Entrepreneur

3 unofficial strategies in Y Combinator’s playbook

Image Credit: Paul Miller/Flickr

Y Combinator’s semiannual Demo Day is today — the day when one of the world’s most influential startup incubators gives its current crowd of entrepreneurs a chance to strut their stuff.

As the media, investors, and participating and aspiring entrepreneurs all prepare for the avalanche of manicured pitches and gimmicky t-shirts, we thought we’d take a look at some of the unofficial approaches that are likely in action at the accelerator program.

To be fair, none of these are official, structured, or even that secret. But as probably the best-known and most venerated accelerator program around, YC has a lot of mythology surrounding it. There’s a lot of misunderstanding, too. So we’re doing this story to help clear a few things up.

Here are three ways YC makes the magic happen.

Some investors are more equal than others

Tomorrow a swarm of reporters and investors will assemble at the Computer History Museum in Mountain View, California for the startups’ debutante ball, their coming out party to the world of investors.

What you may not know is that there are two groups of folks with money that have already gotten a look at the startups before today, and have probably already started to court them with investment offers. These two groups are a selection of investors and YC’s own alumni.

Apparently, YC advises its startups to not talk to investors until one week before demo day (i.e. last Tuesday), which coincidentally was also when YC brought in a selection of top investors to hold office hours with the startups and advise them on their presentations and so on.

Now, while I’m sure the investors indeed provided lots of great advice and feedback (one company’s founders told us they got great feedback), they also got an early chance to check out the startups, chat with them, and naturally start forming interest in them. And now that the startups are finally encouraged to be open to investment, there should be no reason why these conversations couldn’t come out from last Tuesday’s office hours.

The other set of moneyed folks are the YC alumni themselves, who are invited to attend the dress rehearsal, the day before Demo Day itself. Sure, one day early might sound pretty insignificant, and YC likely invites its alumni, again, to provide valuable advice and feedback as “vets” of the stage.

But YC’s alumni regularly invest in fellow YC companies. To name a few, Dropbox’s Drew Houston has invested in alumnus ZenPayroll, Airbnb’s Brian Chesky has invested in SocialCam, and Reddit’s Alexis Ohanian has invested in Move Loot, Lob, SpoonRocket, BloomThat, and many others.

And even if this alumni dress rehearsal doesn’t yield immediate term sheets, the accelerator is well-known for fostering a strong alumni network that goes on to help YC and its startups in a variety of ways including investment, resources, mentoring, knowledge, and so on.

The biggest implication all of this could have is adverse selection, according to one seed-stage investor we spoke with. If other investors have been given an early opportunity to court the startups, the rest of the investors might not get an equal opportunity to invest. But of course, adverse selection can’t be proven here, only hypothesized.

So bottom line, if you are an investor who’s first look at the current startups will be today, be aware that others have already had an early look.

If you’re really hot stuff, YC will recruit you

Let’s imagine that YC is a prestigious university, and that its startups are the freshman class. When entrepreneurs apply for admission, they are effectively raising their hands and saying that they’d like to be chosen to attend this particular school, which then evaluates these inbound leads and picks its freshman class.

But then there are the college’s varsity athletes. For the most part, athletes on college sports teams go through a separate recruitment process, where coaches court and recruit the top athletes in the hopes of getting them on their teams.

That’s the case at YC just as much as it is in Big 10 universities. Some of YC’s startups are these top performing athletes, recruited by partners to apply — even if they hadn’t considered applying before.

Product Hunt, for example, is one of these “recruited” startups. At the recommendation of an alumnus company, Algolia, founder Ryan Hoover met up with YC partner Garry Tan, followed by YC partners Kevin Hale and Alexis Ohanian, who all encouraged Hoover to apply.

In other words, it’s not just application driven. YC’s partners are clearly being proactive about who they’d like to see join the program by encouraging startups they find promising to apply.

“I also believe the growing network of YC partners and alumni also help recruit or encourage great founders they meet to apply to the program. And, why not? There’s no real cost to applying outside of time and energy, and if I were YC, I’d want to leverage the network versus just relying on sourcing via inbound application,” investor Semil Shah told us in an email.

“Put another way, a bit of outbound is likely a very good thing,” he wrote.

Nuclear energy is only one way YC is diversifying

The current batch includes networking app Weave, product-centric community Product Hunt, and two nuclear energy companies among its 80-ish startups. One is a nifty mobile app that’s already functioning and could monetize through ads and business partnerships, one is a successful community still figuring out how to monetize, and one is working in an area that’s usually left to science research and governments.

YC is playing the smart game of investing in obvious and faster wins, as well as moonshots, and everything in between (Quora, anyone?).

Although it’s nice to see the accelerator welcome startups of all shapes, let’s not forget that YC is not operating just out of the goodness of its heart. YC is an investor, and it’s looking out for those interests just as much as it’s providing resources and mentoring to its companies.

“To me, this is a mix of their ‘batch’ model and portfolio theory at work,” Shah told us in an email. “No one really knows what’s going to work when things are so early, what’s going to get big, etc. So, what does one do to increase the chances, to ‘farm black swans,’ as [YC founder Paul Graham] famously wrote? The answer is pattern recognition and filters.”

In simple terms: YC is diversifying its portfolio to mitigate risk.

In his “Black Swan Farming” post, Graham admitted that very few of YC’s companies will hit it big, and that recognizing the winners is hard — counterintuitive even — when selecting the new class.

“It would hurt YC’s brand (at least among the innumerate) if we invested in huge numbers of risky startups that flamed out. … But I know the real reason we’re so conservative is that we just haven’t assimilated the fact of 1000x variation in returns,” Graham wrote.

Whatever the case may be, YC is definitely adding more and more moonshots and companies that could very well take many years to reach any sort of fruition, if at all (I’m looking at you, nuclear energy startups).

More information:

Y Combinator is a venture fund which focuses on seed investments to startup companies. It offers financing as well as business consulting along with other opportunities to 2-4 person companies looking to take an idea to a product. Y Co... read more »

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