The Secret That Silicon Valley's Top Investors All Share

If you look at the YC top companies list, anyone can look at this; this is on the internet. If you actually look at who invested in them, it's all the biggest restaurants. So this is Dalton plus Michael, and today we're going to talk about why the best investors secretly love YC. Very secretly put this up first.

Yeah, so the key word here that Michael is saying is "secretly," because if you talk to a lot of investors, if you read their blog posts or social media, a recurring theme is, "YC sucks." Oh man, maybe it's, you know, "YC is okay, if you must, but it's, you know, not as good as just going directly to our funds because we're number one, and you should raise from us." We are very used to seeing this, and we often get questions about this from founders, which is like, "Hey, I heard from investor X that they said that, you know, doing YC doesn’t make sense for me. What’s your guys' response to that?"

Often while passing, by the way, yeah, that's the best part, is of course the investor is not investing in them either. Yes, they leave them with a parting gift.

And so what we wanted to talk about in the video today is what's actually going on, and the fact is the top investors invest in YC companies a lot. All the time. All the time. And there's a bit of a gap between what they will say to folks that they are passing on, yes, and how they actually behave as investors. So we're going to jump into that.

Let's start with some stats, right? So a16z, Andreessen Horowitz, it's pretty famous, impressive investors, so they've done 234 investments into YC companies. Sequoia, another impressive investor, 139 investments into YC companies. Founders Fund, a very controversial, counter-intuitive investor, has done 104 investments in YC companies, and I could keep going.

If you look at the YC top companies list, anyone can look at this; this is on the internet, and you actually look at who invested in them, it's all the biggest investors. By definition, these investors are voting with their pocketbooks to invest lots of money across the board into the YC portfolio, because they like money, and they're smart, and there were a lot of excellent YC companies to invest in.

Well, let's dig into that, right? So in some ways, we're kind of providing a service to VCs, and like, what do you think the VCs are consuming here? Like why do you think they like to invest in YC?

Yeah, the major reason a normal venture capitalist would not invest in a startup is that it's too early. Yes, and too early just means there's not enough signal that this is one of these epic standout companies, which is their job to invest in. Yes, the average VC only does one deal a year, maybe two deals a year, yes, and the average firm has what, five to ten partners? There actually just aren’t that many slots of deals to do, and so the feedback is generally this is too early for us.

Right, the service that YC provides is it is a very hopeful filter, yes, for what is good and worth paying attention to. Yes, by getting the YC stamp on it, it's odd. We are filtering it. We're doing that job for them. We're taking what is 20,000 applications and turning it into 200-something companies. Even then, they can get to know the YC companies and keep filtering even after that. So having any kind of signal is very helpful.

Yes, in addition, the fact that we get the companies financed means they don't just run out of money. What often happens when you're going to raise from VCs, they say this is too early, and the founder's like, "Whoa, we're too early for them!" You know, we don’t want to do YC, and so then they just shut down.

Yeah, the company doesn’t exist, yeah. And so to the extent that YC just gives these companies money to have a shot at getting far enough along for a VC to invest, yeah, that is a helpful service. Yes, in addition, the advice and the network we give the companies—helping them with sales, helping them with pitching, helping them pivot—a lot of these companies on our top 100 list are companies that pivoted during YC. Yeah, and that's a value-added service we're providing to the investor market, is giving these companies an avenue to change their idea.

I'm going to try out a really, really crazy kind of analogy on you. I think these best VC firms are like really high-end restaurants, and I think that they like to give the impression that they go out to farms and they hand-select live chickens and live— they’re farming themselves, right? The chef is literally farming them. Exactly, yeah. But when you actually look at most of the products on their menu, they come from purveyors who do that work for them—who identify the best ingredients, who prepare the ingredients, who deliver the ingredients in a nice box, in a nice package.

I think that it makes sense if you're one of those firms and you have so much demand, that you'd prefer things in a nice package, pre-selected. So the service that YC provides for VCs, but it's tricky because these VCs also all say we want to be your first check. Yep. So what's the difference between them saying that and why it's hard for them to actually be the first check in most companies?

I think in practice, it's scary when your customers first talk to someone else before you because you can get disintermediated in the future. One of the things that YC does that investors don’t love is we encourage you to talk to many investors. Yes, instead of talking to just one investor. And so again, you can imagine that is not their favorite thing—that we encourage founders to speak to many investors in parallel instead of one, sure.

That is a bit frightening. And so when push comes to shove, they want to be the first people to talk to you to get the first check, so it's a non-competitive conversation. But look, they just are not in a position to do that many deals because of how the firms are set up. Yes, they also have to worry about conflicts, where if they invest in the wrong company earlier, they're not going to be in a position to invest in one of their competitors in the future.

If they're taking board seats, if they invest in an Uber competitor super early and then Uber comes, it makes it harder—they can't write a check. In addition, they just don’t have enough data; like, they need data to invest in things at a higher valuation at a later stage. And so what they want, the perfect situation for a VC, is to see everything, to meet with every company that they can, have the founder love them, yes, and think that everyone else that is not them is bad—like it’s a luxury good, like you’re trying to create brand equity with the founders. Fair enough, yes.

Then when every six months, the founder should come back and pitch them again with a smile on their face, yes, so they're never in a position that someone else funded them. Yes, and so what can often be tricky with YC companies is once a company does YC, they're less likely to do all those things. All those things, and they're much more likely to be desired by a number of other investors, which is, again, competition is often bad for profit margins.

And so, you know, again you can see the dynamic here, but at the end of the day, if one of these investors, we just—Michael just listed them—if there's a really great company, they have to invest. They're not going to say, "No, we don’t want to invest in this company," if they need YC because they're smart.

So if we think about this conflict, right, why do they love YC? Because we can kind of package companies for them in a much better way, and because YC companies tend to be further along than the average company that walks in the door and more technical than the average company that walks the door.

Why is that love secret? Because all things equal, of course, they'd rather be the first check. Yep. And they know if the company does YC, they won’t be the first check, so it's kind of a really tricky game. What about seed funds? How does seed funds kind of play in this dynamic?

Yeah, I mean again, they want to be first checks. They have various ways where they want to meet with as many companies as possible—maybe some of them have a thesis—but, essentially, they want to buy 10 to 20 of a lot of the companies. Yes, which is completely not compatible with a company doing YC. And so it's much more of a zero-sum situation, where any kind of content marketing or viral memes you could put out about YC are essential if you're doing a seed fund.

Yeah, because your job is to be—to get a big ownership in the company and then try to get the VCs to fund them in the next round. Yeah, I would say that seed funds are also more limited than traditional VC funds, because if a VC fund misses your A, they can still do your B or your C, whereas your seed fund kind of knows their primary opportunity to invest in you is at the first round.

Yeah, they can't catch you in the next round, and they also know that from that round forward, they're probably diluted, and that's why they try to get as big of a chunk at as low as a price. I think, you know, seed funds—we could have given numbers for seed funds—every thousands, tens of thousands of checks in YC companies. But the reality is that when they write those checks in YC companies, they're at higher prices.

Yeah, and so, you know, you can't blame seed funds for saying we don’t want you to do YC when if they find you outside of YC, they pay five to ten million dollar price at their evaluation, when they find you after demo day, they pay a 15 to 25 million dollar price. You can't blame them.

But I think as a founder, you need to understand these dynamics, right? Like the people who are marketing to you are running their businesses, and those businesses have dynamics. You understand those dynamics; we're running a business too, right? You can make the best decision for your company, and the important thing you should be thinking about as a founder when someone is giving you advice about all this stuff is: are they offering to invest?

Yes, and if someone is literally offering to invest, you should take them a lot more seriously. If someone says, "I want to invest this amount of money," yes, and you should, you know, not even apply to YC and take the money and all that. Yeah, man, maybe you want to—that's not crazy; it's not the worst offer.

Yeah, like that is reasonable. But the weirdest formative advice is someone that is aggressively not investing and coming up with excuses about why you're not ready or you need to talk to some other people or come back in six months, yes, and that are actually giving you advice to not raise money from another investor, including, you know, such as YC.

Yeah, because reasons. So no, I think to wrap this up, right, I think that I love about what you said is that if you were to look at the best YC companies, all the best VC firms and all of the best seed funds have invested in them. And so maybe you should spend a little bit more time looking at what people do rather than what they say or they meme or they tweet.

Yep. All right, great chatting. Thanks.
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