Though scarcely 24 hours old, the Yuri Milner/Y Combinator/SV Angel announcement has already been dissected, sliced, diced and beaten beyond comprehension. But there are a few salient common sense points missing from the analysis, the most basic of which is: there is a free market in angel investing, and one party has done something bold and surprising in a narrow segment of the market. Though the tech press would have you believe otherwise, there are worthwhile companies in which to invest at the seed stage outside of Y Combinator and, shockingly, outside of Silicon Valley. Messrs Milner, Graham and Conway have made a trade (buying Y Combinator start-up equity) and hopefully secured a call option (having a seat at the table for subsequent Y Combinator start-up financings) in exchange for lavishing $150k on each Y Combinator company on a blind, no strings attached basis. It’s not really that complicated. What is complicated are people’s perceptions of what impact this might have on the angel investing marketplace.
I’m in the “ho hum” camp. Y Combinator is great, the Valley is great, consumer web start-ups are great, etc., etc., etc., but they DO NOT represent anything remotely resembling the investable universe. I’ve had a pretty good time finding good companies in which to invest both as an angel and as a seed stage venture capitalist without ever touching a Y Combinator company. Really. So the fact that Start Fund is proving cheap capital 43 companies, while interesting, is hardly going to distort the market for angel financings. I’m not competing with Paul Graham, Ron Conway or Yuri Milner on a routine basis for deals, and most of the people I hang with in these little places called New York City and Boston aren’t, either. Until Yuri and friends open their checkbooks and start providing this offer to every start-up in the US, I’m really not sweating it. Further, while the gang of three are terrific, I’m not so sure they’re the best investors for every company in every domain. I know quite a few really good investors who can materially help shape the outcome for a start-up by virtue of their particular domain expertise and operating experience, something which people investing blindly across companies on a portfolio basis can’t purport to do. This isn’t to say they’re not awesome; they are. But they are most definitely not the right answer for every company.
Start Fund is simply using Y Combinator as a vehicle for curation and implying that a seat at the table at any price - or at least an unknown price made by a third-party with no price differential for taking first money-in risk - makes it worthwhile. For these guys, I can understand the motivation and as an entrepreneur, I can’t see a logical reason for not taking it as supplement to the money received from Y Combinator program (assuming additional financing is needed at all. If not, no need to incur any incremental dilution). That said, we’re talking about a very small segment of the market representing a tiny amount of the angel and seed stage venture capital deployed in companies across the US.
If start-ups begin approaching me and asking for uncapped convertibles with no discounts as standard terms, I will view this is a phase in space and time akin to junk bonds trading at 200 bps over Treasuries. My response as an investor to such market conditions? Just say no. Rationality will inevitably re-enter the market because over time risk and reward must be priced properly, and receiving debt returns for taking equity risk is not sustainable. So let’s not view this development as anything more than it is: an interesting move by a rich (and smart) maverick in a small segment of the start-up market. Period. Business as usual. Move on.