Dalton & Michael: Why Investors (Secretly) Love Y Combinator

this is Dalton plus Michael, and today we're gonna talk about why the best investors secretly love y c. Very secretly.

Set this up for us, Dalton. Yeah. So so the keyword here that Michael is saying is secretly Because if you, you know, if you talk to a lot of investors, if you read their blog posts in social media, a recurring theme is sucks. Oh, maybe it's, you know, y c okay if you must. But it's, you know, not as good as just going directly to Of course.

Our funds because we're number one that you should raise from Of course. Blah blah blah. And so we are very used to seeing this, and we often get questions about this from founders, which is like, hey, I I heard from investor x that they said that, you know, doing y c doesn't make sense for me. What what's your guys' response to that? Often while passing, by the way. Yes. Yeah. No.

That's the best part is, of course, the investor is not investing in them either. Yes. But they leave them with a partying gift. Yeah. 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 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 gonna jump into that. So let's start with some stats. Right? So.

a 16 z, Andrews Norwood's pretty famous, impressive investors. So they've done 234 investments into YC companies. Sequoia, another impressive investor, a 39 investments into YC companies. Founders Fund, a very controversial, counterintuitive.

investor has done a hundred and four investments in YC companies, and I could keep going. Yeah. And so if you look at the YC top companies list, anyone could look at this, this is on the Internet, and you actually look at who invested in them. It's all the big investors. It's all the big investors. And so so by definition, these investors are voting with their pocketbook Yes.

To invest lots of money Yes. 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, it.

we're kind of providing a service to VCs. And, like, what what do you think the VCs are consuming here? Like, why why do you think they like to invest in YC companies? 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 10 partners?

Yep. So 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? Yep. The service that YC provides is it is a very helpful filter Yes. For what is good and worth paying attention to Yes. By getting the YC stamp on it, it's auto we we are filtering it.

We're doing that job for them. We're taking,.

what is it, 20,000 applications Yes. And turning it into 200 something Companies. And.

even then, they can get to know the YC companies and keep filtering even after that. Yes. And so having any kind of signal is very helpful. Yes. In addition, the fact that we get the company's finance so they don't just run out of money. Yeah. What often happens when you're going to to raise from VCs, they say this is too early.

And the founder's like, well, we're too early for them, and, you know, we don't want to do YC. And so then it just, shut down. Yeah. We have any money. 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 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 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 Yes. To change their idea.

I'm gonna try out a 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 themselves. So the chef is Exactly. Literally, it's farming themselves. Exactly. Yeah.

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 in a nice box, in a nice package. And I think that it makes sense if you're one of those firms and they had so much demand that you'd prefer things in a nice package preselected.

So that's the service that YC provides VCs, but it's tricky because these VCs also all say, we wanna be your first check. Yep. So what's the difference between them seeing that and why it's hard for them to actually be the first check-in most of company? I think in practice,.

it's it's scary when your customers first talk to someone else before you Yes. Because you can get disintermediated Yes. In the future. And 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 could imagine that is not their favorite thing that we encourage founders to speak to many investors in parallel instead of one. Sure. And so that is a bit frightening. And so when push comes to shove, they want be the first people to talk to you to get the first check, so it's a noncompetitive 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. They invest in an Uber.

competitor super early, and then Uber comes. Makes it harder. They can't read a check.

In addition, they're just they don't have enough data. Like, they 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. And then when every six months, the founders 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 y c companies is once a company does y c, they are less likely to do All those things.

All those things. Yeah. 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, you can again, you can see the dynamic here. But at the end of the day, if one of these investors, we just you know, Michael just listed them. If there's a really great company They have to invest.

They're not gonna say, no, we don't want to invest in this company Yes. They did 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 walks in the door and more technical than the average company walks in the door. Why is that love secret? Because all things in equal, of course, they'd rather be the first check. Yep. And they know if a 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. Yeah. 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 y c. And so it's much more of a zero sum situation Yeah.

Where any kind of content marketing or viral memes you could put out Yeah. About about y c are are essential if you're doing a seed fund. Yeah. Because your job is to be is 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 or Yeah. They can't catch you in the next round. And they also know that from that round forward, they're probably gonna be diluted.

And that's when they try to get as big of a chunk at as low as a price. I think, you know, seed funds, we we could have given numbers for seed funds. They write thousands, tens of thousands of checks in YC companies. But the reality is is that when they write those checks in YC companies, they're at higher prices. Yep.

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 5,000,000 to $10,000,000 price for evaluation. And when they find you after demo day, they pay a 15 to $25,000,000 price. You can't 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 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 y c and take the money and all that. Hey, man. Maybe you wanna that's not crazy. It's not the worst offer. Yeah. Like, that's 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 they're actually giving you advice to not raise money from another investor including, you know, such as YC Yeah. Because reasons.

So, no, I I think to 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. Yep. 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. Alright. Great chatting. Thanks.