The startups that are lucky enough to secure funding usually go through long grinds and often heavily dilute themselves prematurely for relatively small sums of capital. It is also common to find onerous investment terms in funding agreements.
Are investments too large?
Against this context, Surge is likely to be seen as a godsend by early-stage entrepreneurs. A large investment with a low dilution at terms that are standardized and therefore likely to be more equitable. Soft benefits such as access to marquee mentors within the Sequoia portfolio and the cohort community will lead to compounding network benefits a la the YCombinator “mafia”. This will, over time, prove invaluable to the participating startups.
This is not to say that there are no risks.
$1.5 million is a lot of money for a seed-stage startup, more so in India where there are Series A rounds that are smaller than this sum. Startups could use this extra ballast to fuel their ambitions over a longer runway and focus on more meaningful metrics and go-to-market strategies or they could just as easily be tempted into following dark patterns by overhiring, overspending or over-speeding.
Secondly, a high initial valuation moves the bar for a follow-on funding round much higher. For instance, the seventeen startups in Surge’s first cohort have raised a total of $36 million ($25.5 million from Sequoia and the balance from co-investors and angels) at an average equity dilution of 15%.
This translates to each startup having an average post-money valuation of $14 million. An extremely high figure for a startup that is probably pre-product, much less pre-product-market-fit. It also mandates that any follow-on round will have to happen at a pre-money valuation of $30 million or thereabouts (greater than 2X the valuation of the previous round)—there have only been a few dozen Indian startups that have successfully raised money at valuations higher than this. In addition, there is a significant signaling risk if Sequoia itself is selective about participating in the follow-on rounds of Surge graduates.
But all of these are probably risks that most early-stage startups would be glad to take.
This would mean that it should be easy to call Surge a disruptive game-changer.
If not for one fly in the ointment.
Black Swan Farming
The economics of VC investing is a power-law. The majority of returns are delivered by Black Swans—the 1% outliers who individually return an entire fund to a VC.
Surge’s mechanics seem to operate on the same playbook. The 17 startups that were finally selected for the first cohort had to stand out in an application pool of over 1,500 submissions—a 1% chance right at the get-go. It goes without saying that to stand out in such a large group, these chosen startups would have to be outliers or exceptional in one sense or the other.
This means that the chances that these companies would get funded anyway, with or without Surge, are likely to have been extremely high in any case. This means that the net additions to the list of funded startups are likely to have been minimal.
The metrics and dimensions along which Sequoia must have measured these startups against are also likely to have fallen under the same investment criteria that they would have applied to companies who apply for funding normally.
Farming optimized for the startups who get everything right and bear good prospects for raising the next round of funding. It means that the real “moonshots”, ideas that seem crazy and downright unfundable at first glance, are unlikely to have been backed.