How do they make millions with only around a 10% success rate?
Y Combinator is a “startup accelerator”, launched in 2005, with the goal of investing in startups and helping them grow. Data released in 2022 showed Y-Combinator’s 271 most successful investments, out of more than 3000 businesses they have invested in over the years, which yields around a 9% success rate.
So what do they do that they can be wrong 9 out of 10 times and still make tens of millions of dollars?
I talked a little about Venture Capitalists and how they earn money here. Well briefly, they invest in companies/startups at the early stages of their life cycles and aim to cash in when these companies raise further funds at some point, or maybe never (but that is a rare case).
Startup funding has several stages:
Seed stage: The function of a seed investment is generally to help with the R&D phase to reach a point where the product or service offered can be introduced to the market. Without this, launching the product and getting it to market is very difficult because of all the hoops a new business has to go through.
Series A, B, C funding and so on: These are the stages where most VC firms want to get in, since the company has a demonstrable product and now needs money to fix any chinks in the armour or enhance marketing efforts. As we go into the later funding rounds, the size of investments required to purchase an amount of stake typically grows as the valuations of the companies grow. The risk, albeit significant still, also typically should decrease as more and more rounds go on since the company should be able to streamline its processes.
IPO: While this may not be the end goal for many startups (maybe they want to sell to a bigger company in the sector and cash in after years of effort), this can be a route. All of the companies you know, like Apple, Microsoft, Tesla, Reliacne, etc. were once startups and went public to raise money for operations or for the exit of existing investors.
So where does Y-Combinator come in during this process?
They have been investing in startups in the seed stage for all their time as a company and have notched up a pretty impressive list of successful investments, some of whom are now a daily part of our lives, like Airbnb, Reddit, Dropbox, Twitch, Zepto and many more.
It is a well-known statistic that most startups fail, and that is also evident from the less than 10% hit rate YC has. But what are the common things in the successful ones? YC co-founder Jessica Livingston sat in a podcast with OpenAI CEO Sam Altman a few years back and answered the question. She said “The most successful founders I’ve noticed are totally focused on two things: building their product & making something people want and talking to their users", and they do not let themselves get distracted by anything else. And that seems so obvious, but what’s not obvious is how easily distracted founders can be by lots of other things going on. And the most successful startups are hyper-focused on their product.”
So this is someone with years of experience telling us that the best companies they’ve invested in have been those that build their product relentlessly and give importance to feedback. If you’re currently working on your business or might do so in the future, and even if you’re part of an organization that‘s trying to bring in a product that you believe in, I think Ms Livingston’s advice is a very potent one.
And if you can find a way to invest in businesses and people, do so, because they can provide more returns than most other investments one can make. But be mindful of the increased risk in this way of investing too. If you enjoyed this article, you can read more from me here. And do let me know if you want a specific topic covered. Subscribe for free to receive more posts like this every day!