How YC is Just as Duplicitous As “Venture” Investors

13 Sep

In August the most recent batch of YC portfolio companies was announced. There were 44 in total on day 1. Techcrunch compiled a compendium for those curious. When reviewing the list, there were a few apparent things.

First, YC is trying to include more foreign companies.

Second, there is a more pronounced trend towards minority-founded startups, or startups focusing on minority groups of customers.

Third, YC has added a lot of unconventional, feel-good companies doing non-profit work.

But all of these are irrelevant in comparison to the most obvious trend:

YC has become a growth equity “accelerator”

Conventionally-speaking, an accelerator is a formalized program where smart people with grandiose ideas work hard for a few months to nail a product and find customers. If successful, the accelerator introduces this newly-minted company to prospective investors that can carry the enterprise through their next stages of development. In return, the accelerator takes a chunk of equity which usually accompanies a cash investment at the beginning of the program.

The purpose of an accelerator is to assist startups in finding what’s termed product/market fit. Pre-accelerator, the startup is just a handful of people who know each other and have a few ideas about what might make a company. The accelerator provides access to entrepreneurs, lawyers, bankers, and potential customers to refine their ideas and build a product. The good ones will ship something to customers and have small traction numbers to demonstrate on post-accelerator demo day. The early signs of promise, hooray!

This means that accelerators are supposed to find and guide companies early in the process of making a company.

Apparently that’s become complete lip service. Instead, “startup” applicants should be growing companies with bottom lines. This is in total conflict with even YC’s published philosophy:

Our goal is to create an environment where you can focus exclusively on getting an initial version built.

Ain’t nobody building a damn product in YC anymore. Let’s stop bullshitting and admit that YC is a growth equity vehicle masquerading as an accelerator – just like “venture” capitalists are pretending to take risk in “startups”.

YC convinces these companies they’re indigent, disrespected “startups” that need the security blanket of YC to make them stars… for 7% of their growing, no-risk company at a $1.7M valuation. It was previously 6% at a $250,000 valuation, so earlier companies were really getting hosed.

But is it fair? Let’s go through it.

Of the list of 44, I’m going to comb through traction where it’s listed. I’ll pull out an annual revenue run rate (ARR) to help us understand business valuation as a revenue multiple.

Flex: charges $20/mo for modern tampons. Have 20,000 customers enrolled and 70% margins. Back envelope math: $400,000 in monthly revenue, $280,000 in monthly gross profit. ARR = $4.8M

JustRide: 7,000 monthly rentals through the platform, of which they take 25%. Assume the average daily rental is $50, that’s $350,000 in monthly booking revenue with $87,500 in gross revenues. ARR = $1.05M

Airfordable: $500,000 in sales and now profitable since launch. Growing 53% MoM. ARR = > $500,000

ZeroDB: partnering with a UK bank that gives them $1M ARR. ARR = > $1M

Skylights: in 100 flights across 4 airlines, bringing in $1M ARR. ARR = > $1M

Techmate: $30K monthly revenue growing 25% WoW. Assuming growth slows to half of that on a weekly basis over the next year… ARR = $3.4M

Lookalive: $120K in monthly merchandise value, growing 25% MoM. ARR = $1.75M

MessageBird: 13,000 customers including Uber, Skype and Domino’s Pizza. They admitted using YC as a springboard to get into the US market, but YC appears to be their only investment to-date. They forecasted $35M in revenue this year with $3M EBITDA and were profitable their first year. ARR = $35M

Burrow: $150,000 in pre-sales (product not live yet) and 40% gross margins. ARR = $1M

Miso: 700 customers use the service at least weekly. Assume the average cleaning costs $30, that’s $84,000 in monthly booking revenues. They’ve also targeted 10% WoW revenue growth. ARR = > $1M

Sixa: $101,000 in monthly revenue. Even if we assume no growth, ARR = $1.2M

ConstructVR: had $7K in monthly revenue at the start of the program with another $50K committed. ARR = $684K

Simbi: $100K in monthly services exchange hands with a 95% MoM growth rate. Simbi likely takes 10%-15% of all activity. Calculating for growth, ARR = > $1M

Mentat: growing 40% WoW with most recent monthly revenues of $70K. They also are finishing a pilot with City of NY University that will be a $5M ARR deal by the end of 2016. ARR = $6.5M

SimpleCitizen: $40K in monthly revenue since launch. ARR = $500K

Yoshi: announced profitability very early in their life. Estimate ARR = $500K

Coub: trumpeting 800M video views per month. If there’s one impression per video at $0.50 per impression, that’s $400K per month. ARR = > $5M

OMG Digital: it’s on pace to be Africa’s biggest consumer website by September with 3M unique monthly visitors. If we back into digital ad impressions ARR = $1M

Wallarm: already profitable earning $100K MRR. Even if it doesn’t grow ARR = $1.2M

The Athletic: 2000 subscribers paying $7/mo, growing 18% per week. Assuming that growth rate holds, there’s a ridiculous ARR = $21.8M

Smartsite: on pace for ARR = $2.4M

I’m removing the 6 companies that have no business being in a capitalistic portfolio except to assuage investor guilt. Of the 38 companies remaining, 21 appear to be solidly growth equity companies.

Some of these companies may have raised money before entering “early stage accelerator” YC, but the majority did not. Reaching $1M ARR organically most assuredly means that you’re profitable, and thus a growth equity investment.

Public SaaS revenue multiples fell earlier this year to an average of 3.3x forward revenues, but they appear to be on the rise again and are somewhere north of 6x. And this is for public companies. Translation: these companies are growing 20%-40% a year, not the 400%+ that early stage companies are growing.

So even if we exclude the rapid growth multiple, the average YC startup should be valued at 6x $1M ARR = $6M… not the $1.7M YC is placing on them.

Let’s take it a step further. We’re going to project next year’s revenues as 4x today’s revenues from these “startups’” 400% YoY growth. So T0 is this year and T1 is next year. We won’t project further out than that because it’s going to make the model too complicated.

For our discount rate – the rate you’d expect to earn on your money if you put it somewhere else – we’ll use a range from 10% (what’s used for public SaaS companies) to 50% (what’s used for really early deals). You can read more about how to arrive at these numbers here, but I’m not turning this article into an investment banking tutorial.

We’ll then project the present value of said companies using last quarter’s public SaaS multiple of 3x forward revenues, and today’s multiples of 6x.

Behold! YC is investing in these growth equity “startups” for anywhere from a 72% discount to a 92% discount.

Now, YC will say they introduce portfolio companies to investors (who will only look to further abuse you) and customers. And if you’re going to be a billion-dollar company in < 3  years and just need money to get there, this might be worth it. But for everyone else? Please.

I’m disgusted for founders everywhere. The valley loves engineering founders because not only do they remove early product risk, they can be easily duped by shark investors pretending to have the entrepreneur’s interests at heart. I hope that founders realize by the time they can get accepted to “early stage accelerators” these days they can establish a non-dilutive line of credit from a commercial bank.

In an homage to Maddox, 12,073 investors read this post and spit out their Louis XIII at the thought of entrepreneurs finding it.