The Cost of Sourcing New DST Deals: $6 Million

By Byrne Hobart

DST has made big profits—and a bigger splash—by pioneering a new kind of deal. Traditional VC deals create a sort of adversarial relationship: venture capitalists can diversify their portfolios, and lean on LPs for additional capital; founders are expected to have an undiversified portfolio consisting of their initial stake in the company. This keeps founders hungry, and it keeps valuations under control.

DST has completely upended this relationship by writing massive checks to established companies—and by buying stock from founders and early shareholders, rather than just investing directly in the company.

This has had a few surprising effects:

  • It has inevitably raised the value of big social media sites. While Twitter didn’t take an investment from DST, the fact that DST was bidding surely raised the final price of their latest round.
  • It has allowed successful tech companies to stay private longer than they otherwise would have by giving companies (and founders) access to as much capital as they need.
  • It’s funded Facebook and Zynga’s continued expansion. Neither company is hurting for cash, of course, but there’s a big difference between reinvesting your profits and tapping an effectively bottomless well of capital.
  • It may have turned May into “Big Tech IPO Season.” Why? The 500-shareholder rule stipulates that companies with 500 or more shareholders at the end of a given fiscal year have 120 days to start filing financials (which, in almost all cases, means they’ll go public, too). Thanks to DST, big companies don’t need to go public until they reach that threshold. Once they do, they have 120 days to file. Facebook played to these regulations when it launched an offering at the start of the year. That gives them the maximum possible time to enjoy the benefits of 500+ shareholders (i.e. extra capital) without the costs (full disclosure). And Facebook won’t be the last. Thanks to DST, the 500-shareholder rule is the main reason for big, successful companies to go public.

DST and YCombinator are both powerful “second-derivative” forces in the startup ecosystem. They both push change to happen slightly faster, and in a marginally more efficient way. When we’re looking at such an integral part of the broader economy, though, that ends up having a massive end effect.

Of course, YCombinator and DST haven’t had any direct interaction. DST works with the largest of startups (where the limiting variable is scalability). YCombinator aims for the other end: funding startups that otherwise would not have launched, or would not have launched so effectively.

So far, YCombinator’s biggest exit has been Heroku, which was purchased for $212 million. That’s far lower than the valuation that DST is interested in. But YCombinator has a few other tricks up its sleeves—companies like AirBNB and Dropbox are rumored to be on track for higher valuations.

What YCombinator has done is this: it’s created an institution that, more than any other, is reputed to produce successful startups. Per-capita, YC alumni appear to have a better entrepreneurial reputation than alumni from, say, MIT, Stanford, or Google.

That’s why Yuri Milner and SV Angel have partnered together to throw more money at them. The ownership stake is fine, but that part of the deal might as well operate at breakeven. The real result:

  • SV Angel gets information on numerous early-stage startups, which it may choose to invest in.
  • YCombinator can afford to consider startups that need a longer runway—or startups whose idea is so absurd that it could take a while to get funded (with the caveat that, holding investor judgment constant, the more absurd an idea is the more likely it is to produce a massive success if it succeeds at all).
  • Forty of the year’s most promising startups will be able to raise a bigger Series A at a higher valuation—making it that much more likely that they’ll be DST material in a few years.

DST has access to as much capital as it needs. Right now, they need investment opportunities. Yuri Milner has identified the limiting reagent in startup formation: he can’t afford to pick early-stage startups, but he can take a group of pre-selected startups and radically increase their chances of a radical success. In a few years, count on DST doing some big deals with companies that raised their first $150K this way.

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