The year of the startup

The meshies think that 2008 is the year of the startup.

“What we have in mind is a one-day event – which we're tentatively calling meshU – that will be filled with small, focused workshops by those who have earned their stripes in the startup game; people who can talk knowledgeably about everything from interface design to using Amazon's S3 distributed server network.”

According to Wired, VC investments have climed to a six year high of $29.6 billion in approximately 3,813 deals. The report [PDF-34kb] form Thomson Financial also states that “112 early-stage focused funds raised $9.7 billion”. It is reminiscent of 2000 and 2001 when firms were raising humongous funds.

A portion of these funds are bound to make it’s way into the plethora of incubators, farms, schools, and labs that are beginning to bring in entrepreneurs, put them through an educational and mentorship process in exchange for cash and equity. BootupLabs, TechStars, Brightspark, InfusionAngels are similar to the YCombinator, Seedcamp, YEurope (not related to YCombinator). I’m still left wondering about the economics, i.e., how big does the fund have to be to have a management fee large enough to sustain the firm, or how quickly do the exits have to happen (IPO, M&A, etc.) for the firm to continue to exist and invest?

The NVCA Venture Backed Exits [PDF] showed that 2007 had 363 Mergers and Acquisitions (155 disclosing the values), and 86 IPOs. The most interesting part for me is the average deal size, M&As – $186.7M versus IPOs – $120.1M). Unfortunately, it’s really hard to do further analysis on the data to determine number of seed and early-stage companies that were part of the M&A process. But you can guess with an average deal value of $186.7M these were companies that were further along.

I wonder if anyone has done the breakdown of YCombinator. Most of the numbers are pretty public, ok, not the valuation numbers, but it should be relatively easy to ballpark. Just a simple back of the napkin calculations using data from Wikipedia and assuming that YCombinator’s investment does not dilute at acquisition (this is a big assumption). 6% of an estimated $10M to $12M is $600,000-$720,000, it’s not a huge win, but it’s worth an initial $6,000 + $12,000 ($6,000/founder) and follow on funding to maintain equity percentages ($100k in seed funding). Timeframe was approximately 18 months from seed investment to exit. I wonder if this covers the operational expenses and the expected return to the fund. Craig Hayashi from Maple Leaf Angels provides his thoughts on exits for an angel portfolio and it’s all tied to valuation. Without knowing the valuation it’s hard to know the full details. We can make assumptions using the initial 6% equity for $24,000. This means that an additional investor put in $76,000 for ~25%. This is a 30x return. And significantly better than the 10x Craig suggests angels need.

The questions for me now begin around, how big of a fund does an entity like YCombinator need to operate successful including what are the management fees or translated what are the operational costs of running the firm. The economics must work, if nothing else, it would be worth doing for PR.