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Growth as a false signal in Y Combinator startups

149 points by happy-go-lucky 10y ago

minimaxir 10y ago
This data analysis is cheating. You can't provide an earnest data visualization and obfuscate the data (the corresponding YC companies) at the same time, as it makes it impossible to validate. True, VCs can't disclose the metrics revealed in a Demo Day, which makes the existence of this article problematic. Additionally: > If we annualized revenue for each company on the twelfth month after demo day, then annualized revenue per company would vary from $1 million to $159 billion. What the hell?
lpolovets 10y ago
As a VC, the premise of this article makes little sense to me. 1) Investors aren't idiots when it comes to growth. No one expects today's growth rates to stay constant. Growth decelerates over time. 2) You can't take averages of revenue and growth across lots of startups and use that as your model. Here's an example with two startups: * Startup 1: $4.99m annual revenue, grew 5% last month. * Startup 2: $10k annual revenue, grew 145% last month. "Hey look, if you average these growth rates out, you have a combined $5m in annual revenue growing 75% monthly. That'll be >$4b in annualized revenue in a year!!1!" No, it won't. The reason investors value high growth in young companies is that growth rates are an okay proxy for a lot of valuable things: product-market fit, execution ability, go to market strategy, etc.
- tempestn 10y ago
  You just forgot to divide the revenue by 2, but your point stands.
  - lpolovets 10y ago
    Fixed, thanks! The article switched between "combined revenue" and "revenue per company," and so did I. I should've made that explicit in the first place.
- CalChris 10y ago
  One thing that confuses me about YC is that they're an accelerator rather an incubator. In particular, this article talks about revenue growth which is an acceleration stage metric. Seed stage needs seed money to prove a hypothesis. Acceleration stage needs A money to accelerate. Stressing revenue growth at seed stage seems like it could be dangerous to a startup's health. (Yeah, ideally you would want the seed/acceleration transition to be c2 continuous.) YC offers seed money for seed percentage, $120k in return for 7%, and attaches accelerator metrics. This transaction just doesn't make sense to me at all. Clearly it makes sense to others, given the number of YC applications.
  - apsec112 10y ago
    I think the history of YC explains the confusion. YC was originally a seed-stage incubator (although they disliked that term, as they were very different from the 1990s "incubator" stereotype). As it became more famous, it focused more and more on later-stage companies, and the investment sizes also grew. From 2005 to now, the fraction of very early stage companies (pre-incorporation) has gone from 100% to ~12%, and the investment amount has increased from ~$20K to $120K. However, YC has (AFAIK) never explicitly acknowledged its transition to accelerator, and much of the writing on YC is years old, which creates some misunderstandings.
    - ProblemFactory 10y ago
      > As it became more famous, it focused more and more on later-stage companies, and the investment sizes also grew. Something I've wondered: was this focus change deliberate? Or is it just a result of becoming more famous, attracting many more applicants, and accepting more mature companies since their success to date looks better?
      - apsec112 10y ago
        Good question, I don't know. If anyone knows anything about this, I'd be very curious to hear.
      - clay_to_n 10y ago
- jasonlotito 10y ago
  From the point of view from someone else: the consumer side of things, and the way I start to approach and recommend companies like this. Basically, if the company still seems to be in growth first phase, I avoid recommending or using the product. This is generally because at that point in time, the product still doesn't have a solid financial plan. B2B offerings are less worrisome, and I imagine with the the SFO culture, easier to sell. After all, if your investors can introduce you to other companies that could use your product, well, it comes across as organic "growth." But at least it has a real business plan. Whether it sticks around, well, again, that really depends on the company and what they are offering. In the end though, most often I see this working out poorly for the consumers in the long run.
- paradite 10y ago
  I don't think the author's math is wrong here. Looking at this sentence, he/she is not taking the average for both like you described, but applying growth rate to revenue for each individual company: If we applied the companies’ monthly growth rates to their reported revenue, then after just one year the 22 companies would be generating about $21 billion in combined monthly revenue, or $963 million monthly revenue per company.
- donmatito 10y ago
  I didn't read in the article that he was taking the other investors for idiots. I think the point of the article was much more directed towards early entrepreneurs. 1) Growth is good but 2) ... don't fake the growth numbers with tricks 3) ... pay attention to other metrics like retention
- garry 10y ago
  Agree completely Leo. Growth rates are a snapshot and no replacement for understanding the market, founders, and product. Further, after having worked with 700 startups at YC, it is obvious to me now that if you can't grow from small numbers, there is no way a company can truly be a good startup. If that's true, then the best advice you can give starting out is to grow. It's just table stakes. The article is an absurd straw man argument.
  - timr 10y ago
    Garry, it might be an exaggerated premise, but how is it an absurd straw man? Every demo day (YC or otherwise) has a large number of startups claiming these high growth rates. What percentage work out, even one year out from demo day? Maybe you can say that the high growth rates from small numbers aren't long-term predictors, but isn't that just what the article is saying? That's what I read. It's obvious that, as you say, growth is "table stakes" for a good startup. But it's also true that competitive metrics are gamed, and that many startups claiming these numbers are, in fact, gaming their metrics. Does this make a difference? Probably not to good investors. But it does change herd dynamics, and makes it harder for teams that are unwilling to do bad things in the name of short-term growth.
- deleted 10y ago
  [deleted]
- mbesto 10y ago
  > That'll be >$4b in annualized revenue in a year!!1!" Sadly, I've seen way too many instances where one month of growth in an early stage means a ridiculously published ARR number to the press. If anything this article is a reflection on TC itself and how they don't properly investigate in their reporting.
coderzach 10y ago
TL;DR Not every company that has a revenue chart shaped like a hockey stick is going to become a multi billion dollar business. Consider looking at metrics other than growth when investing. Is this actually something that needs to be said?
DavidWanjiru 10y ago
Two points. One, my understanding of Paul's basic premise is that it's not the class quality that matters, it's the unicorns that matter. As in, in this game, you're not chasing good classes. You want the one or two superstars, even if they're in a crap class. Secondly, the analysis I'd find useful is one that looks at unicorns using hindsight. How early can you tell them apart? They are the ones we came here for, remember? It's a very hard task, like telling the gender of day-old chicks.
- Lordarminius 10y ago
  > Paul's basic premise is that it's not the class quality that matters, it's the unicorns that matter... You want the one or two superstars, even if they're in a crap class.... I used to wonder at this thinking and so apparently have many other observers until I hit upon the realization that the narrative from YC was misleading. It doesn't make sense to rest your entire strategy on seeking one or two superstars from a crap class. What is really going on, is that they organize the most promising applicants into a class then nurture and wait for unicorns to emerge. The midlings make returns too
philip1209 10y ago
I don't think that growth is a false signal. One major thing that kills startups is that people don't want what the company is building. The second derivative of revenue is a good way (i.e. signal) to measure product-market fit. The other major cause of death is cofounder breakups, and that's hard to predict. Regardless, it's tough to predict the future.
personjerry 10y ago
> Nick Mayberry, director of content at Tandem Capital, contributed to this article. This might explain why the article seems to try so hard to bash YC.
- saycheese 10y ago
  Agree, appears there's a pattern of Tandem Capital referencing YC in a less than positive way.
- garry 10y ago
  The article itself is written by a general partner at Tandem. It is pretty unusual in the business to have that kind of agenda frankly. Seed investing is the least zero sum stage in finance that I can think of. When founders win, seed investors win. I just can't see how this is a good tactic.
  - drenert 10y ago
    Garry, I wrote the article and by no means have any agenda against YC. Tandem owes much of its success to YC companies, and we don't intend to stop backing them now. The main point of the article (as some other commenters pointed out) is simply that not every company needs to be growing through the roof at demo day to be on track for success. Perhaps some don't think that warranted mentioning; I happen to think the reminder is healthy.
truetothepoint 10y ago
Deleted
mck- 10y ago
Am I reading the second chart correctly? $44m in MRR across the 22 companies, ie an average of $2m MRR after demo day? That sounds like Series B metrics? Why did they go through YC?
deleted 10y ago
[deleted]
dangero 10y ago
Tangentially related to this article, a few growth number tricks I've seen from founders recently: -Flying all over the country speaking at conferences giving away tons of schwag while claiming zero dollars spent on advertising. "It's all organic growth!" -Hiring a PR firm to get you mentions on industry blogs while again claiming zero dollars spent on advertising. "We get 1000 new visitors to our website every day and we've never spent any money on advertising." -Un-launching their product when they don't see the growth numbers they want, "Right now we have about 50 users in a pre-launch focus group." AKA "Our first launch failed, so we are going to pretend it didn't happen." Followed by a second "launch" so that growth numbers look good "since launch".
vonnik 10y ago
It's popular to pick fights with YC and its ideas these days. Easy press. Other examples: Gab, CB Insights, various reporters. The recipe goes: Find someone or something famous. Find a bone to pick. Leverage famous something's name to generate headlines. People are going to click.
free2rhyme214 10y ago
The real point of this article isn't to be right, it's to generate more eyeballs and provoke discussions. More TC clickbait.

149 points by happy-go-lucky 10y ago

This data analysis is cheating. You can't provide an earnest data visualization and obfuscate the data (the corresponding YC companies) at the same time, as it makes it impossible to validate. True, VCs can't disclose the metrics revealed in a Demo Day, which makes the existence of this article problematic. Additionally: > If we annualized revenue for each company on the twelfth month after demo day, then annualized revenue per company would vary from $1 million to $159 billion. What the hell?

lpolovets 10y ago

As a VC, the premise of this article makes little sense to me. 1) Investors aren't idiots when it comes to growth. No one expects today's growth rates to stay constant. Growth decelerates over time. 2) You can't take averages of revenue and growth across lots of startups and use that as your model. Here's an example with two startups: * Startup 1: $4.99m annual revenue, grew 5% last month. * Startup 2: $10k annual revenue, grew 145% last month. "Hey look, if you average these growth rates out, you have a combined $5m in annual revenue growing 75% monthly. That'll be >$4b in annualized revenue in a year!!1!" No, it won't. The reason investors value high growth in young companies is that growth rates are an okay proxy for a lot of valuable things: product-market fit, execution ability, go to market strategy, etc.

tempestn 10y ago
You just forgot to divide the revenue by 2, but your point stands.
- lpolovets 10y ago
  Fixed, thanks! The article switched between "combined revenue" and "revenue per company," and so did I. I should've made that explicit in the first place.
CalChris 10y ago
One thing that confuses me about YC is that they're an accelerator rather an incubator. In particular, this article talks about revenue growth which is an acceleration stage metric. Seed stage needs seed money to prove a hypothesis. Acceleration stage needs A money to accelerate. Stressing revenue growth at seed stage seems like it could be dangerous to a startup's health. (Yeah, ideally you would want the seed/acceleration transition to be c2 continuous.) YC offers seed money for seed percentage, $120k in return for 7%, and attaches accelerator metrics. This transaction just doesn't make sense to me at all. Clearly it makes sense to others, given the number of YC applications.
- apsec112 10y ago
  I think the history of YC explains the confusion. YC was originally a seed-stage incubator (although they disliked that term, as they were very different from the 1990s "incubator" stereotype). As it became more famous, it focused more and more on later-stage companies, and the investment sizes also grew. From 2005 to now, the fraction of very early stage companies (pre-incorporation) has gone from 100% to ~12%, and the investment amount has increased from ~$20K to $120K. However, YC has (AFAIK) never explicitly acknowledged its transition to accelerator, and much of the writing on YC is years old, which creates some misunderstandings.
  - ProblemFactory 10y ago
    > As it became more famous, it focused more and more on later-stage companies, and the investment sizes also grew. Something I've wondered: was this focus change deliberate? Or is it just a result of becoming more famous, attracting many more applicants, and accepting more mature companies since their success to date looks better?
    - apsec112 10y ago
      Good question, I don't know. If anyone knows anything about this, I'd be very curious to hear.
    - clay_to_n 10y ago
jasonlotito 10y ago
From the point of view from someone else: the consumer side of things, and the way I start to approach and recommend companies like this. Basically, if the company still seems to be in growth first phase, I avoid recommending or using the product. This is generally because at that point in time, the product still doesn't have a solid financial plan. B2B offerings are less worrisome, and I imagine with the the SFO culture, easier to sell. After all, if your investors can introduce you to other companies that could use your product, well, it comes across as organic "growth." But at least it has a real business plan. Whether it sticks around, well, again, that really depends on the company and what they are offering. In the end though, most often I see this working out poorly for the consumers in the long run.
paradite 10y ago
I don't think the author's math is wrong here. Looking at this sentence, he/she is not taking the average for both like you described, but applying growth rate to revenue for each individual company: If we applied the companies’ monthly growth rates to their reported revenue, then after just one year the 22 companies would be generating about $21 billion in combined monthly revenue, or $963 million monthly revenue per company.
donmatito 10y ago
I didn't read in the article that he was taking the other investors for idiots. I think the point of the article was much more directed towards early entrepreneurs. 1) Growth is good but 2) ... don't fake the growth numbers with tricks 3) ... pay attention to other metrics like retention
garry 10y ago
Agree completely Leo. Growth rates are a snapshot and no replacement for understanding the market, founders, and product. Further, after having worked with 700 startups at YC, it is obvious to me now that if you can't grow from small numbers, there is no way a company can truly be a good startup. If that's true, then the best advice you can give starting out is to grow. It's just table stakes. The article is an absurd straw man argument.
- timr 10y ago
  Garry, it might be an exaggerated premise, but how is it an absurd straw man? Every demo day (YC or otherwise) has a large number of startups claiming these high growth rates. What percentage work out, even one year out from demo day? Maybe you can say that the high growth rates from small numbers aren't long-term predictors, but isn't that just what the article is saying? That's what I read. It's obvious that, as you say, growth is "table stakes" for a good startup. But it's also true that competitive metrics are gamed, and that many startups claiming these numbers are, in fact, gaming their metrics. Does this make a difference? Probably not to good investors. But it does change herd dynamics, and makes it harder for teams that are unwilling to do bad things in the name of short-term growth.
deleted 10y ago
[deleted]
mbesto 10y ago
> That'll be >$4b in annualized revenue in a year!!1!" Sadly, I've seen way too many instances where one month of growth in an early stage means a ridiculously published ARR number to the press. If anything this article is a reflection on TC itself and how they don't properly investigate in their reporting.

coderzach 10y ago

TL;DR Not every company that has a revenue chart shaped like a hockey stick is going to become a multi billion dollar business. Consider looking at metrics other than growth when investing. Is this actually something that needs to be said?

DavidWanjiru 10y ago

Two points. One, my understanding of Paul's basic premise is that it's not the class quality that matters, it's the unicorns that matter. As in, in this game, you're not chasing good classes. You want the one or two superstars, even if they're in a crap class. Secondly, the analysis I'd find useful is one that looks at unicorns using hindsight. How early can you tell them apart? They are the ones we came here for, remember? It's a very hard task, like telling the gender of day-old chicks.

Lordarminius 10y ago
> Paul's basic premise is that it's not the class quality that matters, it's the unicorns that matter... You want the one or two superstars, even if they're in a crap class.... I used to wonder at this thinking and so apparently have many other observers until I hit upon the realization that the narrative from YC was misleading. It doesn't make sense to rest your entire strategy on seeking one or two superstars from a crap class. What is really going on, is that they organize the most promising applicants into a class then nurture and wait for unicorns to emerge. The midlings make returns too

philip1209 10y ago

I don't think that growth is a false signal. One major thing that kills startups is that people don't want what the company is building. The second derivative of revenue is a good way (i.e. signal) to measure product-market fit. The other major cause of death is cofounder breakups, and that's hard to predict. Regardless, it's tough to predict the future.

personjerry 10y ago

> Nick Mayberry, director of content at Tandem Capital, contributed to this article. This might explain why the article seems to try so hard to bash YC.

saycheese 10y ago
Agree, appears there's a pattern of Tandem Capital referencing YC in a less than positive way.
garry 10y ago
The article itself is written by a general partner at Tandem. It is pretty unusual in the business to have that kind of agenda frankly. Seed investing is the least zero sum stage in finance that I can think of. When founders win, seed investors win. I just can't see how this is a good tactic.
- drenert 10y ago
  Garry, I wrote the article and by no means have any agenda against YC. Tandem owes much of its success to YC companies, and we don't intend to stop backing them now. The main point of the article (as some other commenters pointed out) is simply that not every company needs to be growing through the roof at demo day to be on track for success. Perhaps some don't think that warranted mentioning; I happen to think the reminder is healthy.

truetothepoint 10y ago

Deleted

mck- 10y ago

Am I reading the second chart correctly? $44m in MRR across the 22 companies, ie an average of $2m MRR after demo day? That sounds like Series B metrics? Why did they go through YC?

deleted 10y ago

[deleted]

dangero 10y ago

Tangentially related to this article, a few growth number tricks I've seen from founders recently: -Flying all over the country speaking at conferences giving away tons of schwag while claiming zero dollars spent on advertising. "It's all organic growth!" -Hiring a PR firm to get you mentions on industry blogs while again claiming zero dollars spent on advertising. "We get 1000 new visitors to our website every day and we've never spent any money on advertising." -Un-launching their product when they don't see the growth numbers they want, "Right now we have about 50 users in a pre-launch focus group." AKA "Our first launch failed, so we are going to pretend it didn't happen." Followed by a second "launch" so that growth numbers look good "since launch".

vonnik 10y ago

It's popular to pick fights with YC and its ideas these days. Easy press. Other examples: Gab, CB Insights, various reporters. The recipe goes: Find someone or something famous. Find a bone to pick. Leverage famous something's name to generate headlines. People are going to click.

free2rhyme214 10y ago

The real point of this article isn't to be right, it's to generate more eyeballs and provoke discussions. More TC clickbait.