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March 2008, rev May 2013  
  
 _(This essay grew out of something I wrote for myself to figure out what we
do. Even though Y Combinator is now 3 years old, we're still trying to
understand its implications.)_  
  
I was annoyed recently to read a description of Y Combinator that said "Y
Combinator does seed funding for startups." What was especially annoying about
it was that I wrote it. This doesn't really convey what we do. And the reason
it's inaccurate is that, paradoxically, funding very early stage startups is
not mainly about funding.  
  
Saying YC does seed funding for startups is a description in terms of earlier
models. It's like calling a car a horseless carriage.  
  
When you scale animals you can't just keep everything in proportion. For
example, volume grows as the cube of linear dimension, but surface area only
as the square. So as animals get bigger they have trouble radiating heat.
That's why mice and rabbits are furry and elephants and hippos aren't. You
can't make a mouse by scaling down an elephant.  
  
YC represents a new, smaller kind of animal—so much smaller that all the rules
are different.  
  
Before us, most companies in the startup funding business were venture capital
funds. VCs generally fund later stage companies than we do. And they supply so
much money that, even though the other things they do may be very valuable,
it's not that inaccurate to regard VCs as sources of money. Good VCs are
"smart money," but they're still money.  
  
All good investors supply a combination of money and help. But these scale
differently, just as volume and surface area do. Late stage investors supply
huge amounts of money and comparatively little help: when a company about to
go public gets a mezzanine round of $50 million, the deal tends to be almost
entirely about money. As you move earlier in the venture funding process, the
ratio of help to money increases, because earlier stage companies have
different needs. Early stage companies need less money because they're smaller
and cheaper to run, but they need more help because life is so precarious for
them. So when VCs do a series A round for, say, $2 million, they generally
expect to offer a significant amount of help along with the money.  
  
Y Combinator occupies the earliest end of the spectrum. We're at least one and
generally two steps before VC funding. (Though some startups go straight from
YC to VC, the most common trajectory is to do an angel round first.) And what
happens at Y Combinator is as different from what happens in a series A round
as a series A round is from a mezzanine financing.  
  
At our end, money is almost a negligible factor. The startup usually consists
of just the founders. Their living expenses are the company's main expense,
and since most founders are under 30, their living expenses are low. But at
this early stage companies need a lot of help. Practically every question is
still unanswered. Some companies we've funded have been working on their
software for a year or more, but others haven't decided what to work on, or
even who the founders should be.  
  
When PR people and journalists recount the histories of startups after they've
become big, they always underestimate how uncertain things were at first.
They're not being deliberately misleading. When you look at a company like
Google, it's hard to imagine they could once have been small and helpless.
Sure, at one point they were a just a couple guys in a garage—but even then
their greatness was assured, and all they had to do was roll forward along the
railroad tracks of destiny.  
  
Far from it. A lot of startups with just as promising beginnings end up
failing. Google has such momentum now that it would be hard for anyone to stop
them. But all it would have taken in the beginning would have been for two
Google employees to focus on the wrong things for six months, and the company
could have died.  
  
We know, because we've been there, just how vulnerable startups are in the
earliest phases. Curiously enough, that's why founders tend to get so rich
from them. Reward is always proportionate to risk, and very early stage
startups are insanely risky.  
  
What we really do at Y Combinator is get startups launched straight. One of
many metaphors you could use for YC is a steam catapult on an aircraft
carrier. We get startups airborne. Barely airborne, but enough that they can
accelerate fast.  
  
When you're launching planes they have to be set up properly or you're just
launching projectiles. They have to be pointed straight down the deck; the
wings have to be trimmed properly; the engines have to be at full power; the
pilot has to be ready. These are the kind of problems we deal with. After we
fund startups we work closely with them for three months—so closely in fact
that we insist they move to where we are. And what we do in those three months
is make sure everything is set up for launch. If there are tensions between
cofounders we help sort them out. We get all the paperwork set up properly so
there are no nasty surprises later. If the founders aren't sure what to focus
on first, we try to figure that out. If there is some obstacle right in front
of them, we either try to remove it, or shift the startup sideways. The goal
is to get every distraction out of the way so the founders can use that time
to build (or finish building) something impressive. And then near the end of
the three months we push the button on the steam catapult in the form of Demo
Day, where the current group of startups present to pretty much every investor
in Silicon Valley.  
  
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 7% of a company we fund, the founders only have to do 7.5% better
in their next round of funding to end up net ahead. We certainly manage that.  
  
So who is our 7% 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.  
  
It's not surprising something like this would happen. Most fields become more
specialized—more articulated—as they develop, and startups are certainly an
area in which there has been a lot of development over the past couple
decades. The venture business in its present form is only about forty years
old. It stands to reason it would evolve.  
  
And it's natural that the new niche would at first be described, even by its
inhabitants, in terms of the old one. But really Y Combinator is not in the
startup funding business. Really we're more of a small, furry steam catapult.  
  
  
  
  
  
**Thanks** to Trevor Blackwell, Jessica Livingston, and Robert Morris for
reading drafts of this.  
  
Comment on this essay.  
  
  
  
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