Y Combinator Gets The Sequoia Capital Seal Of Approval

Y Combinator, a seed stage venture firm that has invested in a whopping 118 startups since summer 2005, has to date only invested capital provided by its four founders: Paul Graham, Jessica Livingston, Trevor Blackwell and Robert Morris. Now they are raising $2 million in capital themselves, from Sequoia Capital and a number of prominent angel investors. Sequoia partner Greg McAdoo is leading the investment.

Sequoia and the angel investors (Ron Conway, Paul Buchheit and Aydin Senkut) aren’t investing directly in Y Combinator. Instead, they are putting money into a new entity, managed by Y Combinator, that will make investments in new startups going forward. In other words, Y Combinator won’t just be investing their own capital any more, and they’ve got a larger war chest to expand operations.

In the past Y Combinator has invested in 40 or so new startups a year. Investments are small ($5,000 + $5,000/founder) in exchange for around 6% of equity, and the startups are typically very early, usually idea stage. Still, they’ve had some notable successes. Several of the startups have been acquired – Reddit (by Condé Nast), Omnisio (by YouTube), Zenter (by Google), ClickPass (by Synthasite) Auctomatic (by Communicate) and others.

A number of Y Combinator’s current startups are doing very well, too. Their publicly launched portfolio includes: Reddit, Loopt, Scribd, Justin.TV, OMGPOP, Xobni, Disqus, Heroku, Dropbox, Posterous, Backtype, Clustrix and ZumoDrive, among others. Sequoia has invested in three Y Combinator startups in the past (Loopt, Clustrix and Dropbox).

The $2 million in new capital will go a long way for Y Combinator. They say they’ll increase the number of startups they invest in, from around 40/year to 60. But at an average investment of only about $15,000 per startup, that $2 million will last for about two years.

Y Combinator startups get a big head start in the competitive tech world. The founders, often just out of school (or still in school), get enough money to pay the bills for a few months as they work on their projects. They also get mentoring and polish from the Y Combinator team and a chance to present to prominent angel investors and venture capitalists at twice-yearly demo days (example). A surprising percentage of the startups go on to raise bigger venture rounds and become real companies. Many of the founders that fail come back and try again.

Y Combinator says that the investment by Sequoia and the angels won’t change how they do business (other a projected increase in the number of investments). The new investors won’t get any special investment rights in the new startups, or have any obligation to invest further in them. But it is a seal of approval in the Y Combinator model. And dozens more young founders will now get the chance to build their first startup.

Update: Y Combinator announces the news here.