Y Combinator has long allowed its partners to invest their own personal money in the incubator’s startups — often times partners put money into these startups before institutional investors and angels have a look. Unfortunately, whether a partner (or partners) put money into a YC company started to become a signal to outside investors of the good bets in the incubator.
It makes sense. These partners are often integrally involved in helping build these companies inside of Y Combinator. So they would know which startups have the legs to be successful, and potentially have insider knowledge into which startups have the potential for going the distance. To mitigate this signaling effect, Y Combinator is implementing a new policy whereby YC partners can’t be the first money into a startup from the incubator.
Specifically, YC partners can’t be in the first $500,000 a company raises unless it’s three weeks past Demo Day.
As YC co-founder Paul Graham explains to us, the danger of letting the partners at an incubator invest in the startups is that it makes it harder for the ones the partners don’t invest in to raise money. In the early years of YC, this wasn’t as much of an issue because Graham was the only one investing, and he wasn’t systematic about it. But in the last few batches, investors started treating the companies that had investments by YC partners as an indication of what YC thought of the startups.
Currently YC has about a dozen partners involved, including Paul Buchheit, Garry Tan, and Geoff Ralston. What’s also of interest is that any funds that YC partners operate will also fall into this rule as well. So the new fund started by Tan, now part-time partner Harj Taggar, and Reddit co-founder Alexis Ohanian, will not be able to be the first money into a startup.
This is clearly a founder-friendly move, and evens the playing field in some ways for startups to raise money from outside investors. It’s no secret that Y Combinator’s class sizes have steadily risen, and in the effort to save time and optimize their money, investors look for signals on which startups to invest in. Of course, YC partners investing in a startup is just one of many signals investors are looking at when evaluating a startup at the seed stage.
YC also recently debuted a new, easier convertible equity model for founders.