March 2008, rev May 2013(This essay grew out of something I wrote for myself to figureout what we do. Even though Y Combinator is now 3 years old, we're stilltrying to understand its implications.)I was annoyed recently to read a description of Y Combinator thatsaid "Y Combinator does seed funding for startups." What wasespecially annoying about it was that I wrote it. This doesn'treally convey what we do. And the reason it's inaccurate is that,paradoxically, funding very early stage startups is not mainly aboutfunding.Saying YC does seed funding for startups is a description in termsof 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, butsurface area only as the square. So as animals get bigger theyhave trouble radiating heat. That's why mice and rabbits are furryand elephants and hippos aren't. You can't make a mouse by scalingdown an elephant.YC represents a new, smaller kind of animal—so much smallerthat all the rules are different.Before us, most companies in the startup funding business wereventure capital funds. VCs generally fund later stage companiesthan we do. And they supply so much money that, even though theother things they do may be very valuable, it's not that inaccurateto regard VCs as sources of money. Good VCs are "smart money," butthey're still money.All good investors supply a combination of money and help. Butthese scale differently, just as volume and surface area do. Latestage investors supply huge amounts of money andcomparatively little help: when a company about to go public getsa mezzanine round of $50 million, the deal tends to be almostentirely about money. As you move earlier in the venturefunding process, the ratio of help to money increases, becauseearlier stage companies have different needs. Early stage companiesneed less money because they're smaller and cheaper to run, butthey need more help because life is so precarious for them. Sowhen VCs do a series A round for, say, $2 million, they generallyexpect to offer a significant amount of help along with the money.Y Combinator occupies the earliest end of the spectrum. We're atleast one and generally two steps before VC funding. (Though somestartups go straight from YC to VC, the most common trajectory isto do an angel round first.) And what happens at Y Combinator isas different from what happens in a series A round as a series Around is from a mezzanine financing.At our end, money is almost a negligible factor. The startup usuallyconsists of just the founders. Their living expenses are thecompany's main expense, and since most founders are under 30, theirliving expenses are low. But at this early stage companies need alot of help. Practically every question is still unanswered. Somecompanies we've funded have been working on their software for ayear or more, but others haven't decided what to work on, or evenwho the founders should be.When PR people and journalists recount the histories of startupsafter they've become big, they always underestimate how uncertainthings were at first. They're not being deliberately misleading.When you look at a company like Google, it's hard to imagine theycould once have been small and helpless. Sure, at one point theywere a just a couple guys in a garage—but even then theirgreatness was assured, and all they had to do was roll forward alongthe railroad tracks of destiny.Far from it. A lot of startups with just as promising beginningsend up failing. Google has such momentum now that it would be hardfor anyone to stop them. But all it would have taken in the beginningwould have been for two Google employees to focus on the wrongthings for six months, and the company could have died.We know, because we've been there, just how vulnerable startups arein the earliest phases. Curiously enough, that's why founders tendto 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 onan 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 oryou're just launching projectiles. They have to be pointed straightdown the deck; the wings have to be trimmed properly; the engineshave to be at full power; the pilot has to be ready. These are thekind of problems we deal with. After we fund startups we workclosely with them for three months—so closely in fact thatwe insist they move to where we are. And what we do in those threemonths is make sure everything is set up for launch. If there aretensions between cofounders we help sort them out. We get all thepaperwork set up properly so there are no nasty surprises later.If the founders aren't sure what to focus on first, we try to figurethat out. If there is some obstacle right in front of them, weeither try to remove it, or shift the startup sideways. The goalis to get every distraction out of the way so the founders can usethat time to build (or finish building) something impressive. Andthen near the end of the three months we push the button on thesteam catapult in the form of Demo Day, where the current group ofstartups present to pretty much every investor in Silicon Valley.Launching companies isn't identical with launching products. Thoughwe do spend a lot of time on launch strategies for products, thereare some things that take too long to build for a startup to launchthem before raising their next round of funding. Several of themost promising startups we've funded haven't launched their productsyet, but are definitely launched as companies.In the earliest stage, startups not only have more questions toanswer, but they tend to be different kinds of questions. In laterstage startups the questions are about deals, or hiring, ororganization. In the earliest phase they tend to be about technologyand design. What do you make? That's the first problem to solve.That's why our motto is "Make something people want." This isalways a good thing for companies to do, but it's even more importantearly on, because it sets the bounds for every other question. Whoyou hire, how much money you raise, how you market yourself—theyall 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 VCshave technical backgrounds, I don't know any who still write code.Their expertise is mostly in business—as it should be, becausethat's the kind of expertise you need in the phase between seriesA and (if you're lucky) IPO.We're so different from VCs that we're really a different kind ofanimal. Can we claim founders are better off as a result of thisnew type of venture firm? I'm pretty sure the answer is yes, becauseYC is an improved version of what happened to our startup, and ourcase was not atypical. We started Viaweb with $10,000 in seed moneyfrom our friend Julian. He was a lawyer and arranged all ourpaperwork, so we could just code. We spent three months buildinga version 1, which we then presented to investors to raise moremoney. Sounds familiar, doesn't it? But YC improves on thatsignificantly. Julian knew a lot about law and business, but hisadvice ended there; he was not a startup guy. So we made some basicmistakes early on. And when we presented to investors, we presentedto only 2, because that was all we knew. If we'd had our laterselves to encourage and advise us, and Demo Day to present at, wewould have been in much better shape. We probably could have raisedmoney at 3 to 5 times the valuation we did.If we take 7% of a company we fund, the founders only have to do7.5% better in their next round of fundingto end up net ahead. We certainly manage that.So who is our 7% coming out of? If the founders end up net aheadit's not coming out of them. So is it coming out of later stageinvestors? Well, they do end up paying more. But I think they paymore because the company is actually more valuable. And later stageinvestors have no problem with that. The returns of a VC funddepend on the quality of the companies they invest in, not howcheaply they can buy stock in them.If what we do is useful, why wasn't anyone doing it before? Thereare two answers to that. One is that people were doing it before,just haphazardly on a smaller scale. Before us, seed funding cameprimarily from individual angel investors. Larry and Sergey, forexample, got their seed funding from Andy Bechtolsheim, one of thefounders of Sun. And because he was a startup guy he probably gavethem useful advice. But raising money from angel investors is ahit or miss thing. It's a sideline for most of them, so they onlydo a handful of deals a year and they don't spend a lot of time onthe startups they invest in. And they're hard to reach, becausethey don't want random startups pestering them with business plans.The Google guys were lucky because they knew someone who knewBechtolsheim. It generally takes a personal introduction withangels.The other reason no one was doing quite what we do is that tillrecently it was a lot more expensive to start a startup. You'llnotice we haven't funded any biotech startups. That's stillexpensive. But advancing technology has made web startups so cheapthat you really can get a company airborne for $15,000. If youunderstand how to operate a steam catapult, at least.So in effect what's happened is that a new ecological niche hasopened up, and Y Combinator is the new kind of animal that has movedinto it. We're not a replacement for venture capital funds. Weoccupy a new, adjacent niche. And conditions in our niche arereally quite different. It's not just that the problems we faceare different; the whole structure of the business is different.VCs are playing a zero-sum game. They're all competing for a sliceof a fixed amount of "deal flow," and that explains a lot of theirbehavior. Whereas our m.o. is to create new deal flow, by encouraginghackers who would have gotten jobs to start their own startupsinstead. We compete more with employers than VCs.It's not surprising something like this would happen. Most fieldsbecome more specialized—more articulated—as they develop,and startups are certainly an area in which there has been a lotof development over the past couple decades. The venture businessin its present form is only about forty years old. It stands toreason 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 YCombinator is not in the startup funding business. Really we'remore of a small, furry steam catapult.Thanks to Trevor Blackwell, Jessica Livingston, and Robert Morrisfor reading drafts of this.Comment on this essay.
