Even to outsiders, the inner workings of startup accelerators has become familiar: pumped up on camaraderie and energy drinks, scrappy founders do product demos onstage before a room full of buzzy journalists and investors.
Fast-forward two years into a pandemic and, even a stint with the return of hacker homes, much has changed about the way launch pads for startups look, feel and show value today. The earliest investors are rethinking signaling risk, dilution and, most surprisingly, the worth of a traditional demo day.
Pro rata
Let’s start with a juicy topic: pro rata.
Signaling risk happens when a VC chooses to not do pro rata, or follow-on investing, in an existing portfolio company. The idea is that investors who know you best — the ones who bet on you earlier than others — are choosing not to invest in you in your next phase of growth, which must mean that the deal isn’t that great. Negative perception can trickle down to other investors who, despite what their Twitter bios will tell you, are pretty risk-averse folks.
Accelerators have an interesting role to play here. If an accelerator like Y Combinator ever gets to host 1,000 startups per batch, an automatic pro-rata investment in each startup would be both capital-intensive and perhaps unintentionally dilute its own signal. Like clockwork, in 2020, the accelerator changed its policy on automatic pro-rata investments and chose to invest on a case-by-case basis, just like 500 Startups.
“We have significantly exceeded the funds we raised for pro ratas, and the investors who support YC do not have the appetite to fund the pro rata program at the same scale,” the accelerator wrote in a post then. “In addition, processing hundreds of follow-on rounds per year has created significant operational complexities for YC that we did not anticipate.
“Said simply, investing in every round for every YC company requires more capital than we want to raise and manage. We always tell startups to stay small and manage their budgets carefully. In this instance, we failed to follow our own advice.”
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