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Protocol Pipeline
The inside story of the venture capital and startup world by Biz Carson.

'You haven't seen the pain' yet

Mark Suster

Hello, and welcome to Protocol Pipeline! I'm Biz Carson, Protocol's venture capital and startup reporter, and this is my new weekly column about that community. Protocol Pipeline is a work in progress, so I'd love to hear your feedback; email me at biz@protocol.com. If you like what you're reading, sign up here to get it in your inbox.

Anyway, on with business. This week: Y Combinator's new investing strategy, why one VC thinks Q1 2021 will be when startups really start to feel the pain, and the funniest trash-talk over the Midas List.

Biz on biz

'You haven't seen the pain'

Sure, startup CEOs are facing the new reality. But many are still struggling to comprehend the gravity of the current situation, says MaC Venture Capital partner Marlon Nichols.

  • "It feels like retreat to a lot of Type A personalities," Nichols told me. "It's hard for them to be like, it's the right thing to do vs. I feel like a failure."
  • There's a spectrum of companies, from those seeing surging demand and opportunity to companies that didn't have enough cash and are now struggling to raise. And then there's the bucket of startups that were doing OK but then saw their revenues fall to zero.
  • "The biggest thing for me is just CEOs getting their heads wrapped around the reality of where they sit during this time."

But the real pain hasn't even started, warns Upfront Ventures' Mark Suster. There are a lot of funding rounds now and a lot of companies laying off employees, but those are only the companies either in true crisis or really opportunistic positions, he says.

  • "You haven't seen the pain," he told me. "The real pain is Q1 of next year."
  • That's when many startups will find their runway comes to an end. So many companies have a runway of six to 18 months of cash, Suster says. Those CEOs may feel OK during this moment of crisis, but eventually they will have to raise again.
  • Startups need to have a plan for if, and when, demand weakens: Suster thinks a lot of enterprise contracts may not be renewed by the end of the year, for example. What will that do to a startup's ability to raise money?

"Come Q1, a bunch of companies won't have been able to raise money — not all, but a bunch," said Suster. "And you're going to see a lot more bankruptcies."

Overheard

  • The Midas List came out this week and with it the wonderful but rare moments of VCs dunking on each other. Amplify Partners' Sunil Dhaliwal, who ranked No. 87 over Bessemer's Byron Deeter at No. 88, had the most creative taunt: He created a word search with a special hidden message for Deeter.
  • Investors may be falling for media and consumer startups again. One common thread I've heard from investors is renewed interest in social networks or virtual communities — a conversation I haven't had in quite some time. "Anyone that is doing well in the App Store is/will be raising soon," one VC texted me. It makes sense: I've had more invitations to use Houseparty, Netflix Party and JackBox Games in the last month than … well, ever. Question is: Will this kind of use stick — or will people return to doing all of those things in person when things go back to normal?
  • Something you wouldn't have expected from WeWork a year ago: "Every dollar we spend needs to have a measurable impact on sales, member experience, profits or cash. If it doesn't, then really why should we spend the money?" That's from the company's CFO at an all-hands this week according to a Bloomberg report. It's funny because it's WeWork, but every startup should be asking the exact same question right now.

The big story

Y Combinator pulls back

Y Combinator is switching up how it invests in portfolio companies, opting to give at a smaller scale to favorites, and ditch its blanket approach of investing in every priced seed and series A round — something it's done since 2015.

In an internal memo seen by Protocol, YC said the change means it will be investing in a third or less of the rounds — so a lot of its portfolio companies that expected backing will be disappointed. It's a change that was in the works pre-COVID-19, a YC spokesperson said, and the amounts are too small that the pullback won't kill a company.

  • "No company is going to live or die based on a YC pro rata investment. The dollars invested in any one company are just too small," a spokesperson said. "But in aggregate, if YC exercises pro rata rights across hundreds of companies, the capital required is just too big."

It's kind of YC's own fault. The size of its recent classes means it's now graduating nearly 400 companies a year. Big batch sizes and more companies raising rounds meant it quickly exhausted its finances.

  • "We always tell startups to stay small and manage their budgets carefully. In this instance, we failed to follow our own advice," YC wrote.

In theory, YC could've scaled back the number of companies it funds: It's practically doubled in the last five years to nearly 200 companies per batch.

  • "Every investor would love it to be smaller because then you're feeling like it's ultimately a more curated thing," Haystack founder and Lightspeed venture partner Semil Shah told me.
  • But scaling smaller was never really an option given YC's goal is to build more startups, the spokesperson said: "We could never justify turning down a great founder who was applying to YC because we were trying to save money in order to invest in every single follow-on opportunity."
  • Absent a pullback from batch size, it makes sense to Shah that YC would start selecting only a few. "They're getting smarter about the money," he said.

I've heard that some founders are unhappy about the change — particularly at a time when cash on hand is king. "The startups that need this pro rata funding to fill their rounds are likely the same ones who won't get this capital," House Fund's Jeremy Fiance told me. "YC, our firm and others are getting increasingly faced with bridge rounds and asking ourselves, 'Is this a bridge to nowhere?' And unfortunately, in many cases, it will be."

Inside track

  • In January, former Andreessen Horowitz partner Benedict Evans gave his famous presentation on macrotrends in tech at a Protocol event in Davos. But January is frankly a whole different world. In an update, Evans looks at what's changed with "COVID and forced experiments."
  • Bond Capital and Mary Meeker also released their coronavirus market update. It's shorter than her famous 333-slide internet trends report, but still clocks in at a hefty 28 pages.
  • From Protocol: Some founders have never dealt with a cash crunch before. Scaleworks CEO Ed Byrne said it's time for CEOs to learn how to manage one.
  • I keep hearing how references are more important than ever, but they go both ways. Costanoa Ventures' Amy Cheetham has a guide on how to reference check a VC.

Check of the week

$1 billion

That's how much Airbnb raised — again. It's now secured $2 billion in the last two weeks in a combination of debt and equity from investors like Silver Lake, Sixth Street Partners, BlackRock and Fidelity, according to Bloomberg. And the deal terms aren't great. The Information has a profile worth your time on how CEO Brian Chesky is navigating the crisis and where he may want to make cuts.

More money: Stripe banked an extra $600 million in a series G (!) extension. Robinhood is reported to be raising at an $8 billion valuation. Vast Data became a unicorn after raising $100 million. Australia's Airwallex, another unicorn, raised $160 million. Mayfield has a new $750 million across two funds. Lightspeed refilled its coffers with $4.2 billion across three new funds. And the only other person in Silicon Valley to share my name, Biz Stone, may be raising a $200 million fund.

Need to know

Five questions for …

General Catalyst partner Niko Bonatsos

What are some areas you're currently looking at for a company to fund?

Future of dating, especially in the corona or post-corona world, and helping all those people who are unemployed or under-employed get back to work.

Picked up any new habits in quarantine?

I cook a lot more. Double dates on Zoom and Google hangouts — I never thought I would do these, but I do two or three of these a week. The millennial generation, we don't chat much on the phone, but I find myself doing a lot more phone calls to portfolio founders and partners and my parents. They're pretty happy with me.

Who in tech don't you know but want to have dinner with?

I'd like to have dinner with the soon to be famous scientist/founder who will discover the COVID-19 vaccine — or Mr. Bitcoin, Satoshi Nakamoto.

What's the first check you signed as an investor?

Game Closure. This was back in spring 2011. The company is still around right now, and it's a gaming infrastructure company. It's had many, many lives. They have passed the test of perseverance and persistence.

What's over-hyped and under-hyped right now?

Over-hyped: Sectors like online education, telehealth, remote work companies, enterprise security, some of the essential services like supply chain, food delivery and alcohol delivery. They are all going gaga. These companies are leading their best lives right now.

Under-hyped: Travel. The live events world. Anything with SMBs. If you're thinking about investing in those, you might be visionary, or crazy, or both. These are also where the opportunities are.

Thanks for reading the first Protocol Pipeline. Send what you loved, hated and thought I missed to biz@protocol.com. Otherwise, stay safe, stay healthy and stay home. See you next week.

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