Top tier firms like Sequoia already have a de facto right of first refusal on the entire startup market. They already see every deal. So if Sequoia passing on a deal deterred other funds from investing, they wouldn't be able to invest in anything.
Which in turn is why Sequoia was willing to invest in us without imposing any conditions. Because the top tier funds already see every deal, it's in their interest merely to increase the number of startups, just as, because Google has such a big percentage of the search market, it's in their interest merely to increase Internet usage.
Sequoia does get an early look at all the startups, but this was not a condition of the deal. They always have. (All the speakers get an early look at the startups; it would be hard for them not to; and since winter 2006 the VC speaker has always been Greg McAdoo.)
My understanding of the Chris Dixon + Venture Hacks argument is: VC participation in a seed round means that they have a deeper understanding of the company than if they merely see a deal and pass on it. This implied deeper understanding gives them greater leverage in controlling the terms of a future financing.
So Sequoia passing on a deal doesn't deter other VCs because they might just say: "Well, Sequoia might not have given this deal enough scrutiny to see the value." But if Sequoia is already a seed investor, it is more difficult for other VCs to convince themselves of that.
Sequoia doesn't participate in the seed rounds in this case. They have the same relationships to the startups we fund that Sequoia LPs have to startups they fund. They're entitled to a percentage of our returns, but they don't pick the companies or own stock in them.
Also, within the industry the phrase "passing on a deal" does not mean anything as casual as it sounds. It implies that an investor has scrutinized it fairly closely and made a conscious decision not to invest.
Founders who can't take a "pass" and investors who can't stomach investing in one will not make it long term anyways. Those are just egos talking. Great teams will breed success and Sequoia is another great team to add to the YC concept.
>They already see every deal. So if Sequoia passing on a deal deterred other funds from investing, they wouldn't be able to invest in anything.
True, but you can't deny the fact that it's now more likely Sequoia will back YC-funded companies. As a result, other VC's will have some additional reason for concern when Sequoia doesn't invest.
you can't deny the fact that it's now more likely Sequoia will back YC-funded companies
Why should they be any more likely to back YC funded companies? They already funded all the ones they thought
were good enough.
Are you saying they'd now start to fund
borderline cases in order to increase returns from their share of our returns? If you run through the math it's obvious that would be a stupid move.
Why would it be a stupid move to invest in a company whose success would make you more money?
If I were Sequoia, choosing between two companies with the same credentials and equally good business models, I would choose the one backed by YC because its success could potentially make me more money in the long run.
Because if the startup wasn't one they'd have funded otherwise, it would be the world's most extreme case of throwing good money after bad. They'd be investing millions to improve their return on an investment of tens of thousands.
Welcome to the difference between theory and practice. In theory you are right. In practice you are not.
I don't know the terms of the deal, but suppose that Y-combinator had a 10% stake in a startup, and Sequoia gets 1/4 of that. Let's suppose you're looking at a round of financing that would dilute that ownership by half. Then Sequoia's investment amounts to an extra 1.25% stake in the company post deal. So if they could get a 50% stake in another company that has a 2% better returns, they would get a 1% better returns from the better company and a 1.25% better returns from their stake, and therefore should go for the Y-combinator company. Right?
Wrong. Sequoia knows that if they pass on something that is almost good enough for them, it is still likely to be picked up by someone else. (Particularly if they let people know that it was borderline.) So they have to think through the difference of having them versus the next VC investing in that opportunity. There is a difference, but it is not actually that big. Therefore even a 1% difference in the two companies should not change their decision.
And when they are making these decisions, there is no way they are trying to measure things to 1% accuracy. So the right thing for them to do is ignore their stake in the Y-combinator investment entirely.
It's not like Sequoia is capital restricted and has to choose between multiple good investments. They have way more money than good opportunities. If they see two companies that are equal they are probably investing in both or neither.
Which in turn is why Sequoia was willing to invest in us without imposing any conditions. Because the top tier funds already see every deal, it's in their interest merely to increase the number of startups, just as, because Google has such a big percentage of the search market, it's in their interest merely to increase Internet usage.
Sequoia does get an early look at all the startups, but this was not a condition of the deal. They always have. (All the speakers get an early look at the startups; it would be hard for them not to; and since winter 2006 the VC speaker has always been Greg McAdoo.)