everyone in the group had a profile), we’d often invite them, which in turn built this brand as the “Aussie Mafia” catchup. People would get upset they weren’t invited as it was perceived as some industry event. I’ve actually had several confrontations with women on why they weren’t invited! It got to the point where it felt like work and not friends catching up anymore. This practically killed it, as some personalities just ruined the discussions and defeated the purpose of why us time-limited friends would catch up.

And then?
There is no real “Aussie Mafia”: we pay our taxes, we have work visa’s, and we don’t kill anyone that doesn’t pay us protection racket. And I am not the reason why Australia has a tech community — I simply innovated because I identified early on we needed a brand to rally around in Australia, which turned out to be so successful that these journalists credited me for creating the industry!

But there is something in this extended group that’s special, that American entrepreneur friends of ours profess jealousy of. Both Bardia and Stephen bought the building that I gave a tour of in The Next Web  — these two drinking buddies are now business partners. And there are more business arrangements to be announced in the coming months that have been developed along with discussions against trips to Mexico, Vegas and Miami.

There are a bunch of other Aussies and Kiwi’s I haven’t mentioned in this post and they know who they are. It’s an interesting time though because these social friendships (I’ve had some of the funnest nights in my life with the people in the above sketched image) are now becoming commercial relationships. A story of success will come out of this and I guess you could say we’re rewriting our history in this city.

UPDATE: 14 July 2011: Delighted to find out today that Kim Chen was a secret influence behind the Melbourne Silicon Beach drinks. There had been two previous attempts at getting Melbourne to have regular drinks, but it was Kim’s discussion with Roy Hui, Kate Kendall and Stuart Richardson that led to this being a huge success.

The founder mythology’s impact on the talent crunch

In the last month since running StartupBus and reflecting on the boom in seed funding for startups and the talent crunch of engineers in the San Francisco Bay Area,  if it’s one thing I’m seeing a lot more of, it’s the fact that more ‘entrepreneurs’ exist. I’ve been asking myself then, what exactly is a founder?

So it’s good timing to see Chris Dixon to write about the very topic where he defines a true founder from the fake one. But for me, it isn’t so much about glorifying the ‘founder’ as some hero and everyone else ‘not good enough as me’ as Dixon alludes to. Rather, I’m curious: what is it that makes someone a good founder?

When I asked my friend Alisdair Faulkner a few weeks ago on this very topic, he said  that a founder is by the simple fact they are. Meaning, instead of talking — they actually are doing something, which goes to Dixon’s point. I’d argue that’s the fundamental trait of being an entrepreneur, which is the bias to action. But is being a do-er a good founder?

One prominent venture capitalist I spoke to recently remarked that a lot of the startups these days are smart engineers dropping out of Google, thinking they are founders and getting funded because they can. But the truth is, they aren’t good founders and it’s likely they will fail.  The danger of this point, is that we won’t know this, as the increasing trend for companies is to acquire startups for the talent (over the product or profits) which means these failures in capable founders are masked as successes and who in turn will influence the perception of success.

That’s a bad thing and let me explain why. To give you an example in a different context of why this matters, a basic competency for management is the ability to motivate your staff. If you can’t do that, you will create a significant cost to the businesses but which goes unnoticed and impacts the organisation — like a slow growing cancer due to reduced morale. Why is this a problem? Because an incompetent manager will get promoted through their career, continuing on their path of destruction. Problems they caused get masked as other issues, and so incompetency doesn’t get rained in on.

…so let’s step back here. Why does it matter? Because just like the mythology of the CEO, I think we need to clearly set the expectations in the industry that behind all the status, you should be true to yourself.

Let’s look at this from another angle. A good founder is usually a superstar…but  makes a terrible CEO as CEO’s need to be good at delegating rather than doing it all themselves. This weakness is hidden in small environments but becomes apparent when the business needs to scale.

Fred Wilson recounts a story of what a (good) CEO should do. He claims:

Sets the overall vision and strategy of the company and communicates it to all stakeholders. Recruits, hires, and retains the very best talent for the company. Makes sure there is always enough cash in the bank.

And that’s it. Notice no word is mentioned about being a good worker. Good CEO’s make terrible workers (in the sense of building the product, doing admin, etc), in the same way good founders make terrible CEO’s (as they want to work on the product and neglect the management side of being a CEO). And likewise, a terrible CEO is a founder who does what founders do which is experiment when instead they should be focussed on execution and not distracting the business. This is why a startup CEO is a very different animal from a growth-stage CEO — and once again, very different to a mature company CEO. Which is why I have a lot of respect for people who are founders and are willing to hand over the CEO role to another person, as they are making a mature decision that benefits the business, not their ego.

Anyone can be a founder, like how anyone can be a CEO — or an employee — but that doesn’t mean they are good ones. So if starting is what defines a founder, then anyone is a founder — but what makes a good founder is one who starts and is able to finish.  Think you’re a founder or a good CEO? Maybe you are, but the good ones don’t hide behind titles. Feel free to call yourself one, but at least be honest and recognise you can’t be good at everything.

And who knows, maybe this talent crunch might ease up  a bit when smart engineers realise they are…smart engineers and that’s it.

Why the seed investment bubble is exactly that

Jed Christiansen wrote a thesis on the rise of Y-combinator and other seed-accelerators. He also released the data behind his research, which gives an insight into the success of the seed-accelerators. It’s fascinating to look at these numbers, because Silicon Valley is seeing a bubble emerge — and unlike the previous ones like the Dot Com boom when people realised the potential of websites, or the Web2.0 bubble where shiny AJAX and social was the new black — now we are seeing a bubble emerge on the ‘backend’ through the capital investors.

Why is it a bubble? Well first of all, the hype. Last March at SxSW, I met Mark Nathan who told me he was helping yet another seed accelerator. He told me that 44 of them had been created to date in the US. That and the recent success of Angel List by the Venture Hacks crew — which is effectively commoditising the seed market — is seeing a mini revolution occur in the tech sector.

But as I sit here with my buddy Stephen Weir: a serial entrepreneur who’s invented the spoon-less yoghurt cup, licenced super model of the world for a reality TV show, tried the tech startup thing (like launching the biggest online invitation website in Japan and a reward based mobile gambling application on all three carriers in Japan) but now works in property — we asked, are the returns actually supporting this hype?

How good a business is it

Christiansen says the following:

Y Combinator and TechStars are two of the oldest seed accelerators, and are the only two to have had substantial exits. The TechStars exits have likely already generated a profit, and there are several companies that may still exit at some point in the future. The Y Combinator company exits have likely already brought Y Combinator to break-even, even after having funded over 100 companies. More impressive is that there are a good number of companies in the portfolio that could reach substantial exits at some point in the future. (And potentially a handful that could reach the vaunted $1billion+ exit.)

Y Combinator for example has funded 206 companies to date. At an average $10k in capital as well as $600 in travel costs (applicant companies can get up to $600 in reimbursement costs), they’ve put at least $2m in seed capital and assuming 10-20% of companies get accepted (an assumption by us), then reimbursed travel costs are between $450-900k.  (Note: this is extremely conservative to the point of unrealistic, as companies receives $10k per person so the cost is actually  closer to double or $4m in seed investment — but we’re doing this to prove a point.)

And what’s the return? According to Christiansen, of the 206 companies invested in Y Combinator there has been $89,008,000 in exist value generated. Y Combinator claims the average stake in each company is 6-7%, so the group made $5,340,480 on a 6% return. But we think the companies that actually exited would have been able to negotiate a lower rate, as well as the fact Y Combinator would have got diluted by some of the companies that took additional funding. If we use 4%, then the return is $3,560, 320.

After five years, that’s a gross profit of between anywhere between 500k (assuming 900k travel costs, and 4% return) to $3m (assuming 450k travel costs and 6% return). That means on a conservative back-of-envelope guess, the operational side of Y-Combinator gets about $600k a year, which is what a fund manager would make.

Our conclusion

When paying out salary costs and other admin expenses, break-even seems very likely. Or at least, the profits are very ordinary right now. Put a more realistic capital base of 20k per startup, and you’ve got a terrible loss making business in the medium term. Now to be fair, this is doing it over only a few years. For this analysis to be really accurate, it needs to take into account that the window for a return is ten years – you can’t do dollars-in dollars-out in just three years. Otherwise, how would firms like Sequoia have existed so long. And Y Combinator has got some super-star startups that are the talk of the town now, like Dropbox and Airbnb — an exit on either of those will make a huge difference.

But that said, looking at this at a  high level, we’re not sure if the hype is justified. Paul Graham may emerge a wealthy man, but we don’t know how the other 43 seed accelerators will.

How the super angels are saving Silicon Valley

Michael Arrington has written about the current bubble in Silicon Valley: the angel investor. He suggests a war is occurring with this new class of investor, and that entrepreneurs need to pick their faction. I don’t doubt the politics is real, and I’m sure it exists between the angels themselves – let’s hope they realise that united they stand, but divided they will all fall.

But I think this “conflict” is really about a change in times. Much like how the traditional gatekeepers of information – the newspaper industry – are battling the process-journalism innovators that we call ‘bloggers’. (Like, ahem, TechCrunch.) No one appointed the Venture Capital industry as the gatekeeper for technology innovation, which is similar to the arrogance of the newspapers that think they ‘own’ the news and deserve special protection because of it. Maybe these over-sized funds should take a lesson from the newspapers and realise the times have changed and their model needs to change as well.

But where I differ with Arrington’s perspective is his prognosis that this is bad for innovation. Conflating this with ‘bigger ideas not getting funded’ is wrong. The point is, is that more innovation can get funded, more veterans are being developed, and more value is being created in the long run. This should be analysed not by the growth of a single tree, but the overall development of the entire forest.

We need more seed-accelerators, more super-angels, and more incubators – because inevitably, it will lead to more startups. And whilst not all will hit a home run, the odds of ‘the next big idea’ happening will improve dramatically.