Y Combinator’s Big Future

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There’s been a lot of talk in venture circles lately about “signaling risk” and seed-stage investments. The gist: When earlier backers are high-profile venture firms, and these firms decide not to participate in a startup’s next round, it hurts the company’s ability to raise a Series A round.

Although this concern isn’t exactly new, recent numbers published by the firm CB Insights suggest that the issue is worth revisiting. According CB Insights’s findings, while 35 percent of all venture-backed, seed-funded companies go on to raise a Series A, a company that counts a respected venture firm among its seed backers has a 51 percent chance of raising a Series A if that firm participates in the round.

That’s the good news. The bad: If the venture firm decides not participate in the startup’s Series A, the company’s chances of closing its Series A round drop to 27 percent.

The study made us think about Y Combinator, the popular accelerator program, and its plan for the future. Right now, Y Combinator has the best of both worlds. It can make seed-stage investments at scale, for sizable stakes in startups, and not worry in the least about signaling risk: no one expects it to pour more of its capital into follow-on rounds. Its very model is premised on finding and funneling smart companies to other Series A, B, and C investors.

Recently, however, some have speculated that Y Combinator is heading into a future where it is both seed and growth-stage investor. According to a March report from Business Insider, the outfit might raise “several billion dollars” to make later-stage investments in those of its companies that start hot and stay hot (see Airbnb). A source to The Information estimates that the Y Combinator Continuity Fund (as it is listed in an SEC filing) will be closer to $1 billion in size.

Maybe Y Combinator has to go later stage. Maybe it’s too hard to support the organization at its current size without owning more of its home runs, including Airbnb (valued at $24 billion currently) and Twitch, which sold to Amazon last year for $970 million in cash.

Still, if Y Combinator uses its war chest to cherry pick deals from its portfolio of graduates or even if it skips a few stages to invest in a limited number of “very, very late stage” deals, as TechCrunch sources have suggested might happen, it could create huge signaling risk for the many startups it funds. (It’s possible that Y Combinator could follow on in every one of the venture-backed rounds of its portfolio companies, but the moment it doesn’t . . .)

Y Combinator’s big fund could have other consequences. Until now, Y Combinator hasn’t had to displace other investors to earn a place on a company’s cap table, but if it wants to become a growth investor and take significant ownership of particular companies, it will need to win competitive deals against other firms that want to invest. And Y Combinator may find that many of the investors it counts as friends won’t be so friendly when they’re going head-to-head over deals.

Investing in later-stage companies is also a different skill set than mentoring seed-stage companies. Although Y Combinator will undoubtedly hire partners who have experience with later-stage deals, Y Combinator’s DNA is helping companies at the earliest stages figure out who they want to be.  That’s not to say the firm can’t do both, but presumably it will take time to get right and it would seem to spread the firm thin, no matter how many people are involved.

The Information recently suggested if Y Combinator goes later stage, the “only shot” that VCs will have at competing with it will be to “go earlier and earlier themselves.” Maybe, though we imagine that top funds don’t need to sweat it just yet. Entrepreneurs will continue to want other, experienced voices at the table, especially if those voices are coming from places like Sequoia Capital.

The Information further suggested that Y Combinator might be more willing to fund “moonshots” than other firms. We love that idea, though it does bring to mind Kleiner Perkins, which was at the top of its game when it decided to pursue some moonshots of its own in clean energy. As industry watchers know, that didn’t go so well.

We give Y Combinator credit for thinking about its next moves. We admire how much it has changed in the last 17 months under the leadership of Sam Altman. And we don’t doubt that whatever Y Combinator has up its sleeve, it will show original thinking.

We just hope Y Combinator doesn’t lose sight of its core mission. It does seem to have things awfully good right now.