For Y Combinator Graduates, Timing Should Be Everything
I always look forward to Demo Day. Watching passionate entrepreneurs pitch their big ideas in rapid succession is simultaneously energizing and mentally taxing. Was the entrepreneur credible? Can the idea change the world? Is the market large and growing? Just as my mind begins to render an insight, wham! The next promising team hits the stage. Forty-five companies later, I’m admittedly fatigued, but excited to narrow down my list and schedule meetings.
This year, my shortlist consisted of 11 companies from the Y Combinator Spring 2013 graduates. It took me an additional two weeks to get through these first meetings, and now I’ll dig in with some diligence to select my finalists — and then will hopefully put some money to work.
I’ve been through this drill many times and with a variety of incubators. I know what to expect, and I’ve always taken for granted that this coming out party is a win/win for VCs, angels and entrepreneurs.
But this year, for the first time, I started to wonder whether it really works as well as assumed. Are there some ideas that won’t get funded simply because they not only had to succeed on their merits but also outpoint their “graduating class”?
As I pondered this, I realized that I have a stack of resumes sitting on my desk from upcoming graduates of the class of 2013. I have to share with you that I’m an alumni mentor and I offer one piece of advice to all my mentees every year: “Don’t get a job when you graduate.” Could the same type of advice make sense for incubator graduates: “Don’t raise money immediately after Demo Day”?
It turns out that there are parallels between incubator graduating classes and the upcoming spring college graduates.
Let’s start with timing. There is nothing about the pace and rhythm of my portfolio companies that would suggest that their staffing needs are tied to the summer solstice. If anything, job opportunities are more plentiful at the beginning of a new budget cycle. So why would highly skilled and eager recent grads expect that the market is ready to assimilate them when they happen to be available (i.e., graduation time) instead of when companies actually have a need?
It’s the same thing for an incubator startup. Angels and early-stage funds seek great projects at every hour of the day, every day of the year. It doesn’t make sense, intuitively or in practice, that 45 companies would hit their Pareto optimal moment of maturity to seek investment on the exact same day each year. Even if they have, how many investments can I reasonably make at once? Not many.
When a company comes in to pitch — eleven and a half months of the year — it’s being compared to my quality bar and whatever I’ve seen recently that’s on the forefront of my mind.
But for two weeks of the year, the startup has to hit the quality bar and be the best on a relative basis. Why would an entrepreneur willingly subject himself to this additional filter? The answer is simple: It is virtually impossible to convince a graduating incubator entrepreneur to resist raising money after Demo Day — in the same way that it’s impossible for a graduating MBA to fight back the urge to seek or take a job when all of her peers are talking about their plans post-graduation.
So, what really happens? All the startups try to ready themselves for the big day with crisp pitches, growth charts that look up and to the right and concrete milestones associated with their planned raises.
For the lucky few who have the magic combination of team, vision and market, they find a rabid potential investor base, and are even soliciting and receiving offers from firms like ours in advance of the actual Demo Day. It’s like the resume that sits at the top with a great grade point average, strong extracurricular activities and good work history. Offers are plentiful.
What about all the other companies? They not only fall short of their fundraising goals, but — worse yet — they create negative selection bias via their failures. While there is value in getting investor feedback on your idea, entrepreneurs know that a failed attempt at raising money is often worse than no attempt, because the investor now has to find a way to overcome the concern that other investors have looked under the hood and walked away.
The simple reality is that incubators do a great job of helping entrepreneurs advance their businesses in a variety of ways. Some enter the class with a partner and an idea. Others walk through the door with years of operating experience, customers and revenue. Somehow, come graduation day, they are all supposed to be equally attractive to investors. That’s a tall order.
I want to be clear that these are great and passionate entrepreneurs, and their ideas have merit and deserve funding — if not now, then someday. But the odds are that their someday is not the same as everyone else’s someday.
So, for all you incubator graduates: Recognize that seed money is in plentiful supply, and that your objective is to tap into this supply when your story has matured to the point at which it can stand on its own — rather than trying to look good relative to the other class graduates queuing up next to you for their own three-minute coming out party.
For the incubators: Let’s take a page out of the lean startup product release playbook and consider more frequent and smaller release cycles in which the companies selected to show their wares are truly ready to make their pitches. While I love the convenience and time efficiency of a parade, I would be happy to invest more time in exchange for an increase in the hit rate.
Finally, a plea to investors not to judge too quickly: We shouldn’t let an artificial release of a “class” of startups determine how prepared they are to enter the market. Rather, we should strive to foster an environment in which startups don’t feel pressured to fundraise before being absolutely ready.
Again, money is available 24/7, 365 days a year. Ideas are equally plentiful. Let’s not get too enamored with the coming out party. Remember, going with the flow carries the risk of getting swept away.
Charles Moldow is a general partner at Foundation Capital, focusing on consumer Internet companies. He was previously a founding executive at TellMe Networks and at @Home.