💸 What does Y Combinator's new deal mean for early-stage investors & founders?
Good evening Upscalers’ followers.
Time to bring you the 15th edition of our weekly journal. This week, we’ll try to figure out what Y Combinator’s new deal means for early-stage investors & founders 💸
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💸 What does Y Combinator's new deal mean for early-stage investors & founders?
Last week, I told you that Y Combinator had launched a new deal for early-stage founders joining their bi-annual cohorts.
Then, I promised I’d be talking about the deal this week, to assess its wider impact on early-stage founders and investors. As always, I will be adopting a fairly European centric approach to the topic. We’re a European community after all 🇪🇺
Here we go ⬇️
1. What is Y Combinator after all?
I know Y Combinator sounds familiar to most of us, but a little refresh doesn’t hurt.
Y Combinator is a San Francisco based startup accelerator that was created by Paul Graham, Robert Tappan Morris, Trevor Blackwell and Jessica Livingston back in 2005. Since its creation, the company invested / accelerated more than 3,000 companies including some of the most successful startups in the world.
Combined Y Combinator’s portfolio value is $400B+, with 160+ companies valued at more than $150M. Knowing that they invest at the earliest stages of venture funding, that’s pretty impressive.
So what’s behind the numbers? How does it work concretely?
The way YC has been working for years is pretty basic. Each year, they invest a “small” amount of money in a large number of startups through what they call “batches”. They call two batches per year - one from January to March, and the other from June to August.
Startups are allowed to apply through a simple form, and the most promising are offered a meeting with YC’s team before they receive funding… or not. There are approximately 10,000 applicants per batch, with a 1.5% to 2% acceptance rate. So that’s roughly 150-200 startups being funded per batch.
Historically, they invested $125K in each startup that was accepted into the batch program in return of 7% of the company’s shares, on a post-money SAFE. That means that YC invests between $37.5M to $50M per year in early-stage startups. In exchange, startups got experts insights over their ideas and businesses, as well as advices as to how to deal with potential investors and acquirers.
Apart from having funded some of the best tech companies in the world, Y Combinator is widely famous for…
… introducing the pre-money SAFE (2013) and post-money SAFE (2018) documents. The latter is one of the most used early-stage funding document in the world.
… its Demo Days, where startups that have been accepted to YC’s batches can present their products and services to a selected audience of investors and press. Those demo days have been widely adopted by other bootcamps and accelerators such as Techstars, StartupBootcamp… and openly laughed at in such movies as Don’t Look Up!
➡️ Apply here to assist to the next Demo Day
➡️ Haven’t read last week’s newsletter on Don’t Look Up? Catch up here
You understand it, Y Combinator is one of the world’s most influential player in early stage venture capital funding. That’s why any investment / announcement or change they make is such a… big deal.
2. What is this “new YC standard deal” all about?
A few lines back, I told you that YC’s standard deal was to invest $125K in each startup that was accepted into its batches. Well, a little more than a week ago, Y Combinator announced a new standard deal in a groundbreaking blog post.
Yes, you read it properly. Y Combinator now invests $500K in every company that is accepted to its batches. The investment is made on two separated SAFEs, which take effect at the same time:
A post-money safe on which they invest $125K in return for 7% of the company (the $125k traditional SAFE)
An uncapped SAFE on which they invest $375K with a Most Favored Nation (“MFN”) provision (the “MFN safe”). Simply put, they are giving the money now but at the terms founders and YC will negotiate with other investors later. So the dollar amount will not convert into an automatic percentage stake of the company in question.
Those two investments are not contingent on any milestones. Following the announcement, the number of companies accepted in each batch is not going to be reduced. Quite the opposite actually. YC’s president Geoff Ralston sayd he could see YC fund 1,000 startups per batch in the near future.
So they are doubling-down on their strategy to invest “small amounts of money in a large number of startups” and hope for a few to return. Except that $500K is the new “small” now… and that 1,000 startups per batch will soon become the new “large number of startups”.
You can read more about the new Y Combinator deal below.
Now, one could argue that Y Combinator is only reviewing the terms of its initial value proposition to follow recent development in early stage venture capital funding. Provided that there are more and more startups on the market, and that rounds are getting bigger and bigger, they increase the number of startups they invest in and the average ticket they write.
This could make sense. Except we’re talking about YC, which is much more of a market maker than anyone else.
Instead, rewriting the terms of its standard deal seems to be a calculated arbitrage to outdo competition by raising the price of early stage rounds in order to capture more deals with potentially high returns, to the risk of diminishing the value of the “YC stamp”.
Ouch, that was a long sentence. Let me explain 👇
3. Outdoing competition - really?
The competition is heating up at early stages of funding. Raising the price of entry is a way for YC to outpace competition to attract more of the best founders in its nets, and encourage them to raise at higher valuations. Prior to the new standard deal, seed-stage YC startup valuations were typically ~2x higher than their peers. With the new deal, one could expect the gap to become even wider.
Even though some US competitors might match the rising price, this would eventually put more pressure on international investors (European 👋), where Pre-Seed and Seed rounds are typically way smaller, and valuations lower. Having YC writing up a $500K cheque to a European early-stage startup today, is pretty much equivalent to letting them taking the full round. As Matt Clifford - founder of Entrepreneur First, says:
“Their positioning here is ‘skip a round’, which piles pressure less on accelerators and more on conventional pre-seed and seed funds outside the US.”
So basically YC is reviewing its positioning as a global pre-seed fund, to become more attractive to founders other ecosystems. After all, let’s remind that being a YC startup as of today makes is x4.5 more likely to be valued at $100M one day, and x3 more likely to become a unicorn. With the new deal, it wouldn’t be a surprise to see non-US founders rush to get into YC’s batches.
However, as YC increases the size of its batches and the total amount it invests, it inevitably becomes more and more impersonal / industrial. I believe that, as it scales, it is paradoxically giving the opportunity to early-stage investors to compete on being the anti-YC kind of investor.
Investors can add true value beyond money in being curated, small investors with a hands-on and personalized approach. With YC killing the cheques game, I can only see some competitors doubling-down on this approach to stay competitive in the future.
YC’s model is not suited to everyone.
4. Putting YC’s reputation at risk
Of course, increasing cheques and batches size would make a lot of sense for Y Combinator if they are able to keep the quality of founders and the selection criteria at a high level. But it is a complex balance to find:
On the one hand, they could increase chances for startups to succeed as they get more time to focus on the business rather than fundraising, have a longer runway and higher financial resources to build their product or service. But they also make it likely that their founders will suffer from the ‘marginal dollar problem’.
On the other hand, they increase their chances of making bad investments. Is there really that many good startups to fund out there?
YC is taking the (calculated) risk of diminishing its success rate in volume, to maximize its ROI. But is it worth the impact on its reputation?
For a while in the startup ecosystem, being a Y Combinator company meant something. People who’d gone through the program spoke very highly of it and getting the YC stamp was a huge breakthrough for their company.
First, it meant that companies had reached a basic level of competence since they made it through the YC selection process and survived it through the end of the program.
Second, it gave access to early stage investors and smallers funds that were likely to contribute to successful rounds at Demo Days.
Will it still be the case for larger cohorts of heavily-funded startups?
By raising the price of the initial investment, Y Combinator will only make it harder for local investors and smallers VC funds to participate to Demo Days and fund startups that are being built inside their borders However, we all know that having connections to local investors in your home market is important. So it’s likely to get a bit messy. Having a YC stamp could well become a ‘no go’ sign for local investors, who’d be unwilling to match the pricing and valuation standards that’ve been set by the American firm.
Isn’t this a significant blow to YC’s core value proposition? 🤔
Wise would be the one to know how this will play out.
🌍 All eyes on the EU... and elsewhere
European funding in January 🇪🇺
+2 French unicorns 🥐
On Monday, Exotec, a warehouse robotics startup, announced it had raised a $335M round at a $2B valuation, thus becoming the 25 French unicorn.
That deserved a video from the French president right? 😉
Talk about timing, the video is already outdated since Spendesk announced on Tuesday it had raised a $114M Series C round from Tiger Global, reaching a $1.14B valuation, and making it the 26th French unicorn 🦄
Now, I can only imagine Spendesk was angry not to make it to the first 25…
Top 10 women to follow in French Tech 🇫🇷
I know this section might sound a bit French. Sorry for that.
But you know how committed Upscalers is a creating a more diverse ecosystem. So I can only share with you the list of the 10 women entrepreneurs to follow this year in French Tech.
There are some amazing entrepreneurs and investors in there, starting from Aude Guo (founder of Innovafeed), Laura Roguet (Principal at Korelya Capital) or Chloé Hermary (co-founder of Ada Tech School).
Who knows, maybe you’ll get an Upscalers W episode with some of them soon ⌛
Upscalers talking about Women in Tech 😀
Speaking of women in Tech, I had the chance to be interviewed by Authority Magazine on what to do to close the VC gender and racial gap.
Here’s a snapshot of ideas I gave to tackle the issue:
Schools should talk a lot more about entrepreneurship and set up proper career advisory programs where entrepreneurship is revalued as a viable job option for anyone.
Self-education should also be considered as good education as any university program. The Internet is a much more inclusive learning tool than any school or university.
We should invest more in women and minorities fund managers since they are more likely to invest in startups with female founders.
Investors should make diversity a central KPI. Just as they’d look at churn rate or revenue growth!
We should make investing in startups easier and accessible to everyone.
I had so much fun!
Thanks again for reading guys
See you next week 👋