We live in an era where major founder leverage is a fact of life in the startup world. Unlike the bubble era, founders today - or at least those that are among the most talented - have substantial power in determining the direction of their ventures and the investors who most benefit from this are those who win their favor and align their interests along with those of such founders.

YC is an innovative venture capital firm whose model depends heavily on its maintaining credibility with the talented founders who run the ventures it funds. In this sense, it has caught the spirit of the age brilliantly and that is why YC stands out as one of the premier investment firms of our era.

A key element in this approach is for YC to do what it has done all along and that is to take common stock instead of the almost sacrosanct preferred stock that VC firms have always insisted on in the past. This radical innovation in VC-style funding has set YC apart from the pack of VC firms, incubators, and any and all other manner of investor wanting to hitch their wagon to the talented founders who are capable of building successful, massively scaling ventures that seek to transform all of world commerce. Its importance cannot be emphasized enough as a key to YC's success. It has enabled YC both to be in the midst of the fray and to stand above it, all at the same time. It is the founder's ally even while it benefits mightily as an investor.

What then to do after the founding stage to avoid dilution to its initial investment stake without jeopardizing credibility with founders? If YC were to pick and choose in participating in early follow-on rounds, this would selectively help and simultaneously hurt the various founders it works with. Almost by definition, the fact of such an investment would brand some YC ventures as in and others out of YC favor, a result that would prove highly damaging to the aura of goodwill that is not only helpful but absolutely indispensable for YC to maintain with its founders.

So how to maintain that goodwill and still avoid subsequent dilution in the various investment rounds that inevitably follow from the inception of star-quality companies?

Well, you can set up some fixed rules, make such follow-on pro rata investments automatic within the defined bounds that make sense for YC, and use that as a way of extending YC's leverage to help it keep the 7% (or whatever) stake it begins with in each venture.

And that is precisely what YC has done here with its pro-rata program.

Founders usually have no problem with early stage investors being able to participate pro rata in later rounds as long as they are significant investors and as long as such participation does not jeopardize their ability to raise later-stage money on good terms.

YC is of course a significant investor.

As to jeopardizing future funding terms, I believe YC has made a judgment call here that the investors it typically works with will have no problem taking something less than their accustomed full pieces in the later rounds to accommodate YC and will therefore continue to finance YC ventures exactly as before. Hence, no prejudice to founders and no loss of goodwill or credibility among founders.

I believe this is a sound calculation. YC has been able to persuade VCs to deviate from a variety of their traditional rules/requirements as part of being a part of the YC universe. This is just one more to be added to the list. It is a world of increased founder leverage and that means investors who want to stay with the deal flow need to adjust and adapt. I think they will do so here as well.

In a worst case for YC, this might prove a failed experiment. But the downside of the experiment's failing is minimal while the upside in being able to avoid later-stage dilution among a vast group of potentially valuable ventures is huge. Thus, this makes eminent sense for YC for sure and probably for its founders too. As for the VCs who will have to adapt a bit, they will survive and very likely continue happily investing just as before. At least that is how I read it.