Exploding offers are a sign of desperation, but they also serve to filter out young entrepreneurs who have a modicum of business sense.
The VC firm that extends an exploding offer and won't negotiate it is guaranteeing that they'll only fund companies that aren't very good at business.
A few years ago I wrote:
It seems to me that a company that accepts an exploding offer is demonstrating a remarkable lack of basic business aptitude. Every building contractor in New York knows you request bids from five or ten plumbers before you award the contract. If a plumber said, "I'll do it for $x, but if you shop around, deal's off," the contractor would laugh his head off and throw the plumber out on the street. Nothing sends a stronger message that an offer is uncompetitive than refusing to expose it to competition. And that's for a $6000 kitchen installation. Getting $10 million in funding for a business is the biggest and most important deal in the life of a company.
Arguably they're tolerable in the VC world, or at least pretty common. Empirically an expiration date on a termsheet is not always evidence that a VC is desperate or dishonest.
It's when this idea gets imported into seed funding that it really becomes a problem, because of the synchronous nature of this market. And it gets worse as the number of seed firms increases.
The root of the problem is that people think seed funding is regional. They think they're starting the YC of St. Louis, or wherever. Then after they get started they realize that in fact the seed firms are all drawing on the same national applicant pool, and that the default fate of the nth seed firm is not to be the YC of St. Louis, as they'd expected, but to be the YC of the nth quality bucket. That's a pretty grim situation, and it tempts them to take desperate measures. The VC market is more fluid, so VCs aren't subject to such pressures.
Is this not just a reality of this game? You mentioned Universities. For them 'fairness' is an independently important (though probably imposed) quality. Here there is no such force. Since there are always going to be application deadlines, it would take conscious effort or collaboration to avoid an exploding termsheet becoming the norm. Since it would adversely affect the lowest in the pecking order, you'll always have defectors.
A possible solution is more rounds. Even triennial intake is probably enough to let applicants time applications to meet their hierarchy of preferences.
I'd suppose they call it being cutthroat? With the idea being if you can't beat 'em, at least get ahead of them?
YCombinator is the only seed funding firm with a comparatively well-known name. I'd bet that nearly all people applying for any seed funding apply for YCombinator. It's got a bunch of well-known companies, well-known people, and it's located in SF, which is where lots of startups want to be. It's got a competitive advantage that's very hard to combat. Date fixing is one of the methods that other funders can use to give themselves a fighting chance.
I wonder if there are tenants of the funding system itself that a company could change to become a completely different sort of funder. Could a program be as small as YC and yet work in a radically different way? (If any of the seed funders do work radically differently, then it's news to me.)
I guess the next logical step for 'other funds' is to lower the percent of equity they take and to increase the money they invest. That can make startups think twice before turning over to YC.
Sure it does. You know what the offer will be but you might not know what OTHER offers will be. Yes, I know TechStars and others are before YC, but there can be other offers on the table (other funding, acquisition offers, etc)
Thankfully, YC seems to be friendly if there are circumstances like this (Paul gives an example below).
This works because YC has a flexible # of slots. TechStars has a rough way to go here because, with 10 slots, they can't let a deal linger for a month without a firm answer. I don't think it's malicious on their part.
"Using this tactic in a stage where funding happens synchronously is not very ethical. It would be like colleges doing it."
I'm sure pg is aware of how colleges do this, so for readers for whom this cultural reference is not clear, I'll mention that in the United States the most competitive colleges to get into have a joint agreement (through their membership in the National Association for College Admission Counseling) to announce their decisions about whom they will admit by April 1st, allowing admitted applicants who are admitted to more than one college to wait until May 1st to decide at which college to enroll. It's not a perfect system by any means, and I am endlessly fascinated by the peculiarities of college admission in the United States, but it does give all students a month to compare offers.
"What can you do if you find yourself being pressured to decide before you're ready? We advise approaching the situation with confidence. If your startup is going to succeed, you're going to have to learn how to push back against people who try to take advantage of you. So try negotiating."
This is excellent advice. Most of business is negotiation. It's never too soon to practice negotiating.
(YC asks people to decide that day whether or not to accept an offer from us, but we do this because at that point they already know all they need to, not to pre-empt other offers. There is no other seed firm that decides after us.)
If another seed firm did set its decision date a few days or weeks after, would you then give teams more time to decide?
That would be incredibly gracious of YC -- indeed beyond what I would expect of the category leader. But that seems to be the implication of your parenthetical.
Sure. Whenever a group has a specific reason they need more time to decide, we've always given it to them. We once interviewed a startup that got an acquisition offer right in the middle of YC interview weekend. Not only did we give them a couple weeks to see how things played out, we advised them on negotiating with the acquirer.
I agree to some extent, but I still like to think integrity is a function of how you behave at all times, not just when it is advantageous.
For example in the situation above - I perceive you as the kind of person who really believes what he writes and wants to help people get up and running. I mean, your essays date back before YC.
So in my mind, advising this group during the acquisition offer, even if there was a chance you would miss out, is showing a true adherence to some kind of ethical/moral code.
I agree with froo. This is definitely not a powerless situation, as you got to advise the startup. If you had less integrity, you could easily come up with plausible arguments why should they accept your funding before getting acquired.
> Whenever a group has a specific reason they need more time to decide, we've always given it to them
I read before that when you call teams with your offer, they have 5 minutes to accept. Did this change?
Also, I read that your offer is non-negotiable. Yet this advice says to try to negotiate. Did you change this also?
As for the Fleaflicker example, my understanding is he got an acquisition offer before you made your own offer, so it's not comparable to 99% of the other cases. If you do indeed now give teams reasonable amounts of time to decide and negotiate the YC investment terms, that's a significant improvement. Otherwise it sounds like you're doing the same thing you are condemning other seed funders for, with the excuse that "well, we decide last so it's okay for us to require an immediate decision and not negotiate," which seems disingenuous.
Alphalab in Pittsburgh decides after Y Combinator. They generally seem very reputable. The main negative is they have a "stay in Pennsylvania" provision -- if you leave PA, you have to pay back the $25,000 and they keep their 3% equity. They have this because they are funded by the state of PA and the ultimate goal of the funding is to create jobs in Pennsylvania.
Their FAQ at http://www.alphalab.org/faqs.aspx suggests you have to stay in Pittsburgh, which is smaller than Pennsylvania. Even the option to move to Philadelphia would make this more attractive.
On the other hand, their About page at http://www.alphalab.org/about.aspx says "As Innovation Works utilizes funds from the Commonwealth of Pennsylvania, each company receiving funding is expected to maintain a significant presence in Pennsylvania after the program." I guess you would have to ask them for a clearer response, but perhaps they would be OK with anywhere in PA.
The same "exploding offers" are prevalent in the job-seeking world as well. I fell victim to one accidentally: I was trying to happily accept a job but the acceptance deadline detailed on my offer actually expired the day after I received it in the mail. At the time I thought it odd that the company was in such a rush to get a response from me that they couldn't give me a week or so to think about it. Then I got there and found out very quickly why they were pushing me into taking their offer. Three weeks later I had quit. I'll never take an exploding offer seriously again and commend YC for being gracious and flexible in their process.
This happened to me in early summer of 2007. I was actually at the airport to join another program when I followed my gut and took a chance with my Y Combinator application instead. I was subsequently interviewed and accepted, so it worked quite well for me. I would, however, encourage everyone to weigh their options before following their guts as in the end you may get no offers by taking a risk like I did.
Probably part of what prompted my decision was how much integrity this other program didn't have relative to Y Combinator (offering perks and having integrity are sometimes inversely proportional).
This happened with us, We applied to 3 groups and were accepted into two and asked to interview at YC. All the seed groups were pretty cool about it.
The first groups deadline was so early, we wouldn't have known about offers from the two other seed groups. After giving us an offer extended our decision period, by over 2 weeks. The second groups deadline was towards the end of that time and actually told us we were accepted slightly early so we could make a decision between the two groups.
YC invited us out for and interview, but that was going to be so much later that we didn't think we could put off the decision that long. PG was great about giving us his thoughts on the matter and talked on the phone with us some about the situation.
In the end we made our decision to accept one of the offers and not do the YC interview. It worked out well for us, but it was a bit stressful and complicated.
One problem is that the programs start at different times and really out of timing need to make decisions earlier. One of the programs we applied to started a week after the YC interviews and obviously by that time they need to know who is going to be showing up. It would be great if they could all sync up the timing a bit more like college semesters are roughly at the same times.
PG made an interesting analogy to the college admissions process. How long until we see an "Common App" for seed firms, and a common decision timeline?
That may be the answer eventually. The situation now is getting out of control. It's not just us people are trying to pre-empt. They're all trying to pre-empt one another. The result is that they end up setting their deadlines in roughly inverse order of quality, creating a cascade of stressful decision points for the best applicants. And the more new YC-like things people start, the worse it will get.
I don't think there would need to be a common application, but there may have to be a common deadline.
every US Senator and Governor is campaigning for president
Those who are not "natural born citizens" of the United States (such as the current governor of California) cannot become President, by the Constitution, but, yes, for the most part most politicians of national prominence keep a future run for the presidency in mind in most of what they do.
I think the common deadline would be a good idea ... and along with it perhaps some sort of "seed fund consortium" comprised of YC and the other reputable YC-like firms. Going with the college analogy, it would be along the lines of applying to an "accredited" institution.
Not only would the common application make the process easier for startups, it would help them identify worthy funds and keep them from wasting their time with other/shady ones.
It could definitely be a loosely-formed org. Perhaps quarterly deadlines that each firm could choose to accepts apps or not ... plus a simple list of guidelines they follow.
very good point. having been through the process, specifically having received an exploding offer from one of the firms, i can attest to how stressful it is.
in the end we declined the offer and it ended up working out well for us.
to be honest, extending an exploding offer is a statement of character.
I think it says a lot to get through the first round at more than one organization. Even if you took the risk and declined the first offers and ended up with no offer, you gain confidence in your idea(s) and an ice breaker to angel investors (who you'd have to actively find).
That you ended up with no offer could have just been a matter of chance: there were 33 strong companies and only 28 spots so decisions had to be made. So if the other organizations aren't willing to be reasonable, maybe taking the chance is the better choice.
Have you considered rolling admissions now that you're in Cali all year? Those that aren't ready for demo day could wait till the next one. You could have 3 or 4 demo days yearly. That would solve scheduling problems.
It might also make the application process easier on you by trickling in the applications. No cramming to get to them all. You could still do batch interviews monthly.
Just ask around who the other seed firms are, and look at their web pages for their deadlines. Since no other seed firm decides after YC, the answer is pretty much: all of them.
Putting a time limit on offers is not a big deal. I mean who wouldn't say to a good startup, that multiple parties see potential in, saying.. you're past the time limit we'll pass. Financially thats not a good idea. But in the end decisions need to be made and overall its good for all parties for yc to work with the startups that are put in this position.
At the end of the day if they originally wanted you, chances are they still want you, despite deadlines. They won't cut their nose to spite their face. Call their bluff. Chances are they'll want you back.
Not to mention the selection correlation - if you get into some seed organization, you're already more likely to get into YC. It isn't guaranteed, but it's already a good sign.
I don't like this lack of transparency. Why not name companies? It would be great (like TechCrunch w/ TechStars) to showcase the opinions of others on the matter.
This isn't an issue of transparency. This is an issue of a direct conflict of interest. I'm all for their names being brought out to the open, but for slanderous remarks to even be housed on a YC server seems to open a possible chink in armor should other incubators become hostile. That was my only point.
How about accepting applications year round but still having the twice a year 3 month program? If someone knows they are going to be a in say the next summer or winter round it is less likely they would apply elsewhere.
Option 1: You could do an "early decision" round, and a regular round. If the early round is very early (february?), and the regular round at the current schedule, the other seed firms would have to really come out into the open to pre-empt their decision date before early decision.
Option 2: You could move your schedule early up - to have your interviews and decisions wrapped up by March 1 - and give the startups a whole month to decide (Just to signal your integrity). Then if the other seed firms gave just 48 hour exploding notices that would really sit in stark contrast.
You want to force them to signal their bad integrity out and clear in the open. Right now they're able to be dirty in the closet. If you force them to come right out, especially if your actions are diametrically opposite, you win.
The VC firm that extends an exploding offer and won't negotiate it is guaranteeing that they'll only fund companies that aren't very good at business.
A few years ago I wrote:
It seems to me that a company that accepts an exploding offer is demonstrating a remarkable lack of basic business aptitude. Every building contractor in New York knows you request bids from five or ten plumbers before you award the contract. If a plumber said, "I'll do it for $x, but if you shop around, deal's off," the contractor would laugh his head off and throw the plumber out on the street. Nothing sends a stronger message that an offer is uncompetitive than refusing to expose it to competition. And that's for a $6000 kitchen installation. Getting $10 million in funding for a business is the biggest and most important deal in the life of a company.
(http://www.joelonsoftware.com/articles/VC.html)