Essays

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Launching companies isn't identical with launching products. Though we do spend a lot of time on launch strategies for products, there are some things that take too long to build for a startup to launch them before raising their next round of funding. Several of the most promising startups we've funded haven't launched their products yet, but are definitely launched as companies.

In the earliest stage, startups not only have more questions to answer, but they tend to be different kinds of questions. In later stage startups the questions are about deals, or hiring, or organization. In the earliest phase they tend to be about technology and design. What do you make? That's the first problem to solve. That's why our motto is "Make something people want." This is always a good thing for companies to do, but it's even more important early on, because it sets the bounds for every other question. Who you hire, how much money you raise, how you market yourself—they all depend on what you're making.

Because the early problems are so much about technology and design, you probably need to be hackers to do what we do. While some VCs have technical backgrounds, I don't know any who still write code. Their expertise is mostly in business—as it should be, because that's the kind of expertise you need in the phase between series A and (if you're lucky) IPO.

We're so different from VCs that we're really a different kind of animal. Can we claim founders are better off as a result of this new type of venture firm? I'm pretty sure the answer is yes, because YC is an improved version of what happened to our startup, and our case was not atypical. We started Viaweb with $10,000 in seed money from our friend Julian. He was a lawyer and arranged all our paperwork, so we could just code. We spent three months building a version 1, which we then presented to investors to raise more money. Sounds familiar, doesn't it? But YC improves on that significantly. Julian knew a lot about law and business, but his advice ended there; he was not a startup guy. So we made some basic mistakes early on. And when we presented to investors, we presented to only 2, because that was all we knew. If we'd had our later selves to encourage and advise us, and Demo Day to present at, we would have been in much better shape. We probably could have raised money at 3 to 5 times the valuation we did.

If we take 6% of a company we fund, the founders only have to do 6.4% better in their next round of funding to end up net ahead. We certainly manage that.

So who is our 6% coming out of? If the founders end up net ahead it's not coming out of them. So is it coming out of later stage investors? Well, they do end up paying more. But I think they pay more because the company is actually more valuable. And later stage investors have no problem with that. The returns of a VC fund depend on the quality of the companies they invest in, not how cheaply they can buy stock in them.

If what we do is useful, why wasn't anyone doing it before? There are two answers to that. One is that people were doing it before, just haphazardly on a smaller scale. Before us, seed funding came primarily from individual angel investors. Larry and Sergey, for example, got their seed funding from Andy Bechtolsheim, one of the founders of Sun. And because he was a startup guy he probably gave them useful advice. But raising money from angel investors is a hit or miss thing. It's a sideline for most of them, so they only do a handful of deals a year and they don't spend a lot of time on the startups they invest in. And they're hard to reach, because they don't want random startups pestering them with business plans. The Google guys were lucky because they knew someone who knew Bechtolsheim. It generally takes a personal introduction with angels.

The other reason no one was doing quite what we do is that till recently it was a lot more expensive to start a startup. You'll notice we haven't funded any biotech startups. That's still expensive. But advancing technology has made web startups so cheap that you really can get a company airborne for $15,000. If you understand how to operate a steam catapult, at least.

So in effect what's happened is that a new ecological niche has opened up, and Y Combinator is the new kind of animal that has moved into it. We're not a replacement for venture capital funds. We occupy a new, adjacent niche. And conditions in our niche are really quite different. It's not just that the problems we face are different; the whole structure of the business is different. VCs are playing a zero-sum game. They're all competing for a slice of a fixed amount of "deal flow," and that explains a lot of their behavior. Whereas our m.o. is to create new deal flow, by encouraging hackers who would have gotten jobs to start their own startups instead. We compete more with employers than VCs.


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