Valuations are higher and there are too many investors willing to write small checks
If there is one thing that everyone, from entrpenuers to venture capitalists, can agree on its that funding, especially at the seed level, has changed a lot in recent year.
In a sit down with Vator founder and CEO Bambi Francisco at the first-ever Post Seed Conference, hosted by Vator, Bullpen Capital and Venture51. Founder's Fund managing partner Peter Thiel gave his thoughts on what is different now, as well the how the relationship between the two sides has changed.
It was 10 years ago that Thiel was the first outside investor in Facebook, so Francisco asked him if it is now harder or easier as an investor.
"The default is that it certainly seems somewhat harder than a decade ago. The good thing is that there are more great companies being started now than were being started a decade ago. I think the challenge is that there more investors competing to invest in these opportunities and there's a sense in which valuations often seem to bve quite a bit higher," he said.
"So the Facebook investment in summer of 2004 was a $5 million valuation. It was already one 20 college campuses, with 100,000 people signed up, it would launch of 100 more colleges in the Fall. If you had thinks of metrics today I think the valuation probably would be an order of magnitude higher. Probably $50 million or $100 million. That still would have been a good investment but it has become quite a bit more challenging. If you look at Y Combinator, in 05 or 06 you could invest in companies end up being Y Combinator at valuations of $1.5 million to $2 million. Fast forward eight or nine years, it's close to 8 to 10x of what it was eight years ago."
But, Thiel, warns, don't get too hung up on those numbers.
"Valuation is very important but it's often a mistake to be too price sensitive. So when I looked at angel venture investing I've done over the last decade, there have been a few investments where it was just sort of very opportunistic and somehow was actually cheap. I think Facebook would be in that category. But I think most of it has been where it was the things that felt expensive that turned out to be the good investments. And the ones that felt cheap were often just bad companies," said Thiel.
"We invested in the Series C round at Facebook, Spring of 2006, valuation was $525 million, they were up to $39 million in revenue and still not profitable. That felt really, really expensive and that turned out to be the best investment we made in Founders Fund I. And something like that has been true of a lot of these things. So you want to be somewhat sensitive to valuation, but I think it's a much more important variable, what the quality of the team or the quality of the idea is"
Francisco touched on his comment regarding it being more difficult to be an investor in the early stages. Because there are so many company, a lot of investors are diversifying. Thiel, she pointed out, has said that he is skeptical of too much diversification, likening the idea to treating, companies, and their founders, as "lottery tickets."
"Ethically, maybe it's not the right way to invest, but economically isn't there some validity to this diversification strategy, given that's its really tough to know who the winners are at seed stage?" she said.
Thiel noted that "to the extent that you invest in more than one company you end up implicitly diversifying. So I'm not saying you should put all your eggs in one basket or something like that." But massively diversifying "is a bit of a mistake."
"I certainly don’t like the way you end up interacting with the companies, where everyone's just a lottery ticket. That's something of a dysfunctional relationship between the investor and entrepreneur, where you're in a very different zone; one where the entrepreneur is taking all this risk, and it's not even much of a risk for you at all, and you're very misaligned on that level," he said.
"But what I've also found is that when you think of it as a lottery ticket, when you say, 'well, this might work, it might not work, I don't really know,' you've already psyched yourself into losing. Whenever a lottery ticket multiplies small probability by by a big number, it's normally zero. Multiply a small number by a big number, it's a small number when you play the lottery. And if you have that sort of attitude toward investing in startups, the problem is there are far too many lottery tickets you can buy. There are far too many different companies that are out there, and so you sort of talk yourself into not doing quite as much work. And where we've done best over the years, is when we had a lot of conviction, and a lot of money in the bank, and systematically when we've had smaller dollar amounts those have done much worse. I've found it's always easy to say, 'I don’t really know, I'll just do half.' I think that’s a temptation one should resist very strenuously."
He also spoke about the other problem with diversifying: companies taking on too many investors at once.
"One other version of this is when you have a lot of Seed stage opportunities, wher you have 10 different people, and they've been raising $1 million, where 10 people are investing $100,000 each, my instinct, as a default, is to stay away from a company like that. Because, if you have 10 different investors investing, you might say, 'Wow, there are 10 different people who thought about it, so way more people have looked at it.' But I think, in reality, what happens far more typically, is that each of those people is counting on the other people to do their work. No one's really done any work," said Thiel.
When companies have fewer investors, he said, it forces those smaller number to really think about it, rather than relying on someone else to do it for them. Those companies, typically, tend to perform better.
When Francisco countered that she doesn't see what's wrong with taking that $100,000 check, Thiel responded that he doesn't believe "there's anything morally wrong with it. People have the right to invest their money badly."
"I'm describing my own psychology on this, but I think this is actually pretty widespread: there is no wisdom of crowds. When you see a large crowd of people doing something, you should think that nobody’s really thought for themselves."
So does Thiel actually hold it against the company is they have raised money from many different investors?
His answer, "A little bit."
Francisco asked who in the audience considered themselves to be "lottery tickets," a question that was received with a lot of laughter.