Paul Graham is famous for being ahead of the curve. After the first dot.com crash, he founded Y Combinator, an internet incubator, based on the fact that the startups he was seeing needed little more than than Ramen soup money to get off the ground.

Now he’s wondering if this economic downturn is going to deal a deathblow to the traditional VC model, something I’ve wondered. I think it is entirely possible. Entrepreneurs need to consider:

• how much revenue gets you to profitability?
• how much gets you to sustainability?
• what if you spend your time and energy getting to customer #1 and beyond instead of raising capital?

With the shuttered VC and credit markets, a lot more startups might be working on building their business rather than raising capital, and it might have unintended consequences. Graham writes:

The reason startups no longer depend so much on VCs is one that everyone in the startup business knows by now: it has gotten much cheaper to start a startup. There are four main reasons: Moore’s law has made hardware cheap; open source has made software free; the web has made marketing and distribution free; and more powerful programming languages mean development teams can be smaller. These changes have pushed the cost of starting a startup down into the noise. In a lot of startups—probaby most startups funded by Y Combinator—the biggest expense is simply the founders’ living expenses. We’ve had startups that were profitable on revenues of $3000 a month.

$3000 is insignificant as revenues go. Why should anyone care about a startup making $3000 a month? Because, although insignificant as revenue, this amount of money can change a startup’s funding situation completely.

There are some businesses that can’t be built without funding. There are many more that you can bootstrap if you’re willing too. Now’s the time to try. If you can get to sustainability without investment, you’re in the driver’s seat.

Today I came across a blog post by Steve Barsh in which he posted his slide deck from a talk he’s gave in SF recently.

Flipping through the deck, I came across one of the most straightforward and insightful presentations of the numbers that a VC is basing investment decisions on, often called “magic ratios.”

If you are trying to raise $2 mil from a VC at a $5 mil valuation, you will need to be able to show a path to a $100 mil exit in 5 yrs to show a 10x return assuming 50% dilution through future rounds.

The implication of this is very clear. It’s easy to talk about raising $2 mil, but you need to be focused on whether there is an exit for your company at $100 mil, and how you are going to get there. That’s what your VC is thinking about.

Check out slide 4 of the slide deck embedded below. Thanks for the insight & clarity Steve.

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