American Startup: Demo Day Summer 2008

And now our weekly guest post from my Twitter friend Paisano. I've got mixed feelings about Y Combinator and haven't spent enough time with them to have a smart-enough take on what they do. That means I largely just don't cover them. So when I saw Paisano Twitter about how much he loved their startups, I asked him to weigh in on the latter-day incubator's recent demo day. Enjoy!:

Y Combinator is a seed stage investor with a network of entrepreneurs, Venture Capitalists and others needed to start a company. Think of the Y Combinator as the American Idol for startups. They select companies to finance and consult twice a year. Instead of the winners getting a ticket to Hollywood, the companies that the judges from the Y Combinator pick get to go to Cambridge, Massachusetts in the summer or Mountain View, CA in the winter.  Instead of the winners getting a recording contract, the winning startups generally receive $5,000 plus an additional $5,000 per founder.

Although the comparison to American Idol is tongue in cheek, there are some unfortunate real similarities.

It's well-known that the recording deals that the Idol winners sign are extremely one-sided in favor of the producers and record companies and rather unfair to the artist. The same can be said for the "winners" of Y Combinator funding. Sure, they get some cash and valuable guidance and experience but they have no choice but to give up a sizable chunk of potential revenue. Generally, they give up on average 2 to 10 % *** of ownership which Y combinator argues is crucial for the success of the project.

Ultimately, Y Combinator does provide a great opportunity for many startups that never would've seen the light of day otherwise. So, hey, at least users benefit from the transaction. 

Y Combinator success stories? 

Y Combinator has invested in and supported over 100 startups*** which is very impressive. While the majority of them are still struggling and/or plugging away, there have been a few successful exits and acquisitions. They've included; Reddit, Zenter, Anywhere.FM, Loopt, Justin.tv, Scribd, Xobni, and Disqus, to name a few. While some of these names are well-known, none of them can be considered home runs ala YouTube, eBay, or even Digg or Twitter. (The latter two still haven't cashed in their chips yet.)

Despite the many cool hip services that continue to come out of this factory, the hit ratio appears to be a little low (but the jury is still out on what THAT ratio should be). One can't find fault with the startups but perhaps with the selection process and the members that make the selections. It's a skill that can't be taught, much like making selections in professional sports on draft day. You either have the touch or you don't. Doesn't matter how much money you have, if you don't spend it wisely than you've lost. It's like being a quarterback with a multi-million dollar arm but a ten cent head.

Summer 2008 Hopefuls
Here's a roundup of the most recent "DEMO DAY" at Y Combinator for the summer of 2008. A small group of startups pitched their products and services hoping to receive the funding and support they will need in order to achieve success. Some have launched already while others are hoping to achieve lift off.

• Posterous is like Tumblr but you post to it via email. Clean and simple interface.
• Anyvite is another invitation management service like eVite and Pingg.
• ididwork Tracks what you've done at work for easy review by supervisors.   
• TicketStumbler  helps find tickets at the best available prices across several sites.
• Picwing takes picture frames to the web by allowing instant display of photographs.
• Popcuts  lets you purchase songs for $.99. Every subsequent purchase of that song nets you a cut of the revenue. The earlier you buy, the bigger the cut you receive.
• Slinkset lets you create your own social news site
• People and Pages describes their service as “a better Google Groups” but it does more.
• MeetCast is yet another WebEx online meeting service with more social media tools.
• BackType is a search engine for comments that crawls every kind of blog on the web.
• CO2Stats measures the carbon footprint of your website. Al Gore invented it (Just kidding!)
• Youlicit gives one-click access to the information and users most relevant to the immediate context
• JobSyndicate provides widgets that pays the website owner whenever a click-thru leads to a job hire.   
• Frogmetrics puts touchscreen devices into the hands of customers to get accurate, realtime feedback at the point of experience
• Snipd lets users "snip" content from webpages including graphics, videos and text.

Most Likely to Succeed?
It's always difficult to predict which startups will succeed and which ones will flame out. Here are the services that look and feel like winners to me. (In other words, who really knows.)

TicketStumbler appears to have generated the strongest buzz even though there's stiff competition in their space such as StubHub.

Picwing is promising because of its simplicity. Even non-technical types will be itching to buy this thing. Anything that makes life easier is poised for success.

Posterous has also gotten lots of attention because of its easy simple design. Just send an email and it's posted on your blog.

JobSyndicate has a good shot with its monetizing widget. Look for the big job sites to start sniffing around with their wallets open.

Here's a video recap with highlights of YCombinator's Demo Day for Summer 2008

Conclusion

Like them or not, the future of the web depends on these seed fund incubators like YCombinator, TechStars, SeedCamp and Highland Capital Partners, among many others. For those startups that can't generate the funds necessary to keep their dreams alive thru the regular channels, these alternatives are a Godsend. The most important thing every entrepreneur and investor needs to ask themselves about any new startup is this: "Is this a nice to have or a must have?"

For example, my Information Technology experience has taught me a valuable lesson when it comes to purchasing and investment in technology. Whenever someone comes to me with a purchase request for something new I ask them a simple question, "Is this a WANT or is this a NEED?" Most of the time, the person becomes silent and slowly slinks away.

Sometimes the best thing we can do is just be brutally honest, especially with ourselves. If we were to apply this type of tough love and evaluate the best of the offerings for Y Combinator's latest Demo Day here's what we'd get:

TicketStumbler could be the MUST Have service, depending on how it competes with existing services in their space such as StubHub which has been at it a long time. Sometimes existing services see extreme value in a new startup and decides it's better to purchase them and integrate their new features rather than develop their own similar options. We'll see what happens here.

Picwing serves too small a niche to seriously be considered a must have. It's sweet and fun but sorry.

Posterous suffers from a glut of existing similar services so it will be tough to differentiate itself enough to warrant the funding it would need to continue to innovate this stale space. Still, I like the simplicity of their service. If anything it has fired a salvo which has awakened their competitors. While it's important, it's not a MUST HAVE at this point.

JobSyndicate serves an important niche. Unemployment is a serious matter and anything helps people possibly land a new position that will allow them to support their family and the economy is a must have in my book. If it uses monetary compensation in order to influence website owners to help others find a job then all the better. It sounds like a win-win situation for everyone involved. 

***Editor's Note: After communicating with Paul Graham the decision was made to change two  statistics that were not as accurate as it could have been. The two areas have been highlighted in bold and followed with ***. The original text was "approximately 10%" which was replaced with "2 to 10%".
The other statistic that was updated was the number of funded startups which is now "over 100" where the original text had "80". There was no axe to grind or hatred involved in this piece.

Comments

[Paul Graham]

The number of errors in this post is so large one can't help but conclude they're deliberate.

YC takes 10% of each startup? Actually the median is 6%.

Founders "give up a great deal of control over their startup?" They don't give up any at all.

"The majority of them have failed?" 18 of the 80 prior to this batch have died; the rest are either still operating or have been acquired.

It's pretty clear your Twitter friend has some kind of axe to grind here. I think I know who he is, and why this post is so different in tone from his previously gushing coverage of YC.

[Hugh Bien]

I'm confused where you get your facts.

It's around 6% in stock not 10%.

No control is given up at all. I think Y Combinator just gives useful advice which NONE of the founders have to follow.

[John Stokes]

Whilst PG acts like somewhat of a father figure to the startup's - he's not their father (!!) and so should strike reasonable business deals - which he does.

At 20K for 6% of the company we are talking a pre-money valuation of almost $300K. Given that they are investing in first time entrepreneurs who have not even had to define their revenue model this is more than reasonable.

Furthermore, Y-Combinator doesn't really invest in the ideas (many are a twist, or a novel implementation, on an existing idea), they invest in the people - and it's been shown time and again that if the ideas fail, they'll continue to support the people. That support is what first time entrepreneurs really need.

[AR]

Perhaps this is what happens when a person writes about something that they know absolutely nothing about?

Has this person ever founded a startup? Has she ever even worked at a startup?

From where does she derive her credibility?

[Paisano]

Thanks for the feedback. Feels like one of those celebrity roasts. Take my wife, please. (Rim shot)
But seriously, folks. Thanks for taking the time to read this. Yes, I could've written a few things better but every writer can say that about everything they ever write. Hindsite is always 20/20. In any event, I said approximately 10% which was based on facts from ycomb's own website where it says the percentage can range from 2% to 10%. The average is indeed 6% thus I changed it to "from 6% to 10%.
As for the comment about needing experience launching a startup in order to be able to comment on such things? If that were truly necessary then everyone would have to stop blogging and writing except for those things they've done. I disagree there totally.
I do have vast experience working with many startups as a beta tester and adviser on their board. I like to think I know what makes a site successful or at the very least as functional as possible.
In any event, despite some elements that look bad taken out of context, I think my message was clear: Y Combinator and others like them provide a valuable service to startups and the internet community. Can they improve what they do and give entrepreneurs a better deal, you betcha! Just glad we're all discussing this though. Innovation is critical for the future of the web.
Now excuse me as I remove these arrows from my back. Ouch.

Pai

[Shafqat]

I was pretty disappointed in the quality of the post, but glad to see Pai come back and address some of the concerns. We all live and learn.

But the point is that YC merely has to improve a startup's prospects by 6.4% to make the investment worthwhile (see here for the math http://www.paulgraham.com/equity.html). I think everyone would agree that this is entirely possible and very likely.

@AR - This was a guest post FYI, not written by Sarah.

[AR]

In most cases, a blog will be more effective if the blogger has some experience in the space that he or she is covering. Sometimes this experience isn't abundant in nature, for example if you wanted to blog about what it would be like to be the President of United States. In the case of startups, there are sufficient numbers of willing bloggers who have actually founded a company, such that the lack of said experience would severely hamper a blog's effectiveness.

It's not a coincidence that most of the people throwing stones at organizations like YC have probably never had the experience of launching a company, let alone have an understanding of what goes on behind the closed doors.

It also strikes me that you claim the "hit ratio" for YC is low. May I ask what ratio you would deem acceptable?

[Tony Wright]

(no need to be mean, commenters! The poster may be mistaken a time or two... Not a big deal)

Two clarifications from a founders perspective.

1) Regarding the (low) hit-rate. It's REALLY important to note that YC is just barely 3 years old, making the vast majority of its portfolio a year or two old. It's hit rate is nothing short of astounding, with that in mind. As you say, no "out of the park" hits yet-- but those almost always take more than 12-24 months. There are a few likely candidates out there. YC (AFAIK) always encourages founders to NOT sell early, but supports them if they want to.

2) Regarding 6% being steep. First of all, a LOT of founders come to YC with "two guys and an idea". As a previous commenter mentioned, 6% for $15-20k means that YC is effectively saying that the barely formed product is worth 200-350k or so. Their equity is common stock with no liquidity prefs (very founder-friendly).

Two additional things to consider here.

Disregarding whether YC adds to your chances of getting bought, does the YC "brand" add a 6% premium? Asked another way: If these since-sold YC startups made the same progress and got buy offers, would they be the same offers?

And, most importantly. Startups are really hard. The thing to optimize for is your CHANCE of success/liquidity- not the magnitude of your personal windfall if you do.

[Paisano]

@Tony
Thanks for calm and rational response. Much appreciated. I also appreciate the excellent information that you shared. Good stuff about success ratio and how severe is the 6%. Also important to note that they've only been around 3 years themselves and funded over 100 startups already.

Pai

[Sean Murphy]

I am puzzled as to what you view as a good hit rate for seed stage investing. It's normally based on funds returned not the number of investments that succeed. One winner can redeem two or three dozen investments. It's going to be hard to evaluate YCombinator as a fund for at least another 5 years.

As I read your article my take away is that you would not invest in most of the start-ups that were presenting at Demo Day. Everyone is certainly entitled to their own opinion but I am confused by this passage "One can't find fault with the startups but perhaps with the selection process and the members that make the selections. It's a skill that can't be taught, much like making selections in professional sports on draft day. You either have the touch or you don't. Doesn't matter how much money you have, if you don't spend it wisely than you've lost. It's like being a quarterback with a multi-million dollar arm but a ten cent head."

It seems to be a gratuitous slam without substantiation. Who are the seed funds that you are benchmarking YC against.

[Sashi]

"...give up a sizable chunk of potential revenue." Hmm really? Never heard of a VC taking portion on your revenue!

And do we say YouTube and Twitter are a 'want' or a 'need'! I guess we too have to 'slink away'.

While the cash investment is less than $20K, the hand holding you get is twice that value. Plus the savings in time and money by avoiding common stuff like incorporating and other legal stuff that a typical entrepreneur has to go through 'all alone' is worth another $25K to $50K. So, the value contribution of YC is more in the range of $60K to $100K, IMHO. And 6% for that is a fair game.
I bet there are many startups ready to get into YC, even if they have to pay the $20K themselves.

[Märt Ridala]

We run a rather similar venture like YCombinator, but of a smaller size. In starting it up YCombinator has been a really good example and Paul Graham-s posts really educational: http://ycombinator.com/lib.html. So at least on the educational side YCombinator is a "good thing". And the 18/80 failure rate is not bad at all if the Venture Capitalists speak usually of some 10% success rate.

[David S Rose]

As someone completely unaffiliated with YC and PG, but completely familiar with the world of angel investing into startup tech companies, I feel compelled to jump in here along with everyone else and note that this post is *really* off base

Despite the left-handed compliments about how "Like them or not, the future of the web depends on these seed fund incubators like YCombinator..." and "For those startups that can't generate the funds necessary to keep their dreams alive thru the regular channels..." the snarky tone of the piece is simply out of touch with reality. The tiny percentage of Common that YC takes for all the services it provides is, without question, the best game in town. The YC process is not right for every company, but for the ones it's aimed at (one-to-three person, seed stage teams with a good idea), it's not only eminently fair, it's almost like hitting the jackpot.

To put things in perspective, take a hard look at the current live industry-wide statistics for angel investing at http://www.angelsoft.net/industry. You will see that of the many tens of thousands of startup companies that seek angel financing each year, fewer than 1.4% actually get funded. The typical organized angel group in the US invests in fewer than ten companies each year...and it's much less than that for VC funds. The fact that YC has invested in over 100 companies so far, and provided them with mentoring, networking, publicity and startup financing, means that they have become a very significant player in the industry in a very short period of time.

Add to that the fact that Paul is a very savvy guy who provides excellent advice (including advice about how hard the fundraising process really is, see http://www.paulgraham.com/fundraising.html), and I wouldn't hesitate to recommend YC to any appropriate startup.

[TicketStumbler]

Hi.

Just a quick update, we soft launched concert tickets at http://ticketstumbler.com.

Compare, find and buy sports & concert tickets. :)