The leader of Silicon Valley's top start-up factory, Y Combinator, warned in a blog post published Wednesday that a lot of start-ups are raising too much money and in the process selling too much of their companies to investors.
Sam Altman replaced Y Combinator founder Paul Graham as the organization's president in 2014, and has uncommon insight into trends in Silicon Valley start-ups, as hundreds of start-ups pass through Y Combinator every year.
He noted that several years ago, when investor money was relatively scarce, the best advice to start-ups was to "raise as much as they reasonably could."
But over the last five years, Altman says, there's been unprecedented demand from investors to put money into start-ups, and a lot of young companies are chasing unnecessary dollars and high valuations — and in the process giving up way more of their companies than they should.
He writes:
It sounds like a better deal to raise $5 million on a $10 million pre-money valuation (selling 33% of the company to investors) than $615,000 at a $2.4 million pre-money valuation (selling ~20% of the company to investors, which is what Airbnb did). But this is only true if you put the money to exceptionally good use. Otherwise, you may end up with a lower dollar value of the equity you keep.
Today, each percentage point of Airbnb is worth about $300 million. I expect them to be worth more in future. If you hope your company will one day be extremely successful, then treat your equity as such.
He also warns that founders who sell too many shares in their companies early on will find it harder to raise rounds later.
In other words, if you think you've got a hit on your hands, take only the money you absolutely need for growth, otherwise you'll be kicking yourself later.
This advice comes on the eve of the largest tech IPO in several years: Snap, formerly known as Snapchat, is expected to go public on Thursday at a valuation of $24 billion.
Snap co-founder Evan Spiegel clashed with early investor Jeremy Liew of Lightspeed Venture Partners over some of the terms of the investment, including Lightspeed's right of first refusal to later fundraising rounds, according to a report in The New York Times. The company later got Lightspeed to agree to drop those terms. Lightspeed still owns a little less than 2 percent of the company, which will be worth about $1.4 billion when Snap goes public tomorrow.