Why Combinator? Should You Join Paul Graham's Gang For The Gifted?

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Why Combinator? Should You Join Paul Graham's Gang For The Gifted?

 

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.

That's all I have for now. Overall, if it were me and I was just out of undergrad and looking to build a software startup, I think I probably would have applied to YC. I started my first company with $10k (so the funding itself is not that important nor necessary), but the other components are extremely helpful.

Posted by Dharmesh Shah on Fri, Mar 23, 2007

COMMENTS

Nice article. I disagree with #7. I am willing to bet that Paul Graham has modeled out the hit rate for these 15K investments, and that that it is a high-ROI moat building strategy. His streamlined approach is another testament to a well thought out financial outcome. I see nothing wrong with "build it and they will come". If YC builds say 100 of these, one is bound to be super successful, say $150 mill exit..wouldn't you agree? At a combined investment of $1.5 mill ($15K X 100), the fully diluted return on that one venture can definitely be expected to yield $3 mill to YC (assuming that the initial 6% ownership has diluted to 2% at exit). So that's the worst case...a 100% return in say 3 years, or an IRR of 26%. Hats off to Paul.

posted on Friday, March 23, 2007 at 7:15 PM by prakster


I don't think forced focus is a great idea. I think focusing on 3 good bets for 6 months after the site or product is built is a good idea, and then switching gears after that. I like the idea of micro-angel-investing. We need more of it. We probably already have more of it, but not organizations as vocal as YC. YC likes the idea of relocation, and think nirvana can only be achieved in certain cities. I disagree. Of course, I don't have facts to back that up, but just common sense. I think it's a bit cruel for some startup guys to be forced to relocate. And now with the advent of high-speed VPN from home, or the ability to do video conference (sort of) from home or (even better) at Kinko's, it might be successful too. I also think that startup clubs like this should not contain purely college grads with no families. I think it should be a bit more flexible than that.

posted on Friday, March 23, 2007 at 10:19 PM by Supermike


There is a similar program going on this summer in Boulder, Colorado. It’s called Tech Stars and will be accepting 10 companies. Tech Stars is structured similar to the Y Combinator and the list of advisors is incredible. Check it out - http://www.techstars.org. You gotta act quick though – the app deadline is coming soon. Boulder is a beautiful place with a thriving entrepreneurial scene. If you are fortunate enough to get an invite, look me up. I work in Denver, but live in Boulder. This is an incredible opportunity and if it was around earlier in my career I would have been all over it.

posted on Saturday, March 24, 2007 at 1:24 AM by Kevin Cawley


I will be attending YCombinator's startup school tomorrow in Palo Alto. I will be blogging about the presentations at http://www.sumolabs.com Kind Regards, J

posted on Saturday, March 24, 2007 at 2:52 AM by Jordan Willms


Teams vs Individuals: I can understand why there is an assumption that if one can't attract others to co-found a startup with them that it suggests the founder has issues. However, I am a single founder and I can tell you from experience that sometimes you just don't have quality choices in your social network. For example, I know many people who are technically gifted but lack the drive necessary to see things through. They are into the project but not the business. Imagine If I were to accept one or more of these technically gifted but questionably motivated persons as co-founders, they could drag the business down when they become disinterested in doing the hard work of building a real business. Sometimes not having a co-founder has nothing to do with the quality of the founder but of the quality of those that they can tap.

posted on Sunday, March 25, 2007 at 11:09 AM by Ken Seville


Supermike - I think you do need a forced focus, both on product and on location. For the product, forced focus will quickly let you know whether it's a good idea or can be discarded (allowing you to focus on the next one - Kiko goes to Justin.tv). By pretending you're being smart and playing the field, you're really diluting your energies in an area where you need to apply all the energy you can muster.

Location wise, in addition to the requirement weeding the not-so-focussed from the super-keen, there are some benefits from being together in person that cannot be replicated by VPN. Talking through a problem over a meal or late-night beer can be the difference between cracking it and not.

I do agree with you on not restricting the demographic of founders, and also Ken's comment about not needing co-founders (in some situations), but my understanding is that Y Combinator has some flexibility on these issues. As a broad brush, however, there are benefits to those limitations.

posted on Monday, March 26, 2007 at 1:37 AM by Jacob Aldridge


What makes this of interest to me is that I have a brilliant idea, but Im already devoting a lot of my time and energy to a startup. This kind of capital is what I would need to get the ball rolling with one developer on this new "project".

posted on Tuesday, March 27, 2007 at 3:24 PM by Colin Nederkoorn


In the Netherlands, I feel we lack a Cambridge or bay area. What we do have is young talent and innovative ideas. So my one question is: 'Who's your Dutch counterpart(ner)?' I really like reading some of your posts and it inspires me to push harder to 'startup', but relocation from Amsterdam to overseas is a bit to much for now.

posted on Tuesday, April 03, 2007 at 4:50 AM by Hilco


Hilico - we, at Futurist Fund, have started the same (well not exactly the same but close) early stage fund in Europe. Approach is a little bit different, which we think makes way more sense for Europe. We already invested in few projects. Our site is not yet well developed, so if you mind for more info - just drop me an email and I'll be happy to explain further.

posted on Tuesday, April 03, 2007 at 6:12 PM by Dmitry


Dharmesh, as usual a very well thought out and articulated piece . I agree with your analysis; there are pros and cons to being part of the program. Its not for everyone. Having said that, it seems to me that Y Combinator is a helpful part of the consumer web ecosystem.

posted on Wednesday, April 11, 2007 at 9:12 PM by Chris Sheehan


I'd like someone to forcefully remove my ex, she's been raped, had her vagina cut open with a pocket knife, she is in a gang (bloods), is a stalker, a gruesome murderor, and needs to get shot, if your interested in helping me end my corrupt ex, her name is Shelby, has red hair, blue eye's (wears glasses), 20 years old, for picture and location look at her myspace profile, her email address is RedRavenChyld@live.com

posted on Sunday, February 22, 2009 at 9:39 PM by Josh


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