Paul Graham on the VC Squeeze - Signal vs. Noise (by 37signals)

Paul Graham on the VC Squeeze Ryan 04 Nov 2005

23 comments Latest by Humphrey Bogus

I like what Paul is doing with VC. His Y Combinator makes a lot of sense. When I read the name I always say “Y C” as in “why take capital?” I think Paul’s small-dollars approach to VC is a good answer. After all, less money is a competitive advantage.

His recent piece on the VC squeeze is right on the money. As mentioned in my talk on Less at Web 2.0 (linked above), you need less money because software is free, hardware is nearly free, marketing is nearly free (if you’re good, as Paul noted), and money doesn’t buy you time or passion. And no matter what you do, if you ain’t got passion you ain’t got a chance.

His point about outsourcing to a new language instead of to another country also rang true:

During the Bubble, a lot of people predicted that startups would outsource their development to India. I think a better model for the future is David Heinemeier Hansson, who outsourced his development to a more powerful language instead. A lot of well-known applications are now, like Basecamp, written by just one programmer. And one guy is more than 10x cheaper than ten, because (a) he won’t waste any time in meetings, and (b) since he’s probably a founder, he can pay himself nothing.

Why toss an app over the pond to a programmer body shop in India when you can do it here at home with one guy? That’s what Ruby on Rails lets you do. And that’s one of the reasons we open-sourced it. Everyone can benefit. We not only want to make software that’s dead simple to use, we want to make tools that make it dead simple to write software.

One thing we are starting to see from VCs these days (we’ve been contacted by over 20 so far — this figure is just for sample size, not horn tootin’) is the idea of selling “Founder’s Shares.” They’re starting to pitch liquidity instead of money to grow. Sort of a pre-exit stategy. Interesting angle and probably a good move for many who want to take a little risk off the table and be rewarded for their blood, sweat, and tears thus far.

Time will tell how the VC industry adapts, but Paul and Y seem to be ahead of the curve.

23 comments (comments are closed)

Geof Harries 04 Nov 05

With guys like Paul getting on his well-publicized soapbox about how to intelligently run a business, how are the leagues of fly-by-night Web 2.0 companies supposed to sucker VCs into injecting them with cash?

Thanks a lot, Paul Graham. Now what I am supposed to do with my beta RSS social bookmarking Google API mega app?

Barry Welch 04 Nov 05

Geof, perhaps you don’t know how VC funding works… but what Paul is saying in his article is quite positive for founders. In fact, he is saying that to remain competitive, VCs should pay founders some cold cash up front. Read the whole thing. Then you’ll feel a little better about throwing your alpha local quasi-social mashup into the ring. ;)

John 05 Nov 05

Barry - I get the feeling Geof was being somewhat facetious ;)

Dan Hartung 05 Nov 05

I’m not sure how Paul manages to hit them out of the ballpark every time. I suspect a corked bat, personally.

Anyway, no, I didn’t see him discouraging VC investment at all — he’s actually saying that the current regulatory environment is already discouraging or frustrating the VC market. It’s seemed like good news for founders right and left the last year, but a lot of that is acquisition — which isn’t usually what VCs want. If he’d expand on that point it might be a tiny bit clearer. But I saw it as him telling VCs that if they modify their strategy they can still invest successfully.

Barry Welch 05 Nov 05

John, I see what you mean, but really, how can you tell? :). We all seem to agree, in any case, that Paul Graham is awesome.

Daniel Schutzsmith 05 Nov 05

We are living in the time of the developer and its a beautiful thing. Thanks for making your contribution with Rails!

Geof Harries 05 Nov 05

Sarcasm is fun.

Shane 05 Nov 05

Hold on. Wasn’t DHH based in Denmark when the majority of Basecamp was developed? Isn’t that outsourcing? He wasn’t even a full-time Signal until Rails became huge.

I do agree w/ Mr. Graham. Rails is a great alternative to outsourcing. Most outsourcing providers take a while to adpot new technologies. So while they dabble in Java and .NET, we can keep banging out the Rails apps in record time.

Java guy 06 Nov 05

Keep banging out the todolists, everybody needs one!

warren 06 Nov 05

have fun with your edit-compile-run cycle, java man.

this is what you are, java man: a relic of an age gone by.

thank god we’ve evolved pass the age of the java man. :)

the image is at http://www.naturalhistorymag.com/0204/images/javaman4.jpg .

Comment 06 Nov 05

Rails works in India too.

Don Wilson 06 Nov 05

Why toss an app over the pond to a programmer body shop in India when you can do it here at home with one guy? That�s what Ruby on Rails lets you do.

As a PHP developer, I find that really, really funny.

Michael Ward 07 Nov 05

Why?

Rich 07 Nov 05

I wouldn’t count Java out just yet. As you learn Ruby and RoR, it becomes quite obvious that you can’t use it for everything. Trust me, the web apps my company makes could not be written in Ruby. Some jobs require much more flexibility than RoR can offer. Some jobs will get swamped in the complexity that comes with java web apps. You have to use the right tool for the job.

JF 07 Nov 05

As you learn Ruby and RoR, it becomes quite obvious that you can�t use it for everything.

Who said anything about everything? Nothing can be used for everything. “Everything” has never been Rails’ pitch.

Cooper 07 Nov 05

Jason, can you talk more about the “selling founder’s shares” option? How’s it work? If the founder gets the cash, how does the business get cash for growth? And don’t VCs want founders to “stay hungry”?

Cooper you’ll have to ask a VC about this. We haven’t taken any money or sold founder’s shares so I don’t know exactly how it works.

Any VCs out there want to speak up?

JF - my comment was specifically directed at…

…not at RoR. I am totally onboard with RoR and I am very grateful for your donation of it to world. People are doing great things with it. It is by far the best way to build a dynamic web app at this point.

I would wager that the people that bash Java as being outdated have experience developing web sites, but very little experience developing software. As you obviously know, there is a big difference. There is so much more to building software than just collecting form data and saving it.

My company develops custom web applications for lenders. When somebody clicks “Submit” in our applications, we have to pull a credit report, pull various public record reports, look up interest rates, run scorecards, make lending decisions, and much, much more. From this perspective, RoR just is not feasible option (yet?).

I AM using RoR for one of my side projects, and it seems to fit the bill perfectly. Doing this in Java would have been complete overkill. Like I said: You have to use the right tool for the job.

Don Wilson 07 Nov 05

Because every programming language has that feature. Rails is just an addon to Ruby, the basic language. PHP developers individually have their own type of system to aid in their speedy development. It just comes down to the point of would you rather make your own and know exactly what it does, or let someone else do it for you, wait for updates and rarely know all of the features.

Humphrey Bogus 17 Nov 05

Speaking as a VC:
Selling founders’ shares is just that—purchasing common stock (usually) owned by the founders for cash in a private sale. This money goes into the founder’s pocket (minus capital gains taxes), not into the company. It is typically a device to 1) grant the founder some liquidity and “take money off the table” vs. waiting to sell the entire company or take it public; 2) gain ownership in the company for the investor.

If the company sells additional shares to a new investor, the company gets the money and existing shareholders hold proportionally less than they did previously. If an existing shareholder (in this case the founder) sells shares s/he owns to a new investor, the money goes to the selling shareholder and other existing investors hold the same amount they held previously.

It is most often found in situations where there is a profitable business but the founder wants to partially cash out—eHarmony being a good example.