On Monday, January 10, 2022, startup accelerator Y Combinator announced that it would increase the size of future investments from $ 125,000 to $ 500,000. For many, the news was great because the founders could get more money from the accelerator.
However, quite a few people have expressed concern about what this means for founders and investors. Here we will look at this deal and what it means for the founders of Africa.
What is the YC New Deal?
According to New Deal terms, Y Combinator will continue to invest $ 125,000 in 7% of companies. However, we will also invest an additional $ 375,000 in an “unlimited vault with Most Favored Nation (” MFN “) clauses.” This second provision is worrisome for some people, but first, what is MFN?
NB: SAFE stands for Simple Agreement on Future Fairness. This is a contract that allows an investor to invest in a company that has been promised by the company to provide shares to the investor when procuring a priced round.
Most favored nation treatment is not unique to the world of venture capital and has been used for many years in international trade and politics. According to Investopedia, the MFN clause requires that all World Trade Organization (WTO) member states offer the same concessions that one country offers to one country.
Extrapolating to venture capital and YC deals, when YC startups raise the next round, YC’s $ 375,000 investment will be converted into company stock on the most favorable terms for round investors. Means. In other words, YC is giving startups an additional $ 375,000 in future ratings that they (Y Combinator) do not control.
What does this mean for African startups and founders?
On the surface, this seems like a better deal for African startup founders. Prepaid $ 500,000 is a huge sum of money and can help you avoid the pressure to pull up quickly if your startup is running lean.
Kevin Simmons finds this a daunting task for the founders. “From the founder’s point of view, for example, if YC is willing to offer half that amount to raise $ 1 million, it’s easy to undertake a deal and get a balance from another investor.
“It may also mean that the founders are increasingly chasing YC. Therefore, if you are a competitor and your customers are moving in one direction, you don’t want to lose the best company, so you compete. You need to offer more money or better terms to do. “
One of the issues raised is how difficult it is for African start-ups to procure with high praise. But that’s not entirely correct.Founders need to convince investors that their business is as valuable as they say, so it will always be difficult to raise money with high praise.
However, as the funding situation is growing astronomically, stakeholders are currently discussing a very high startup rating. This is a problem that didn’t exist just a few years ago. In 2021, African start-ups raised about $ 4.3 billion. That’s 2.5 times the amount raised in 2020. The influx of money into the ecosystem makes it easier for start-ups to raise money at high valuations.
Most startups raise money to float before joining YC. However, acceptance of YC has been seen as a sign of verification for startups, especially African startups. This has increased investor awareness and made it easier to raise funds from investors after YC Demo Day.
According to Simmons, “There are two ways to look at Y Combinator deals. When you enter Y Combinator, you’re meeting high expectations anyway. That’s why YC thoroughly screens and selects good startups. These expectations fall to the dollar and cents, which means that after YC, we need to raise them with higher valuations and build bigger businesses. “
With the New Deal, YC will get a larger part of the post-YC startup at the same value as subsequent investors. For the founders, that means giving up most of their company before they enter a series A round.
Since its announcement, many investors have expressed concern that most of them come from minority regions such as Latin America and Africa, which could lock local investors out of the cap table. .. Provided by the investor. However, not all investors in these regions agree.
Angel investor Biola Alabi believes that the benefits of going through YC outweigh the perceived disadvantages of this transaction.
“Most early-stage investors will benefit as long as they invest early. The advantage of going through YC is the first anxiety around if this affects smaller investors. More than a few. The most important thing is to believe and invest with confidence. The valuation works well. The market will ultimately decide these. “
Despite increasing investment in African start-ups, there is still a need for very early investors who can enter either pre-seed or at the seed stage. In most cases, African start-ups at this stage usually raise very little less than $ 2 million. However, the YC move could exclude most angel investors and small VCs investing in this round.
It’s still unclear how this change will affect other accelerators and investors, but Simmons’ growth witnessed in 2021 makes it easier for local investors to raise money from LPs. We believe that we will be able to invest more money in startups.
He also points out that startups will reconsider joining YC just for the brand.
“If you went to YC before and thought 7% wasn’t a big sacrifice, now it’s going to cost $ 500,000. Yes, not all are 7%, but it’s more influential. I have.”
As a result, raising future rounds with a low rating means giving up most of the company, so the founder must either raise a small amount or give up the idea altogether before joining YC. On the contrary, this could mean that local investors bet on these startups fast enough without waiting for verification with YC approval.
Investors have typically avoided the use of unlimited SAFEs, but YC’s willingness to use them could be a game changer.
“Because YC is a very large brand, will other investors be willing to adopt uncapped SAFE? As SAFE has become a standard practice, uncapped SAFE will be more accepted. Will it be? “Simons asked.
Modupe Odele, Lawyer, Founder of Vazi Legal advice Startups wishing to have YC must ensure that they receive an angel check before signing YC’s MFN SAFE. In addition, a lawyer is required to confirm the terms to ensure that the MFN clause is not retroactive. However, according to YC’s announcement, it doesn’t seem to be the case.
There is no sign that the YC deal should keep the founders up late. Since funding the first African startups in 2009, we have only funded 66 African startups. More than 800 transactions were made in Africa in 2021, which is a small part of the transactions made in Africa. It can be annoying if other investors follow.
African startup funding is not yet at the level of the US or Europe, so if you want to take advantage of Y Combinator, it can be even more difficult for African startups to raise money locally. On the other hand, it may encourage more local investors to scout and invest in businesses at a really early stage.
Chimgozirim Nwokoma
A coincidental writer covering the landscape of African startups and their heroes.
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