Paul Graham on the Future of Start-up Investing

Y-combinator’s Paul Graham did an excellent piece on his vision for the future of start-up investing.  Much of what he says echoes things I wrote about last March.

One thing missing from the discussion, however, is the impact that this flood of smaller investments has on the business model of the investors themselves – or not (as is mostly the case) – and more importantly what that means for entrepreneurs. While its true that there is a tremendous amount of room for more players in the seed-round market – that’s not necessarily a good thing for start-up managers. The real need is more availability of these type of investments – but not necessarily more investors. Why? Because investment at the seed stage is more than just about the money… the amount of investment is generally too small. Its more about creating the necessary legitimacy to be able to attract the next investment – a meaningfully large investment from VCs or other source. An explosion in the number of seed-stage investors means a more confusing universe for both the entrepreneurs AND later stage investors to navigate.

One of the most valuable advantages that current micro-VCs create for entrepreneurs is to function as a quality screen for later-stage investors who are time-constrained and can rely on micro-VCs to do a certain amount of “weeding” of opportunities for them. This streamlines fund raising for start-ups by essentially “pre-qualifying” them.

This pre-qualification will be drastically diluted by a large influx of new seed-stage “players” that VCs don’t have the time to get to know or trust to use as an effective pre-qualification source.

The result will likely be no change compared to today’s environment for most start-ups – except that in addition to not knowing who you are, they wont know who your micro-VC or super-angel is either.

Adding more Investors doesn’t improve the situation for start-ups because it doesn’t solve the choke point associated with getting a meaningfully large investment – it just puts a layer of small investments in front of that choke-point.

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