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New YC Partner Investment Policy (ycombinator.com)
219 points by jamesjyu on Jan 31, 2014 | hide | past | favorite | 100 comments

"This should fix the problem. If it doesn't we'll try something else."

That's an interesting phrase. This should really be implicit in everything we say or do. It stands to reason, if something doesn't work, you try something different.

But when you're famous and have thousands of people who constantly try to undermine you or misquote you or take something out of context, you start to need to be explicit in calling this out. Otherwise next month's tech rag headline says "YC partner recants failed investment policy".

Oh I'm sure it'll happen, they'll just ignore the existence of this policy altogether when they do: "PG Prevents Partners from Investing in Minority-Founded Startup"

Come on, mocking straw men just makes things worse for everyone.

That's not a straw man, it's satire.

are you saying he's attacking a straw man of strawmen?

satire is a subset of a strawman

If either of those is a subset of the other then strawman would be a subset of satire.

Yeah, subset wasn't the right term. The sets intersect. Exaggeration (a form of satire) is a strawman.

Truly gratuitous thread-crapping.

This is one of the things I really admire about YC as a business -- it still acts like a start-up.

can you elaborate?

They change things. See what works. Iterate.

That's called being rational; nothing startup-specific about it.

It is being rational, but it's also absent from many other organizations. I don't think it's because the people involved wouldn't want to try something else when their initial solution is failing. It seems to be all about face saving. The culture around them is partly to blame for that. New companies have a fresh culture and the people involved know that failure is a very real possibility.

Big companies forget step three. They tend to head down a path, see what worked, then retroactively redefine goals so that everyone hits their target.

I think the startup-specific part is being willing to identify mistakes.

"This should really be implicit in everything we say or do."

My version of this problem is almost always having to insert the word "generally" into generally almost all of the things that I state (note the redundancy in that sentence).

A corollary to this is to have to preface things that you say in order to not offend one group or another or a particular person that was held in high esteem by others.

"But when you're famous and have thousands of people "

Same issue that celebrities have. We can call it the "sucks to be you" problem. You become so famous that you can't even go out without getting accosted by photographers.

It's particularly bad in politics. Politicians tie themselves to a particular solution and seem to persist with it even when it's clear that it will never work well.

and those that do change are branded flip floppers

Yeah, "flip-floppers" or "weak". So much so that it actually takes the most strength to admit that something isn't working and try something else. (risking electoral defeat)

That's smart. When we did it (Summer 2007) investors we talked to still didn't even know you guys did that. A couple asked, most didn't. I won't lie, we used it to our advantage.

I'm sure it only took a couple rounds before people started noticing you (and some alums) in the cap tables and realizing what's going on. Word spread. I have no doubt that now it is considered a signal.

Investing is like dating. You need to be right for them, and they need to be right for you. Just because you don't want to invest in someone doesn't mean they're a bad investment. Smarter angels & VCs probably realize this, but there's plenty of perfectly good money that would not go to companies who might be a good fit amongst the less savvy.

Super interesting story, and thanks for sharing. I think you're referring to your time at DraftMix, right? Admittedly that was a really hard connection to find online [see below].

That said, quietly using partner/alumni investment as a signal for VCs doesn't quite fit the "Startups are a perfect meritocracy" narrative I'd prefer to believe...


Interestingly, searching for "Matt Maroon" (on Google, Crunchbase, AngelList, etc) yields results like [0] that only mention Blue Frog. Same for your blog. Wouldn't care otherwise, but I wanted to know if your story could be true or to dismiss as an internet rant.

However there was one interview-like-thing [1] still hanging around the Google Index that connected DraftMix [2] with a "Matthew Maroon" as the CEO [3]

[0] http://www.crunchbase.com/person/matt-maroon

[1] http://en.wikioffuture.org/DraftMix

[2] http://www.crunchbase.com/company/draftmix

[3] http://www.crunchbase.com/person/matthew-maroon

For some reason this strikes me as kind of creepy.

...and people talk about the death of privacy like it's no big thing. Remember, the real creeps don't post their research on a public forum (unless it's for harassment).

Posting that kind of research is needlessly creepy.

People claiming to have gone though YC on HN without a known name will get called out. Hang around HN long enough and you'll know who is who.

quietly using partner/alumni investment as a signal for VCs doesn't quite fit the "Startups are a perfect meritocracy" narrative I'd prefer to believe...

What led you believe that? I'd guess startup investment is 90% social, 5% metrics and 5% technical. Witness, for example, the YC investment thesis of it being all about the team applying. Team dynamics aren't a meritocracy (except in the most broad sense I guess).

How does looking at who previously invested as a signal invalidate the idea of a meritocracy?

I agree with the other commenter. You spent way too much time spying on Matt Maroon today.

Blue Frog Gaming is the company. Draftmix was our first product, which we went through YC with, but no longer exists.

Most investors think because a YC Partner invested, that must be the best company. And the YC Partners should know, they've spent the last three months with every company!

I'm sure the YC Partners' track record of "picking" is no better than SV Angel, a16z, Greylock, etc.

I think this tweak to the investment policy will contribute to eliminating the sub-par angel investors who base a majority of their investments on which companies received funding from YC partners. PG taking action to make his dreams a reality [1]

[1] http://paulgraham.com/invtrend.html

that must be the best company

I don't think this is the case; they only need to infer "better than average" or "not a lemmon". The problem is everyone else is trading-off the research of others and abnormal volatility# results, which has dis-utility to the companies involved. In fact, it eventually would become a dis-incentive to join YC. It is this latter outcome that surely YC wants to avoid. They are not going to benefit from the pricing of current companies, so much as they would lose long-term value of their franchise. Ie, if it becomes a very "hit or miss" investment of Founder's time, the more capable founders may seek to mitigate their exposure to such a process.

# Not bias, per-se

I am assuming that "YC partners not able to invest till the start has raised atleast $500K or 3 weeks after demo day" will mean YC founders follow the rule in letter and spirit i.e. no pre-discussions with YC partners leading to pitching claims like "One of the YC partners has committed to investing after first $500K" ...

We're small enough that we can enforce things easily on our side. We can't control what founders say to investors. But experienced investors wouldn't believe a YC partner had agreed to invest without being able to confirm it.

This is interesting, and actually similar to a policy that a lot of elite high schools in the US follow: not ranking their students. If you have good unis accepting 50% of your class, ranking your students unnecessarily makes your 50th percentile weaker candidates than the 95th percentile at schools that rank (often even if those schools only have 2-3% getting into top-flight unis).

However, the downside of not ranking is that your top 1-5% of students are not clear to the extreme elite (Harvard, Stanford, MIT) schools, meaning there is no one who is "guaranteed" those positions, as even your top 5% has to compete with students in the top 20 or 30% for admittance. For high schools that couldn't hope to admit more than 5% of their class in top tier unis, it makes sense to rank (as then you get to showcase your top students as being exceptional). If you expect 20% or more to be competitive candidates though, it's usually better to stay quiet on relative success.

This is a nice example of what's wrong with elitism in higher-education, mis-applying metrics to "rank" students.

Yeah, it's funny. A friend of mine got one B in high school and ended up outside the top 5% of his class (which matters for some scholarships) because there were twelve kids with straight A's. If he had been a year younger he would have been second in his class.

Yeah, my high school stopped publishing class ranks in transcripts as of my graduating class because something like you got down to 50 or 60 out of a class of nearly 300 before you got below a 4.0 GPA and it was hurting kids on college admissions.

20% of the student body had straight A's? Sounds like grade inflation to me.

Liberal arts magnet school that only took the top students in a metro area of 250k people. You had to test in to be admitted and failing any one class meant you went back to one of the area's non-magnet high schools.

So not inflation, just that the student body was limited to kids that were going to make high grades anyway with very heavy AP course loads (which push GPAs over 4.0 since they're weighted).

It usually comes across pretty clearly in the recommendation letters, which admissions teams value over GPA, test scores, etc, since everyone's numbers are high.

Kudos. This was an issue in my batch. If you didn't have YC partner money you weren't necessarily a black sheep, but you definitely weren't awesome.

Getting YC Partner Buy-In sounds like pledging a fraternity.

It isn't, at all. It's not some popularity contest. The best companies do in fact tend to have YC partners invested in them. It's just because they are..the best companies.

The only reason it's bad is because there are lots of great startups in the batch that can be hurt by it, which is obviously not what the partners intend.

I think the most interesting bit is that it decreases a sort of self fulfilling prophecy.

Investors "treat investment by YC partners as an accurate sign of how promising we thought a startup was." So then, the company raises more money - and appears to look more promising.

Sure, partners may have less incentive immediately (as mathattack said) - but the real winners will be more clear to the partners after demo day (and three weeks).

They will have a list of winners (in their mind) before demo day. Then, investors at demo day will pick a list of winners (who they invest in). And YC partners will see the overlap - those who are picked as winners by YC Partners and independent investors.

The reactions of investors after Demo Day don't change our opinions much. We've just spent the last 3 months working closely with these companies.

For what it's worth, 500startups has done this for long time. They don't tell companies whether they are going to provide follow-on funding (even though it's in the original terms as an option) until significantly after Demo Day, for the same reason.

That's not the same, YC has never provided follow-on investment and this doesn't change that.

This policy affects investments made by individual partners. I'm sure 500 startups does not stop it's mentors from investing right after demo day, or does it explicitly do that?

It actively encourages mentors to invest. The reason is because a) there are so many that most companies can raise a little from at least one mentor, b) all companies in a batch are encouraged to raise a small amount of money prior to demo day, and c) mentor investment isn't typically seen as a signaler as they aren't 500 partners. It helps, as any outside investment helps, but 500 following on is the real signaler, at least in my experience.

Does Dave McClure wait to invest personally? I could see his investment having a similar signaling effect.

He actually has a rule of not investing personally. Granted I don't know if that's explicitly true, but I haven't heard of him investing personally since 500 was founded.

Partners can't invest. 500startups mentors != YC partners - the closest to that is basically 500startups investing a follow-on, it has the same signal as YC partners investing in YC companies during the accelerator program.

P.S: I'm the co-founder of a company who was in Batch 6 of 500startups.

Is this a common policy in the VC world in general (prohibiting personal investments by general partners in the firm's companies)?

It is in VC funds in the narrower sense, because their LP agreements often forbid any individual investments in startups. VCs' LPs don't want the VC partners siphoning off the best of the firm's deal flow for themselves.

Long long time ago when I was a kid and my dad was buying real estate I asked him why the realtor didn't buy the property if it was so good. He answered by saying that if he did that you might then infer that the properties that he didn't buy were not good.

I also point this out because what I've found in business is that so many basic principles end up repeating themselves in different situations. Things that you don't learn in school or in books but by listening to others and real life experiences. One reason that certain people who have grown up in business families have a nice advantage over those that don't. [1] You have a seat of the pants feel for things because everything is just a variation of something that has already happened.

[1] But it's not just growing up in the family but also interacting and listening and thinking. My siblings grew up with the same parents but are vastly different than I am in their thinking and understanding even given the same trough of water.

I understand your meta point, but a better answer would have been, "The realtor doesn't have enough money to buy the property, even if it was the greatest deal ever."

I asked him why the realtor didn't buy the property if it was so good

Hmm. The way to effect this as a broker is to take comission, with 3rd part capital backing the acquisition. The broker "pump and dumps" the property and takes a comission. The structure is opaque to the purchaser, and avoids the signalling 'tell' alluded to in the narrative above. This isn n% as profitable as a outright "front-run" or "flip", but can be executed at greater leverage/scale, since it is easily repeatable and the conflict of interest is far less obvious.

Any realtor who knows a good investment becomes an investor, not a realtor.

This sounds nice rolling off the tongue, but there is clearly no truth to it. Did you just make it up?

Why not prohibit this outright for the YC partners ( instead of the 3 week/500k numbers).

Umm because the YC partners are smart, helpful and therefore awesome to have as investors in your startup. Why would you want to prevent some of the best angel investors in the business from investing in the best startups?

Since YC itself doesn't do follow-on investments it doesn't have to worry about competing with its own partners (unlike the VC LPs).

This new policy seems to be addressing a specific problem: demo day is meant to be an opportunity for all the presenting startups, not a competition for attention between them. I.e. for YC's sake, it should never hurt a startup to present at demo day, so its a problem if not having a yc partner invest looks like a signal of relative weakness.

As the other replies mentioned, this is pretty standard. I think there's sometimes an exception for companies that a fund passes on, or for very small investments (e.g. if you personally invest $10k into a $5m company, then your fund's LPs probably won't care).

The main concern is this: let's say your fund passes on Twitter during its seed round, but you put $25k into it personally. 8 years later, the company has an IPO and you get a 100x or 1000x return. LPs are going to be frustrated that they let you invest on their behalf, but you took such a great investment for yourself. Even if the fund passed, there will always be the perception of "maybe they just passed so that Partner X could invest individually because the company looked very promising."

diff funds have very different policies - most top tier funds (from my experience) have a hard rule against it, given the potential signalling issues. That being said, I know at least one Tier-1 fund that lets partners invest in an existing portfolio company if and only if the firm chooses to pass on the investment in a round - take the pro-rata as it were.

Interesting snippet: "... a startup's fundraising trajectory is almost always established, one way or another, by 3 weeks after Demo Day..."

I never knew fund raising worked so quickly.

It really doesn't anywhere except after that particular event.

It sounds like YC serves as a vehicle to bring deals to YC partners, who make a killing funding the most promising candidates from the YC batch. This has made so much money for YC partners that they still want to continue to pick winners, but they don't want to kill the golden goose, so they withhold their blessings for three weeks. YC companies will still prefer the partners for funding over some random VC, so they still get the deals, but now the relative losers from the YC batch will get more funding from the more clueless VCs.

That's not true. An angel investment after demo day is worth a lot less equity than the YC investment. Most YC companies raise their seed rounds at $5 million - $20 million valuations, so it would take many hundreds of thousands or even a couple million to end up with the same 7% that YC gets.*

That kind of money would usually be put in by a larger fund. Most angels write checks for $25k-$100k.

* One difference being that the demo day investors will have preferred shares upon conversion and YC takes the same common shares that the founders and employees get.

Yes it could be worth a lot less equity but you can still make a killing with those small investments in the right companies

Yeah, what individual would want to even bother with only 1% of AirBnB or Dropbox!

This seems to solve one problem, but does it create another? Does it diminish the incentive for partners? Or wind up penalizing the winners (better firms coming out of demo day) by reducing their exposure to firms most likely to invest in them?

My sense is net this is positive.

I can't speak for the other partners, but I love that we're willing to do whatever it takes to help our startups succeed. I don't work at YC for the money. I work there because they are the best at what they do and are always trying to do the right thing for their founders. It was my experience when I went through the program and it's reinforced by actions like this.

Ahh - I misinterpreted partners. I thoughts it was the coinvestors providing converts. This makes much more sense to me now, and is obvious in hindsight.

I don't think it diminishes incentive for partners - if anything, it gives them a bigger window to decide who to invest in based on a larger market response - though I think for most of them this isn't really necessary as they tend to be forward thinking already (and have spent 3 months with the founders) vs having "herd mentality" and reacting to the market.

Why not just prevent partners from individually investing?

Maybe I have the wrong end of the stick but this seems unnecessarily forced. Surely, given time, the system should equilibrate. If YC partners investing in startups is treated as a signal of winners, investors will be able to derive their own conclusions in time about whether this is a trustworthy metric.

If it is trustworthy, then surely this would mean that great startups prosper faster and those that aren't that great know it even earlier, meaning that they can pivot after spending much less time on building their business.

If it is not trustworthy, the numbers will show that to be the case, with investors being able to directly assess which companies backed by YC-partners actually make it big. In this case, surely investors will wise up and not go by YC-partner investments as a signal of success.

If I'm missing something, I'd appreciate it if someone could point out where my logic falls short. Otherwise, I stand by my conclusion that this seems unnecessary.

Its the same reason you lock your door when you leave the house. You not accusing your neighbors of being criminal, its just wiser not to tempt fate. That way, you are not inviting bad things to happen.

This "peace of mind" factor has significant economic value, in that it frees up resources from "monitoring" potentially ambiguous motives and situations, and this improves the throughput for tasks related to running the business and making profits.

With respect to the "market equilibrium" notion, theory and practice differ. Gaming the (any) system increases in liklihood as the un-eveness of outcomes is exaggerated; information flows become more assymetric; and/or they become more opaque.

That is precisely the description of early stage investments. More or less. Hopefully this makes a bit of sense.

The counter-argument as to "letting the market" reveal the information, is that it is unlikely to do so. There simply are not formal mechanisms for privately trades companies to disclose such information in a timely and transparent way. Remember, the companies are private explicitly to prevent this from occurring.

This would devalue the signal of YC accepting a company, and inflate the value of the signal of a YC partner investing in company. In fact, not having both could be a negative signal, at which point YC is poisoning itself. This also leads to YC subsidizing one of their partners, and works against its best interests. YC's goal here is not to maximize efficiency of the market as a whole, it is doing this for self-preservation.

Aside from that, if PG feels that the signal is overvalued, the remainder of his own portfolio becomes toxic unnecessarily. So it's a bad outcome if the signal is accurate, and a worse outcome if it isn't.

The problem isn't really whether or not the YC partners are good investors, it's really more of a question if they know something that the startups aren't telling everyone.

Early investment by any of the YC partners after a startup has been accepted to YC could give the impression that the YC partners may be doing some sort of insider trading based on the meetings that they had with the company. That probably isn't an issue at all, but the perception is there.

I don't really understand the issue with that perception, cause surely it is true that YC partners have the inside scoop. Isn't that the wonderful deal of being involved with YC in any capacity? I don't see what the "insider trading" part of the deal is. To me it just makes common sense that YC partners reap the rewards of the clamour that exists for people to get into the system.

I think I might just be missing the point entirely. We are not talking about publicly listed companies, so if you're smart enough to have fashioned a position as a YC-partner for yourself, then kudos to you and surely that just challenges external investors to get better at picking YC winners even earlier.

It's in YC's best interest for every company accepted by them to succeed and get funding. When a YC partner funds startup A instead of startup B, the perception(which, again, probably is not reality) is that startup A has something better than the ones that aren't funded. So it puts startup B in a disadvantaged position from startup A.

It's a question of information asymmetry. You think that "given time," the system, whatever you mean by that, will equalize, but the essay describes difficulties in funding for those without separate investments by YC partners. That seems kind of like evidence of a signal they're trying to remove with this policy.

The interest of the individual YC partner (in this case) through a direct investment in the "best" ones, is not offset by the interest of YC as a whole (and those YC partners through their interests in YC as an entire entity) which would prefer investment in all their companies, or at least not providing a negative signal to those they choose not to invest in.

Incidentally, the new policy also masks YC partners' winner-picking success rate. If YC partners are seen as less successful in picking the winners than widely presumed, one could conclude that being accepted into YC itself is not a reliable signal.

" Which meant we were now making it harder for the startups that partners didn't invest in to raise money."

An analogy to this is what happened during the financial crisis when they got all banks to agree to take money so as not to send a signal showing what banks were the weaker ones.

It looks to me like this is going to put pressure on the window size (currently 3 weeks). Folks can now wait for 3 weeks if they really want the YC signal to kick in, unless other forces are working to counter act the waiting.

Think of it as a star which is trying to explode because of all those gases burning away, and gravity is keeping it together. The size of the star is the equilibrium point of the differential equations describing this dynamic.

One of the signals that was keeping the 3 week window to 3 weeks could have been the YC investments (gravity), but now that gravity has been set to a lower level, the 3 week window will expand..to account for this.

That's not how things work. Most YC companies tend to be oversubscribed, anyway, so what keeps the window small is competition between angels/VCs.

YC company approaches VC and says we have a soft commit from a YC partner. VC calls the YC partner and invests. I am not saying there is anything wrong in the old world. It is what it is. When its your company and there is money involved people get creative and work around rules. Some companies raise successfully and some others dont. If VC's (with all their resources) are taking their cues from YC Partners then something else is broken not the entrepreneur.

Obvious answer: YC partners are not allowed to soft commit either.

Not realistically enforceable.

Impressed that this issue is recognised and a mechanism created to mitigate it. However, doesn't this merely delay the signal (which is mentioned) so it may simply defer the problem down the line. If after $500k you haven't had a YC partner join, raising more becomes difficult (assuming you were trying to raise more than that to begin with).

Curious whether this will actually matter in the long run but I guess they'll adjust if needed.

This might impact startup fundraising trajectory. Investors may prefer to wait out for 3 weeks if VC partner's investment is a strong enough signal for them.

But then isn't this just the other way around? Now will YC invest in the company if they see that they're not raising much from outside investors?

Question for PG: Do the partners commit to fund companies in secret immediately on demo day or do they now make decisions based on how well external funding goes? In some ways, it sort of seems we have the same problem, but now the partners are the ones to take advantage of 'signals'.

If a YC company could no longer get a personal investment from a YC partner, it doesn't matter much. If they can't get funding from any VC, they almost certainly die. So even if one thinks that the comparatively low-value signal of a VC investment is now going to be exploited by a partner, YC is not worse off.

Seems like a great idea, PG. Are the partners prohibited from signalling to favored investors their intentions? What's to stop someone from giving a wink to a friend?

Partners who decide that they are not going to follow the rules to the detriment of the founders, and therefore YC and other partners, would likely be excluded from participating in future batches.

YC is in a strong enough position that they are likely not dependent upon one particular partner, and most partners would prefer to have access to future batches. They probably don't need to have a contract that slaps on additional legal damages, because at such an early stage the small gain for favoring their own investments does not outweigh the longterm gains from continued early access.

Theoretically your point makes sense. But in practicality, sounds like nothing prevents a partner from winking at their buddy in a VC. After all, who's to know? And how could it ever be enforced? Insider trading didn't stop just because it became illegal. This is not in any way meant to cast aspersions on the partners per se. Color me jaded when it comes to money.

I wager the % of the YC companies that raise $500k within three weeks of demo day is <10% making this rule effectively meaningless.

What's wrong with being a 'signal' to investors? There are multiform reasons why YC chooses to invests or not.

Those startups that join demo day realize that they're putting themselves on a public platform to be assessed, etc. If they don't get funded by YC, that's their problem; not YCs.

There's a problem with PGs policy since it rules out the possibility of YC being a first rounder. Which is a huge reason why VCs exist in the first place.

Seeing has how YC has an equity steak in every startup, how is a startup who can't receive funding not a problem for them? From an investment point of view, they want ALL of their companies to receive funding. If signaling is negatively influencing how investors evaluate every company, than this policy makes a ton of sense.

You think this might cause startups to close their funding later as investors all wait around to see who pg chose? :)

this seems really smart, although I worry that it could affect many startups ability to raise the initial $500k.

True, perhaps even more than the first $500k, I worry about those that are trying to raise $100-$250k.

Seems good.

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