The founder of Y Combinator says start-ups should lower their expectations when raising funds, warning Facebook’s disastrous IPO performance could hurt their funding prospects.
Facebook’s stock, which fell almost 3% on Monday to $26.90, is now down 29% from its offering price of $38 a share, causing significant losses for investors.
According to Paul Graham, founder of US-based start-up incubator Y Combinator, Facebook’s disappointing IPO could have dire consequences for early stage start-ups seeking funds.
In a letter to all Y Combinator companies, Graham outlined his concerns for the start-up funding market, and what start-ups should do.
“Airbnb and Dropbox prove you can raise money at a fraction of recent valuations, and do just fine,” Graham conceded.
“What I do worry about is (a) it may be harder to raise money at all, regardless of price and (b) that companies that previously raised money at high valuations will now face ‘down rounds’.”
According to Graham, start-ups that are yet to raise any money should lower their expectations.
“How much should you lower them? We don’t know yet how hard it will be to raise money or what will happen to valuations for those who do,” he wrote.
“Which means it’s more important than ever to be flexible about the valuation you expect and the amount you want to raise.”
“First, talk to investors about whether they want to invest at all, then negotiate price.”
Graham said start-ups that raised money in an equity round at a high valuation may now find they can only access funds at a lower valuation, “which is bad”.
“‘Down rounds’ not only dilute you horribly, but make you seem and perhaps even feel like damaged goods,” he said.
“The best solution is not to need money. The less you need investor money, (a) the more investors like you, in all markets, and (b) the less you’re harmed by bad markets.”
“I often tell start-ups after raising money that they should act as if it’s the last they’re ever going to get.”
According to Graham, the start-ups that “really get hosed” will be the ones that have easy money built into the structure of their company.
“[These start-ups are] the ones that raise a lot on easy terms, and are then led thereby to spend a lot and to pay little attention to profitability,” he said.
“That kind of start-up gets destroyed when markets tighten up. So don’t be that start-up.”
“If you’ve raised a lot, don’t spend it. Not merely for the obvious reason that you’ll run out faster, but because it will turn you into the wrong sort of company to thrive in bad times.”