And that's not including the risk premium and required risk-free return, both of which have been implicitly priced into the contract. To stay competitive, VCs often require an expected annual return on new investments of 30-40%. Because YC invests at such an early stage, I would suspect that their required return should be much higher.

A 50% discount rate would lead to significantly larger average valuations @ 5% equity ($15k invested): $450,000 after first year; $675,000 at second year; $1 million at third year.

Since any later financing would dilute their stake, the expected post-money valuations should be even larger.

OH MY GOD! Its like you're brainwashed!

Let me ask you this- - you're buying a car. You're going to use this car to deliver papers and make some money delivering pizza on the side. You're going to build a little business here that's worth 10 times the value of the car after a year or two.

Do you go to the bank who gives you %100 of the purchase price of the car in exchange for %9 interest each year? Or do you go to the local loan shark who charges you ("to stay competitive, of course") %30-%40 of the value of the loan, plus-- if you decide to sell the car-- 4 times the value of the loan at liquidation?

YC says you go to the loan shark and pay %400 for your money.

Slashdot "Trolls" say "that's way too much"... and you think they are engaging in bad math?!?!

YC doesn't say that. YC isn't competing with the larger VCs, and as far as I know large VCs wouldn't deal with a company the size of a YC candidate. Also, the bank isn't giving you a list of customers whose credit card statements show pizza and newspaper purchases in the last year.

Your analogy doesn't work; YC is buying equity just like anyone else. They're getting it cheap because they're paying for a couple undergrads to work for the summer -- your analogy would work if the bank would only give the loan if you had an established business and promised to work full-time for years.

Since we have the math, there's no reason to make up emotionally charged analogies. YC values these companies at somewhere between $100K ($10K for 10%) and $1.5 million ($15K for 1%). They do some legal work, and offer lots of advice and connections. Obviously, this isn't a good deal for everyone (given the industry I'm in, for example, I'd probably pass on YC), but if you're having trouble understanding why anyone would accept it, you may just have trouble thinking like a smart, ambitious, well-informed twenty-something.

And judging by the quality of your writing, age is not what sets you apart.

My analogy does work, but I wasn't talking aobut YC, I was talking about VC. I wasn't saying the YC model was broken, I was saying the VC model is broken.

This is not an "emotionally charged" analogy, it is exatly correct. This is probably not apparent because people tend to ignore the cost of VC money.

"And judging by the quality of your writing, age is not what sets you apart."

Seems all you got is insults... great argument technique.

As someone who's double majoring in Economics & Commerce with a double concentration in Finance & Accounting while simultaneously pursuing a masters degree in Accounting, YES you might say I'm brainwashed.

However, society brainwashes us all in some way - don't you think?

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OK, let me try to condense 4 years of finance education into few paragraphs, so that I can point out the fundamental errors you're making:

First, you have to understand the capital asset pricing model (CAPM): E(r) = B(Rm + Rf) + Rf

E(r) = Expected return; B = beta = the risk of a firm; Rm = the market risk premium; Rf = Risk free rate

OK, so the capital asset pricing model basically states that the riskier the investment, the higher the return the market will demand. This makes sense. Investing in McDonalds is much safer than investing in Justin.TV, because you're almost guaranteed that McDonalds will be around in 5 years.

This is why VCs demand a 30-40% expected return - because there's a very high risk the companies will fail. This isn't "unfair" - this is how the stock market, and the rest of the financial world, works. When you buy a stock, its price has been shown to correlate to the expected risk. Higher risk stocks earn a higher return, as predicted by the CAPM.

Now, I think you're confusing debt with equity. Of course you could take out $15,000 of debt for 9%, but you're entering into a contract to repay it. If you don't, they get your house, car, etc. This is why the debt isn't as expensive - the bank knows they're getting their money back, one way or another. The bank is using the same CAPM calculation, except with a lower beta.

Finally, if you choose equity, you obviously will want to go with the firm that values you the highest (and gives you the best deal). The argument I was making is that YC already values these startups at a very high level. It's not very often that someone will value 3 months worth of your work for $332,000K [($15K/5%) x (1.5^0.25)].

You're still missing the point. The biggest advantage of YC is advice and connections. (Actually, I suspect an even bigger advantage is a supportive peer group and a sense that you don't want to let your investors down, but nobody's mentioned that yet.) That's worth a lot more than a bank loan, because it's a lot more than money. A bank loan for $15,000 will not increase your startup's chances of success nearly as much as being accepted to YC.

No, you're missing the point. I wasn't arguing against YC, but against VC money.

YC doesn't have liquidation preferences, and if it did, the multiple of $20k would be so small its not really relevant in this discussion.

Why the "YC says you go to the loan shark and pay %400 for your money" then?

Because those are the terms that VCs offer, and the YC program is organized around getting a VC investment

Firstly, that's not my impression of YC. Reddit took only angel funding before being acquired. Very few of their startups actually seem to take VC: the ones I can think of are Loopt and Scribd. Most use angel capital only. If you actually had paying customers at the end of the 3 months, I doubt YC would object to simple revenue-based growth.

Secondly, what do you propose instead? Most banks will not give bank loans to revenue-less Internet startups, because they have no guarantee of being repaid. Bootstrapping off savings is ideal (it's what I'm doing...), but not every idea is bootstrappable.