Deal Roundup, Feb 19, 2008

February 20, 2008

Who invests in who? Who buys who? Who sells?

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Silicon Valley start-ups begin hitting the brakes

February 20, 2008

VCs urge companies to raise cash now, pass up deals that look too pricey Investors worry a tough economy will slash big companies’ spending on products sold by start-ups and may also damp online ad spending.

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Venture Capital Roundup

February 17, 2008

Nerites Corporation completed a $5.7 million Series A round of funding; New Earth Solutions Ltd attracted Gbp4 million; ActionBase raised $6.5M; Q Therapeutics, Inc. raised $15 million Series B financing; Sparkplay Media Inc. secured $4.25 million in financing; Albireo raised $27 million and anticipates receiving up to $40m in a Series A financing round; Coverity has raised $22 million.

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What is Kopelman sick of seeing from startups

October 18, 2007

If you’re an Internet entrepreneur in search of seed funding, Josh Kopelman should be high on the list of people you want to run into at a cocktail party. Kopelman is himself a successful entrepreneur three times over—most notably as the founder of, which was acquired by eBay in 2000 for around $350 million. Now, with his three-year-old early-stage venture fund, First Round Capital, Kopelman is putting his expertise to work backing Web software startups such as StumbleUpon—which was also acquired by eBay in May, for $75 million—VideoEgg, and Satisfaction.

Three recurring themes that Kopelman says he’s sick of seeing from startups—plus one thing he’d like to see more of.

1. Business plans that depend on getting acquired by Google.

There are more people that win $5 million in the New York lottery than get acquired by Google. I do not think companies should be built solely to be acquired by three or five companies in a quick period of time. I don’t think you should be building “hamburger companies” that are built to flip.

That said, it’s always validating when someone comes to you and expresses interest in acquiring your company early. You’ve got to give kudos to Facebook for turning down probably an awful lot of acquisition offers on the way up, recognizing that they’d create more value if they stayed independent. As a VC, I often now see young people who are in the mercenary mode vs. people who really are passionate about what they believe. The most successful entrepreneurs I’ve seen are really excited by what they’re doing—they’re not passionate about creating an exit.

2. Revenue models that revolve around advertising from Google AdSense.

Often the companies we see tend to say, “We think there are three or four different ways we can make money. We might not know which ones will work or which ones will scale.” We’re comfortable signing on to that kind of risk. But if a company comes to us and says, sort of, “The way we’ll generate revenue is by putting Google AdSense on our pages,” and really hasn’t thought through anything beyond that—those are the companies we tend to really pause at. We’re not looking for someone who can predict the future, but we do like people who are thoughtful and deliberate about how they’re going to build a business that solves an urgent and pervasive customer need, and also how they could maybe generate revenue from that.

3. Businesses that piggyback on Facebook instead of picking up where Google left off.

I think I’ve seen my fair share of white-label social networks, and I’ve seen my share of cute Facebook apps. We haven’t funded any Facebook apps since they launched. I think a Facebook application is now a necessary component (BusinessWeek, 8/22/07) in an online marketing and customer acquisition strategy—I just don’t know if you’re going to find venture-backable companies there. We like to see companies that offer the consumer real value. One could argue that amusement is real value, and I agree, but I’m not sure if today’s app du jour is going to be what does it.

Matching Interest to Offer

Amusement apps tend to be very faddish, and I also think those are the hardest to monetize because the use of those apps doesn’t derive from intent like a search query does. So, just because I super-poked you or bit you and turned you into a zombie doesn’t really give me anything as an advertiser to figure out your intent or something to target against.

What Google did a very good job with was to recognize that when someone is searching for something, they’re indicating interest. And if you can match interest with an offer, those ads are going to be far more successful than those that don’t. The advertising business is still an incredibly wasteful business. I don’t think the game’s over in that space. By looking at Google, you can see how someone who can create efficiency out of what was inefficient can create value. There’s real money to be made there.

Source: Business Week Online

Y Combinator Inspires Imitators

September 26, 2007

by Kerry Miller

Paul Graham knows that most startups will eventually fail. But at Y Combinator, the hacker guru’s seed fund for young techies, they’re encouraged to fail fast and fail cheap—and then to reboot and start again. Designed with the new economics of Web-based entrepreneurship in mind, Y Combinator is a new type of venture fund—dispensing tiny amounts of cash but lots of hands-on mentoring.

Since its founding in 2005, Y Combinator has funded 58 startups—nearly all in software or Web services—bringing in a new crop twice a year (in Cambridge, Mass., in the summer; in the San Francisco Bay Area in the winter) for a three-month crash course in the Graham-ian philosophy of entrepreneurship (BusinessWeek, 9/26/07). Each team gets a small sum to cover basic expenses ($5,000, plus $5,000 per founder) and the chance to pitch their idea to a roomful of top angel investors and venture capitalists. The insider status of Graham himself—a Web software pioneer who sold his startup to Yahoo! (YHOO) in 1999 for $49 million—lends additional cachet.

“Cheaper Equity”

In return, Graham and his four partners get a stake in the company, usually about 6%. So far, Y Combinator investments like the social news site Reddit, acquired by Condé Nast in 2006, and slide show app-maker Zenter, acquired by Google (GOOG) earlier this summer, both for undisclosed amounts, are positive signs that the formula works. Because the sums Y Combinator invests are so small, even early-stage acquisitions can translate into relatively big paydays.

After two years, Y Combinator’s portfolio is still too young to fully evaluate the success of Graham’s strategy—but that hasn’t discouraged a growing number of investors around the globe from launching their own copycat programs.

One main reason? “It’s cheaper equity,” says David Cohen, the executive director of the most established Y Combinator counterpart, a Boulder (Colo.) program called TechStars, which ran its first three-month session in May, 2007. “If you look at the companies that are getting to an A-round, the model that we’ve created gives a significant discount to those valuations.” Critics say that makes the arrangement exploitative for the startups involved, but Cohen disagrees: “I think for a first-time entrepreneur, it’s actually an incredible deal.”

Both Cohen and Graham say money is actually among the least important things they offer to entrepreneurs, since drastically cheaper hardware, software, and bandwidth—among other factors—have made it much easier to start a company than it was a decade ago (BusinessWeek, 5/31/07).

Dating Before Marriage

But disappearing barriers to entry also make it harder for any one startup to stand out in the crowd—a challenge that’s as tricky for investors as it is for entrepreneurs themselves. Without a track record to go on, after all, how do you discern a future Mark Zuckerberg (Facebook) or Kevin Rose (Digg) from a sea of equally fresh-faced, Red Bull-swilling computer whizzes? With a program like Y Combinator, investors get three months of hands-on experience with talented entrepreneurs—and an early look at their work—before reaching for their checkbooks.

Cohen says he’s already fielded inquiries from angel investors in 20-odd cities, all interested in starting similar programs of their own. “You’re going to see a massive proliferation of this model,” he predicts.

Graham, a widely read essayist who has written prolifically on topics like “What Business Can Learn From Open Source,” isn’t flattered by the unauthorized open-sourcing of his own model—including one clone in Vienna shamelessly named YEurope. (His opinion about such copycats is made clear on Y Combinator’s FAQ. Question: “Will you help us set up something like Y Combinator in our town?” The answer: “There already is a Y Combinator in your town: Y Combinator.”)

Why Reinvent the Wheel?

Many of Graham’s admirers, however, say they respectfully disagree. Among them is Web industry veteran Saul Klein (BusinessWeek, 6/7/07), a partner at London venture capital firm Index Ventures and a former executive at Skype (EBAY). Klein helms the most prominent Y Combinator lookalike in Europe thus far: the London-based Seedcamp, which launched in September. In a slightly novel twist, Seedcamp began its competition by bringing 20 startups—plucked from an application pool of 268—for an “unconference” (BusinessWeek, 5/14/07) before selecting six companies to participate in the three-month program. Each of the six companies received €50,000 (about $70,614) in seed money—a considerably heftier sum than other Y Combinator-like programs—with Seedcamp taking a larger, 10%, stake in each.

And bona fide venture hubs like London aren’t the only place the Y Combinator model is attracting interest. Cities such as Lexington, Ky., and Milwaukee are taking note, too. In Atlanta, a small group of angel investors hopes to replicate the Y Combinator model with a program called BoostPhase. Co-founder Wayt King says he envisions BoostPhase, set to launch this fall, as “a Y Combinator for the Southeast.”

“We have huge respect for Paul Graham and what he’s done, and we figured there’s not much sense in reinventing the wheel,” King says—adding that he doesn’t see BoostPhase as competition for Graham’s original. “There are a lot of entrepreneurs who don’t want to or simply can’t move to Silicon Valley or Boston.”

Standing Out from the Crowd

TechStars’ Cohen says he’s not worried about the competition. “There’s a pretty clear demand for this,” Cohen says, noting that the 10 startups TechStars funded represented only 26 of 302 applicants. Y Combinator accepted an even smaller number for its summer 2007 round—19 of 435 applicants—making an applicant’s chances of getting tapped for Y Combinator (4.4%) only slightly higher than those of the brainiacs vying for a Rhodes scholarship (last year’s acceptance rate: 3.6%).

For participants, the real draw of a program like Y Combinator isn’t the money, it’s credibility—and not just with investors. The traffic bump from an early mention about getting funded on an influential blog like TechCrunch can be just as crucial as a Series-A round in helping a Web startup gain traction over its rivals. And by adding structure to an otherwise nebulous pursuit, Y Combinator also makes a startup a less risky endeavor for entrepreneurs themselves—both practically and psychologically. “Y Combinator provided a socially acceptable way to drop out or postpone my college education and focus on the company full-time,” says Kevin Fischer, a 21-year-old industrial engineering student at the University of Pittsburgh who applied to both Y Combinator and TechStars. Plus, he adds, “It seems like even the people that fail still go on to jobs at Google—no one does too badly.”


How Y Combinator Helped Shape Reddit

September 26, 2007

by Kerry Miller

Alexis Ohanian and Steve Huffman, co-founders of the social news site Reddit, have become Y Combinator (BusinessWeek, 9/26/07) poster children since their company was snapped up by Condé Nast for an undisclosed (but no doubt, tidy) sum in 2006. Their success is one example tech superstar Paul Graham points to when he says Y Combinator, his ultracompetitive seed-funding program, is a better way of developing early-stage companies than traditional incubators, venture funds, or business plan competitions.

The difference, Graham says, is that Y Combinator picks people, not business plans—or even business ideas. “The idea is going to change anyway, so the most valuable thing about the idea is what it tells you about the people,” he says. Of course, picking people is easier said than done. In fact, Reddit’s co-founders were initially Y Combinator rejects—like 95% of the program’s applicants.

Second Thoughts

At the time, the two University of Virginia seniors had their own doubts about Y Combinator. Ohanian says it took several months to convince Huffman that “he didn’t want to take the very appealing job close to his girlfriend back in Virginia, and to instead try living with me in near-poverty for some indefinite period of time.” Even after submitting their Y Combinator application, the two debated the wisdom of picking up and moving to Cambridge, Mass. Why not just stay in Charlottesville, Va., where at least the rent was cheap? “Of course,” Ohanian says, “as soon as they rejected us, we desperately wanted to get in.”

After drowning their sorrows at a local pub, the two decided they’d go ahead with the startup anyway. Huffman would take the software development job he’d been offered in Virginia, Ohanian would do freelance Web design, and they’d live together and collaborate when they had time. It’s a strategy that, in hindsight, Ohanian says almost certainly would not have worked. Launching a successful startup, he says, “really does require nearly undivided attention.” (That’s another Graham tenet—and the rationale for insisting that Y Combinator startups commit to relocating for three months of full-time work.)

The next day, however, they got a second phone call from Graham—he’d changed his mind. While he hadn’t been crazy about their business idea (a mobile application), Graham said he thought Ohanian and Huffman had potential, and he was offering them a slot in the Y Combinator program. The two jumped on the first train to Boston.

Opening Wallets and Doors

When they got there, Ohanian says, Graham sat them down for a talk. “I believe his words were, ‘Let’s come up with something for you guys to do.'” At the end of the conversation, Ohanian and Huffman left with a $12,000 check and a brand-new business idea that would become the social news site Reddit.

Ohanian says they didn’t waste much time thinking about how they would make money from the idea, confident in Graham’s conviction that “if you make something that people want, there’s always some way to make money from it.” Soon after, a dinner conversation with another software guru, Joel Spolsky—who asked them to create a white-label version of Reddit for his own site—led the team to a business model and, indirectly, to a successful exit, when a licensed version of Reddit created for Condé Nast turned into an acquisition offer.

For Y Combinator, which had close to a 10% stake in what was likely a multimillion-dollar figure, the Condé Nast deal was a handsome return on the fund’s initial $12,000 investment, an amount Ohanian concedes he and his partner could have easily bootstrapped. But Ohanian says the valuable publicity—in particular, mentions in several of Graham’s widely read essays—that he credits with jump-starting the site’s popularity would have been harder to achieve. While the Y Combinator model isn’t the best fit for every startup, he says, “For what we did with Reddit, it was definitely worth it.”