even for outsiders, the inner workings of startup accelerators have become familiar: spurred on by camaraderie and energy drinks, the disjointed founders stage product demonstrations in front of a room full of excited journalists and investors.
Fast forward two years into a pandemic, and even a period with hackers returning home, a lot has changed in the way startup launch pads look, feel, and show value today. Early investors are rethinking the risk signal, dilution and, most surprisingly, the value of a traditional demo day.
Let’s start with an interesting topic: pro rata.
Signaling risk occurs when a VC chooses not to make pro rata investments, or subsequent investments, in an existing portfolio company. The idea is that investors who know you best – those who bet on you earlier than others – are choosing not to invest in you in your next phase of growth, which must mean the business is not so good. The negative perception may reach other investors who, despite what their Twitter bios will tell you, are very risk-averse people.
Accelerators have an interesting role to play here. If an accelerator like Y Combinator were to host 1,000 startups per batch, an automatic pro-rata investment in each startup would be capital intensive and perhaps unwittingly dilute its own signal. Like clockwork, in 2020, the accelerator changed its automatic pro rata investment policy and opted to invest on a case-by-case basis, as well as 500 Startups.
“We have significantly exceeded the funds we raise pro rata, and investors who support YC have no appetite to fund the program pro rata on the same scale,” the accelerator wrote in a post at the time. “Plus, processing hundreds of tracking rounds per year has created significant operational complexities for YC that we didn’t anticipate.
“Simply put, investing in each round for each 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 case, we fail to follow our own advice.”