disclosure: I am a board member of Cove Markets and investor in Robinhood.
needs competition
I have been following with fascination the Y Combinator magic bean printing machine develop over the last 10 years. According to Pitchbook, 5 of the top 25 most valuable VC backed companies in the US went through Y Combinator. This is more than impressive, it’s epic.
The question is, can there really be only one?
YC has funded 1900 companies since inception. Clearly, there is enormous value and a huge network effect in joining YC. It is also true that companies are much better off either joining the top accelerator or not going through one at all. Going through an accelerator means giving up equity and time. If a company is not actually accelerated after coming out one of these programs, it is a negative signal to future investors and a waste of precious early equity and founder energy.
YC Is Expensive
I am not claiming that YC is not “worth it”. Of course, it is. What I am saying is, in order to go through YC, a company must do two things:
- Give up 7% of equtiy in exchange for 150K on a post-money SAFE.
- Move to Silicon Valley ( or commute very frequently to attend events )
Leaving aside the astronomical cost of living in Silicon Valley, giving up 7% of your company very early on is quite expensive for the entrepreneurs. Any accelerator that tries to mimic YC by offering entepreneurs the same expensive terms is likely to fail, or at least generate low IRR for its backers.
This directly follows from the issue of adverse selection. A founder knows her own worth. A founder who knows she is worth a lot, all things being equal, will be reluctant to give up too much equity too soon. It may be worth doing for the enormous 1900 company network, but it certainly won’t be worth doing for the ABC Crap Accelerator program.
Therefore, because of network effects, YC will only grow stronger and other accelerator programs will suffer from adverse selection.
What If
Let’s do rough math. YC has invested 150k in roughly 2,000 companies, or 300 mln in total. Total market cap of YC backed companies is in excess of $100 B. Let’s assume with dilution that YC owns between 2-4% of each of those companies. That’s a 7–12x multiple on the money invested to date. It’s not clear what the YC IRR is, since I don’t know precise timing of each round, but I estimate it somewhere in the neighborhood of 40%.
What if another accelerator recognized the massive adverse selection problem and did not try to blindly copy YC terms. Instead, I propose the following:
- Invest 300k for 5% of the company, post money SAFE. Not 150K for 7%.
- Do it in a cheap city: Chicago, Austin.
- Assemble a great network of mentors, corporate executives, entrepreneurs, angel investors, VCs to help.
Worst case scenario, if the IRR of this crazy enteprise turns out to be nowhere near YC levels, at least many more entrepreneurs will get help in starting companies and that is good for everyone. However, I would not be surprised if the returns from doing this right turned out decent enough.
This is Stupid, It Will Never Work
The value of YC is basically that coming out of it, a company can raise at a 10–20 MM cap 3 months later. Who cares about giving up 7%. OK. Are we arguing that there should be one good startup accelerator in all of United States for all eternity? I don’t buy it. Everyone would be better off if viable alternatives existed.