Y Combinator Asks These 4 Questions to Every Startup
Based on Sam Altman’s Most Recent YC Annual Letter
Last week I wrote an article (originally) entitled “Advice for First-Time Entrepreneurs.” It was based on my insights from having read Peter Thiel’s Zero to One over that weekend. The article gained some popularity on LinkedIn before being picked up by Tadas Viskanta at Abnormal Returns. Tadas renamed it to “Seven Insights from Peter Thiel’s Zero to One.” I decided to go with that title instead (Thank you, sir).
Jason Lemkin’s Advice about Investing
The relevance to my earlier article is that Jason M. Lemkin wrote an answer on Quora about this question:
What are the most important characteristics that an investor or a VC firm should have?
The gist of his answer? Proven processes.
His point is that any investor can justify almost any investment. What separates the average run-of-the-mill investor from the great investors is the ability to set their investment process and stick to them. As Jason said:
There’s a reason YC has turned out Airbnb, Stripe, DropBox, and so many other winners. Almost like clockwork.
It’s not just brand, folks. It ain’t just IQ. Those do matter. But.
It’s proven processes. They stick to them, invest in them, have fierce quality lines, and take measured and aggressive risks against them.
So WHAT ARE Y-Combinator’s (YC) proven processes? Are they secret, or does YC have something to say about their investment processes?
Annual Letter from Sam Altman
YC president Sam Altman penned his annual letter on February 16, 2017, detailing the four things the accelerator asks every company before deciding whether to invest. They are based on Peter Thiel’s investment philosophy so if they look similar to you, you may have found a pattern of proven processes.
1) Will this company build something lots of people really love?
“If so, and if ‘lots’ is sufficiently large, the company has the chance to produce substantial earnings.”
Sam’s litmus test for this is:
“Do any users love our product so much they spontaneously tell other people to use it?” Until that’s a “yes”, founders are generally better off focusing on this instead of a growth target.
If your product or service is not at the point where people are spreading it, you have not hit your goal of making something lots of people really love.
2) Will this company be easy to copy?
“The most successful companies I’ve worked with have a significant competitive advantage — network effect, proprietary technology, complex coordination, or barrier to entry of some other sort. I understand in theory it’s possible to build a very successful commodity company, but I don’t know how to do it.”
This comes down to competition and building competitive moats — the ultimate goal of monopolies. If you’re competing against the likes of Amazon, Facebook, Google, Apple, and Microsoft, they wield huge advantages most founders and investors still do not yet fully grasp. Why?
“I expect that they [big tech companies] will continue to do a lot of things well, have significant data and computation advantages, be able to attract a large percentage of the most talented engineers, and aggressively buy companies that get off to promising starts. This trend is unlikely to reverse without antitrust action, and I suggest people carefully consider its implications for startups.”
Google and Facebook take a combined 85% of dollars on digital ad spend. That’s 85 cents of every dollar spent on advertising over the Internet. If that’s your direct competition, you will either get swallowed up (in an M&A takeover) or they will out-compete you. There is no third option.
3) Will these founders develop into “forces of nature”?
“As most people say, it’s hard to make money unless you invest in great founders. Defining what that means is usually left as an exercise to the reader. Here are some questions I ask myself: Are these founders relentlessly determined? Are they original thinkers? Are they smart, and especially do they have new insights I haven’t heard before? Are they good communicators (and so will they be able to hire, sell, raise money, talk to the press, etc)? Are they focused and intense? Do they always seem to find a way around obstacles? Would I work for them?
“This is the often the hardest factor for me to evaluate, because you have to make a judgment about trajectory — you are trying to predict where someone will be in five years.”
4) Does this company have a clear and important mission?
“Without this, I usually get bored. More importantly, companies that don’t have this usually have a hard time recruiting enough great people to work with them, and thus struggle to become very large.”
This comes down to “Find Your Purpose.” Do you have an attractive and compelling story? If not, why would investors choose you over any other startup out there? See my article last week where Peter Thiel was quoted:
“Poor sales rather than bad product is the most common cause of failure.”
Conclusion
Sam Altman notes in his annual letter that unconventional characters with “non-traditional backgrounds” are among YC’s biggest success stories. By contrast, founders with extremely “tracked” lives (the pedigreed school, degree, and professional experience) may not be in startups for the right reason, a mindset Altman describes as “bringing an idea they’re obsessed with to life, and willing to do something unreasonable to see it happen.” Sam has deconstructed his proven process for investment — have you done the same for your own company?
Chris Harvey, Esq. is a startup lawyer for entrepreneurs in Los Angeles. Chris was selected in the class of Top Writers (2017) on Quora. You can find him trolling on Twitter at @ChrisHarveyEsq. For more information, please visit https://harveyesq.com.
