Entrepreneur

Y Combinator may be removing VCs from its list of backers

Y Combinator startups are excited about all the value the incubator is creating
Image Credit: Al Abut

Major changes may be already underway at Y Combinator, the startup incubator that counts Airbnb, Stripe, and Dropbox among its alumni.

According to a report in Fortune, startups enrolled in the program may soon receive funding from an entirely new source: Traditional limited partners. These LPs tend to be family offices, pension funds, and universities.

For the first time in its nine-year history, YC might ditch the VCs entirely.

The reasons might have to do with eliminating the middlemen — going directly to LPs instead of through VCs — and also with avoiding “signaling risk.”

As Tommy Leep of Rothenberg Ventures explained by phone: If a venture capital firm known for cutting big checks (Khosla, Andreessen Horowitz, and the rest of the YC VC partners) invest early in a YC startup, they are typically in a strong position to make a follow-up investment.

But if that firm opts out of making a follow-on investment, this might give other firms a signal (true or not) that the firm believes the startup won’t succeed.

Leep said founders of early-stage startups are aware of this ‘signaling risk,’ so many choose to take money from a seed-stage investor, not a bigger investor, in order to avoid the signaling risk.

YC’s investment structure has already undergone a few incarnations. Prior to the Winter 2013 class, Russian billionaire Yuri Milner and SV Angel offered a $150,000 convertible note investment. That entity was known as the “Start Fund.” Start Fund was then replaced by a new fund called “YC VC,” with founders receiving $80,000 from Andreessen Horowitz, General Catalyst, Maverick Capital, and more recently, Khosla Ventures (that firm replaced Milner). That reduction in initial capital was a result of founder Paul Graham’s thesis that the cost of software development is decreasing over time.

Paul Graham recently announced a successor to head up YC: Sam Altman, a former YC entrepreneur and longtime advisor to the startups. (For more on Altman, check out this excellent profile in Recode.)

The proposed new structure makes some sense. YC does seem to have a knack for picking winners, so it’s unsurprising that the program is in a position to raise a fund from traditional LPs.

“YC partners do an incredible job of picking strong startups,” said Leep. “But like anyone else, they’re constantly learning and adapting.”

We’ve reached out to YC alumni and representatives from the venture firms behind YC for more information. So far, no spokespeople from these various firms have responded with a confirmation. We’ll update you when we learn more.


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