
Y Combinator cuts its pro rata stake and makes later investments case-by-case - jmsflknr
https://techcrunch.com/2020/04/16/changing-policy-y-combinator-cuts-its-pro-rata-stake-and-makes-investments-case-by-case/
======
jypepin
YC is supposed to be an exclusive program funding companies they believe will
work.

I find it interesting that they choose to change their investing program
instead of changing their application program. Why not keep the program
smaller and more exclusive instead?

~~~
nogabebop23
Because they want to have their cake and eat it too. YC has followed a similar
trajectory to many successful tech innovations. A novel approach that has
aligned goals with their clients, strong & visible leadership, a huge emerging
market, an appetite for a new approach - we're now essentially 2 generations
of leadership removed from PG & co and while I have no doubt the people in
charge are very smart and good at VC'ing, YC is now a totally different beast
from 10+ years ago. It's motivations, goals and practices have changed and I
have no doubt the next incarnation will come along and eat their lunch too.

~~~
Harj
In what ways does it seems the motivations and goals have changed? I’m
particularly interested in this as I just rejoined YC as a partner after
running a startup for five years. I first joined as a partner 10 years ago.

~~~
felipellrocha
For starters, back in the day, YC was mostly seen as a place anyone could get
funding and build a great company whether or not they had a great network.
Nowadays, it seems more and more like having that network is the primary thing
that gets you in YC.

(Not a criticism, and I can see the merits of that choice. But, when I talk to
my friends about YC that usually comes up.)

~~~
chii
> YC was mostly seen as a place anyone could get funding and build a great
> company whether or not they had a great network.

that's likely because before the success, there was no way anyone with the
network would come to YC as a first port of call. And with technical partners
able to judge the incoming seed company on the merits the founders themselves,
YC managed to pick the successful ones (mostly - obviously there are
failures).

When the success of YC's model became so prominent that it is a culture all on
its own, the technical partners no longer work the same way as the old way. I
don't think it's possible. So network, and human capital is used as a filter,
rather than deal with the massive amounts of no-name people.

~~~
dannyw
I mean, your explanation makes sense, but fundamentally YC felt a lot more
meritocratic and open back in the smaller days.

------
sudosteph
I'll disagree with some of the other comments here and say I'm very happy that
YC made this change instead of shrinking class size. YC is still one of the
most exclusive programs around, and always will be. Anyone who has the
privilege of attending will always have an advantage over those who don't -
even if it's just because they'll learn from the best and make great
connections. Follow on funding is great, but with how inflated some series A
valuations have been lately - it's just too costly to the core YC program to
keep doing that type of funding indiscriminately. I'm sure this was a
difficult decision to make, but it feels consistent with the YC mission. And
it seems like the right thing to do.

------
tptacek
Refusing to commit either way until a lead investor term sheet happens seems
like a clean way to mitigate the signaling risk. What am I missing about that?
If that works, couldn't YC have always picked and chosen investments to follow
on with?

~~~
daniel_levine
Overall, it's a solid solution. Some hiccups: \- It's common for new investors
to ask about pro rata ahead of writing a term sheet (can impact the investment
case/deal). \- Especially in difficult times, new investors might invest under
the condition that existing investors do their pro rata.

~~~
mrkurt
Hopefully YC has enough power to slap firms around if they try and slip a
contingency on YC pro rata into a term sheet.

~~~
daniel_levine
No firm does, especially in a tricky environment. That's a wild comment to
make...

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timavr
The problem here is that everyone will know if YC will follow up or not during
the process.

Investing is game of information. If an investor can’t figure out who else
will be on the cap table, they have much bigger problem.

The way it is going to go down is that investor during meeting will ask if
founders think YC is in that round. If founders say something along the lines
of YC decides after term sheet, it basically means no.

In the end , the overall result is that less YC companies will raise, but the
good once still will, but it was always the case.

~~~
smallgovt
> If founders say something along the lines of YC decides after term sheet, it
> basically means no.

Why would it basically mean no? It seems like the new policy makes the answer
"Maybe, and there's no way to find out until a lead investor has signed on the
dotted line".

~~~
timavr
YC partners doing a lot of introduction during the fundraising process.

It puts them in a tough spot. If YC partner writes to an investor, this
company is awesome, plz invest and then investor asks if YC is going to
invest?

And they get back, you commit first and then we decide, it just doesn't
look/sound good.

It is important to remember is that a lot of companies in YC batch fundraise
on SAFE, so when a priced round comes along probably 90% of them are not even
in a position to fundraise, because a product didn't work out, team issues
etc.

Also, there is YC Series A program which basically is going to be the sign of
approval for investors and I am pretty sure YC is going to follow in 100% of
cases for that one.

~~~
vikramkr
If they just do that for everyone and get a reputation for sticking to writing
back that they wont decide until you've committed though, that would mitigate
the signal

~~~
IMTDb
As an investor, if YC contacts me with a "great investment opportunity" and
does not invest themselves even tho I _know_ they could have, the investment
better be successful. Because otherwise, I will feel cheated on. "Do as I say,
not as I do" type of relationship is not exactly what I am looking for.

In the previous system, they had skin in the game, they literally were putting
money where their mouth was: same companies, same valuation. If I make money
they make money, if I lose money, so do they. You can't beat that.

------
quezzle
There used to be prestige, mystique, exclusivity, and desirability associated
with being a YC company.

I kinda feel now it’s just become a numbers game machine.... back as many as
possible, some will win. There doesn’t see anything special about the
investors or the investors in this model, it’s just about churning out as many
companies as possible and playing the numbers.

Am I right or being overly cynical?

~~~
gbronner
I got the sense that the personal and network support given initially might
have been worth 7% of the company (especially for founders who needed that
kind of advising), but the partners' ability to add value has gone down
recently, making follow-on investments less likely to succeed.

------
vikramkr
Is waiting to see a term sheet from a lead investor enough of a move to
mitigate concerns about optics? I'm not too familiar with the series A process
- is the round basically over by that point? Or is there still work to do in
assembling the rest of the syndicate or an opportunity for the term sheet to
be revoked? It seems like no matter what, the continuing desire of an early
investor to participate on follow on rounds is a strong signal to future
investors about the company (especially if it's a prominent early investor
like YC) - and there will be a lot of incentive to acquire that sort of
information before the funding round is finalized.

------
crazypyro
So now if you are a YC company and YC declines to invest, every other investor
loses out.

Does this not strongly dilute the power of being in YC? Seems nuts to me. Why
not just shrink the number of incoming companies?

~~~
mattmireles
No, the opposite. Every other investor wins because they can invest more $$$
and own a bigger % of the company. Before, YC had a right to maintain its 7%
stake, leaving less room for new investors to acquire ownership.

~~~
chii
if YC doesn't invest, won't that be a signal that they don't believe the 7% is
worth it?

it makes it hard for startups that would need more money to prove their
profitability to lose out on new rounds, or have to give up more for those
rounds (as investors will need better incentive to invest without the YC
signal).

------
euix
I am having thinking about doing a startup for a while, whatever trips me up
is how to go about acquiring customers short of cold calling. Are incubators
helpful in introducing you to potential clients? Especially if your product is
b2b or enterprise, having worked in large corporate enterprises I can't
imagine how it works to get your foot in the door.

~~~
sbarre
If your product is Enterprise or B2B, you need a few things (in my
experience):

1) A first client to take a chance on you, because no one wants to be the
first client, very few companies will buy something that no one else has
bought. In my experience your first client (or first few) is the result of
some existing personal connection to the client (i.e. a favour/referral), and
expect to be at their beck and call for a while, and probably take a bath on
the price.

2) You need an experienced sales team that knows how to sell to
enterprise/B2B. This is not something you can "pick up" or learn on the job
(or at least is very difficult to do). You need to hire someone who has done
it before, otherwise you will stumble and spend your way through months-long
sales cycles only to have them fail at some late stage because you didn't know
how to prepare.

3) You likely need standards certifications and third-party testing. Look into
ISO 27001 and other similar standards if you're a software company. Get third-
party security testing done up front. Have pre-written answers and "white
papers" around privacy, data governance, scaling, deployment, etc..

I've been on both sides of selling into enterprise and medium/large B2B and
it's a solid 50/50 mix of your actual product capabilities and your company's
ability to navigate procurement and due diligence.

~~~
ghiculescu
#2 and #3 are probably true for enterprise but definitely not true for SME
B2B. Source: we’ve been targeting that niche (15-500 employee companies) for 8
years. Have made two experienced sales hires both in the last year, and dont
have any standards certifications. Most businesses are very reasonable and
just want you to solve their problems.

~~~
sbarre
Fair enough, I was definitely thinking medium-size B2B and up, where the
people you're dealing with while trying to sell the product are (probably) not
the internal stakeholders who want to buy it (i.e. procurement, IT/security,
etc)

It also depends on what you're selling of course. My experience is in data
management solutions (including PII data), and standards/requirements can be
pretty demanding in that world.

------
jayzalowitz
This has major signaling issues. That being said I understand it.

------
mattmireles
Is YC cutting prices? Is the new YC deal $150k for 4%?

The article suggests that YC is reducing its stake to 4%, however the quotes
presented don’t seem to be really saying that.

I’m not sure if this story is a technical announcement about how they handle
pro rata, or an updated version of the YC Deal for newly admitted startups?

~~~
snowmaker
No, this is a smaller and more technical change. YC's standard deal ($150K for
7%) isn't changing. This is about how we handle pro rata investments.

------
new_realist
YC was always about exploiting the startup mystique by creating a sweat shop
of fruit fly startups, some of which will make it big by sheer dumb luck. It’s
the index fund of the startup scene, but naive new grads who can’t get
audiences with first-tier VC firms still fall for it.

~~~
gowld
Have any of the founders that made it big and exited rich turned around and
said they feel ripped off by YC?

~~~
skolsuper
How many lottery winners feel ripped off by the lottery? Not agreeing with the
GP comment but your question is just silly

------
DrNuke
It does not change much for the two very ends of the spectrum, that is the
solo-hero bootstrapping from scratch and the moonshots however needing a lot
of cash... while anything in the middle gets squeezed if not profitable on its
own. Good to me as an observer: less serialization and templates, more
unorthodox and fun.

------
xwdv
This might be an unpopular opinion, but I think YC’s days are numbered, as are
many other startup accelerators, and this is just another sign. The model is
breaking down and isn’t really up to date with the way startups develop these
days. And with the raging bull market of the 2010s winding down, it’s clearly
looking like the end of an era.

Without another entrepreneurship catalyst (in the early 2010s it was the rise
of mobile app markets and social media) we are unlikely to see the return of
the accelerator model in its full glory.

------
threeseed
I am actually surprised they were doing this at all.

They have no obligation to support the startup beyond the initial 7%
investment more so for the Series A. Companies who can't stand on their own
two feet and raise money on their own simply don't deserve to survive.

I actually wish YC would take it a step further and offer an option where they
don't invest any money at all. You participate in the accelerator, have access
to their resources, are part of the alumni but simply don't accept the $150k
and 7% equity dilution.

~~~
goatherders
YC is a for profit entity. Why would they offer a free cup of coffee much less
access to the resources and network if they aren't getting anything out of it?
I like YC and enjoy HN, but the altruism comes after the profit (as it
should).

~~~
threeseed
I should have clarified. I meant an option where they take some fraction of
7%. Not sure whether this is necessarily a great deal for YC or not. Depends
how cheaply they can raise the $150k they need for each company in each batch.

I just know for many startups like mine $150k is basically worthless. It's not
enough to hire and you just stay somewhere cheaper and commute into YC for the
program.

~~~
anticsapp
You're right. A no investment incubator would kind of suck but there are pay
to play incubators?! Reverse investing? Makes no sense, but your scenario
would be better than that. Nothing wrong with a Harvard scholarship.

~~~
travisjungroth
There are few government run 0% equity accelerators. Start-Up Chile gives $35k
in reimbursed expenses and six months of office space + mentorship. Their hope
is you stay in Chile and they make it back in taxes.

------
sandGorgon
My prediction here is that for natural and totally understandable reasons, it
will be hard to gauge the investability of international companies vs US
startups.

So over a period of time, we might see prorata moving to US startups fairly
naturally . Given the other issues around travel in a post-COVID world, this
will might to a return to US centric portfolio allocation.

------
say_it_as_it_is
This could be a result of a failed investment strategy by YC or insufficient
interest by investors to raise additional investment for new funding. I
sincerely hope that it is the latter and not the former. The latter can be
addressed far easier.

In 2017, it was announced that YC was trying to raise a Billion dollar fund.
How did fundraising turn out?

------
ausjke
Can someone put this whole piece into plain English, e.g. we're going to fund
less startups? or no more 150K for 7%, now it's 100K for 4% or something like
that in the first paragraph? I have no idea about "pro rata stake", or what
"case-by-case" exactly different from what it has been doing.

------
brenden2
I don't think there's any opportunity anymore. The market is super saturated,
capital has dried up, and only insiders have a shot at funding. The cards are
stacked against outsiders.

I've lost hope on the Silicon Valley dream and decided to just use my big
brain to make money in public markets, which is surprisingly easy given how
much effort the government puts into pumping up the stock market.

I used to think YC was great, I applied several times, but YC doesn't really
represent what it used to anymore (to me at least).

Just my 2 cents.

~~~
harryh
The coronavirus situation has certainly altered capital markets but outside of
that your comment doesn't conform to the data. There was more capital deployed
in the last several years, at all levels, then we've ever seen.

~~~
brenden2
I wish I could say that was my experience.

~~~
harryh
Making generalizations about the world at large based on your personal
experience is a mistake. Look at the data.

~~~
dvt
I mean, yeah, look at the data:
[https://pitchbook.com/news/articles/21-charts-showing-
curren...](https://pitchbook.com/news/articles/21-charts-showing-current-
trends-in-us-venture-capital)

It's not really a secret that angel and seed funding has been steadily
dropping since the mid-2010s.

With that said, I think that @brenden2 is overvaluing funding. Most people
around here build software -- which can be _easily_ bootstrapped. For those in
hardware/biotech/energy/etc. it's much harder to get out an MVP without
funding.

~~~
harryh
Ya, I believe 2014 was the peak when it comes to seed deals per year so fair,
we are below peak. But there was a TREMENDOUS rise starting in about 2005 or
so (a combination of coming out of the dotcom bust then the rise of mobile
with iOS/Android).

Overall I see the availability of seed funding as still quite high.

Very much agree with your last point about overvaluing funding. It's never
been easier to bootstrap something for a year or two. Get an actual product
working, maybe have a few users, and then go for funding to scale up. We see
this in the data too with median company ages at the time of seed funding
rising.

------
ptrenko
YC is nothing like it once was. PG was the man.

PG was high priest of what was once a secretive religion for people who liked
productizing tech.

Over the years its become just another Sandhill VC firm.

I haven't heard of any big companies out of YC recently. Is it because PG left
and the culture changed?

------
xxpor
Other than "have a shitload of money", how does one become an LP in a YC fund?

~~~
jonwalch
Found a successful company, but I suppose that is also "have a shit load of
money".

------
soniman
This raises the question, why didn't AirBNB and Stripe go public when the
market was ready? Looks like the strategy of staying private for longer isn't
really working out for anybody.

~~~
stingraycharles
From what I saw in the news, it doesn’t appear Stripe has had any problems
attracting funding without going public.

~~~
soniman
AirBNB raised $1B and Stripe $600M. Just a guess but terms would've been MUCH
better if they'd done it in the stock market. Really puzzling why they didn't
go public when markets were ripe, now YC is paying the price.

~~~
serverQuestion
I wouldn't be surprised that companies like Stripe arrive at a point where
they want fewer investors controlling their company.

When you are Stripe big, what does YC do for you that you can't do with your
own money printing machine? Aside from cash, there must be other advantages to
having investors.

------
quaquaqua1
``` “In addition, processing hundreds of follow-on rounds per year has created
significant operational complexities for YC that we did not anticipate. Said
simply, investing in every round for every YC company requires more capital
than we want to raise and manage. We always tell startups to stay small and
manage their budgets carefully. In this instance, we failed to follow our own
advice.” ```

Is picking winners difficult? Or is it that the economy has a hard cap on how
many winners will occur every year?

~~~
goatherders
Both. YC batches are littered with companies that disappeared. That's not a
criticism of YC, that's reality.

~~~
quaquaqua1
I completely agree. But I am curious as to why the economy only allows a
certain number of winners. As in, why do 90% fail?

Additionally, if you fund 100% of companies equally, if 1 becomes FB and 99
become nothing, dont the winnings from FB pay for the losses of the 99?

~~~
threeseed
1) It has nothing to do with the economy and everything to do with whether
people love your product and you have product-market fit. Getting to that
point takes time and mostly companies run out of money before they get there.

2) Yes that is how VC works.

~~~
quaquaqua1
With regard to 2), if that's indeed how VC works, then YC just needs to fund
every company. There's no need to do vetting if you are guaranteed to fund the
next FB and the earnings will outweigh all operational expenditure on non-FBs.

1) People would definitely love a machine that prints gourmet food for them in
their house, but it's really difficult to do that. It's so difficult that the
amount of money it would take to make such a machine is pronably greater than
all of the money in the world. This is what I mean by "the economy has a cap
on the number of new ideas that can be funded"

------
joshuakelly
The pro rata was never guaranteed anyways, isn't the the nature of a pro rata?
It's an option to act.

------
naveen99
It’ll be nice when startinvest launches their alternative trading system for
crowdfunded startups.

------
ML_Clockwise
I'm assuming this won't change how YC runs their continuity fund?..

------
hibbelig
The hero image shows a person, but the article doesn't say who that is.

~~~
dlubarov
Yeah that's a bit odd. It's Michael Seibel, YC's CEO.

------
readams
Going to 4% makes YC much more attractive. At 7% it's really hard to justify,
though even at 4% for such a small investment it may be a hard pill to swallow
for founders who aren't right out of college.

~~~
daniel_levine
I believe YC is still taking an initial stake of 7%, the 4% corresponds to pro
ratas and follow on deals. I think the article just messed that up

~~~
anticsapp
Yeah, I think you're right, I had trouble following the article.

------
lifeisstillgood
So, and I may have misunderstood, a company can now get _into_ YC, but might
not be invested _in_ by YC?

So its a two tier system. We like you gorgeous, but not enough to sleep with
you (sorry, invest in you).

Why not just pick the ones you _will_ sleep with (sorry invest in). Why have
the half way signal? If investors don't like investing pro-rata, that's not
because they don't like making money - its because they think YC is not
picking all winners.

Isn't that the problem? Competition?

Edit: Perhaps I need to understand raising finance better. But, re-reading the
announcement as quoted, it still seems there is a two-tier system, and it
looks to me that YC will have placed a bullseye on its shirt - if they will
only pick 1/3 of companies, then any investor must assume YC has some extra
information in the market for lemons - in which case the simple solution is
just wait for YC to invest / SAFE / whatever, and invest in that. If a YC
company tries to raise a round without a letter from YC, it just won't get
anything ... ?

Instead of every investor now either making its own decisions, they just wait
for YC to signal its own special knowledge.

I would like to see how many companies close a round without YC from now on?

~~~
daniel_levine
I believe this is related to follow-on investments from YC after the initial
investment

~~~
lifeisstillgood
But that does not matter - YC will always be assumed to know something extra
than other investors. They will have seen something at the weekly dinner,
whatever.

So YC's decisions will impact meaningfully on the ability to raise subsequent
rounds.

That probably was true for series B anyway, but now its true at the priced
seed round.

I get it - its silly to throw gobs of money at companies that will fold next
week, especially if you know they will. But ...

~~~
travisjungroth
It does matter because you misunderstood (like your first sentence in your
first comment said). Every company that gets into a YC batch is still invested
in by YC. You cannot be in YC without being invested in by YC.

What's changing is the follow-on investments are not automatic. It used to be
they would automatically exercise their right to maintain their 7% stake by
investing more. Now they're going to maintain a smaller stake, and it's not
going to be for every company. Only about 1/3rd of them.

