Y-Combinator, a startup bootcamp of sorts, provides seed money (generally less than $20k), advice, and connections to startups. It has grown rapidly since its launch in 2005 and has had some high profile wins, including Posterous.
But the news this weekend that SV Angel and Yuri Milner are offering every Y-Combinator startup $150,000 in convertible debt, with no cap and no discount is still surprising. Convertible debt is a common tool for early stage investment because it allows deferral of tough valuation decisions but investors usually include clauses to ‘sweeten’ the fact that they are investing earlier, for example a discount on equity at later stages and a cap on the valuation of their equity. In this case there are no such clauses – there is no discount or ceiling whatsoever.
SV Angel is offering all 40 startups in this 3 month Y-Combinator cycle a free $150k loan. Why would an investment firm ever offer such a large investment to 40 startups, some of which it presumably knows nothing of, with no preferential terms for investing earlier? Surely this is investor suicide?
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The more I’ve thought about it the more smart I think SV Angel is being: this deal is all about access. Paul Graham, the founder of Y-Combinator has always said “This is a hits driven business”, and SV Angel’s offer gives it access to the ‘hits’.
Counter-intuitively, the generous terms really help with this. If the firm was offering onerous conditions surely only the least promising startups would accept the investment and the ‘hits’ would slip through the net, a sort of negative selection bias. However, under these terms I imagine all the startups will take the investment.
So, this offer effectively becomes a broad bet on Y Combinator startups, and a means by which to access the ‘hits’ (and potentially invest in them in subsequent rounds).
When Y-Combinator launched in 2005 it invested in 8 startups, in the current cycle there are 40 – this growth rate and the high profile ‘hits’ to date , including Scribd, reddit, Justin.tv, Dropbox and Posterous make this a smart bet. The offer may even improve the outcomes for Y-Combinator startups if it enables them to focus on the important stuff, like finding a business model, rather than worrying about fundraising.
- Remembering to look for the hidden cost of driving a hard bargain – are you creating a negative selection bias?
Techcrunch article here