Brave New World

Paul Graham, founder of the Y-Combinator accelerator, recently posted this piece about startup investing trends over the past 2 years or so. I recommend you read it in its entirety but here are some key points:

  • The initial costs of founding a startup are drastically lower today than during the dot-com boom of the late 90s.
  • As a result, there are many more startups being founded by young entreprenuers than in the past. On a related note, it is becoming increasingly acceptable to go the startup route right out of school as opposed to joining a corporate environment.
  • Since startups require less initial capital, the environment for angel investors is favorable with many more opportunities available and fewer restrictions.

There’s more but the points I listed are germane to what I want to write about. These trends (which are undoubtedly true) have strong implications for software engineers such as myself. Costs have been driven down to the point where a well-rounded software developer or a small team of just 2 or 3 can spin up a full stack web app with scalable backend and web/mobile client components for minimal upfront costs. As a frame of reference, my monthly operating expense for Butterfly Radio is about $20. The main expense is time and the opportunity costs associated with it. As the cloud computing environment evolves, these points become increasingly true as prices continue to fall and higher level backend services like Parse and Kinvey grow in popularity. Eventually, developing a full stack web app will be similar to setting up and installing a WordPress site – still a professional pursuit but requiring only a fraction of the technical sophistication a well-built backend demands today.

This is good news for software developers and bad news for idea guys and startups with no technical founder. With the prohibitive costs of managing dedicated servers with a system administrator practically eliminated, programmers can quickly put together a minimum viable product and validate their ideas without seeking investment or breaking their piggy banks. If the idea floats, they can iterate upon it and seek financing. If not, they probably lost no more than a couple weeks of spare time – if done right, the MVP should be bare-bones simple and shouldn’t take an exorbitant amount of time.

For the idea guy, it’s going to be a much tougher road ahead. Now that setting up a web app is fairly simple, it will take a lot more to convince good developers to join an idea person with no prototype, users, or financing. Someone in this position will basically have zero chance of convincing a good developer to join the team on an idea alone. Anyone he does manage to convince is probably not very good or extremely naive and will wise up quickly. The demands on the idea guy are now far greater. He has to bring much more to the table than what he considers a ground-breaking idea. Some combination of considerable financing and user traction will likely get a developer’s attention but without a prototype, it’s basically impossible to establish either one. As I see it, idea guys are SOL.

Funded startups have the advantage of money and hopefully, traction. These are still desirable positions for software developers but only if you are one of the founders or maybe employee 3-5. After that, the options packages usually range in the 0.5 to 2% zone for employees. I have been tendered three full time packages from startups that include vesting options (one of them was a convertible debt package so it was harder to price). The highest offer was 4.5% and the other two were around the 1% mark. This is before any additional dilution that would have occured during a series A or subsequent institutional rounds. Assuming your options were worth 1% of a company that exits for $100 million after 5 years – your portion would be theoretically worth $1 million which sounds great. But put differently, that’s $200,000 per year for 5 years. Most good engineers should be in the 150k range which is obviously less the $200k but remember, the scenario I decribed assumes a very nice exit and NO dilution. Most engineers consider options worthless and if they amount to anything, think of it as a bonus.

So what does all this mean? It means startups are no longer competing with other startups for talent. They are competing with the talent itself. I have been a contract engineer in New York City for 1.5 years now and have recieved several full time offers including options. The reason I have turned them down is because I still consider myself the better bet – as a contractor and hopefully running Butterfly Radio as a startup soon. Sure enough, one of the companies that extended an offer is already out of business. While I am still reasonably young and without major expenses such as a mortgage and children, I will continue to gamble on myself unless a company with an undeniable track record offers a substantial equity position to join them. I am not arguing that every software developer thinks this way and perhaps my risk tolerance is higher than normal, but the fact remains that on a macro level, the environment is now much more conducive to my approach as an engineer. On that basis alone, we can expect considerable changes to the startup battle for talent and the investment scene.