By Fortune Editors
October 17, 2011

By Semil Shah, contributor

Andreessen Horowitz recently announced that it will cover $50,000 of the $150,000 that each Y Combinator (YC) startup receives from Yuri Milner’s “Start Fund.” That works out to roughly $3 million per batch, in return for an uncapped convertible note on each startup accepts the handout.

This is a significant development, as A16Z has quickly vaulted to top tier status in the world of venture capital in less than three years. Whether you agree with YC’s approach or not, no one can deny the fact that Paul Graham’s program attracts a high concentration of entrepreneurial and technical talent. As a result, YC’s “Demo Days” are jam-packed with the who’s who of consumer, mobile, and enterprise investors hoping to find the next big thing. Because of the $150,000 note each one has access to, valuations get higher than they would be otherwise, offering founders a bit more leverage in investment discussions. And, YC companies gain access not only to a vibrant YC and YC alum network, but they are generally able to meet any venture capital firm they’d like to.

And, as more and more institutions participate in early-stage rounds, the competition to access new talent and concepts is at an all-time high. For instance, Sequoia Capital, which itself is an investor in YC, presumably has access to more intel prior to other firms, although I don’t think they have any sort of first rights. All the other investors (angels, microVCs, and VCs) compete to meet with, vet and invest in YC companies so as not to miss out on the next big thing. YC has done such a terrific job of attracting technical talent and packaging it around PG’s frameworks that it makes it very easy for investors to “feed,” though there are more fish in the bowl competing for less food.

Now, A16Z, fresh off making huge bets that literally baffle other investors, makes another bold move. Assuming every YC company accepts the “Start Fund” capital, A16Z automatically purchases equity in every YC company, which means that any other VC firm that participates in a YC funding round will be co-investing with their new Sand Hill neighbor. While A16Z may not lead in many of these situations, it will be there at some stage. This deal gives it incredible ground cover.

Expect other firms to react, each in their own unique way. People assume consumer, mobile and enterprise VC is this monolithic industry where every firm is the same — this is just my perspective, but each firm is composed of very different people and therefore behave in different ways. Here are some things any one of the firms may do as a result of this news:

  • Hire YC Founder Alums – YC has an extremely strong network of founders that all talk to each other and help out, reviewing applications, speaking, mentoring, and the like. It’s possible that VCs now try to hire a few alums who have strong connections in these networks in order to keep their finger on the pulse of what’s going on in each batch.
  • Establish Similar Partnerships with Other Incubators – There are many other incubators in the SF Bay Area, as well as Denver, Boston, NYC, Austin, and growing in other cities, too. A VC firm may also seek to overlay the DST/A16Z approach on another incubator, assuming they’re interested in the talent each one is able to attract. These could also theoretically expand into universities and magnet schools. (Not kidding.)
  • Focus Seed Stage Investments Sourced Through Internal Networks –Some firms that don’t participate in seed rounds do make exceptions for founders they know well and/or have worked with before as a founder. Instead of casting a wide net, some VCs may decide to focus more on sourcing through their own networks from portfolio companies, more so than they do now.
  • Expand Geographical Reach (Inter)nationally – As some of the other incubators listed above are outside of SF and Silicon Valley, firms may look to hire key partners or principals in cities in which they don’t have a presence, ranging from NYC to Austin to a place like Berlin or China. These changes aren’t made quickly and take time to execute. There’s also tremendous risk involved in terms of personnel and brand.

I’d be curious to know, what others things might other venture capital firms do as a result of this news?

Semil Shah (@semilshah) manages operations for social media startup Rexly.

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