sabato 5 novembre 2011

What's so special about Y Combinator?

On the surface, it seems like the Y Combinator formula is “money and mentoring for equity”. That seems like a simple enough formula, and clones around the world are rushing to replicate it. Unfortunately I think they mostly miss the point, because there is so much more to YC which the others lack.

When we applied to YC, we had already launched and didn’t really need the $20k they were offering (investors had started contacting us from the day that Rapportive first hit the press). Looking at the other startups who joined YC at the same time of us, most of them got profitable or secured substantial angel/VC funding at good valuations soon afterwards. So although the money is nice, it’s probably not the main attraction.

As to mentoring, press and investor contacts… as an entrepreneur, you’re probably already quite good at getting attention and feedback from relevant people, using your personal network. How much more value could you get?

Network and knowledge

The things that are really special about Y Combinator, in my opinion, are less frequently talked about:

There is a genuine, strong sense of camaraderie and mutual support amongst YC alumni. Many organisations claim to have strong alumni networks, but I have often found these claims to be empty words: often, the only participants in these networks are those who want to take, not those who want to give, because those who have something to give feel their time is wasted. It is hard to maintain a high standard in a network, and YC’s is the only example I have seen where the high standard is consistently upheld. Even the most busy founders of the most successful startups are genuinely supportive, and will spend surprisingly large amounts of time to answer questions, give practical advice, make introductions and recommendations, etc. They are real friends, not just utilitarian business contacts. This culture is truly remarkable.

It sounds trite, but the YC partners are all really great people. They are exceptionally bright and talented, outspoken, honest, straight-to-the-point and totally bullshit-free – hardly anyone else I know even comes near in terms of these qualities. They have lots of time for their companies (surprisingly, given the number of companies they’ve funded), and I have only ever seen them do things that are good for founders. It seems altruistic, but Paul Graham maintains that it’s simply the best business strategy for YC.

Between them, the YC partners have seen it all. They’ve seen big exits and small exits, profitable companies and train-wrecks, fast growth and slow growth, dream teams and founder disputes, and all manner of great ideas and screw-ups. Startups are unpredictable; you never know what surprises lie around the next corner. When we talk to YC, no matter whether we have good news or bad news, chances are that they’ve seen the situation before, and their pattern-matching will enable them to make good predictions.

The YC team know everybody who’s worth knowing in the startup scene, and everyone respects them. This makes them ideally placed for introducing you to the kind of people you want to meet. Demo Day is one aspect of this, a maximum-efficiency batch process for introducing startups and investors to each other, but YC also make individual introductions all the time. They also know who is worth talking to, who is actively investing, and which people are just fishing for information.

If there is a change in the startup ecosystem, YC are amongst the first to see it — because they have insight into a uniquely high proportion of startup deals, and they work actively to spot patterns and learn from them. As a YC startup, you get to hear about these changes first, something that you can use to your advantage.

If you are new to Silicon Valley, like we were, YC is a fantastic way to get yourself established and find your feet. They are welcoming to outsiders, and you can bootstrap your valley network from those who already know their way around. You can celebrate with them when things go well, and to get encouragement from them in hard times. You couldn’t ask for a better group of people to hang out with.

Because YC has a proven track record of funding great companies, being accepted to YC carries a strong signalling effect, making it more likely for others to believe that you are doing something interesting by default.

Being part of the best

A lot of the points above are remarkable, but not intrinsically unique to Y Combinator; what’s particularly special about YC is that it is simply number one. Being number one is very different from being number two or any number below.

One friend from our YC batch remarked at Demo Day: “This room contains the future of the IT industry.” He was right. Since many of the world’s best startups go through YC, they collectively form a force which has the power and drive to shape the entire industry for many years to come. That’s not because there is any centralised agenda; it’s more comparable to being a graduate from one of the top universities in the world.

Ever wonder why so many leading figures in business, science and politics are graduates of Harvard, Yale, Cambridge, Oxford, MIT or Stanford? I don’t think their teaching is really that much better than any other university, or than reading the textbooks by yourself. But you do get two valuable things from a top university:

a signalling effect: other people can see that a reputable organisation thinks that at one point in your life (when you took your exams), you were reasonably motivated and not entirely stupid;you build a network of talented people.

I think we are seeing something similar with YC. The fact that YC has brought forth a number of successful startups is merely a correlation; by itself it doesn’t say anything about cause and effect. But when people see a correlation, it has a signalling effect nevertheless. (The reputation of a good university is also mostly due to the observed correlation between its graduates and their later success.)

Startups are risky and full of unknowns, and you as startup founder are in the business of convincing everyone that you are going to be the big, successful one. You need all the positive signals you can get.

But is it worth the cost?

Y Combinator takes 2–10% of your company’s equity. How do you figure out whether the value you get from YC is worth the cost? If you are wondering whether to apply for YC, this is probably the question you’re trying to answer.

Firstly, note this: dilution makes an incremental difference to your outcome: if you sell 5% of the company to an investor, you reduce your pay-out by 5% if you sell the company. However, whether you have or don’t have an investor can make a huge difference. Say you give 5% of the company to…

someone who later makes that one critical introduction that leads to the deal which saves your company.someone who helps you negotiate with your acquirer and doubles the value of your exit.someone who encourages you to make a particular pivot, which turns out to unlock a billion-dollar market.someone who prevents you from making a stupid mistake that would have set you back by 12 months.

Whether any of these scenarios will actually happen is unknown in advance, but my point is: probability of success tends to move in discontinuous jumps. An extra per cent of equity may make absolutely no difference at all to your success, or it may turn out to make the difference between epic fail and massive win. A bit of equity may buy you an “unfair advantage”, or it may be a complete waste.

You need to figure out which investors might make the big difference, and which probably won’t. Your job as founder is to figure out how to play your cards such as to maximise the chances of massive win. Dilution changes incrementally, but probability of success is much more variable. Therefore, if you can figure out a way of substantially increasing your chances of success (putting yourself on the good side of some of those discontinuities), the equity cost is secondary. It’s not irrelevant, but as long as it’s in the right ballpark, it’s ok.

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