Facebook's IPO will hurt startups, warns Y Combinator founder

(CNET) One of the most prominent people in Silicon Valley's startup world is warning that Facebook's disastrous IPO performance will lead to hard times for startups.

Paul Graham, the co-founder of the first and most influential startup incubator anywhere, sent an e-mail to his portfolio companies warning them that Facebook has made it a lot harder to raise money. Graham wrote that "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 went on: "That kind of startup gets destroyed when markets tighten up. So don't be that startup. If you've raised a lot, don't spend it; not merely for the obvious reason that you'll run out faster, but because it will turn you into the wrong sort of company to thrive in bad times."

In the e-mail, he said that he and Jessica Livingston, his wife and also a co-founder, had recently had dinner with a prominent investor who seemed certain that Facebook's dreadful stock performance would hurt funding for early stage startups.

"But no one knows yet how much," Graham wrote. "Possibly only a little. Possibly a lot, if it becomes a vicious circle."

Facebook's stock, which fell almost 3 percent Monday to $26.90, is now down 29 percent from its offering price of $38 a share. That's a huge sell-off in just 12 days of trading.

Evidence of fallout from Facebook emerged quickly. The travel listing site, Kayak Software, last week yanked its IPO plans, and a PC components maker, Corsair, did the same the prior week.

Even so, much of the early speculation - as I discussed in this piece - has mostly been about how the IPO would make it harder for companies seeking big valuations of, say, $500 million or more.

Graham has this advice for startups that haven't yet raised money:

If you haven't raised money yet, lower your expectations for fundraising. How much should you lower them? We don't know yet how hard it will be to raise money or what will happen to valuations for those who do. Which means it's more important than ever to be flexible about the valuation you expect and the amount you want to raise (which, odd as it may seem, are connected). First talk to investors about whether they want to invest at all, then negotiate price.

And his words carry a lot of weight in Silicon Valley. A spot at Y Combinator comes with smart money. Y Combinator puts in about $20,000 and three other investment groups - Ron Conway's SV Angel, Andreessen Horowitz, and Yuri Milner - each put in $50,000. So from the get go, a startup begins with about $170,000.

This article first appeared at CNET.