Microfunding for MicroISVs: YCombinator.

YCombinatorBy Tony Wright
founder of http://rescuetime.com
http://blog.rescuetime.com (company blog)

[Tony Wright is the CEO of RescueTime, a web service that allows people and businesses to understand exactly how they spend their time with functionally zero data entry. RescueTime was funded by Ycombinator and is currently engaged in raising a seed round. Tony sincerely apologizes if this sounds like a YCombinator infomercial. You can ping him with questions at tony [at] rescuetime [dot] com]

My company started as the most micro of Micro ISVs—pretty much just a few friends sitting around the table talking about an idea. In 8 months, it’s gone from conversation to prototype to product, and we’re now working on closing our seed funding round. While we’re happy to take a lot of the credit for our success, a ton of credit belongs to YCombinator, a new venture animal that is part VC and part incubator—they are accepting applications right now for their Summer funding round)

This post details how we went through the process, how and why we made the decisions that we did, and the value that we got out of the YCombinator experience.

Step 1 – Can You Build Something People Want?

After the initial “what if” conversation, the next logical step was to see if anyone else wanted what we wanted to build. We needed to know if there really was a problem there that anyone wanted to solve. Software success is a function of how many people have the problem you’re solving * how burning their need is * how well you can pull off a solution * how crappy all of the other available solutions are.

I think one of the keys in this phase is to realize that even for great product ideas, most people aren’t going to want it. So if you’re market analysis consists of asking ten people what they think, understand that having 9 of ‘em tell you, “I would never use that”, is perfectly okay. What you want to focus on (initially) is the second part of the equation—“How burning is the need?”. You’d much rather have 1 friend say, “I’d mug my own mother for software that does that” than 4 friends say, “Meh—I might use something like that every once in a while”.

The trick with this phase is to get out there and talk to the target audience. Talk to people who would be customers. Friends are a good start, but tend to tell you what you want to hear. Thankfully, the Internet is a wonderful place to get buried in criticism and feedback. Having just read Bob’s ebook, I would heartily recommend reading it before this step—you might find that the people aren’t interested in what you’re building because you aren’t describing it in a compelling way. Would you rather have a nice juicy steak or a muscle tissue sample from a castrated bull? The words that you choose are critical.

Step 2 – What’s the Business Goal

Most startup folks talk about this first, but I think it should be a distant second—your goal of a hyper-growth software company is pretty irrelevant if you can’t find a collection of people that want what you’re building.

Once you get an inkling that people want what you’re building, make sure everyone involved—why did we want to build this? Fame? Riches? Growth? To have a lifestyle/cash cow business? We were a 3-person business, but we didn’t talk about this enough– that was a painful mistake. As people continued to clamor for what we were building, two of us plunged ahead, eventually quitting our day-jobs. The third kept his day job, burned out and bowed out—If we’d had the discussion, we could’ve avoided that.

Step 3 – If you’re “Going Big”, you need help

The biggest mistake I see in startup founders is a failure to admit that they need help and an obsession over control/ownership.

If you didn’t start with one, a co-founder is strongly correlative with success. Make sure you have one or two. If you disagree, grab a list of the top 10 wildly successful software startups in the last decade and point out the ones that had solo founders. You won’t be doing much pointing.

Don’t be shy about trading equity for co-founders or investors. It’s easy to fall into the belief that you can’t fail, but the fact is that most startups do. If you can bump your chance of success by a few percentage points, it’s worth it. Most people overvalue ownership—the truth is it’s largely valueless unless you sell the company.

You cannot overestimate how challenging it is to get investors unless you already have great growth and traction… Even then, it’s a time consuming process that’s fraught with peril for neophytes… Which is why we leapt at the chance to apply to Ycombinator.

Step 4 – The YC Difference

Getting funding is only the right thing if you’re going BIG. Investors would much rather invest in a company with a 1% chance of being a billion dollar company than a company with a 10% chance of being a 100 million dollar company (this is especially true for VCs and can be less true for angels). There’s nothing wrong with building a million dollar “lifestyle” business, but don’t try to go the funding route if that’s your goal.

This doesn’t mean you need to solve HUGE and COMPLEX problems with your startup. Just have a good story about how you can expand your offering and market once you’ve nailed the core problem for your passionate-but-small userbase.

Just the act of applying to Ycombinator was liberating. It was a clear and obvious line where we publicly declared, “this is our job. This is no longer a hobby. We’re done screwing around, and we think that our product is more promising than the other thousands applications that YC gets.”

YC funds early stage companies with $15-20k in exchange for about 6% of your company and they require you to relocate most/all of your team to be near YC. Thousands apply to Ycombinator and about 20 companies were accepted into our “session”. They don’t provide office space, and there’s very little structure to the program. In exchange for their investment they:

  • Give you relatively unfettered access to Paul Graham, Jessica Livingston, and Trevor Blackwell– probably some of the smartest startup folks on the planet. They’ve made our product and the way we talk about it 500% better.
  • Provide weekly dinners with guests like Marc Andreessen, Ron Conway, and dozens of other Valley Titans. Not only do they bury you in hard-won wisdom, but they are amazing connections to have.
  • Provide included legal assistance in setting up your company so you can focus on software.
  • Provide great PR. Ycombinator is a phenomenon. Assuming you don’t drop the ball and fail to launch something, it’s good for major coverage on the top blogs and in MSM.
  • Provide instant credibility. If I wasn’t already swimming in introductions, I could cold-call a lot of investors and probably get a meeting based entirely on the YC “brand”.
  • Provide a great network of YC Founders, which is incredibly valuable for recruiting, advice, and more.
  • Provide a great (and condensed) investor marketplace. This is (IMO) the biggest value YC provides. Talking to investors is hard enough that each investor is a multi-month investment of time. YC has a big “coming out” presentation (called “Demo Day”) where you get introduced to pretty much the most impressive angels and VCs on the planet. It’s literally standing room only. By condensing this process, you get to spend more time on your product and you generally get better terms from investors.

If you balk at the 6% ownership issue—I think it’s worth asking the following question: Will Ycombinator’s involvement result in your company ultimately result in doing 6.4% better in the next round of funding? I literally can’t imagine a scenario where it wouldn’t.

Step 5 – What’s Next?

Ycombinator (or any other funding) is not a victory- it’s a milestone. I’ve seen founders get so wrapped up in fundraising that they forget that their core goal needs to be solving the needs of their customers. But funding (especially from YC) lends credibility and gives you a deep well of resources to draw from if you are seeking meteoric growth. It’s incredibly motivating to have people believe in you and (despite the fact that I’d already built and sold a company before this) was the most educational experience of my life.