Y Combinator founder Paul Graham, the influential advisor to dozens of startups like Dropbox and Airbnb, sent his entrepreneurs an email Wednesday afternoon cautioning them against taking "lowball offers"—in particular, he said, from Google Ventures.
Graham's startups go through a months-long process of coaching to help them build products and raise money. Notes like this are part of Graham's ongoing process of steering them through the thickets of Silicon Valley startup life.
According to Graham, Google Ventures, a venture-capital firm backed by the tech giant, has systematically been offering to make seed investments in recent Y Combinator graduates, but only on substantially more favorable terms than other investors received.
Google Ventures managing partner Bill Maris strongly denied Graham's accusations, calling them "patently absurd."
"I don't know what Paul's thinking," Maris said. "It's just not true. Our portfolio speaks for itself."
Google Ventures has made more than 100 seed investments, Maris said, including some past and present Y Combinator companies, and is making one to two new ones a week.
Parse, one of the most-anticipated startups in Silicon Valley these days, went through Y Combinator last year and raised seed money from Google Ventures, for example.
Many if not most seed investments in startups these days are done in the form of convertible debt, which is a loan that can convert to equity in a subsequent financing. If the convertible debt has a "valuation cap" feature, the price at which the investor's debt converts into shares has a maximum. The higher the cap, the better it is for the entrepreneur; the lower the cap, the better it is for the investor, since they may get their shares at a lower price than they otherwise might.
According to Graham's email, Google Ventures has been seeking to cap the price at which their loans will convert into shares at half the price other investors are willing to take.
Maris said the firm did not have any "policy or practice" along these lines.
"Do we negotiate?" Maris said. "Sure. Sometimes we pay the market price because that's what's on the table."
It's simply not in Google Ventures' self-interest to behave in the way Graham alleges it has, Maris said: "We work really hard on our relationships and our reputation ... and most of us are entrepreneurs ourselves."
Here's what Graham wrote:
If you're talking to Google Ventures you may be part of a pattern. The pattern is: you've already raised some money at a cap of $x. Then GV says they're interested and wants to invest at a cap of $x/2.
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If this happens to you in isolation, you worry "Oh dear, maybe my cap is too high." But in fact for some bizarre reason this is just their standard m.o.
What do you do in response? Just focus on other investors instead. Maybe you'll find enough from other sources that you can blow off GV. Or maybe you won't, and you'll need that offer to fall back upon. Either way it's better to wait.
At face value, this advice seems very different from the message Graham sent just a few months ago, in the wake of Facebook's poor IPO performance:
If it means new startups raise their first money on worse terms than they would have a few months ago, that's not the end of the world, because by historical standards valuations had been high.
Convertible notes technically don't set a price for startups. The whole point is to provide a fast, easy form of financing that avoids wrestling over valuation. But the convertible cap has increasingly been used as a guide for valuation. So ultimately, setting the cap has become a proxy for what founders and investors think a startup is worth.
What does this incident tell us?
First, the valuation of early-stage startups remains frothy and fraught with uncertainty.
And of course a venture-capital investor and an advisor to entrepreneurs would take opposite sides in a price negotiation.
It makes sense that Google Ventures might see an opportunity to make more seed investments at lower prices now, as other venture investors pull back on their seed programs.
While all Google Ventures partners make some seed investments, the firm recently hired Digg founder Kevin Rose as a partner; Rose focuses on early-stage and seed investments, drawing on his extensive experience as an angel investor.
Google Ventures also has extensive programs to help the entrepreneurs it backs with technology, analytics, design, and marketing—for which it might reasonably believe it should command good terms when investing.
What is surprising is that whatever approach Google Ventures took to these Y Combinator startups caused enough friction to provoke Graham's cautionary note.
Maris notes that not all of Graham's companies seem to be heeding his advice.
"We've already closed investments on companies from this class, so they don't seem to feel that way," Maris said.
We asked Y Combinator several times for comment and didn't hear back, though we understand our inquiry generated considerable discussion within the startup program.
