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|  **Want to start a startup?** Get funded by Y Combinator.  
  
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September 2012  
  
A startup is a company designed to grow fast. Being newly founded does not in
itself make a company a startup. Nor is it necessary for a startup to work on
technology, or take venture funding, or have some sort of "exit." The only
essential thing is growth. Everything else we associate with startups follows
from growth.  
  
If you want to start one it's important to understand that. Startups are so
hard that you can't be pointed off to the side and hope to succeed. You have
to know that growth is what you're after. The good news is, if you get growth,
everything else tends to fall into place. Which means you can use growth like
a compass to make almost every decision you face.  
  
**Redwoods**  
  
Let's start with a distinction that should be obvious but is often overlooked:
not every newly founded company is a startup. Millions of companies are
started every year in the US. Only a tiny fraction are startups. Most are
service businesses — restaurants, barbershops, plumbers, and so on. These are
not startups, except in a few unusual cases. A barbershop isn't designed to
grow fast. Whereas a search engine, for example, is.  
  
When I say startups are designed to grow fast, I mean it in two senses. Partly
I mean designed in the sense of intended, because most startups fail. But I
also mean startups are different by nature, in the same way a redwood seedling
has a different destiny from a bean sprout.  
  
That difference is why there's a distinct word, "startup," for companies
designed to grow fast. If all companies were essentially similar, but some
through luck or the efforts of their founders ended up growing very fast, we
wouldn't need a separate word. We could just talk about super-successful
companies and less successful ones. But in fact startups do have a different
sort of DNA from other businesses. Google is not just a barbershop whose
founders were unusually lucky and hard-working. Google was different from the
beginning.  
  
To grow rapidly, you need to make something you can sell to a big market.
That's the difference between Google and a barbershop. A barbershop doesn't
scale.  
  
For a company to grow really big, it must (a) make something lots of people
want, and (b) reach and serve all those people. Barbershops are doing fine in
the (a) department. Almost everyone needs their hair cut. The problem for a
barbershop, as for any retail establishment, is (b). A barbershop serves
customers in person, and few will travel far for a haircut. And even if they
did, the barbershop couldn't accomodate them.   
  
Writing software is a great way to solve (b), but you can still end up
constrained in (a). If you write software to teach Tibetan to Hungarian
speakers, you'll be able to reach most of the people who want it, but there
won't be many of them. If you make software to teach English to Chinese
speakers, however, you're in startup territory.  
  
Most businesses are tightly constrained in (a) or (b). The distinctive feature
of successful startups is that they're not.  
  
**Ideas**  
  
It might seem that it would always be better to start a startup than an
ordinary business. If you're going to start a company, why not start the type
with the most potential? The catch is that this is a (fairly) efficient
market. If you write software to teach Tibetan to Hungarians, you won't have
much competition. If you write software to teach English to Chinese speakers,
you'll face ferocious competition, precisely because that's such a larger
prize.   
  
The constraints that limit ordinary companies also protect them. That's the
tradeoff. If you start a barbershop, you only have to compete with other local
barbers. If you start a search engine you have to compete with the whole
world.  
  
The most important thing that the constraints on a normal business protect it
from is not competition, however, but the difficulty of coming up with new
ideas. If you open a bar in a particular neighborhood, as well as limiting
your potential and protecting you from competitors, that geographic constraint
also helps define your company. Bar + neighborhood is a sufficient idea for a
small business. Similarly for companies constrained in (a). Your niche both
protects and defines you.  
  
Whereas if you want to start a startup, you're probably going to have to think
of something fairly novel. A startup has to make something it can deliver to a
large market, and ideas of that type are so valuable that all the obvious ones
are already taken.  
  
That space of ideas has been so thoroughly picked over that a startup
generally has to work on something everyone else has overlooked. I was going
to write that one has to make a conscious effort to find ideas everyone else
has overlooked. But that's not how most startups get started. Usually
successful startups happen because the founders are sufficiently different
from other people that ideas few others can see seem obvious to them. Perhaps
later they step back and notice they've found an idea in everyone else's blind
spot, and from that point make a deliberate effort to stay there.  But at
the moment when successful startups get started, much of the innovation is
unconscious.  
  
What's different about successful founders is that they can see different
problems. It's a particularly good combination both to be good at technology
and to face problems that can be solved by it, because technology changes so
rapidly that formerly bad ideas often become good without anyone noticing.
Steve Wozniak's problem was that he wanted his own computer. That was an
unusual problem to have in 1975. But technological change was about to make it
a much more common one. Because he not only wanted a computer but knew how to
build them, Wozniak was able to make himself one. And the problem he solved
for himself became one that Apple solved for millions of people in the coming
years. But by the time it was obvious to ordinary people that this was a big
market, Apple was already established.  
  
Google has similar origins. Larry Page and Sergey Brin wanted to search the
web. But unlike most people they had the technical expertise both to notice
that existing search engines were not as good as they could be, and to know
how to improve them. Over the next few years their problem became everyone's
problem, as the web grew to a size where you didn't have to be a picky search
expert to notice the old algorithms weren't good enough. But as happened with
Apple, by the time everyone else realized how important search was, Google was
entrenched.  
  
That's one connection between startup ideas and technology. Rapid change in
one area uncovers big, soluble problems in other areas. Sometimes the changes
are advances, and what they change is solubility. That was the kind of change
that yielded Apple; advances in chip technology finally let Steve Wozniak
design a computer he could afford. But in Google's case the most important
change was the growth of the web. What changed there was not solubility but
bigness.  
  
The other connection between startups and technology is that startups create
new ways of doing things, and new ways of doing things are, in the broader
sense of the word, new technology. When a startup both begins with an idea
exposed by technological change and makes a product consisting of technology
in the narrower sense (what used to be called "high technology"), it's easy to
conflate the two. But the two connections are distinct and in principle one
could start a startup that was neither driven by technological change, nor
whose product consisted of technology except in the broader sense.   
  
**Rate**  
  
How fast does a company have to grow to be considered a startup? There's no
precise answer to that. "Startup" is a pole, not a threshold. Starting one is
at first no more than a declaration of one's ambitions. You're committing not
just to starting a company, but to starting a fast growing one, and you're
thus committing to search for one of the rare ideas of that type. But at first
you have no more than commitment. Starting a startup is like being an actor in
that respect. "Actor" too is a pole rather than a threshold. At the beginning
of his career, an actor is a waiter who goes to auditions. Getting work makes
him a successful actor, but he doesn't only become an actor when he's
successful.  
  
So the real question is not what growth rate makes a company a startup, but
what growth rate successful startups tend to have. For founders that's more
than a theoretical question, because it's equivalent to asking if they're on
the right path.  
  
The growth of a successful startup usually has three phases:

  1. There's an initial period of slow or no growth while the startup tries to figure out what it's doing.  
  

  2. As the startup figures out how to make something lots of people want and how to reach those people, there's a period of rapid growth.  
  

  3. Eventually a successful startup will grow into a big company. Growth will slow, partly due to internal limits and partly because the company is starting to bump up against the limits of the markets it serves. 

Together these three phases produce an S-curve. The phase whose growth defines
the startup is the second one, the ascent. Its length and slope determine how
big the company will be.  
  
The slope is the company's growth rate. If there's one number every founder
should always know, it's the company's growth rate. That's the measure of a
startup. If you don't know that number, you don't even know if you're doing
well or badly.  
  
When I first meet founders and ask what their growth rate is, sometimes they
tell me "we get about a hundred new customers a month." That's not a rate.
What matters is not the absolute number of new customers, but the ratio of new
customers to existing ones. If you're really getting a constant number of new
customers every month, you're in trouble, because that means your growth rate
is decreasing.  
  
During Y Combinator we measure growth rate per week, partly because there is
so little time before Demo Day, and partly because startups early on need
frequent feedback from their users to tweak what they're doing.   
  
A good growth rate during YC is 5-7% a week. If you can hit 10% a week you're
doing exceptionally well. If you can only manage 1%, it's a sign you haven't
yet figured out what you're doing.  
  
The best thing to measure the growth rate of is revenue. The next best, for
startups that aren't charging initially, is active users. That's a reasonable
proxy for revenue growth because whenever the startup does start trying to
make money, their revenues will probably be a constant multiple of active
users.   
  
**Compass**  
  
We usually advise startups to pick a growth rate they think they can hit, and
then just try to hit it every week. The key word here is "just." If they
decide to grow at 7% a week and they hit that number, they're successful for
that week. There's nothing more they need to do. But if they don't hit it,
they've failed in the only thing that mattered, and should be correspondingly
alarmed.  
  
Programmers will recognize what we're doing here. We're turning starting a
startup into an optimization problem. And anyone who has tried optimizing code
knows how wonderfully effective that sort of narrow focus can be. Optimizing
code means taking an existing program and changing it to use less of
something, usually time or memory. You don't have to think about what the
program should do, just make it faster. For most programmers this is very
satisfying work. The narrow focus makes it a sort of puzzle, and you're
generally surprised how fast you can solve it.  
  
Focusing on hitting a growth rate reduces the otherwise bewilderingly
multifarious problem of starting a startup to a single problem. You can use
that target growth rate to make all your decisions for you; anything that gets
you the growth you need is ipso facto right. Should you spend two days at a
conference? Should you hire another programmer? Should you focus more on
marketing? Should you spend time courting some big customer? Should you add x
feature? Whatever gets you your target growth rate.   
  
Judging yourself by weekly growth doesn't mean you can look no more than a
week ahead. Once you experience the pain of missing your target one week (it
was the only thing that mattered, and you failed at it), you become interested
in anything that could spare you such pain in the future. So you'll be willing
for example to hire another programmer, who won't contribute to this week's
growth but perhaps in a month will have implemented some new feature that will
get you more users. But only if (a) the distraction of hiring someone won't
make you miss your numbers in the short term, and (b) you're sufficiently
worried about whether you can keep hitting your numbers without hiring someone
new.  
  
It's not that you don't think about the future, just that you think about it
no more than necessary.  
  
In theory this sort of hill-climbing could get a startup into trouble. They
could end up on a local maximum. But in practice that never happens. Having to
hit a growth number every week forces founders to act, and acting versus not
acting is the high bit of succeeding. Nine times out of ten, sitting around
strategizing is just a form of procrastination. Whereas founders' intuitions
about which hill to climb are usually better than they realize. Plus the
maxima in the space of startup ideas are not spiky and isolated. Most fairly
good ideas are adjacent to even better ones.  
  
The fascinating thing about optimizing for growth is that it can actually
discover startup ideas. You can use the need for growth as a form of
evolutionary pressure. If you start out with some initial plan and modify it
as necessary to keep hitting, say, 10% weekly growth, you may end up with a
quite different company than you meant to start. But anything that grows
consistently at 10% a week is almost certainly a better idea than you started
with.  
  
There's a parallel here to small businesses. Just as the constraint of being
located in a particular neighborhood helps define a bar, the constraint of
growing at a certain rate can help define a startup.  
  
You'll generally do best to follow that constraint wherever it leads rather
than being influenced by some initial vision, just as a scientist is better
off following the truth wherever it leads rather than being influenced by what
he wishes were the case. When Richard Feynman said that the imagination of
nature was greater than the imagination of man, he meant that if you just keep
following the truth you'll discover cooler things than you could ever have
made up. For startups, growth is a constraint much like truth. Every
successful startup is at least partly a product of the imagination of growth.
  
  
**Value**  
  
It's hard to find something that grows consistently at several percent a week,
but if you do you may have found something surprisingly valuable. If we
project forward we see why.  
  
weekly| yearly  
---|---  
1%| 1.7x  
2%| 2.8x  
5%| 12.6x  
7%| 33.7x  
10%| 142.0x  
  
A company that grows at 1% a week will grow 1.7x a year, whereas a company
that grows at 5% a week will grow 12.6x. A company making $1000 a month (a
typical number early in YC) and growing at 1% a week will 4 years later be
making $7900 a month, which is less than a good programmer makes in salary in
Silicon Valley. A startup that grows at 5% a week will in 4 years be making
$25 million a month.   
  
Our ancestors must rarely have encountered cases of exponential growth,
because our intuitions are no guide here. What happens to fast growing
startups tends to surprise even the founders.  
  
Small variations in growth rate produce qualitatively different outcomes.
That's why there's a separate word for startups, and why startups do things
that ordinary companies don't, like raising money and getting acquired. And,
strangely enough, it's also why they fail so frequently.  
  
Considering how valuable a successful startup can become, anyone familiar with
the concept of expected value would be surprised if the failure rate weren't
high. If a successful startup could make a founder $100 million, then even if
the chance of succeeding were only 1%, the expected value of starting one
would be $1 million. And the probability of a group of sufficiently smart and
determined founders succeeding on that scale might be significantly over 1%.
For the right people — e.g. the young Bill Gates — the probability might be
20% or even 50%. So it's not surprising that so many want to take a shot at
it. In an efficient market, the number of failed startups should be
proportionate to the size of the successes. And since the latter is huge the
former should be too.   
  
What this means is that at any given time, the great majority of startups will
be working on something that's never going to go anywhere, and yet glorifying
their doomed efforts with the grandiose title of "startup."  
  
This doesn't bother me. It's the same with other high-beta vocations, like
being an actor or a novelist. I've long since gotten used to it. But it seems
to bother a lot of people, particularly those who've started ordinary
businesses. Many are annoyed that these so-called startups get all the
attention, when hardly any of them will amount to anything.  
  
If they stepped back and looked at the whole picture they might be less
indignant. The mistake they're making is that by basing their opinions on
anecdotal evidence they're implicitly judging by the median rather than the
average. If you judge by the median startup, the whole concept of a startup
seems like a fraud. You have to invent a bubble to explain why founders want
to start them or investors want to fund them. But it's a mistake to use the
median in a domain with so much variation. If you look at the average outcome
rather than the median, you can understand why investors like them, and why,
if they aren't median people, it's a rational choice for founders to start
them.  
  
**Deals**  
  
Why do investors like startups so much? Why are they so hot to invest in
photo-sharing apps, rather than solid money-making businesses? Not only for
the obvious reason.  
  
The test of any investment is the ratio of return to risk. Startups pass that
test because although they're appallingly risky, the returns when they do
succeed are so high. But that's not the only reason investors like startups.
An ordinary slower-growing business might have just as good a ratio of return
to risk, if both were lower. So why are VCs interested only in high-growth
companies? The reason is that they get paid by getting their capital back,
ideally after the startup IPOs, or failing that when it's acquired.  
  
The other way to get returns from an investment is in the form of dividends.
Why isn't there a parallel VC industry that invests in ordinary companies in
return for a percentage of their profits? Because it's too easy for people who
control a private company to funnel its revenues to themselves (e.g. by buying
overpriced components from a supplier they control) while making it look like
the company is making little profit. Anyone who invested in private companies
in return for dividends would have to pay close attention to their books.  
  
The reason VCs like to invest in startups is not simply the returns, but also
because such investments are so easy to oversee. The founders can't enrich
themselves without also enriching the investors.   
  
Why do founders want to take the VCs' money? Growth, again. The constraint
between good ideas and growth operates in both directions. It's not merely
that you need a scalable idea to grow. If you have such an idea and don't grow
fast enough, competitors will. Growing too slowly is particularly dangerous in
a business with network effects, which the best startups usually have to some
degree.  
  
Almost every company needs some amount of funding to get started. But startups
often raise money even when they are or could be profitable. It might seem
foolish to sell stock in a profitable company for less than you think it will
later be worth, but it's no more foolish than buying insurance. Fundamentally
that's how the most successful startups view fundraising. They could grow the
company on its own revenues, but the extra money and help supplied by VCs will
let them grow even faster. Raising money lets you _choose_ your growth rate.  
  
Money to grow faster is always at the command of the most successful startups,
because the VCs need them more than they need the VCs. A profitable startup
could if it wanted just grow on its own revenues. Growing slower might be
slightly dangerous, but chances are it wouldn't kill them. Whereas VCs need to
invest in startups, and in particular the most successful startups, or they'll
be out of business. Which means that any sufficiently promising startup will
be offered money on terms they'd be crazy to refuse. And yet because of the
scale of the successes in the startup business, VCs can still make money from
such investments. You'd have to be crazy to believe your company was going to
become as valuable as a high growth rate can make it, but some do.  
  
Pretty much every successful startup will get acquisition offers too. Why?
What is it about startups that makes other companies want to buy them?   
  
Fundamentally the same thing that makes everyone else want the stock of
successful startups: a rapidly growing company is valuable. It's a good thing
eBay bought Paypal, for example, because Paypal is now responsible for 43% of
their sales and probably more of their growth.  
  
But acquirers have an additional reason to want startups. A rapidly growing
company is not merely valuable, but dangerous. If it keeps expanding, it might
expand into the acquirer's own territory. Most product acquisitions have some
component of fear. Even if an acquirer isn't threatened by the startup itself,
they might be alarmed at the thought of what a competitor could do with it.
And because startups are in this sense doubly valuable to acquirers, acquirers
will often pay more than an ordinary investor would.   
  
**Understand**  
  
The combination of founders, investors, and acquirers forms a natural
ecosystem. It works so well that those who don't understand it are driven to
invent conspiracy theories to explain how neatly things sometimes turn out.
Just as our ancestors did to explain the apparently too neat workings of the
natural world. But there is no secret cabal making it all work.  
  
If you start from the mistaken assumption that Instagram was worthless, you
have to invent a secret boss to force Mark Zuckerberg to buy it. To anyone who
knows Mark Zuckerberg, that is the reductio ad absurdum of the initial
assumption. The reason he bought Instagram was that it was valuable and
dangerous, and what made it so was growth.  
  
If you want to understand startups, understand growth. Growth drives
everything in this world. Growth is why startups usually work on technology —
because ideas for fast growing companies are so rare that the best way to find
new ones is to discover those recently made viable by change, and technology
is the best source of rapid change. Growth is why it's a rational choice
economically for so many founders to try starting a startup: growth makes the
successful companies so valuable that the expected value is high even though
the risk is too. Growth is why VCs want to invest in startups: not just
because the returns are high but also because generating returns from capital
gains is easier to manage than generating returns from dividends. Growth
explains why the most successful startups take VC money even if they don't
need to: it lets them choose their growth rate. And growth explains why
successful startups almost invariably get acquisition offers. To acquirers a
fast-growing company is not merely valuable but dangerous too.  
  
It's not just that if you want to succeed in some domain, you have to
understand the forces driving it. Understanding growth is what starting a
startup _consists_ of. What you're really doing (and to the dismay of some
observers, all you're really doing) when you start a startup is committing to
solve a harder type of problem than ordinary businesses do. You're committing
to search for one of the rare ideas that generates rapid growth. Because these
ideas are so valuable, finding one is hard. The startup is the embodiment of
your discoveries so far. Starting a startup is thus very much like deciding to
be a research scientist: you're not committing to solve any specific problem;
you don't know for sure which problems are soluble; but you're committing to
try to discover something no one knew before. A startup founder is in effect
an economic research scientist. Most don't discover anything that remarkable,
but some discover relativity.  
  
  
  
  
  
  
  
  
  
**