Y Combinator's new model wants to help "ugly ducklings"

By Richard Nieva , written on November 26, 2012

From The News Desk

Tomorrow, interviews for startup bootcamp begin. But today, Y Combinator, the seed accelerator that is behind companies like Dropbox, Airbnb, and reddit, announced a restructuring in its model that will change the experience for the startups that get selected. The company is starting its own official VC program.

For those who worry the incubator already has too much power in Silicon Valley, it just grabbed a little more. The winners appear to be YC who can now control the program and offer organized perks like office hours from the participating venture firms. The loser appears to be Ron Conway's SV Angel who isn't mentioned among the new backers.

There has been an unofficial program for about two years, when Yuri Milner and Conway decided to create the Start Fund and invest $150,000 in convertible notes to each YC startup. The incubator didn't start this program and after living with it for a while, has decided it needed to take more control of it. "Although we didn't organize this program, over the years we ended up de facto managing it, and it was awkward to manage something we hadn't started," said the company in a statement.

Though the chunk of money was a great boon for the startups, YC said that amount has been too large and sometimes problematic for startups, and have changed the funding to $80,000 instead. While the startups will receive less money, they will have more access to the participating VCs, who will hold office hours with the founders. This backs up some of YC co-founder Paul Graham's previous warnings that things were getting a little too overheated in seed space and that startups should be more careful to husband their resources.

It is a sage move given the frenzy around backing YC companies generally. It's always good to enforce discipline before it is forced on you. It's not only smart -- it's rare in Silicon Valley where entrepreneurs frequently take everything they can get.

In the new program, there will be four investors, giving $20,000 each: Yuri Milner, Andreessen Horowitz, General Catalyst, and Maverick Capital. This means that Conway and SV Angel are noticeably absent. "We still love them and would have been happy to have them, but it didn't make sense given their fund size," said Graham, citing SV Angel's role as a super angel.

The magic number came from studying the company's past startups and seeing how much money they needed to spend on living expenses for a year. Most of their successful startups didn't need more than $80k, Graham said in an interview. The smaller amount also decreased the chances of messy in-fighting for startups that fall apart.  "We saw cases where one founder would fire another, and the other would say, 'Okay, give me half of the money,'" Graham says. "It became like a divorce when there was large fortune at stake."

Graham indicated that YC is still experimenting with getting the investment amount just right. The motivation was finding the sweet spot for a certain type of startup. He said every company they seed falls into one of three cases: the startup that will succeed no matter what, the startup that's doomed to fail and the startup that needs a little more time to flourish -- or the "ugly duckling" case. That is the kind of company the program is really trying to help, said Graham. "The goal is to try and decrease the cost to us when a startup explodes, while still helping the ugly duckling," he said. "There are people who don't look good on demo day that end up succeeding, that part is clear," he said.

At last month's PandoMonthly, AngelList's Naval Ravikant referred to Y Combinator as a de facto startup "union" in Silicon Valley. It just got a little more powerful.
[Image courtesy JD Hancock]