Did Facebook POP the Startup Bubble?

Startup incubator Y Combinator’s Paul Graham thinks Facebook’s (NASDAQ:FB) disastrous IPO may have hurt funding opportunities for other technology companies just starting out. Graham expressed his concerns in a letter sent to companies that are part of the Y Combinator startup program.

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… I had dinner recently with a prominent investor,” Graham wrote. “He seemed sure the bad performance of the Facebook IPO will hurt the funding market for earlier stage startups. But no one knows yet how much. Possibly only a little. Possibly a lot, if it becomes a vicious circle.”

Y Combinator provided early help to companies including Reddit, Scribd, Disqus, Dropbox, and Posterous.

“What I do worry about is A) it may be harder to raise money at all, regardless of price, and B) that companies that previously raised money at high valuations will now face “down rounds,” which can be damaging,” Graham added.

However, the investor did have a solution in mind: asking the companies to be profitable. “The best solution is not to need money. The less you need investor money,  A) the more investors like you, in all markets, and B) the less you’re harmed by bad markets,” he suggested.

“I often tell startups after raising money that they should act as if it’s the last they’re ever going to get,” Graham added. “In the past that has been a useful heuristic, because doing that is the best way to ensure it’s easy to raise more. But if the funding market tanks, it’s going to be more than a heuristic.”

According to Graham, venture capitalists and other financiers may only see major losses that have been made in the Facebook IPO and overreact. “The startups that really get hosed are going to be the ones that have easy money built into the structure of their company: the ones that raise a lot on easy terms, and are then led thereby to spend a lot, and to pay little attention to profitability,” he said.

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