Are Incubators and Angels Gaining Leverage On Larger VC Firms? – ReadWriteStart

ycombinator_logo_mar10.jpgBeing a resident of the Phoenix area, which is a significant distance from Silicon Valley, I wasn’t able to attend the Demo Day show-and-tell pitch-fest at the end of Y Combinator (YC), but luckily, other reporters were there and have been slowly releasing stories about the companies and the event. Peter Kafka of All Things Digital published a video interview Thursday with YC co-founder Paul Graham from Demo Day in which he provides some interesting insights into how the investment community is rebounding and possibly how incubators are beginning to have influence on the larger VC firms.

This group of YC grads included 26 companies, of which 20-25% Graham would expect statistically to go on to receive Series A funding. However, this number could potentially be higher with this newest class as Graham has seen a drastic change in the attitudes of the investors.

“Judging by the reactions of investors, the recessions seems to be over,” Graham said in his interview with Kafka. “I don’t think we’ve ever had a batch that had so much investor interest so early as this one.”

As Graham points out, some of the companies had spoken with or secured angel funding well before demo day – another surprise, he says. An interesting opinion he shared in his interview included the idea that it is hard to place a statistical number on how many companies emerge from YC to become “successful” businesses. Who defines what “successful” is?

paul_graham_mar10.jpgGraham says that historically, 70% of YC companies have raised additional funding since leaving the program, or have not needed to because they managed to become profitable without additional help. But how does Graham truly gauge success for the entrepreneurs? “The founders end up rich, basically. That’s the definition,” he says.

The other interesting quote Graham gave during his brief interview sparked an interesting thought in my mind about the state of the start-up and investment community as a whole. When Kafka suggested that angel investors tend to get squeezed how by more powerful VC firms that flood companies with cash in future rounds of funding, Graham replied that firms would be foolish to attempt this with YC startups. To paraphrase, Graham basically said, “The firms wouldn’t dare squeeze out the angels on YC companies because that would mean they would be squeezing us too, and that wouldn’t be wise if they wanted to continue to have access to our alumni.”

What this got me thinking about is how the growing popularity of incubator programs like Y Combinator and TechStars is affecting the venture capital community. Are firms less likely to squeeze out angel investors from these kinds of companies because the incubators continually graduate companies with high potential? Is Graham saying that if the VCs want continued access to the best startups around that they had better play nice with the angels?

If so, is this good or bad for the startup community? If this is really having a significant impact on how VC firms approach these companies, then it surely benefits the angel investors, but do the startups ultimately gain anything from it? I wonder if there has been a case of VC firms deciding not to invest in a YC company because they would rather be able to have more control over term negotiations.

I would think that a VC firm would be more interested in the opportunity to work with high-potential companies than in a power struggle in the board room, but I could be wrong. Or I could just be over analyzing a simple quote.

Photo by Flickr user pragdave.

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