Editor’s note: Guest author Chris Yeh is an independent angel investor and VP of Marketing for PBworks, one of his investments. He has been involved with Internet startups since 1995. His Twitter handle is @chrisyeh.
Update: This post originally referred to DST as the investor in Start Fund when it actually is Yuri Milner personally investing, along with Ron Conway’s fund SV Angel.
Update II: This has been corrected below.
The big news this morning is Yuri Milner’s announcement that he and Ron Conway will be investing $150,000 in *every* Y Combinator startup on a no-discount, no-cap convertible loan.
Many people have already weighed in with instant reactions—”It’s a bubble!” “It’s the greatest thing to happen to the US economy!” As usual, these off-the-cuff reactions focus on a single part of the story, rather than looking at the big picture.
Let’s walk through the news, step-by-step, and see what it really means. Ultimately, my take is that it’s good for Y Combinator and Milner, but bad for the rest of Silicon Valley.
1) “Yuri is a fool who believes he can sell to a greater fool.”
Many people mocked DST when it began investing in companies like Facebook at “outlandish” valuations. DST invested in Facebook at a $10 billion valuation; with the valuation now above $50 billion, I’d say Yuri is having the last laugh (for now).
If Milner is investing in YC companies on these terms, it’s because Milner believes it can make money on these terms (more on this later).
2) “I can’t believe all the money going into YC’s dipshit companies.”
Once upon a time, Y Combinator’s companies were features masquerading as companies. But anyone who still thinks that isn’t paying attention. The quality of YC companies has risen considerably; the companies graduating from YC these days are much more polished and accomplished. And with monster successes like Dropbox and AirBnB (along with Heroku’s exit), YC’s company quality is looking better and better.
3) “Finally, someone who’s willing to take risks, unlike today’s pantywaist angels and VCs!”
Now we’re getting to something more substantive. There seems to be a feeling among entrepreneurs that investors are no longer willing to take risks, and that no one is willing to invest in ideas any more. My response to that is simple—if startups are really so low-risk, why is it that only a tiny fraction of the companies that do get funded (which are presumably “no-brainer” investments for all the cautious VCs) actually return any money to investors?
Of course I try to invest in companies that I expect to be “sure things,” but I also know that history predicts that at least 60% of my investments are going to be complete financial failures. The reason Milner is willing to take on such risk is simple—in addition to the actual investment, it’s also buying option value.
Option value is what makes the VC system work—by investing in stages, investors are able to abandon companies that don’t look likely to succeed. This is why startups are so much more effective than big companies at innovation—a big company’s internal politics make it difficult to try lots of things that will probably fail. Milner has additional option value available to them that traditional angels do not because of its ability to invest at later stages. By investing in the seed round, Yuri – and DST – gets the inside track on any future financings.
Let’s say that I was lucky enough to invest in Facebook’s seed round (I wasn’t). As the company raised further rounds of funding at $100 million and $10 billion valuations, I would have to come up with increasingly large checks to maintain my ownership position. Buying 0.1% of the company is pretty easy at a $5 million valuation (that’s just $5,000). It gets harder at $100 million ($100,000) and $10 billion ($10,000,000).
For Milner, however, investing a few million in YC companies is well worth it if it gives him the inside track to do a $100 million expansion round in the future. Moreover, is Milner really making it easier for entrepreneurs to raise money? I was not under the impression that YC grads were having difficulties raising money. It’s not like Milner is giving $150K to anyone who asks—the investment is reserved for companies which pass YC’s rigorous screening process.
4) Okay, Mr. Smarty-Pants, why is this bad for Silicon Valley then?
In the TechCrunch comments, Ted Rheingold of Dogster fame says simply, “This is not going to be healthy for the ecosystem.” I think he’s right, but the reasons he’s right are subtle. Allow me to explain.
a) Independent angel investors need to be able to invest at reasonable valuations.
As I explained in (3) above, folks like me need to be able to invest at reasonable valuations. That means either priced rounds or convertibles with valuation caps, and seed round valuations of $1-3 million. We don’t have the money to stay in the game with the VCs and DSTs of the world, so if seed funding shifted to a model of no-cap convertibles, we would be priced out of the ecosystem.
In today’s environment, many companies skip straight from a seed round to $20 million+ valuations, and angels simply won’t get rewarded for the extra risk they assume without priced rounds or caps.
b) The Milner/YC partnership could end up upsetting this delicate balance
As I’ve argued in the past, angel investing is a fragmented game. No one has enough power to collude on valuations. However, someone who is influential enough can influence what is and isn’t considered “standard.”
Once upon a time, there was no such thing as a convertible note with a cap. There were convertible notes, and there were priced rounds, and nothing in between. Then a few years ago, a number of prominent players in the ecosystem (YC included) began pushing the concept of a capped convertible. Today, even though there are plenty of angels who despise any kind of convertible note, capped or not, the capped convertible is pretty much the standard seed financing instrument.
Now imagine the impact of YC, the most influential incubator, standardizing on uncapped, no-discount convertibles. It’s not difficult to envision a scenario in which the entire industry moves in this direction. The problem is that this shift eliminates the incentive for independent angels to participate in the ecosystem.
Angels play an important part in the ecosystem because we are willing to take on more risk than the VCs. Some of that is non-economic behavior, but some of that is also due to the fact that we get compensated for that risk-taking with much lower valuations. Eliminating that compensation will surely reduce the number of independent angel investments.
The irony is that the Milner/YC deal didn’t have to cause problems for independent angel investors. If Milner committed to providing $150K to every YC company, at whatever terms were determined by the lead investor in the syndicate, he wouldn’t be pricing the angels out of the ecosystem.
c) Removing independent angel investors from the ecosystem is a bad idea
Naturally, angels like me will be upset about getting shut out of the ecosystem, but why is that bad for Silicon Valley? After all, between YC, TechStars, the Founders Institute, and all the other incubators and quasi-incubators, who needs us? Let the incubators pick the winners, and let the DSTs fund them.
The problem is that the chaotic, fragmented, Darwinian nature of Silicon Valley is an integral part of what makes it great. We need those random mutations to generate innovation, especially breakthrough innovation.
If we concentrate the decision-making on who does and doesn’t get funding in the hands of a small number of institutions, we hurt Silicon Valley as a whole, no matter how smart those institutions are.
I tell many people that Paul Graham is a genius. He saw the opportunity to start YC, and he’s done the Valley a huge favor by broadening the pool of company founders. But I don’t want Paul to be one of a small group of people who decides which companies get funding—not because he isn’t smart (he is) or a great guy (he is). When it comes to innovation, central decision-making is bad, no matter how good the decision-makers are.
For all our flaws, independent angels serve the important role of enabling the “genetic diversity” of the startup population. That diversity is at the heart of Silicon Valley’s success, and that’s something we don’t want to lose.
Everyone calls Keisher McLeod-Wells “Fire"—or, more formally, “Fire the Boxing Diva." That second one is a bit of marketing hype, though, as she’s generally very un-diva-like, and can often be found working the front desk at Gleason’s Gym, perched behind an old desk from some long-forgotten school.
Fire is a rare species: the professional boxer-model-actress. The acting and modeling came first. She’s 33, and she’s been boxing since 2002, when she wandered into the gym after her agent suggested to her that she’d have a better shot landing a role in Terminator: 3 if she got some muscle on her arms like Linda Hamilton. And boxing just seemed like a natural, for that, though she was “not a boxing fan" at the time. A year later, she had her first amateur title; now she’s a pro. She says that the novelty of her boxing career has helped her land modeling gigs (you can catch her plastered all over the New York City subway system right now in ads for NBC New York, bearing the slogan “I am not your average girl.” NBC didn’t pay her for that one, she noted, a little ruefully). In this sense, she is luckier than the average mono-careerist schlub: she can pursue acting, modeling and boxing, and pick whichever one works out best: "Right now,” she said, “it’s boxing.” Fighting, with fists, for money, has proven to be easier than making a fortune at modeling.
Fire’s style, appropriately, does not involve slugging it out until one girl or the other drops with a newly misshapen face. She’s all long arms and legs, sticking and moving, using her reach and speed. She had her fifth pro fight on February 9th at B.B. King’s, in the heart of Times Square. Hers was the sixth fight on a nine-fight card, and the only female bout. That’s good; only three fights were judged to be bigger than hers. Equality creeps into our nation’s most testosteroned corners, slowly but surely.
The night began with Allan “El Mexicano” Benitez’s pro debut, which was ruined—sombrero and all—by Newark’s Joseliz Cepeda, who found the following holes in young Allan’s defense: the right to the body, and the right over the top to the head; and, in the later rounds, also the left to the body, and the left to the head. Once Benitez takes care of those flaws, who knows how far he could go?
California’s Ishwar Amador brought a ton of fearsome accoutrements into the ring with him: his nickname, “El Diablo”; a fierce red-spangled devilish hoodie to match; and cornermen sporting t-shirts from “Capital Punishment Boxing Club,” which seems like a harsh brand, even by boxing club standards. When the announcer read his name he held up his arms in a fearsome “X” symbol. His opponent, Steven Martinez, was completely guileless, skinny in plain blue trunks, a downright nice-looking kid, who knocked out El Diablo one minute and eleven seconds into the first round with a hook-right-hook that pounded the consciousness out of him sequentially, so that after the last punch his eyes went glassy, and his body slumped, in what I imagine is the same way someone acts when they die.
Deano "Badnewz" Burrell, half of a London-born pair of twins that have moved to Brooklyn to pursue boxing careers (and, like Fire, train at Gleason’s), was up next, with his second pro fight. The way these things usually work is, the prospect (Deano) is eased into his career with ten or fifteen easy fights that he’s bound to win, which get progressively more challenging (though not challenging enough to actually lose), until his record is gaudy enough to earn him a shot with a big-name fighter. The way the thing worked on this night was that Burrell was matched up with Sidell Blocker, whose 0-3 record marked him as an easy opponent, but whose egregiously long arms and awkward style marked him as possible trouble.
Blocker’s reach was his salvation. He was clearly the inferior fighter, but his arms were so long that, even though Burrell was able to slip most of his gawky, swinging punches, he ended up so far away that Blocker’s defense was reset by the time Burrell could step back in range to counter. And even though Blocker whiffed on about four out of five of his big hooks, every fifth one landed. In the first round, Burrell caught one that bruised his right eye, and got mad. He started rushing in, off balance, throwing big overhands, trying to take Blocker’s head off. As a consequence, he went down in the first round, and again in the second, both times less a “knock down” than a case of his body getting away from his legs. Burrell, raging, kept loading up on his punches, which served to make them slower, which served to make Blocker look more competitive than he actually was. In the end Blocker won a disappointing decision. Burrell will be fine, as long as his managers line him up some normal, wildly inferior opponents who aren’t long-armed enough to keep him out of punching range.
The act that Fire had to follow was Boyd Melson, a thoroughly mediocre fighter but enough of an Inspirational Good Guy to make you sick. Not to go into his whole damn story, but he was an Army veteran and after his fight was over he gave a speech urging everyone in the crowd to donate to spinal injury research, name-checking his wheelchair-bound friend in the crowd while surrounded by more than a dozen West Point cadets. I mean, man: talk about poisoning the well of bloodlust. The only notable thing about Melson’s fight was a stern-looking man who I assume was his father (or Father Figure) who kept barking out combo sequences for Boyd to throw during the rounds: “2-3-2! 4-6!” As if he could seamlessly listen, mentally translate those numbers into punches, throw them properly, and score a K.O., thanks to the hollering guy at ringside. (He couldn’t; he was busy being in a fight.) Boxing has stage dads too, apparently.
Fire came out in a gold tank top and miniskirt-looking trunks with a red belt, for the full Wonder Woman effect. Her opponent was “Mighty” Melissa McMorrow, a five-foot-nothing fireplug from California with cornrow braids and a Tysonesque pugnacity. The fight was as straightforward as it gets: tall vs. short. Outside vs. inside. Reach vs. power. If Fire could move, stay away and use her reach, she'd win; if McMorrow could go low, get inside and bang hard, she'd win.
Reach in boxing is what height is in basketball. It’s a natural advantage, a factor that will, all other things being equal, allow one fighter to beat another. It’s not impossible to overcome by any means; there’s a long and proud tradition of short boxers with short arms. There are a few different ways to beat someone with a longer reach than you. You can duck low under their shots and weave your way in, pop up inside, right under their chin, and suddenly their long arms are a disadvantage, being that you’re so close and all; you can time them, slipping their long punches and then shooting inside, hitting them, and pulling back out of range; or, if you’re of a certain punchy disposition, you can just walk through their punches, taking what they have in order to get close enough to hit them yourself.
But in every contest in which one fighter has a longer reach, there is a zone, a certain box of space between the two fighters, in which the fighter with the longer reach can hit the opponent, while the opponent cannot reach them. Smart fighters with long arms, therefore, endeavor to keep their opponent in this space constantly—they punch, and move back, allowing the opponent to always be moving forward into that free fire zone; smart fighters with short arms endeavor to only be outside that space (farther away) or inside it (closer), but never to spend much time in it.
The drawback faced by the taller fighter, though, is that they end up punching down at their opponent, and downward punches are weak, because you can’t put your legs into a punch that’s traveling down. (Try it.) Fire spent the first two rounds doing exactly this at McMorrow, and the shorter girl did manage to rush inside and smack Fire repeatedly with overhands to the face. But in the third and fourth, Fire found her groove; she pop-popped one-twos to McMorrow’s head as she moved in, then spun away, moving back, keeping her distance. As the rounds progressed, fatigue took hold, and McMorrow’s hands began to drop as she rushed in, making her even easier to hit. She did indeed fight mightily, but after a rough beginning, Fire’s reach and movement won her a unanimous decision.
The only thing missing was some male ring card models, for the sake of equality.
I’d pitched a story about this fight to a magazine; the magazine declined it on the grounds that they didn’t want a story about a girl getting beat up. Fire did not get beat up. But in the next fight, Angel Gonzalez, who looks quite a bit like Radio Raheem from Do The Right Thing, got TKO’ed by Irish Seanie Monaghan. Gonzalez did, in fact, get beat up. When the ref stopped the fight at the end of the third round, he gave an angry, animalistic roar, raging against the man who’d taken away his right to keep trading uppercuts. Gonzalez appeared to have lost a tooth. Or maybe it was already like that.
Previously:
• Boxing Is a Bad Job, Badass
• Douchebag as Role Model: The Case of Paulie Malignaggi
• Five Lessons from the New York Golden Gloves Finals
• The Glorious Racism of Boxing
Hamilton Nolan is the media editor of Gawker.
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