What do Airbnb, Dropbox, Zenefits, Stripe, and Instacart all have in common? Besides their astronomical valuations, they all got early funding from Y Combinator. YC is the most prominent startup accelerator in the world. Founded in 2005 and based in Mountain View, CA, YC invests in startups at the earliest stage and provides special resources to help entrepreneurs get off the ground. To date, Y Combinator has funded roughly 900 startups (typically investing $120k for a 7% stake). The value of YC’s investments, led by six $1 billion+ “unicorns,” is now likely in the billions, delivering a phenomenal return that has yet to be fully cashed in (there have been some prominent YC exits including Twitch and Reddit). Recently, YC raised a fund to enter late-stage investing as well, complementing its early-stage business.
Fundamentally, YC’s business model is to invest low amounts of capital into a large volume of high-risk startups (that may not even have a functioning prototype), with the hopes striking gold among a few investments. So far, this strategy has proven successful. But the “cast a wide net” business model in itself is not differentiated from that of the broader venture capital community. What separates Y Combinator, as well as Techstars and other accelerators, is the value-added resources and structure that the accelerator program provides to startups. Here is where YC’s operating model is key to its success.
Traditional angel and venture capital investors sometimes provide value-added resources (e.g., legal advice) to startup founders that are stretched beyond their core competencies. YC provides these resources in a high-impact, systematic way at scale. When YC invests in a startup, it requires its founders to relocate to the Bay Area and participate in a three-month program (referred to by some as a “boot camp”) During this time, the startup must work on building its product and acquiring users. The founders have access to YC expert counselors (YC’s partners) who can help with solving legal issues such incorporation, patent filing, and dispute mediation, but also with building business competencies such as salesmanship and finding talent. YC strives to relieve founders of inevitable distractions so they can remained focused on building a viable product, which will enable them to achieve credibility sooner, and consequently, raise more funds, more quickly.
YC also provides startup founders with an immediate network of other founders as well as weekly speaker events with high-profile guests such as Mark Zuckerberg and other industry veterans. The convergence of people, ideas, and resources in one place provides an ideal environment for startups, with benefits seen during the program and after. At the end of the program, startups pitch their products at Demo Day, attended by high-profile investors and journalists. In some cases, startups can receive significant funding from investors they meet at Demo Day. Given the prime opportunity to access investors, startups entering the accelerator are highly incentivized to deliver something tangible and compelling at the end of their three months.
In requiring startups to participate in a program on-site, efficiently connecting them with resources, and putting in place structure, timeline, and incentive around a single goal (building a great product), YC has developed an operating model that increases the likelihood that startups make quick progress and build momentum.
Beyond program execution, YC’s overall management of its funding cycles also gives them an edge. YC runs two funding cycles per year (3 months each) and utilizes a relatively straightforward application and interview process that systematically collects inbound interest. This generates a high-volume and stable investment pipeline. Furthermore, YC’s standardization of its program and investment terms increases its marketability to startups and investors by simplifying the discussion of what YC is and can do, while enabling scale that generates buzz and excitement. In recent cycles, YC has received 2,500+ applications and has selected ~50 inductees per cycle.
On its website, YC states as some of its goals: to “be the preferred source of seed funding,” to “get [startups] through the first phase… to the point where [they’ve] built something impressive enough to raise money on a large scale,” and ultimately, “to help startups really take off.” Of course, most startups will not be home runs, but all YC needs is a higher batting average and/or slugging percentage to meet and exceed its investment objectives. YC’s operating model is designed to that end and Silicon Valley has been taking note.