[jparker165]

This may greatly change incentives for YC.

I've always thought being an LP in YC would be fantastic because of the valuation bump companies get on demo day. Let's say a company could raise money at $5mm valuation, but instead gives 7% to YC, and as a result can raise at a $10mm valuation => (1) founders win by keeping more equity, (2) YC wins by their investments getting cash with less dilution, and (3) post-YC investors pay more (maybe still great investments, but not as good as getting in at $5mm).

But to maintain 7% in companies up to a $250mm valuation, it seems that the vast majority of YC's deployed capital will be in the place of what was previous a "post-YC" investment.

YC should still be in the business of finding great companies, but might not makes sense for them to help get gangbuster valuations at demo day.

[sama]

It is a statement that we believe investing in YC companies at post-YC valuations is still a great deal.

[jacquesm]

I notice you use the words 'aim' and 'try' in your message, what do you think is the risk that if YC does not simply always do this it will be perceived as a very negative signal by other investors in later rounds?

[larrys]

I'd like to know the answer to your question but note the fact that sama says this:

"we believe investing in YC companies at post-YC valuations is still a great deal"

but also says this (from the post):

"And by doing this in every YC company, there will be no signaling issue of us supporting some companies and not others."

So how can you have both statements be true?

In other words how can you say "still a great deal" and also acknowledge that you are investing in all companies, not only ones that are a "great deal", simply so there is no signaling?

[nostrademons]

I assume that he's running the calculation as a whole, on the entire body of startups. In other words, given that these pro-rata investments must be all-or-nothing to avoid signaling risks, what're the financial returns of investing in the entire body of YC startups that raise follow-up funding, regardless of whether they're actually a good deal individually?

I can see how this could easily turn out in YC's favor. For one, the really obvious failures often flame out during YC itself and fail to raise follow-up funding, and so YC wouldn't have any obligation there anyways. And the really big successes become worth far more than $250M, enough to subsidize many failures.

The big question for me is what it does to incentive alignment - it seems like YC now has an incentive to ensure that companies it doesn't like don't raise follow-up funds, as well as incentives to get lower valuations on the early funding rounds. It also in theory should make them pickier about their application process, knowing they're committed to participating in any follow-up rounds. On the plus side, they have an incentive to ensure that promising startups do raise follow-up funding (rather than go out of business), it avoids some of their misaligned incentives relative to the rest of the investment community, and they have an incentive to keep helping their investments later in life.

[rl3]

>On the plus side, they have an incentive to ensure that promising startups do raise follow-up funding (rather than go out of business), it avoids some of their misaligned incentives relative to the rest of the investment community, and they have an incentive to keep helping their investments later in life.

YC already has incentive to do this; their post-dilution stake in wildly successful companies still shakes out as being far from trivial.

That said, it would certainly be fair to say that these changes probably do serve to strengthen existing incentives.

[jparker165]

Clearly you think "post-YC" investments are a good deal, and I agree in aggregate. But the problem is that they can always be a better deal and some companies will be better than others.

Let's look at a company who takes $120k from YC in exchange for 7% equity. On demo day they get term sheets for (A) $10mm at a $20mm post-money valuation, and (B) $10mm at a $250mm post-money valuation

In either case the pro-rata vehicle has to take down $700k of the $10mm to keep the 7%. As long as the pre-demo day and post demo-day money are coming from the same fund, it's all good

But let's say the terms sheets are: (C) $10mm at a $250mm post-money valuation, and (D) $50mm at a $250mm post-money valuation

Term sheet (C) requires the same $700k, but term sheet (D) means YC has to shell out $3.5mm.

If you're less than excited about this particular company, would you be more likely to mention that "$10mm is plenty of cash and term sheet (C) lets the founders maintain far more equity"?

I doubt it. And conflicts of interest don't necessarily cause problems. But, this clearly going to cause friction at some point.

[vasilipupkin]

This is not going to be a problem. The company either needs 50 mln or it doesn't need it. if it needs it, then talking about how 10mln cash is plenty is pointless. And if it doesn't need 50 mln, it really shouldn't be raising it in the first place. In practice, YC will probably stay away from maintaining pro rata in some rounds, especially if there is no issue with negative signaling

[nostrademons]

It occurred to me that this shifts YC incentives from the early-stage to the late stage. They're not as incentivized to get great valuations at demo day, but they're more incentivized to continue assisting startups throughout their lifetime.

Whether this is good or bad for a founder depends on what they're using YC for. It may remove the immediate valuation "pop" from the calculus: right now, YC is almost worth it regardless of what they do because whatever equity they take ends up coming out of future investors' shares through the the valuation pop, and that effect may disappear. OTOH, it also means that YC can be expected to help provide advice and introductions throughout later rounds as well, as they maintain their financial incentive all the way up to $250M.

It seems to fit with YC's stated mission of trying to build more sustainable, world-changing businesses, along with other actions they've taken like experimenting with late-stage funding and taking on more partners with operational experience.