Why Start Fund is a big deal (to founders)
Last Friday news came out that Yuri Milner of the Russian investment firm DST, along with legendary investor Ron Conway’s firm SV Angel announced that their Start Fund would offer all Y Combinator companies $150K in convertible debt — without a cap or a discount.
- This is “the end of angel investing”
- This is an “incredibly savvy media buy”
- This is a sweetheart deal, “how did others miss it?”
- Is this sure sign “the bubble is back?“
- Is this “a threat to Silicon Valley?”
- Is this “a VC killer?”
- What do the “angels themselves think about this?”
My favorite coverage though is from Roger Ehrenberg. His blog is one of my favorites and I respect his opinion highly. He wrote a great post where he argued that Start Fund is no big deal and it’s business as usual. Other highly respected VCs Fred Wilson and Brad Feld both agreed in the comments.
I largely agree as well. From the investor perspective, this is not a big deal. Essentially Milner and SV Angel were able to act as a LP in Y Combinator without paying the industry standard 2% management fees. They created an index fund across an already well vetted portfolio of companies with the hope of having a seat at the table for subsequent financings. But let’s not call it more than it is. It is a brazen, well played move by a few investors in a very small segment of the startup market. Time to move on.
Example: If the conversion discount was 20% and the price of the VC Series A was $1.00 per share, then each $0.80 of the note would convert into one share of Series A.
The terms of Start Fund’s convertible notes have no discount. This means that the note converts 100% at the price set in the Series A.
“Either the cap or the discount applies on a conversion, not both. E.g. if there is a 30% discount to the next round with a $5M cap, and the next round is done at $6M pre, then the 30% discount would apply and the note would convert at $6m x (1-30%) = $4.2M pre. If the next round is done at a $10M pre then the 30% discount implies a $7M pre money conversions which is higher than the $5M cap, so the cap applies.”
The purpose of discounts and caps is to compensate the investor for the risk they are taking for investing in the company before the VC Series A round.
The effect of a convertible note with no discount and no cap means the investor takes the economic risk of investing early, while only getting the same economic benefit as a later investor who comes in when the company has been ‘de-risked.’
Milner and SV Angel have given YC founders the best imaginable deal. As an entrepreneur, it isn’t possible get a better deal than this. I can’t think of a logical reason to not take it.
From the founders perspective, Start Fund is a very big deal.
Fundraising is a huge time suck for startup founders. It takes a TON of time and is very stressful. Paul Graham said it better than I ever could that money matters can easily become the top idea in your mind and consume you. Start Fund takes that stress off of founders and lets them focus on where they should be focused: their product.