
Venture Firms Fret as Y Combinator Soars - samnm
http://news.genius.com/Eric-newcomer-venture-firms-fret-as-y-combinator-soars-annotated
======
grellas
Y Combinator is in itself a venture capital firm whose genius has been to use
innovative ways to capture and control deal flow for premiere startup
ventures.

Back in the day, top VCs would not be caught dead investing in an early stage
seed funding. It was considered undignified. These were the firms that managed
the best IPOs, that spawned the greatest tech ventures, that brought a value-
add to their portfolio companies that was beyond measure as they would bring
their formidable network of contacts into play for the benefit of their
companies. And in return for their conferring such benefits on the ventures
they expected to control things, or at least to have a formidable say in how
things went. Yes, at the time of a successful IPO, they would convert to
common stock just like the rest of the equity holders (though even there
usually with the privilege of exercising registration rights) but before that
they could and would exert liquidation preferences, conversion privileges, and
control mechanisms in ways that left no doubt that they had the final say on
most everything. And, if their interests clashed with those of the founders,
it was not the investors who suffered. Top VCs valued their reputations and
would tend to play it straight in not engaging in overt founder abuse. Yet the
institutional mechanisms often gave them overwhelming leverage that left
founders at a severe disadvantage: 2x, 3x, or higher liquidation preferences,
full ratchet conversion adjustments on down rounds, etc. Lower-tier VCs went
further and engaged in overt abuse on some occasions, to the point where the
name "VC" often would make founders shudder.

Before YC, the only investors who actually took only common stock for their
money were unsophisticated friends and family investors who didn't even know
what preferred stock was. When YC came along, it took only common stock for
its investment. Investors historically would look for ways to gain clout and
squeeze founders through tactics such as 2x or 3x liquidation preferences in
preferred stock rights, through lopsided conversion privileges used to wipe
out founder interests in down rounds, through control tactics by which
founders were put in defenseless positions and booted only to have the bulk of
their founders' stock bought back at forfeiture rates, etc., etc. The persons
being abused in such cases were primarily founders but the tactics wound up
destroying or seriously compromising the interests of anyone who held common
stock in such a venture. That sort of thing could prove very effective from an
investor perspective when founders had no choice but to submit if they wanted
the investors' money.

So founders basically had to come hat in hand to the VCs and play the game
strictly by their rules, which amounted to the rules of a stacked deck. There
is nothing inherently wrong with this. Money does indeed talk and, if founders
wanted to take several million dollars as an investment from someone, they did
what was needed to satisfy the investor requirements as they found them.

Y Combinator is an "accelerator" and all of that but what it mainly is is a VC
firm that made the critical decision to align its interests with those of the
founders right from the start.

So, out the window went the idea that a dignified VC would not soil its hands
with a seed-stage investment. YC invested right from the start.

Out the window went the idea that a VC would take only preferred stock for its
interest. YC took only common.

Out the window went the idea that a VC had to control the board, or at least
had to have shared control, or at a minimum at least one board seat. YC left
the board in the hands of the founders.

These innovations by themselves would likely have changed nothing but YC also
built an incredible following of top founders inspired by Paul Graham and
others who sought to build a network structure characterized by the highest
level of talent. This too worked and YC companies thus got access to a rich
treasure trove of resources that gave a value-add far exceeding that offered
by a traditional VC firm. This in turn established YC as an _omnium gatherum_
of much of what was and is best in the startup world.

With its interests largely aligned with the interests of founders, and with a
formidable array of top founders populating its ranks, YC has set rules and
norms for startup investing to which traditional VCs have had to yield if they
wanted to partake in the opportunities. These have consisted of a shaking up
of all the old assumptions of what VCs did or could do, with the result that
top VCs today will invest early and often in funding for startups right out
the gate, that top VCs will invest in convertible notes and convertible
securities (SAFEs) in ways that were once unthinkable, and, of late, that top
VCs (and other investors) will have to abide by some founder-friendly rules
about whether or not they are permitted to use high-pressure tactics in
structuring their offers, in whether or not the are permitted to yank term
sheets without consequence, and in many other areas as well.

I have no doubt that YC did all this for its own interests as well as for a
broader goal of using its investments to further its idea of the startup
ideal. I also have no doubt that this phenomenon is fueled by broader
developments by which founders are now well-connected and able to know and
understand what is going on in ways that founders in, say, the 1990s had no
clue about. None of it would have worked otherwise. Yet, founders are now
well-connected, they know a sucker-deal when they see it, and they know value
when they see it.

YC does not offer value for everyone. Many founders have no desire to give up
7% of their company for a little cash and access to the YC network. But, for
many (and especially younger) founders, the value offered is phenomenal.
Hence, the huge YC draw of top-talented founders. And that is where the action
is. If the traditional VCs want a part of that, they perforce must conform to
YC's expectations and founder-friendly rules. And they have done so.

Top VCs will continue to have enormous clout. But it is no longer lopsided the
way it was a decade ago and before. It is now far more balanced and one of the
big reasons is that a different style of venture firm in the form of YC came
along to set new standards that now govern a big part of how the game is
played. YC rethought the rules of being a VC and did it radically differently.
It has paid off. The venture business will never be the same again.

------
chaostheory
This is what happens when (as an industry) you don't treat people well, when
you feel have the power to do as you please. Let me explain: pre-Ycombinator a
lot of VCs would routinely either abuse or just simply ignore a lot of
entrepreneurs. Someone can correct me but YC was a response to that. One
reason everyone flocks to YC is because everyone knows that YC is fair and
trustworthy. That's not the case anywhere else (at least back then).

~~~
ChuckMcM
Actually angel investing was the response to that, individuals who weren't
wealthy enough to join a fund and become an LP but had enough disposable
assets that if they put $50,000 - $1M at risk it wouldn't ruin their
retirement if they lost it all.

One of the things that I haven't read about is what is the 'YC' of movies? In
many ways the money in Hollywood is there but there isn't nearly the
organization like there is at startup incubators. There are so many
corollaries between the two environments I would expect something between the
studios and Kickstarter to have emerged by now.

~~~
bellerocky
Individuals have a lot of sway in Hollywood. It's all star power. Money and
talent flock to the stars, and by stars I include producers, writers and
directors in addition to actors and actresses. They make money and are
prestigious to work with, especially if the movie is successful. In addition
to individual behavior there are also the various unions like the Writers
Guild of America, the Screen Actors Guild, the Directors Guild of America and
organizations like the MPAA and AMPAS and in television ATAS which all wield
considerable influence and money. Though it is TV and not movies, Netflix
succeeded because it played by their rules.

You can't just disrupt this because it's more than wealth, it's a culture that
has been around many generations now and created film making what it is today.
There's an incredible gravitational well that sucks all the incredible skill
and talent found in the world right into Hollywood. It's not going anywhere.

~~~
ChuckMcM
You could argue its all 'star power' in the valley too, money and talent do
seem to follow people who have a couple of big exits on their resume. One of
the differences though is the artistic element. Engineering startups is an
'art' but it isn't the kind that brings out the 'artist temperament' as some
refer to it.

I don't have enough real knowledge about how that gets done so I can't really
say if such a thing could happen, but I do see a lot of similarities between
Bay Area culture and So Cal culture which are both warped a bit by their
respective economic engines.

------
coffeemug
I don't think traditional VC firms are competing with YC at all.

There are two "black holes" in venture capital right now. One black hole is YC
+ angel investment. When you're getting started, it's pretty much standard
practice to go through YC and/or raise seed capital from angels to get your
startup off the ground.

The other black hole are a few top VC firms (off the top of my head, a16z and
Sequoia). These firms pretty much figured out that it's impossible to predict
success, so they're putting large amounts of capital into companies that are
already succeeding. They've essentially eliminated guessing; they can get away
with it because they established themselves as _the_ VC firms you go to if
your company is succeeding (so they have no issues with deal flow).

Then there are traditional VC firms in the middle, who can actually operate by
perpetually losing money due to a slightly weird wider financial climate and
the incentives of their LPs (see
[http://pmarchive.com/truth_about_vcs_part1.html](http://pmarchive.com/truth_about_vcs_part1.html),
[http://pmarchive.com/truth_about_vcs_part2.html](http://pmarchive.com/truth_about_vcs_part2.html),
[http://pmarchive.com/truth_about_vcs_part3.html](http://pmarchive.com/truth_about_vcs_part3.html)).

So everything is much more complicated (and much more interesting) than the
original post would lead you to believe!

~~~
billyhoffman
uhhh, I think you mean "funds" not "firms." Defining 3 regions and pigeon
holing firms is too much of a simplification of VC markets.

Firms raise funds, that can target specific markets/verticals, as well as
company size/maturity.

a16z is a firm. They have multiple funds, including a seed fund, surprisingly
named "Seed" which competes directly with YC.

[http://a16z.com/portfolio/](http://a16z.com/portfolio/)

Some Firms have only 1 fund. Firms manage and guide their funds, and charge a
management fee. While managing a fund is a largely personal intensive
business, much like consulting, there are some economies of scale which is why
many Firms will have multiple funds. This also further protects against risk.

YC and other accelerators are Firms, potentially with multiple funds, but all
of their funds are at the low/angel end.

------
jacquesm
Network effects at work. VCs will probably not find it amusing if - and of
course when - they realize that _they_ have been disrupted. But it is a funny
kind of poetic justice.

Everything, even capital markets can be disrupted (or at a minimum greatly
shaken up) by a dedicated player with a technological advantage.

And once the network effects kick in you're going to have a very hard time
gaining back lost ground.

I predicted YC moving in on capital providers a while ago and I expect that
trend to continue once YC has cashed out on their first batch of major hits.
They'll be so flush with money that the only reasonable way to use it will be
to do their own series 'A'.

Right now that's not in the cards and they should probably deny such a
possibility as strongly as they could. But once the money is in they're going
to be very much tempted to broaden the scope and become a two stage rocket
even though there are obvious drawbacks to that strategy as well.

~~~
agwa
> They'll be so flush with money that the only reasonable way to use it will
> be to do their own series 'A'.

The other way to use that money would be to have gigantic batches. Remember,
pg and sama have said that they're trying to build something akin to a
university with Y Combinator. Using their money to do series A's instead
(which is what other accelerators are already doing) would just be so
conventional, and not what I'd expect from an organization as innovative as
YC.

~~~
outericky
This. I'd think batches with 200 (500? 1000? startups) will come before Series
A's. If only on principle.

~~~
jacquesm
With batches that large the positive effects of the 'classes' model will
vanish, it will also require a much more efficient way of processing the
applications and that will lead to (percentage wise) more rejections of good
applicants.

YC is as good as they are because they _really_ work hard on processing those
applications and even though it is software assisted it is still to a very
large extent handwork.

~~~
walterbell
Yes, this leads to philosophical questions about the relative compounding of
labor, creativity, capital and future-constraining financial instruments.

------
staunch
YC doesn't have anything like a monopoly on great startups. If investors can't
find their own great startups they don't deserve to be successful as
investors.

What all SV investors should be worried about is crowdfunding. Most of them
don't have anything to offer beyond money and that doesn't count for much if
users pay millions in advance.

Oculus took VC money but you can bet it was on incredibly advantageous terms
due to their millions in kickstarter revenues. A16Z was merely the strongest
among the weak and paid for the privilege of investing.

The fact that Oculus was immediately acquired for billions by a company Marc
Andreessen sits on the board of is not necessarily a good outcome for the
world. A fully crowdfunded Oculus may never had chosen that route.

~~~
ig1
Except a16z was their Series B investor, Oculus raised their Series A from a
bunch of mid-tier VCs which implies it wasn't a hugely competitive round hence
probably wasn't on particularly favourable terms.

By the time a16z invested Oculus had John Carmack as CTO and they already
demoed to huge interest at E3. It was already a much later stage company by
that point.

~~~
staunch
Their Series A was $16M at a likely ~$100M valuation. Incredibly successful by
any standard and only possible because of crowdfunding.

------
nl
How does Genius get away with copying an entire (paywalled) article with a
single link back?

Perhaps the commentary is transformational enough to make it arguable legal,
but it seems entirely wrong to me.

~~~
walterbell
Would it be sufficient to add a Disqus widget to the article? If so, why
couldn't reddit or HN repost entire articles? Perhaps The Information has
licensed their content to Genius, in exchange for visibility and branded
commenters.

In-place annotations are part of ongoing work at W3C
([http://www.w3.org/2014/04/annotation/](http://www.w3.org/2014/04/annotation/)),
and will allow bring-your-own-annotation servers. Genius.com wants to
"annotate the web", making the site a possible future HN substitute. Does
Genius.com plan to license guest posts, until such time as content providers
enable 3rd-party annotations?

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jaksmit
How does copyright work in a situation like this then? You're taking a
paywalled (expensive paywall at that) article and posting it elsewhere. How's
it not copyright infringement?

~~~
timcederman
I'm guessing it'd be claimed as fair use because it's transformative.

~~~
walterbell
Because of the annotations?

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nostromo
I don't use Rap Genius often, so I almost missed sama's responses.

Be sure to click on the annotations to see them.

~~~
pconner
I use Genius almost exclusively for its rap annotations, so reading news on
this platform felt strange to me. While I can definitely see its merits for
lyrics/poetry, I'm not sure how much I like it in this context. I think that
expository/news articles should be written well-enough that annotations (other
than hyperlinks, I guess) are unnecessary.

~~~
terravion
The point of this annotation was for someone who disagrees with the author to
offer a point by point take down in the context of the original article.

You could understand the article (at least the view the author wants to
promote) just fine without the annotation--the annotation provides a
counterpoint that systematically undermines the premise of the article. [edit
spelling]

~~~
seats
Agree! I was going to reply to some of Sam's comments, but stopped because
this is not at all what Genius was designed for and my reply to his comments
wouldn't fit the UX.

~~~
yuhong
Did you notice the comments button?

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sparkzilla
Worst user interface on the planet.

~~~
Crito
Insanely laggy in chrome on an S5. Really no excuse for that when I'm only on
the page to read a few paragraphs of text...

~~~
exhilaration
Works fine on an S4 in Chrome as well.

------
wlucas
It's hard to believe credible venture institutions would be upset by these
moves. I can't speak on specific deep-pocketed VCs who offer nothing more than
cash -- which is not what most startups need. However, firms that offer
nothing more have their fodder here to complain here as they'll have to rely
on real value also to keep them in play. They'll be forced to step it up.
Reminds me of Jay Z's quotes on sports agents:

[http://profootballtalk.nbcsports.com/2013/07/12/jay-z-
says-h...](http://profootballtalk.nbcsports.com/2013/07/12/jay-z-says-hes-a-
problem-for-agents/)

------
mathattack
"So it shouldn’t be surprising that venture capital firms are starting to
worry that YC might start elbowing into the capital allocation part of the
businesses."

It seems like YC currently doesn't have the whole Investor Relations
infrastructure (or mindset of dealing with pensions) to get into the mainline
VC business. I do think they are protecting their franchise against poor VC
behavior though.

------
ericvorheese
_This “signaling issue” is a huge problem, by the way—accelerators that do the
Series As for their top 3 companies deeply wound all the rest._ \- Sam Altman

How is this different from a VC firm like Andreessen doing Series As for their
top 3 seed companies? Isn't signaling part-and-parcel of the startup economy?
Why should YC be worried about signaling when a firm like Andreessen isn't?

~~~
ig1
It is an issue. It's even worse for big VCs because they have the funds to do
the follow-on for any seed company they think is doing well. So it's not just
a signal of being "top 3" it's a signal of being good.

[There are other reasons why VCs chose not to do follow-on, such a conflicts-
of-interest, disagreements on valuation, etc. but any other VC you speak to
will ask you why your seed investor isn't following-on]

Founders will often take money from seed-only funds or will take money from
several multi-stage funds in order to mitigate the signalling risk.

------
myleskeating
Genius seems to be getting a lot of hate here and I'm not sure why. The UI is
certainly odd. To me, it feels like the design is trying so hard to be
futuristic and "cool" that it trips over itself and loses some ease of use.

But come on, you can get over that, and to me this was the first use of Genius
I've come across where I thought "Damn that was cool, I'll have to use this
for more than the occasional lyric."

This was really cool to me because it provided an interactive forum for
multiple relevant parties (Sam Altman and Marc Andreessen) to have a debate.
I'll get over the funky UI for that content any day.

------
foobarqux
I hope genius isn't the future of writing, that was painful to read.

~~~
tdurden
I couldn't even get through it

------
oakleygolf
I think VCs are used to being the only guys on the block and don't like that
they aren't fully in control any more. It's the same thing that has happened
to Wall St. But different in that the VCs had even more control and some back
room deals going. YC isn't the the real issue. They are providing a good
education and strong ideas which help to prove them to be the best of all the
accelerators out there today.

------
precyse
I really like to see one day YC goes for an IPO of its own. As long as YC
keeps it's process transparent, it is really hard to beat them. As you grow
YC, keep it fair and honest. Don't give into any bias.

