"Before, if somebody offered to invest in your company, you just jumped at the chance," says Harjeet Taggar of Y Combinator. "It meant your idea is not going to die. But for the first time, people are starting to grill investors on why they should take the capital, if they can get the capital elsewhere."
Taggar is a venture partner at Y Combinator, a VC that makes small investments in startups (rarely more than $20,000) in exchange for small stakes in the companies (around 2% to 10%). Rather than seduce startups with offers of millions in seed money, Y Combinator is part of a growing trend of investors that offer what Taggar describes as a mix of mentorship, networking, leverage, and brand value.
"You're starting to see a trend of investors having to work harder to convince founders that they should be able to invest in that company," he explains. "There is very much early-stage capital available for startups—many are getting involved in angel investing, and lots of traditional VCs are too. Founders are now asking investors, What are you going to do? Why should I take your money over the other angels? On a day-to-day basis, why is having you in my company going to be a good thing? These are questions that people never asked before."
While landing seed money may have been the primary goal in years past, Y Combinator and other similar VCs have realigned the priorities of startups. This past cycle, the company chose 36 groups to fund. For a "semester," Y Combinator trains the early-stage startups, providing advice, introducing investors, and helping to develop ideas. Upon "graduation," the companies will join a strong network of founders, which strengthens the Y Combinator brand and gives startups leverage to raise later stage investments.
"There's a perception from afar that $20,000 for about 6% is crazy," says David Tisch, director of TechStars, a company that makes similarly small investments in exchange for mentorship. "But there's not a company that does TechStars for the money. There's not a company that does Y Combinator for the money. People are doing these programs for the network, for the mentorship, for the brand."
Both TechStars and Y Combinator have seen remarkable success. Scribd, Reddit, and Dropbox were all products of Y Combinator's funding and training program. TechStars saw six of its first 20 startups acquired for more than $2 million each. TechStars is expanding to New York City this year, and will provide mentorship from Foursquare founders Dennis Crowley and Naveen Selvadurai, Tumblr founder David Karp, and Union Square Ventures partner Fred Wilson, to name just a few.
"A big reason a lot of people stay at companies and don't do a startup is because you go from an environment where you're surrounded by a large number of people to being on your own," says Taggar. "At Y Combinator, you're part of a group of people." The tight-knit community of startups also creates a healthy competitiveness that would otherwise be lost for companies founded independently.
"It's community-driven mentorship. All the companies work out of the same office," echoes Tisch. "You're under competitor pressure, but not drawn from competition."
"The companies are pushing each other to do more faster," he says.