When it comes to the world of tech start-ups and Silicon Valley, you’ll struggle to find a more respected and influential start-up incubator than Y Combinator. Founded in 2005 by Paul Graham, Jessica Livingston, Trevor Blackwell and Robert Tappan Morris, it has helped some major companies get off the ground and find a workable business model. Y combinator alums include Dropbox, Airbnb and Reddit.
Getting into Y Combinator, as you might expect, isn’t easy. Two batches of around 50 to 100 start-ups are accepted every year. That might seem like quite a lot, but it’s estimated that the incubator receives between
1 000 and 2 000 applications for every intake, with only 3% of start-ups actually making the cut. And even if you get in, you’re expected to move to Silicon Valley for three months to work closely with the folks at Y Combinator. For many start-ups, especially international ones, this can be difficult to do. Not only is it expensive, but moving a whole business to San Francisco can be impractical. So, while many founders would love to grow their businesses with the help of Y Combinator, few can actually achieve this dream.
However, even if you can’t attend Y Combinator personally, you can still learn a lot from the incubator. According to Sam Altman, the current president of Y Combinator, about 70% of what the mentors discuss at the incubator is specific to the start-ups they deal with, but the other 30% is generic and applicable to all, and this info has been made available to the public.
Y Combinator, along with some very prominent and influential guest lecturers, hosted a series of lectures at Stanford in 2014, and these sessions were recently released in podcast form. Every lecture is incredibly dense, packed with fantastic advice and insights. It is definitely worth listening to every single one in its entirety. You can find the episodes on podcast platforms like iTunes, or you can visit startupclass.samaltman.com for videos of the lectures, as well as annotated transcripts and other resources.
There’s nowhere near enough space here to discuss all the info provided, but below you’ll find some of the most interesting tips and lessons from the various lectures. Specifically, we’ll be looking at the counter-intuitive insights that are only gleaned from years in the trenches.
1. A great idea doesn’t look like a great idea
“The hardest part about coming up with great ideas, is that the best ideas often look terrible at the beginning. The thirteenth search engine, and without all the features of a web portal? Most people thought that was pointless. Search was done, and anyway, it didn’t matter that much. Portals were where the value was. The tenth social network, and limited only to college students with no money? Also terrible. MySpace has won and who wants college students as customers? Or a way to stay on strangers’ couches. That just sounds terrible all around.” — Sam Altman, Y Combinator President.
Lesson: The obviously ‘great’ ideas are already taken. As Altman says: “If they sounded really good, there would be too many people working on them.” So, you want something that doesn’t seem like a truly great business idea at first. This means facing a lot of risk and rejection, but it also provides great opportunity. The alternative, argues Altman, is a clone of an already-existing idea with a small or made up differentiator, and these businesses don’t tend to last.
2. Looking for a great idea is not a great idea
“The way to get start-up ideas is not to try to think of start-up ideas. If you make a conscious effort to try to think of start-up ideas, you will think of ideas that are not only bad, but bad and plausible sounding. Meaning you and everybody else will be fooled by them. You’ll waste a lot of time before realising they’re no good. The way to come up with good start-up ideas is to take a step back. Instead of trying to make a conscious effort to think of start-up ideas, turn your brain into the type that has start-up ideas unconsciously.” — Paul Graham, Y Combinator Founder
Lesson: Great start-up ideas tend to pop up when you’re not actively trying to start a business. A lot of great companies, like Google, Facebook and Apple, were not started as businesses, but purely as side projects that interested the founders. So, follow your curiosity and don’t search too hard for an idea. The truly great ones are almost never obvious start-up ideas.
“The very best ideas almost always have to start as side projects because they’re always such outliers that your conscious mind would reject them as ideas for companies,” says Graham.
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3. Competition is for losers
“You want to be a one-of-a-kind company. You want to be the only player in a small ecosystem. You don’t want to be the fourth online pet food company. You don’t want to be the tenth solar panel company. You don’t want to be the hundredth restaurant in Palo Alto. Large existing markets typically mean that you have tons of competition, so it’s very, very hard to differentiate. The first very counter-intuitive idea is to go after small markets; markets that are so small people often don’t even think that they make sense. That’s where you get a foothold, and then if those markets are able to expand, you can scale into a big monopoly business.” — Peter Thiel, entrepreneur and venture capitalist.
Lesson: Many successful, high-growth companies started out catering to markets that appeared small and unpromising at first. Facebook didn’t start off as a social media platform for the globe, it started off catering to a single university — a tiny market. Too many start-ups wade into a saturated market purely because the size of the market is tempting. A better idea is to find that small market that is ready to explode. What industry will be massive ten years from now?
4. Grow big by thinking small
“My philosophy behind a lot of things that I teach in start-ups is, the best way to get to $1 billion is to focus on the values that help you get that first dollar to acquire that first user. If you get that right, everything else will take care of itself. It’s a sort of faith thing.” — Kevin Hale, Y Combinator Partner.
Lesson: Large-scale, long-term success depends on creating a product or service that truly surprises and delights your customers. The problem is, you can’t do this if you’re too focused on the big picture. If you’re too worried about building a R1 billion business, you’re not taking the time and effort to think about the individual customer experience. So, don’t look at customers as numbers on a spreadsheet, even if your business is already hugely successful. And, if your business is still new, do whatever’s needed to delight the customer, even if your approach seems unscalable. Stay true to the approach that bagged you that very first sale.
5. Do things that don’t scale
“The lesson that I’ve been learning lately is that you want to do things that don’t scale as long as possible. There’s not some magical moment; it’s not Series A, or it’s not when you hit a certain revenue milestone, that you stop doing things that don’t scale. This is one of your biggest advantages as a company, and the moment you give it up, you’re giving your competitors that are smaller and can still do these things an advantage over you. So as long as humanly possible, as long as it is a net positive, you need to spend time talking to your users, you need to move as fast as possible in development, but don’t give it up willingly; it should be ripped from you.” — Walker Williams, founder of Teespring.
Lesson: Don’t worry too much if your actions aren’t scalable. View it as an advantage. The longer you can do things that don’t scale, the bigger your advantage over the competition. There will come a time when you’re too big to do these things, but don’t fret over it in the early days.
6. You get funding if you don’t need funding
“I was so frustrated from this experience of having tried for two years to raise money from VCs and I sort of decided, to hell with it. You cannot count on there being capital available to you. This business that I started seemed like one that maybe I could do without raising money at all. There was enough cash flow, it seemed compelling enough that I could do that. It turns out that those are exactly the kinds of businesses that investors love to invest in and it made it incredibly easy.” — Parker Conrad, founder of Zenefits.
Lesson: Finding funding isn’t easy, especially if your company is hanging on by a thread and desperately in need of a cash infusion. The safest way to build a business is to bootstrap and become cash-positive as quickly as possible. The fact of the matter is, investors will be more attracted to a business that has proven its business model and is making money. Launch as cheaply as possible, get some traction, make some money, and then go to investors when you’re ready to scale.
7. Growth is as much about retention as acquisition
“My contrarian viewpoint is, if you’re a start-up, you shouldn’t have a growth team. Start-ups should not have growth teams. The whole company should be the growth team. The CEO should be the head of growth. Mark Zuckerberg is a fantastic example of that. Back when Facebook started, a lot of people were putting out their registered user numbers. Mark put out monthly active users, as the number he held everyone to internally, and said we need everyone on Facebook, but that means everyone active on Facebook, not everyone signed up on Facebook, so monthly active people was the number internally, and it was also the number he published externally. It was the number he made the whole world hold Facebook to, as a number that we cared about.” — Alex Schultz, Head of Growth Marketing at Facebook.
Lesson: Growing your company isn’t as simple as signing up new customers. Sure, this is important, but ultimately, retention is more important than acquisition when it comes to long-term success. You want people to stick around and continue doing business with you, so, right from the beginning, focus on retention. Make that one of the key metrics that you track and use to evaluate the business. Even if you are landing new clients at an impressive rate, it doesn’t bode well if retention is a problem. Retention says a lot more about the viability of your start-up than new acquisitions do.
Y Combinator’s events are known for their high-calibre guest speakers, including Facebook founder Mark Zuckerburg and Zappos founder Tony Hsieh. In 2014 Y Combinator hosted a series of lectures at Stanford. These have recently been released in podcast form.
How to Start a Startup can be downloaded from iTunes or for videos of the lectures, go to startupclass.samaltman.com
Alan Knott-Craig Answers Your Questions On Money And Partners
From starting the right business, to managing business partners and finding your magic number, there is a secret to happiness.
If I get rich will I be happy? — JC Lately
Does money equal happiness? Mostly, yes. Research in the US shows that your happiness is proportionate to your earnings up until you earn $80 000 per annum. Thereafter, incremental income gains have a negligible effect on your happiness.
In other words: More money will make you happy as long as you’re poor. Once you break out of poverty and enter a comfortable middle-class existence, more money will not make you happier.
These are the top three for old folks:
- I wish I’d spent more time with family.
- I wish I’d taken more risks.
- I wish I’d travelled more.
Therein lies the secret to happiness. Spend time with your family. Take risks. Travel.
But first, make money. Don’t do any of the above until you’re making enough money not be stressed about money.
What is the magic number? — Mushti
The magic number is the amount of money you need to not worry about money ever again. If you don’t need toys like Ferraris, yachts and jets, the magic number is R130 million. Here’s the math: R130 million will earn R9,1 million in interest annually (assuming 7% interest). After tax that is R5,46 million.
Assuming you need 50% to maintain a good lifestyle, that leaves approximately R2,7 million for reinvestment, which is enough to keep your capital amount in touch with inflation for 50 years. The balance of R2,7 million (after tax) is for your living costs. In South Africa, R2,7 million will afford you a lifestyle that allows you to send your kids to a great school and university, to travel overseas a couple of times a year, and to live in a comfortable house.
Over time your living costs (and inflation) will eat into your capital amount. After 50 years you should be down to nil, assuming you earn zero other income in that time.
In 50 years, you will probably be dead. If you’re not dead, your kids will be able to support you (because they love you and they have a great university education).
I am the sole director of a company (the others still have full-time jobs and don’t want to be conflicted) and there is pro-rata shareholding based on our initial shareholder loans. However, I am putting in most of the hard work, together with one of the other actuaries. How best do I manage the director/shareholder dynamic? I obviously want to make as much progress as possible but there are times when I need the input from the others (and their responses aren’t always as quick as I would like). — Mike
If you have any perception of unfairness regarding effort/risk vs reward, deal with it NOW! You can’t do so later. The best approach is honesty. Call your partners together. Explain your thinking. Perhaps argue for 25% ‘sweat equity’ for yourself. Everyone dilutes accordingly. Ideally cut a deal whereby you have an option to pay back all their loans, plus interest, within six months, and you get 100% of equity (unless they quit their jobs and join full-time).
Equity dissent must be resolved long before the business makes money, otherwise it will never be resolved.
What do you think of WiFi in taxis?— Ntembeko
It’s a good idea, but not original. Before embarking on a start-up, you should survey the landscape for competitors. Just because there are none doesn’t mean no one has tried your idea.
It just means that everyone that tried has failed. You need to be 100% sure that you have some ‘edge’ that makes you different from everyone who came before you (and failed). Otherwise you will fail. What is your advantage that is different to everyone who came before?
Read ‘Be A Hero’ today
What You Need To Know About The Lean Start-up Model
The Lean Start-up philosophy was developed by Eric Ries, a Silicon Valley-based entrepreneur who also sat on venture capital advisory boards. He published The Lean Startup in 2011, igniting a movement around a new way of doing business.
The model follows key precepts that include:
Taking untested products to market
The fact that too many start-ups begin with an idea for a product that they think people want, spending months (or even years) perfecting that product without ever testing it in the market with prospective customers.
When they fail to reach broad uptake from customers, it’s often because they never spoke to prospective customers and determined whether or not the product was interesting. The earlier you can determine customer feedback, the quicker you can adjust your model to suit market needs.
The ‘build-measure-learn’ feedback loop is a core component of lean start-up methodology
The first step is figuring out the problem that needs to be solved and then developing a minimum viable product (MVP) to begin the process of learning as quickly as possible. Once the MVP is established, a start-up can work on tuning the engine. This will involve measurement and learning and must include actionable metrics that can demonstrate cause and effect.
Utilising an investigative development method called the ‘Five Whys’
This involves asking simple questions to study and solve problems across the business journey. When this process of measuring and learning is done correctly, it will be clear that a company is either moving the drivers of the business model or not. If not, it is a sign that it is time to pivot or make a structural course correction to test a new fundamental hypothesis about the product, strategy and engine of growth.
Lean isn’t only about spending less money
It’s also not only about failing fast and as cheaply as possible. It’s about putting a process in place, and following a methodology around product development that allows the business to course correct.
Progress in manufacturing is measured by the production of high quality goods
The unit of progress for lean start-ups is validated learning. This is a rigorous method for demonstrating progress when an entrepreneur is embedded in the soil of extreme uncertainty. Once entrepreneurs embrace validated learning, the development process can shrink substantially. When you focus on figuring the right thing to build — the thing customers want and will pay for, rather than an idea you think is good — you need not spend months waiting for a product beta launch to change the company’s direction. Instead, entrepreneurs can adapt their plans incrementally, inch by inch, minute by minute.
Start-Up Law: I’m A Start-up Founder. Can I Pay Employees With Shares?
Bulking up employee salaries with equity is a common method to attract, retain and incentivise top talent.
Every early stage start-up company battles with restricted cash flow and not being able to pay market related salaries to their employees. Bulking up employee salaries with equity is a common method to attract, retain and incentivise top talent.
Can I pay salaries with shares?
South African labour laws require that employees be paid certain minimum wages, and “remuneration”, as defined within the Basic Conditions of Employment Amendment Act, either means in ‘money or in kind’. ’In kind’ does not include shares or participation in share incentive schemes, as determined by the Minister of Labour. As such, there is no room for start-ups to completely substitute paying salaries with shares or share options. However, there is no restriction in topping up below market related salaries with equity via an employee share ownership plan (‘ESOP‘).
Employee Share Ownership Plans
There are a variety of ways in which employees can be incentivised, and it will always be important for the start-up founders to consider what goal they wish to achieve by incentivising their employees.
ESOPs can be structured in several ways, for example: employees may be offered direct shareholding in the company, options for the acquisition of shares in the future; or alternatively, a phantom / notional share scheme can be set up.
ESOPs permit employees to share in the company’s success without requiring a start-up business to spend precious cash. In fact, ESOPs can contribute capital to a company where employees need to pay an exercise price for their share options or shares.
The primary disadvantage of ESOPs is the possible dilution of the Founder’s equity. For employees, the main disadvantage of an ESOP compared to cash bonuses or bigger salaries, is the lack of liquidity. If the company does not grow bigger and its shares does not become more valuable, the shares may ultimately prove to be worthless.
Some key features to consider when setting up an ESOP are:
- ELIGIBILITY – who will be allowed to participate? Full time employees? Part-time employees? Advisors?
- POOL SIZE – what percentage of shares will be allocated to incentivise employees?
- RESTRICTIONS – will employees be able to sell their shares immediately?
- VESTING – will there be a minimum period that service employees will have to serve with the start-up to receive the economic benefit of his or her shares?
Employee share ownership plans are great corporate structuring mechanisms for attracting and retaining employees, as well as fostering an understanding of the company ethos and encouraging loyalty and productivity. It is essential when implementing an ESOP that all the tax implications are considered and that the correct structure and legal documentation are in place.
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