VC killer? SV Angel’s David Lee talks about the controversial Start Fund

February 1, 2011, 10:42 PM UTC

David Lee

There has been lots of venture capital consternation over Start Fund, a new early-stage investment effort funded by Ron Conway’s SV Angel and DST boss Yuri Milner. The idea is to offer $150,000 in convertible note funding to each and every company participating in Y Combinator, the IT startup incubator run by Paul Graham.

Why the controversy? Well, some people are upset that SV Angel and Milner will have first crack at YC companies. Others are upset that Conway and Milner are perceived to be excluding startups that won’t relocate (and least temporarily) to YC’s Silicon Valley campus. And isn’t this the type of “dumb money” deal that signals a bubble is at hand?

My gut take is twofold: This is far less important than many people are making it out to be (YC represents just a tiny sliver of the startup universe) and it’s probably a smart move for SV Angel (from an ROI perspective).

But rather than blather on, it seemed best to go straight to the source: David Lee, Conway’s partner at SV Angel and point-man for Start Fund. What follows is an edited transcript of a conversation we had yesterday afternoon:

Fortune: You suggested in a blog comment that the YC/SV Angel relationship is similar to the University of Florida/New England Patriots relationship, in that Bill Belichick often leans toward drafting players that have been coached by people he knows and trusts – with a particular emphasis on mental toughness. We’re both from Boston, so expand on this one for me.

David Lee: Sure. This isn’t to say that all of Belichick’s picks from Florida have worked out – just look at Chad Jackson, Urban Meyer vouched for him and he was a disaster – but Belichick believes there will be more hits than misses because he trusted Meyer’s filter. He obviously doesn’t limit himself to only those players — just like we aren’t limiting ourselves to YC companies — but he does pay particular attention to them. It’s the same with us and the folks at YC.

Ok, what is it that you trust about Paul Graham and the YC team?

The number one thing we look at is the founder. A lot of founders build products for themselves, and we like that, because they personify their business and their core product. We focus more on that and less on product market fit. YC is the same way. We both trust that certain founders will find and attack big problems in big markets eventually.

We screen for the hardest thing to spot and measure: mental toughness. It’s great if you’re brilliant, but not if you’re soft. I’d rather have a tough as nails entrepreneur who isn’t the smartest person in the room, than a brilliant entrepreneur who isn’t persistent.

Have you been surprised by the backlash to Start Fund?

I don’t have a lot of experience with this sort of thing. I know we live in an echo-chamber of Twitter and blogs, particularly in technology, so I knew there would be some attention – and I also knew that it could be misconstrued. But people are forgetting some of the important details…

Such as?

The most important thing is that this is only $150,000. One founder said to me, without a hint of irony: “Now I can buy a computer.” It’s extra runway for building a product, so they can produce more data to show if their hypothesis is working or not.

The second thing to reiterate is that because it’s only $150,000, the really good companies still will seek out the really good value-add investors. If we were investing $1.5 million, then it would be worthy of controversy.

Are you concerned about signaling risk, particularly if you don’t exercise pro rata rights on a particular company?

We tried to handle signaling risk by making this a blind investment. We really don’t know who the founders are before we send out the offer letters. We may know a company’s name, but not much more. After that we’ll go through our normal process of evaluating each company and deciding if we want to invest. We do not have any information advantage. We may say no to a company not because it’s a bad company, but just because it’s product doesn’t fit our strategy.

It’s been suggested that SV Angel and Yuri basically have become limited partners of YC. How are your own investors reacting to the arrangement?

Very enthusiastically. I don’t want to speak for all of them, of course, but the feedback I’ve gotten so far is very positive.

As for the LP issue, I don’t necessarily view it that way. This obviously is a new program for us. It’s not a marketing expense – we expect to make money off of this. Everybody obviously can judge this on day one, but the real judgment will be based on if it generates a nice return. We’re pretty sure it will, of course, based on YC’s track record. The bigger risk is that it doesn’t scale and we’re overworked.