Y Combinator continued

April 16, 2007 | Matt Marshall | Comments | |

ycombinatorlogo1.jpgSome readers took issue with VentureBeat’s recent assessment that Y Combinator had successfully “nailed” the start-up incubator model. There’s one particular critique we should address.

In return for its advice and money, Y Combinator does take its pound of flesh, in the form of six percent of a company’s stock, on average, which some people think is excessive. In our earlier, favorable assessment of Y Combinator, we were referring mainly to the vibrancy of the start-ups emerging from the group — a sure sign that something is right. But let’s look a bit closer at this six percent policy.

We asked Y Combinator partner, Jessica Livingston, more about Y Combinator’s stock policy. Turns out, Y Combinator takes ordinary common stock, she told us.

That makes Y Combinator look better than some critics have made it out to be.

“I have a real problem with Y Combinator,” said Jeff Clavier of seed capital firm SofttechVC at the Web 2.0 Expo yesterday. “Y Combinator is a rip off. They give you $6k per founder for six percent of the company. I’d be happy to double that [$6k] and I’d still be getting my stock for cheaper than I usually invest.”

What Clavier failed to mention until later, when pressed by VentureBeat, is that his firm only takes preferred stock when it does its angel rounds.

VentureBeat thus believes Y Combinator’s approach offers an advantage to entrepreneurs because they’re not held hostage by the often onerous privileged rights that preferred shareholders often demand, such as minimum payouts upon acquisition or dissolution, rights to receive compensation before common, or anti-dilution rights. Common stock aligns the interests of Y Combinator with the interests of the founders and employees, who also hold common.

And while six percent is high everything equal, these companies are often very early stage companies — often little more than an idea — and so carry significant risk. They usually require more hands-on help.

(Most of the reporting for this story was done by contributing author, Mark Coker)

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Matt Marshall is editor and CEO of VentureBeat. Follow him on Twitter at @mmarshall, and follow VentureBeat on Twitter at @venturebeat.

  • Six percent is hardly asking a lot to help bootstrap an idea. The mentoring and ability to prevent common mistakes is pretty valuable to any company, let alone a startup with "just an idea."
  • This is one of those controversies that the market has a way of ironing out over time -- it's almost like arguing over whether the Yankees or the Red Sox are a better team when the two teams are in the sixth inning of a game. Just look at the scoreboard!

    There's no magic to what Y-C does; they're basically trying to institutionalize the angel model and extend it to the low end. If their model actually works (and there isn't a ton of evidence that it does or does not yet), then others will imitate it. If it doesn't, then investors will keep doing what they're doing.
  • fewquid
    Some thoughts.

    1) YCombinator invests earlier than almost anyone else. And remember, we're not talking seasoned entrepreneurs with a solid business plan, we're talking young hackers often on their first time out. The implied valuations seem more than fair to me given the high level of risk. If you don't like it, beg/borrow/steal your way to the $6k per person that they offer.

    2) Participating companies apparently get more than just the money i.e. contacts and help with their first formal round. That's something many Angels can't provide.

    3) This money isn't really even a seed round. A company they invest in could be looking at a follow on seed round and an a-round etc. In other words, they will get pretty diluted over time. Given that reality, 6% seems pretty fair.

    4) We're talking about COMMON STOCK. YCombinator are in the same boat as the founders. No fancy tricks to jack up their ownership.


    In short, YCombinator seem to act more like a wealthy Uncle joining as a silent co-founder than an investor.

    There are aspects of YCombinator that I'm not crazy about, but it is quite clear that they are helping spark some real innovation and getting other investors to really think about early stage investments, all of which is good.

    If you don't like the deal, don't apply for the $$. There are much worse deals to be had out there...
  • >>They give you $6k per founder for six percent of the company.

    Actually, the correct amount is $5k/founder + an additional $5k to build the company. As a budding entrepreneur, I find that $5000(1 + n) is enough to grow a startup from nothing. As Jeffrey mentioned, if YC's model actually works, then others will imitate it...and they have! TechStars, among a few others, has based their investment strategy largely on Y Combinator's model.

    Jawad Shuaib
    jawad.exe@gmail.com
  • Matt,

    Back in early 2006 when I first came across YCombinator, I had the same first impression as the investor at web2.0 meet.

    However, here in 2007, having started a start-up that is growing by the day, I have to say that YCombinator is a near perfect thing for our current needs! We don't need much cash; we do need SOME cash; we do need LOTS of advice; we don't have time for days of presentations and meetings needed to even get a shot at funding.

    Note that my start-up is live, growing and STILL I feel YC is the best option for us. That is why I'm flying to Mountain View this Friday:)

    I think if any VC throws a vague critique of YC, it only makes it obvious that traditional VCs are actually concerned about this. Talk to folks who have taken gone threw the three months(I haven't) and all you will hear "Best time of my life" repeated over and over.

    --Zaid
  • batman22
    C'mon people, $5k or $10k in a company does not buy you a whole lot of stock no matter if it's preferred or not. As a VC if you have millions, you're still better off playing in the Sequoia/Kleiner ballpark, but the problem is, you're competing against Sequoia/Kleiner. And if you're an angel, you better have connections to the Sequoia/Kleiners or your company will fall thru the cracks.

    So YC is merely finding its niche to play in the game and not get squashed, which it still might get considering 6% can become diluted pretty fast when Sequoia/KP comes in and adds another few orders of magnitude to $10k. Or maybe YC is looking for the quick 6-digit sale on eBay/VentureBoard? A 1,000x return will still net YC "only" $10 mil. YC is the closest thing you can have to starting the company yourself without actually starting the company. In fact, YC might be better off hiring these kids and maintaining control of its own companies.

    I only wish more YC-type entrepreneurs would learn that establishing good personal credit is #1. Then finding a corporate job for a few years outta college, establishing a bank account with 5+ figures, is #2. Then being able to sell yourself, at the very least to friends and family is #3 (prerequisite: making friends and having/loving family). I'm dismayed that these entrepreneurs, some out of distinguished universities where the tuition itself was probably $10k, can't equivalently fund their ideas at a mere $5k each the same way thru credit cards or friends and family. You young bucks gotta learn how not to give up control. And I'm not sure that the connections as offered by YC are needed at that bootstrap level yet. Kids, just build the product and sell, sell, sell. If it don't make money, let it be your hobby till you can figure out how.

    Nevertheless, YC is on an uptick right now. Everyone involved, enjoy it while it lasts. When the downhill slope comes (and it always does), go back to the fundamentals in the previous paragraph.
  • Y Combinator is basically buying cheap stock in promising startups with the brand value that comes from being a Y Combinator startup (the cash they're putting in is really inconsequential from the perspective of Y Combinator). It's really quite brilliant. Is it a good deal for entrepreneurs? Not clear.
  • Couple of comments about the context of my statement "YCombinator is a rip-off":
    - We were discussing about the amount of funding that are currently being raised at seed stage, and the typical pre/post money. The deals I see/participate to would involve $750K/$1M for 15 to 20% of a company. And yes these days, we price these deals and get Preferred shares at very plain vanilla terms (1X liquidation preference, non participating). So getting 6% at these valuations would involve a few hundred thousand dollars invested. I appreciate that YCombinator invests very early stage, but so do a lot of angels/seed stage firms.
    - The cost of money, and the ability to negotiate terms, comes from the ability of a company to create multiple funding opportunities. If only one firm is ready to invest money and time behind a project, then the cost of their money is whatever they have to offer.

    Where I am taking issue is in the actual amounts: some have already commented, an initial funding of a few $K only gets you to last a short period of time, and it is not clear to me how much you can achieve in terms of milestones in such a timeframe. A couple of YC startups did subsequently get Tier 1 financing, proving that the model allows some companies to get to the next stage. But given the cost of the money, entrepreneurs should 1) make sure that there is no other source of capital, and 2) that they really get a ton of value out of the program.

    Finally on the Preferred vs. Common: there is a cost involved in creating a class of shares for investors, etc. and given the amounts involved, it would not make any sense for YC to get anything but common shares. But using Preferred shares for an equity financing does not mean that investors are "trickying" founders and/or employees. There are also very good reasons why you don't want to price/sell common shares to an investor.
  • Our company did the Y Combinator thing for this years Winter Founders Program, and I'd do it again in a heartbeat. You cannot put a price on the experience, the contacts, and the weekly healthy meal with great people.

    The Wufoo guys (who did last years Winter Founders Program) and I were talking two days ago about our thoughts on YC, and the thing that we have universally noticed is that no one who has done the program has thought it was anything but fantastic. Many have done it a second time with a new idea (Justin.TV, Buythislook, probably some others that I can't think of). Everyone who's been lucky enough to be involved seems to agree that YC kicks ass.

    The best thing you can do when you're wondering whether a product (or investor) is great is ask previous customers (companies)...you won't find anyone who wishes they had their 6% back (5% in our case...the percentage is variable based on state of the company).

    I think the criticisms are worth bringing up, but one should also judge from whence they come. I'd take the advice of companies who have dealt with YC, rather than investors who are competing for the best talent. That's not to say YC is above judgment (they need to fix those damned benches for one thing), but if every one of their companies is praising YC, you're best bet is to listen. While some of the YC companies are young and not really savvy to business...many of us have plenty of experience (I'm 32, and this is my second company).
  • Jeff, I want to ask you from the more known YC companies that you see, how many would you have invested in?

    I don't really think YC competes with the bigger VCs, even those investing small amounts like you. YC has its niche and as the previous poster said, near everyone who has been with YC is super happy. That tells more about YC than the model because I can easily see others trying to replicate the YC model screw it up in the execution. And until those taking the investment are happy, I don't think there is a problem.

    --Zaid
  • pwb
    Clavier is comaring his $1m to Yc's $6k? And he's taking 20% to get a company roughly to the same stage? That is idiotic. Ycombinatior is getting products to market for a measly 6%. I don't see how anyone could remotely make the case that that is anywhere near a rip-off.
  • I think, however, that 6k goes a little less far when you consider you're living in Boston and San Fran, mandatory, for a certain number of months. That much money does not go far in those cities at all (and this is coming from a current New Yorker).
  • At the end of the day, no one puts a gun to the head of the Ycombinator entrepreneurs and forces them to take the money. The fact is that people are lining up to apply for the program. And by the way, the main benefit of the program is its ability to hype your startup, not the measly amount of money on offer.

    Now if I were to choose between taking money from Paul or taking money from Jeff, I would take money from Jeff--as an individual angel investor, he has achieved an order of magnitude (or two) more returns for his entrepreneurs than Ycombinator has. But I would gladly take money from Paul under the right circumstances.

    I also think that Paul has done a great job of convincing more young people to start companies, which is good for all of us.

    That being said, I can't help but be envious of Paul. I wish I could invest $5K for 6% of a company, common stock or no!
  • Marcus
    Have you seen the companies coming out of Y-C?

    Justin.tv? What a joke.. they failed to capitalize on their 15 minutes of fame.. what a waste.. 6% is fair given the type of individuals they're investing in. If you can't raise $5k/per founder on your own.. then 6% of your company isn't that bad.. besides.. like I said before, they're playing pull tabs at 5k a pop. Hoping one will hit.
  • "Have you seen the companies coming out of Y-C?"

    Actually, about 50% of the first program founders are now rich, by some definition of rich...but it's a definition that involves six zeros, so it'll do for me. It's looking like the second round folks are going to have pretty close to the same success rate. Remember, it's been going on for less than two years, so we don't know exactly which ones are winners--it often takes more than a year to build a successful company...but things are looking good for several of them.

    Having seen the companies from Winter 2007 firsthand, I'd bet on at least 40% of them getting to the same place (even if I disqualify my own company from consideration, which I obviously bet is going to be very successful). Obvious winners are Zenter (you won't believe it until you see it, but they'll be rich this time next year, or I'm a blind idiot) and Octopart (vertical search is extremely hot right now, with good reason, and the Octopart guys have hit the implementation spot on). Weebly is cool, and will probably be acquired for a nice sum before the year is up. If Heysan actually launch before any good competitors, they'll become a de facto standard in their space.

    And, to come back to your example...I thought Justin.TV was stupid, too. But then I saw the exposure. They are everywhere, all the time. I saw them on TV tonight, entirely by accident (and I almost never watch TV!). They've hit on something huge and I can't believe no one has done it before. They're also a frightfully good business team. Technically, it's your usual set of scaling problems, but from a marketing and partnerships standpoint it's unique, and they're pulling it all together in a way that is stunning to see.
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