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For a startup being funded by Y Combinator is seen as a big stamp of approval. Many of the well-known companies like Airbnb, Stripe, Dropbox, and even Reddit, were once backed by Y Combinator (YC).
Although YC’s support is a matter of great prestige for startups and helps them attract investors, the recent collapse of the Silicon Valley Bank may have stirred up the old controversy for YC with renewed passion. The SVB Financial Group, the parent company of Silicon Valley Bank, collapsed on March 10, 2023, making it the largest bank to fail since the 2008 financial crisis. The bank was ranked 16th biggest in the US, with $209 billion in assets.
Afterwards, California banking regulators closed the bank and appointed the Federal Deposit Insurance Corporation (FDIC) as the receiver for the later disposition of its assets. Depositors of SVB will have access to their funds and no losses will be borne by the taxpayer.
Ripple Effect
The ripple effect was felt in India as well. Rahul Mathur, Founder and CEO of Verak, posted on LinkedIn after the financial crisis saying that his company was one of the affected customers of the Silicon Valley Bank. “A majority of YC-backed companies have > $250K in their SVB bank account. And, the FDIC insurance limit is $250K,” wrote Mathur, “This means some startups could be at risk of losing serious money”.
According to Mathur, around 10% of the YC companies—so far YC has more than 200 active investments in India—operating in India have more than $1M in SVB accounts. The reasoning behind this was that the updated basic deal of YC is now $500K, which adds up to the money the founders raised from other investors.
As of now, the startups set up in India but selected for Y Combinator’s batches are mandated to shift their headquarters to Delaware, US, which essentially turns the India-registered entity into a wholly-owned subsidiary of a new US parent. However, none of this would have happened if YC had been a little more relaxed in its fascination with transforming Indian startups into American entities for the ‘purpose of funding’.
Why SVB?
Silicon Valley Bank, often referred to as the ‘SBI of startups’ by Indian entrepreneurs, is special for many reasons. In the startup ecosystem, it is even more popular than JP Morgan Chase, the largest bank in the USA. There are reports that claim that more than half of the startups in the USA were affiliated with SVB.
However, why SVB? One of the main reasons is that SVB was known for its venture debts. The startups can’t take basic loans, such as ‘Home Loan’, because they usually do not have enough assets. Thus, the go-to bank that provided venture debts—which are high on interest and for shorter periods of time—was SVB.
The bank had more than $74 billion worth of loans on its book, in which venture debts played a major role. As per Crunchbase, SVB had a large private wealth management division that had significant synergies with its commercial banking operations, helping the same VCs and entrepreneurs with home mortgages and personal loans after it just helped their startup close a big financing round.
The familiarity with the VCs and accelerators made the bank trust new startups while providing venture debts, thus making it popular in the startup ecosystem.
Why Delaware?
YC, along with other companies, prefers a startup incorporated in Delaware because it is, more or less, a tax-haven. It is also known for the ‘Delaware Loophole,’ which essentially enables companies to avoid paying the state corporate income tax where they earn the revenue.
Due to this policy, there is rarely any US-based startup accelerator which invests money in a company which is not a Delaware Corporation. Once the company is incorporated in Delaware, the startups receive an EIN, or Employee Identification Number.
With the EIN, the startup can then open a bank account. The accelerator—in this case YC—will then execute necessary legal documents with you on behalf of your company and transfer the money—their promised investment—into a bank account, SVB in this case.
With the collapse of the Silicon Valley Bank, Indian startups—which went through the same tedious process—are facing new challenges. While the FDIC involvement has given them a ray of hope, the transactions are still likely to take time to resume.
The good ol’ controversy
This controversy was trending back in 2020 and even the likes of Sanjeev Bikhchandani, executive vice chairman, InfoEdge, had commented and shared their opinions on the matter. On Twitter, he had compared the situation with East India Company saying, “Indian market, Indian customers, Indian developers, Indian workforce. However 100% foreign ownership, foreign investors. IP and data transferred overseas”.
In a media interaction, Bikhchandani had said, “So, you have a bunch of foreign investors who tell our best young startups that they will invest in their companies provided they shift their company domicile overseas”.
As part of the deal, the startups generally had to get incorporated in the Delaware state of the USA. Y Combinator insists that if a company is unincorporated when it is accepted into YC, the combinator will help the founders to get it incorporated in Delaware and, in case it is already incorporated elsewhere, the founders will have to re-incorporate in Delaware.
This means that the ownership of the startup, IP and all the data, shifts overseas. But the rest of the operations, i.e., production, marketing, markets and more remain in India. Additionally, with being incorporated in Delaware, most of these YC-backed startups have to deposit the amount received in funding in the Silicon Valley Bank.
This begs the question: Is this the right time for Indian startups to think that going forward on the path of American accelerators might not be the best path?
