OnStartups

April 2 is a significant date for many early-stage entrepreneurs as this is the deadline for applying to Paul Graham's Y Combinator this summer. If you don't know about Y Combinator, then I encourage you to read up on it as they are one of the few groups doing anything remotely interesting as it relates to very early-stage investment in startups (with an emphasis on software startups).

I've been following Y Combinator for a while now and have known people that have applied and been accepted, applied and not been accepted or consciously chose not to apply at all. In preparation for this article, I contacted several of these people to get a sense of the high-level pros and cons of joining the group. Thanks to all of those that offered their insights and comments.

Disclaimer: I am in no way affiliated with Y Combinator other than having followed the group for a while and having met both Paul Graham and Jessica Livingston. As an early stage investor myself, I guess I compete at some level, but my investment activity is not that significant and my approach is very different.

So without further preamble, here are my thoughts:

Why You Should (Or Shouldn't) Apply To Y Combinator

1. Forced Focus: Lots of early stage entrepreneurs have several ideas in their heads (and sometimes even several semi-working projects too). One of the toughest things to do in this situation is to actually pick one of the ideas and dig into it a little bit deeper. Since it is unlikely that Y Combinator will fund a "portfolio of ideas" from a single founding team, it forces a degree of focus. This is a good thing.

2. Great Network: I must admit that I'm a little envious of the network of exceptional people that are involved with Y Combinator. This extends beyond just Paul Graham and Jessica Livingston and goes to all the great people starting companies and those that are following what Y Combinator is doing and provide their support.

3. Instant Early Adopters: One of the hardest things to do when getting a new project off the ground is finding that early mass of users to actually try it and tell you why it sucks. No doubt it sucks, because all early software projects suck in some ways, you need to know why it sucks. Y Combinator is exceptionally good at delivering some instant users for any project/company that it is involved with.

4. Limited Funding: The amount of capital invested by Y Combinator in any founding team is limited. The amount is $5k base + $5k per founder. So, if you're a two person team, you can expect about $15k in funding. This is not a lot of money, but it seems to be enough for many teams of "capital efficient" founders to get a prototype built over the summer. I think the amount if a bit arbitrary, but I can't fault them for that as trying to make case-specific decisions doesn't scale. As an entrepreneur (even an early stage one), I just don't think that level of capital is interesting enough to make it worth taking outside capital. So, if you're applying to Y Combinator, chances are, you aren't really doing it for the funding – but mostly the other benefits.

5. Follow-On Investments: Y Combinator has a reasonably good reputation for producing "interesting" companies. As such, for those startups that need funding beyond what YC puts in, the fact that they've been one of the chosen few likely gives them an edge over a random startup looking for angel/VC money. Paul's network is also pretty strong and he can "draw in" outside investors. I was invited to the last "Angel Investor Day" the company held whereby each of the YC startups had a chance to present to a group of interested potential investors. What I liked about this particular forum (from the entrepreneur's perspective) is that it is held on their "home turf" and was relatively informal and easy-going. Very different from the unpleasantness that is usually associated with meetings with VCs.

6. Relocation Requirement: If you're accepted, YC requires you to relocate to one of two locations (Cambridge for the summer program and the bay area for the winter program). Whether you want to relocate or not is a personal decision, but I agree with the forced relocation. There is a lot to be gained by being in the physical proximity of both the YC network and being in one of the major centers of startup activity here in the U.S. I think for early-stage software entrepreneurs building web companies, it's particularly important to be in a conducive environment.

7. Projects vs. Businesses: Personally, I think YC is really selecting interesting teams and projects and not really concerned with selecting what may (or may not) become "real" companies. Though there's nothing intrinsically wrong with that – it's simply an investment selection thesis they've formed, I'm not convinced that it's really good for the entrepreneur. Though I like the idea of focusing on users/customers first and letting the details work themselves out later (i.e. projects), I think there's some value to actually thinking about business models earlier in the process. Simply identifying market opportunity (i.e. how do you make money) does not necessarily reduce creativity and your ability to succeed at building a product people will like. I think YC leans a bit too heavily towards the "build it and they will come" model and for inexperienced entrepreneurs (just about all of the YC founders), this can distort reality. It's much for fun to think about the project, and I'm all for being passionate about the right thing – but a little bit of balance is healthy.

8. Teams vs. Individuals: YC leans strongly towards selecting startups that two or more founders. I'm a strong advocate of this myself as I believe that having two or more founders in an early-stage startup significantly improves the chances of success. By explicitly stating this requirement, YC forces early-stage entrepreneurs to find co-founders. This is a good thing as if there's a problem with finding a co-founder, that's an early signal of a problem (either with the founder or the idea or both), and everyone's better off knowing that sooner rather than later.

9. Startup Valuations: Early-stage valuations are a black art. There's very little data to go on, so it simply ends up being a combination of market forces (who else is looking to invest) and prior precedence ("…most Series A VC startups are getting between a $4MM - $6MM pre-money valuation…"). Though the valuations that YC provides for early-stage companies is rumored to be low (< $500k in most cases), it's not really fair to call this valuation low. For one, they're not competing with many other early-stage investors. This is the stage I like to invest in (i.e. smart founding teams with a decent idea and the ability to crank out a product people might love), but to be candid, I'm no Paul Graham. So, in the absence ofno multiple potential buyers, there's no real "market" so it'd be wrong to call the valuation low or high. It just is what it is. If it were me, and all the other positive YC forces weren't in play, I'd be bootstrapping in the early days, validating the idea as quickly as possible and then looking for outside investors.