September 2012
A startup is a company designed to grow fast. Being newly founded
does not in itself make a company a startup. Nor is it necessary
for a startup to work on technology, or take venture funding, or
have some sort of "exit." The only essential thing is growth.
Everything else we associate with startups follows from growth.
If you want to start one it's important to understand that. Startups
are so hard that you can't be pointed off to the side and hope to
succeed. You have to know that growth is what you're after. The
good news is, if you get growth, everything else tends to fall into
place. Which means you can use growth like a compass to make almost
every decision you face.
Redwoods
Let's start with a distinction that should be obvious but is often
overlooked: not every newly founded company is a startup. Millions
of companies are started every year in the US. Only a tiny fraction
are startups. Most are service businesses — restaurants, barbershops,
plumbers, and so on. These are not startups, except in a few unusual
cases. A barbershop isn't designed to grow fast. Whereas a search
engine, for example, is.
When I say startups are designed to grow fast, I mean it in two
senses. Partly I mean designed in the sense of intended, because
most startups fail. But I also mean startups are different by
nature, in the same way a redwood seedling has a different destiny
from a bean sprout.
That difference is why there's a distinct word, "startup," for
companies designed to grow fast. If all companies were essentially
similar, but some through luck or the efforts of their founders
ended up growing very fast, we wouldn't need a separate word. We
could just talk about super-successful companies and less successful
ones. But in fact startups do have a different sort of DNA from
other businesses. Google is not just a barbershop whose founders
were unusually lucky and hard-working. Google was different from
the beginning.
To grow rapidly, you need to make something you can sell to a big
market. That's the difference between Google and a barbershop. A
barbershop doesn't scale.
For a company to grow really big, it must (a) make something lots
of people want, and (b) reach and serve all those people. Barbershops
are doing fine in the (a) department. Almost everyone needs their
hair cut. The problem for a barbershop, as for any retail
establishment, is (b). A barbershop serves customers in person,
and few will travel far for a haircut. And even if they did, the
barbershop couldn't accomodate them.
[1]
Writing software is a great way to solve (b), but you can still end
up constrained in (a). If you write software to teach Tibetan to
Hungarian speakers, you'll be able to reach most of the people who
want it, but there won't be many of them. If you make software
to teach English to Chinese speakers, however, you're in startup
territory.
Most businesses are tightly constrained in (a) or (b). The distinctive
feature of successful startups is that they're not.
Ideas
It might seem that it would always be better to start a startup
than an ordinary business. If you're going to start a company, why
not start the type with the most potential? The catch is that this
is a (fairly) efficient market. If you write software to teach
Tibetan to Hungarians, you won't have much competition. If you
write software to teach English to Chinese speakers, you'll face
ferocious competition, precisely because that's such a larger prize.
[2]
The constraints that limit ordinary companies also protect them.
That's the tradeoff. If you start a barbershop, you only have to
compete with other local barbers. If you start a search engine you
have to compete with the whole world.
The most important thing that the constraints on a normal business
protect it from is not competition, however, but the difficulty of
coming up with new ideas. If you open a bar in a particular
neighborhood, as well as limiting your potential and protecting you
from competitors, that geographic constraint also helps define your
company. Bar + neighborhood is a sufficient idea for a small
business. Similarly for companies constrained in (a). Your niche
both protects and defines you.
Whereas if you want to start a startup, you're probably going to
have to think of something fairly novel. A startup has to make
something it can deliver to a large market, and ideas of that type
are so valuable that all the obvious ones are already taken.
That space of ideas has been so thoroughly picked over that a startup
generally has to work on something everyone else has overlooked.
I was going to write that one has to make a conscious effort to
find ideas everyone else has overlooked. But that's not how most
startups get started. Usually successful startups happen because
the founders are sufficiently different from other people that ideas
few others can see seem obvious to them. Perhaps later they step
back and notice they've found an idea in everyone else's blind spot,
and from that point make a deliberate effort to stay there.
[3]
But at the moment when successful startups get started, much of the
innovation is unconscious.
What's different about successful founders is that they can see
different problems. It's a particularly good combination both to
be good at technology and to face problems that can be solved by
it, because technology changes so rapidly that formerly bad ideas
often become good without anyone noticing. Steve Wozniak's problem
was that he wanted his own computer. That was an unusual problem
to have in 1975. But technological change was about to make it a
much more common one. Because he not only wanted a computer but
knew how to build them, Wozniak was able to make himself one. And
the problem he solved for himself became one that Apple solved for
millions of people in the coming years. But by the time it was
obvious to ordinary people that this was a big market, Apple was
already established.
Google has similar origins. Larry Page and Sergey Brin wanted to
search the web. But unlike most people they had the technical
expertise both to notice that existing search engines were not as
good as they could be, and to know how to improve them. Over the
next few years their problem became everyone's problem, as the web
grew to a size where you didn't have to be a picky search expert
to notice the old algorithms weren't good enough. But as happened
with Apple, by the time everyone else realized how important search
was, Google was entrenched.
That's one connection between startup ideas and technology. Rapid
change in one area uncovers big, soluble problems in other areas.
Sometimes the changes are advances, and what they change is solubility.
That was the kind of change that yielded Apple; advances in chip
technology finally let Steve Wozniak design a computer he could
afford. But in Google's case the most important change was the
growth of the web. What changed there was not solubility but bigness.
The other connection between startups and technology is that startups
create new ways of doing things, and new ways of doing things are,
in the broader sense of the word, new technology.
When a startup both begins with an
idea exposed by technological change and makes a product consisting
of technology in the narrower sense (what used to be called "high
technology"), it's easy to conflate the two. But the two connections
are distinct and in principle one could start a startup that was
neither driven by technological change, nor whose product consisted
of technology except in the broader sense.
[4]
Rate
How fast does a company have to grow to be considered a startup?
There's no precise answer to that. "Startup" is a pole, not a
threshold. Starting one is at first no more than a declaration of
one's ambitions. You're committing not just to starting a company,
but to starting a fast growing one, and you're thus committing to
search for one of the rare ideas of that type. But at first you
have no more than commitment. Starting a startup is like being an
actor in that respect. "Actor" too is a pole rather than a threshold.
At the beginning of his career, an actor is a waiter who goes to
auditions. Getting work makes him a successful actor, but he doesn't
only become an actor when he's successful.
So the real question is not what growth rate makes a company a
startup, but what growth rate successful startups tend to have.
For founders that's more than a theoretical question, because it's
equivalent to asking if they're on the right path.
The growth of a successful startup usually has three phases:
- There's an initial period of slow or no growth while the startup
tries to figure out what it's doing.
- As the startup figures out how to make something lots of people
want and how to reach those people, there's a period of rapid
growth.
- Eventually a successful startup will grow into a big company.
Growth will slow, partly due to internal limits and partly because
the company is starting to bump up against the limits of the
markets it serves.
[5]
Together these three phases produce an S-curve. The phase whose
growth defines the startup is the second one, the ascent. Its
length and slope determine how big the company will be.
The slope is the company's growth rate. If there's one number every
founder should always know, it's the company's growth rate. That's
the measure of a startup. If you don't know that number, you don't
even know if you're doing well or badly.
When I first meet founders and ask what their growth rate is,
sometimes they tell me "we get about a hundred new customers a
month." That's not a rate. What matters is not the absolute number
of new customers, but the ratio of new customers to existing ones.
If you're really getting a constant number of new customers every
month, you're in trouble, because that means your growth rate is
decreasing.
During Y Combinator we measure growth rate per week, partly because
there is so little time before Demo Day, and partly because startups
early on need frequent feedback from their users to tweak what
they're doing.
[6]
A good growth rate during YC is 5-7% a week. If you can hit 10% a
week you're doing exceptionally well. If you can only manage 1%,
it's a sign you haven't yet figured out what you're doing.
The best thing to measure the growth rate of is revenue. The next
best, for startups that aren't charging initially, is active users.
That's a reasonable proxy for revenue growth because whenever the
startup does start trying to make money, their revenues will probably
be a constant multiple of active users.
[7]
Compass
We usually advise startups to pick a growth rate they think they
can hit, and then just try to hit it every week. The key word here
is "just." If they decide to grow at 7% a week and they hit that
number, they're successful for that week. There's nothing more
they need to do. But if they don't hit it, they've failed in the
only thing that mattered, and should be correspondingly alarmed.
Programmers will recognize what we're doing here. We're turning
starting a startup into an optimization problem. And anyone who
has tried optimizing code knows how wonderfully effective that sort
of narrow focus can be. Optimizing code means taking an existing
program and changing it to use less of something, usually time or
memory. You don't have to think about what the program should do,
just make it faster. For most programmers this is very satisfying
work. The narrow focus makes it a sort of puzzle, and you're
generally surprised how fast you can solve it.
Focusing on hitting a growth rate reduces the otherwise bewilderingly
multifarious problem of starting a startup to a single problem.
You can use that target growth rate to make all your decisions for
you; anything that gets you the growth you need is ipso facto right.
Should you spend two days at a conference? Should you hire another
programmer? Should you focus more on marketing? Should you spend
time courting some big customer? Should you add x feature? Whatever
gets you your target growth rate.
[8]
Judging yourself by weekly growth doesn't mean you can look no more
than a week ahead. Once you experience the pain of missing your
target one week (it was the only thing that mattered, and you failed
at it), you become interested in anything that could spare you such
pain in the future. So you'll be willing for example to hire another
programmer, who won't contribute to this week's growth but perhaps
in a month will have implemented some new feature that will get you
more users. But only if (a) the distraction of hiring someone
won't make you miss your numbers in the short term, and (b) you're
sufficiently worried about whether you can keep hitting your numbers
without hiring someone new.
It's not that you don't think about the future, just that you think
about it no more than necessary.
In theory this sort of hill-climbing could get a startup into
trouble. They could end up on a local maximum. But in practice
that never happens. Having to hit a growth number every week forces
founders to act, and acting versus not acting is the high bit of
succeeding. Nine times out of ten, sitting around strategizing is
just a form of procrastination. Whereas founders' intuitions about
which hill to climb are usually better than they realize. Plus the
maxima in the space of startup ideas are not spiky and isolated.
Most fairly good ideas are adjacent to even better ones.
The fascinating thing about optimizing for growth is that it can
actually discover startup ideas. You can use the need for growth
as a form of evolutionary pressure. If you start out with some
initial plan and modify it as necessary to keep hitting, say, 10%
weekly growth, you may end up with a quite different company than
you meant to start. But anything that grows consistently at 10% a
week is almost certainly a better idea than you started with.
There's a parallel here to small businesses. Just as the constraint
of being located in a particular neighborhood helps define a bar,
the constraint of growing at a certain rate can help define a
startup.
You'll generally do best to follow that constraint wherever it leads
rather than being influenced by some initial vision, just as a
scientist is better off following the truth wherever it leads rather
than being influenced by what he wishes were the case. When Richard
Feynman said that the imagination of nature was greater than the
imagination of man, he meant that if you just keep following the
truth you'll discover cooler things than you could ever have made
up. For startups, growth is a constraint much like truth. Every
successful startup is at least partly a product of the imagination
of growth.
[9]
Value
It's hard to find something that grows consistently at several
percent a week, but if you do you may have found something surprisingly
valuable. If we project forward we see why.
| weekly | yearly |
| 1% | 1.7x |
| 2% | 2.8x |
| 5% | 12.6x |
| 7% | 33.7x |
| 10% | 142.0x |
A company that grows at 1% a week will grow 1.7x a year, whereas a
company that grows at 5% a week will grow 12.6x. A company making
$1000 a month (a typical number early in YC) and growing at 1% a
week will 4 years later be making $7900 a month, which is less than
a good programmer makes in salary in Silicon Valley. A startup
that grows at 5% a week will in 4 years be making $25 million a
month.
[10]
Our ancestors must rarely have encountered cases of exponential
growth, because our intuitions are no guide here. What happens
to fast growing startups tends to surprise even the founders.
Small variations in growth rate produce qualitatively different
outcomes. That's why there's a separate word for startups, and why
startups do things that ordinary companies don't, like raising money
and getting acquired. And, strangely enough, it's also why they
fail so frequently.
Considering how valuable a successful startup can become, anyone
familiar with the concept of expected value would be surprised if
the failure rate weren't high. If a successful startup could make
a founder $100 million, then even if the chance of succeeding were
only 1%, the expected value of starting one would be $1 million.
And the probability of a group of sufficiently smart and determined
founders succeeding on that scale might be significantly over 1%.
For the right people — e.g. the young Bill Gates — the probability
might be 20% or even 50%. So it's not surprising that so many want
to take a shot at it. In an efficient market, the number of failed
startups should be proportionate to the size of the successes. And
since the latter is huge the former should be too.
[11]
What this means is that at any given time, the great majority of
startups will be working on something that's never going to go
anywhere, and yet glorifying their doomed efforts with the grandiose
title of "startup."
This doesn't bother me. It's the same with other high-beta vocations,
like being an actor or a novelist. I've long since gotten used to
it. But it seems to bother a lot of people, particularly those
who've started ordinary businesses. Many are annoyed that these
so-called startups get all the attention, when hardly any of them
will amount to anything.
If they stepped back and looked at the whole picture they might be
less indignant. The mistake they're making is that by basing their
opinions on anecdotal evidence they're implicitly judging by the
median rather than the average. If you judge by the median startup,
the whole concept of a startup seems like a fraud. You have to
invent a bubble to explain why founders want to start them or
investors want to fund them. But it's a mistake to use the median
in a domain with so much variation. If you look at the average
outcome rather than the median, you can understand why investors
like them, and why, if they aren't median people, it's a rational
choice for founders to start them.
Deals
Why do investors like startups so much? Why are they so hot to
invest in photo-sharing apps, rather than solid money-making
businesses? Not only for the obvious reason.
The test of any investment is the ratio of return to risk. Startups
pass that test because although they're appallingly risky, the
returns when they do succeed are so high. But that's not the only
reason investors like startups. An ordinary slower-growing business
might have just as good a ratio of return to risk, if both were
lower. So why are VCs interested only in high-growth companies?
The reason is that they get paid by getting their capital back,
ideally after the startup IPOs, or failing that when it's acquired.
The other way to get returns from an investment is in the form of
dividends. Why isn't there a parallel VC industry that invests in
ordinary companies in return for a percentage of their profits?
Because it's too easy for people who control a private company to
funnel its revenues to themselves (e.g. by buying overpriced
components from a supplier they control) while making it look like
the company is making little profit. Anyone who invested in private
companies in return for dividends would have to pay close attention
to their books.
The reason VCs like to invest in startups is not simply the returns,
but also because such investments are so easy to oversee. The
founders can't enrich themselves without also enriching the investors.
[12]
Why do founders want to take the VCs' money? Growth, again. The
constraint between good ideas and growth operates in both directions.
It's not merely that you need a scalable idea to grow. If you have
such an idea and don't grow fast enough, competitors will. Growing
too slowly is particularly dangerous in a business with network
effects, which the best startups usually have to some degree.
Almost every company needs some amount of funding to get started.
But startups often raise money even when they are or could be
profitable. It might seem foolish to sell stock in a profitable
company for less than you think it will later be worth, but it's
no more foolish than buying insurance. Fundamentally that's how
the most successful startups view fundraising. They could grow the
company on its own revenues, but the extra money and help supplied
by VCs will let them grow even faster. Raising money lets you
choose your growth rate.
Money to grow faster is always at the command of the most successful
startups, because the VCs need them more than they need the VCs.
A profitable startup could if it wanted just grow on its own revenues.
Growing slower might be slightly dangerous, but chances are it
wouldn't kill them. Whereas VCs need to invest in startups, and
in particular the most successful startups, or they'll be out of
business. Which means that any sufficiently promising startup will
be offered money on terms they'd be crazy to refuse. And yet because
of the scale of the successes in the startup business, VCs can still
make money from such investments. You'd have to be crazy to believe
your company was going to become as valuable as a high growth rate
can make it, but some do.
Pretty much every successful startup will get acquisition offers
too. Why? What is it about startups that makes other companies
want to buy them?
[13]
Fundamentally the same thing that makes everyone else want the stock
of successful startups: a rapidly growing company is valuable. It's
a good thing eBay bought Paypal, for example, because Paypal is now
responsible for 43% of their sales and probably more of their growth.
But acquirers have an additional reason to want startups. A rapidly
growing company is not merely valuable, but dangerous. If it keeps
expanding, it might expand into the acquirer's own territory. Most
product acquisitions have some component of fear. Even if an
acquirer isn't threatened by the startup itself, they might be
alarmed at the thought of what a competitor could do with it. And
because startups are in this sense doubly valuable to acquirers,
acquirers will often pay more than an ordinary investor would.
[14]
Understand
The combination of founders, investors, and acquirers forms a natural
ecosystem. It works so well that those who don't understand it are
driven to invent conspiracy theories to explain how neatly things
sometimes turn out. Just as our ancestors did to explain the
apparently too neat workings of the natural world. But there is
no secret cabal making it all work.
If you start from the mistaken assumption that Instagram was
worthless, you have to invent a secret boss to force Mark Zuckerberg
to buy it. To anyone who knows Mark Zuckerberg, that is the reductio
ad absurdum of the initial assumption. The reason he bought Instagram
was that it was valuable and dangerous, and what made it so was
growth.
If you want to understand startups, understand growth. Growth
drives everything in this world. Growth is why startups usually
work on technology — because ideas for fast growing companies are
so rare that the best way to find new ones is to discover those
recently made viable by change, and technology is the best source
of rapid change. Growth is why it's a rational choice economically
for so many founders to try starting a startup: growth makes the
successful companies so valuable that the expected value is high
even though the risk is too. Growth is why VCs want to invest in
startups: not just because the returns are high but also because
generating returns from capital gains is easier to manage than
generating returns from dividends. Growth explains why the most
successful startups take VC money even if they don't need to: it
lets them choose their growth rate. And growth explains why
successful startups almost invariably get acquisition offers. To
acquirers a fast-growing company is not merely valuable but dangerous
too.
It's not just that if you want to succeed in some domain, you have
to understand the forces driving it. Understanding growth is what
starting a startup consists of. What you're really doing (and
to the dismay of some observers, all you're really doing) when you
start a startup is committing to solve a harder type of problem
than ordinary businesses do. You're committing to search for one
of the rare ideas that generates rapid growth. Because these ideas
are so valuable, finding one is hard. The startup is the embodiment
of your discoveries so far. Starting a startup is thus very much
like deciding to be a research scientist: you're not committing to
solve any specific problem; you don't know for sure which problems
are soluble; but you're committing to try to discover something no
one knew before. A startup founder is in effect an economic research
scientist. Most don't discover anything that remarkable, but some
discover relativity.
Notes
[1]
Strictly speaking it's not lots of customers you need but a big
market, meaning a high product of number of customers times how
much they'll pay. But it's dangerous to have too few customers
even if they pay a lot, or the power that individual customers have
over you could turn you into a de facto consulting firm. So whatever
market you're in, you'll usually do best to err on the side of
making the broadest type of product for it.
[2]
One year at Startup School David Heinemeier Hansson encouraged
programmers who wanted to start businesses to use a restaurant as
a model. What he meant, I believe, is that it's fine to start
software companies constrained in (a) in the same way a restaurant
is constrained in (b). I agree. Most people should not try to
start startups.
[3]
That sort of stepping back is one of the things we focus on at
Y Combinator. It's common for founders to have discovered something
intuitively without understanding all its implications. That's
probably true of the biggest discoveries in any field.
[4]
I got it wrong in "How to Make Wealth" when I said that a
startup was a small company that takes on a hard technical
problem. That is the most common recipe but not the only one.
[5]
In principle companies aren't limited by the size of the markets
they serve, because they could just expand into new markets. But
there seem to be limits on the ability of big companies to do that.
Which means the slowdown that comes from bumping up against the
limits of one's markets is ultimately just another way in which
internal limits are expressed.
It may be that some of these limits could be overcome by changing
the shape of the organization — specifically by sharding it.
[6]
This is, obviously, only for startups that have already launched
or can launch during YC. A startup building a new database will
probably not do that. On the other hand, launching something small
and then using growth rate as evolutionary pressure is such a
valuable technique that any company that could start this way
probably should.
[7]
If the startup is taking the Facebook/Twitter route and building
something they hope will be very popular but from which they don't
yet have a definite plan to make money, the growth rate has to be
higher, even though it's a proxy for revenue growth, because such
companies need huge numbers of users to succeed at all.
Beware too of the edge case where something spreads rapidly but the
churn is high as well, so that you have good net growth till you run
through all the potential users, at which point it suddenly stops.
[8]
Within YC when we say it's ipso facto right to do whatever gets
you growth, it's implicit that this excludes trickery like buying
users for more than their lifetime value, counting users as active
when they're really not, bleeding out invites at a regularly
increasing rate to manufacture a perfect growth curve, etc. Even
if you were able to fool investors with such tricks, you'd ultimately
be hurting yourself, because you're throwing off your own compass.
[9]
Which is why it's such a dangerous mistake to believe that
successful startups are simply the embodiment of some brilliant
initial idea. What you're looking for initially is not so much a
great idea as an idea that could evolve into a great one. The
danger is that promising ideas are not merely blurry versions of
great ones. They're often different in kind, because the early
adopters you evolve the idea upon have different needs from the
rest of the market. For example, the idea that evolves into Facebook
isn't merely a subset of Facebook; the idea that evolves into
Facebook is a site for Harvard undergrads.
[10]
What if a company grew at 1.7x a year for a really long time?
Could it not grow just as big as any successful startup? In principle
yes, of course. If our hypothetical company making $1000 a month
grew at 1% a week for 19 years, it would grow as big as a company
growing at 5% a week for 4 years. But while such trajectories may
be common in, say, real estate development, you don't see them much
in the technology business. In technology, companies that grow
slowly tend not to grow as big.
[11]
Any expected value calculation varies from person to person
depending on their utility function for money. I.e. the first
million is worth more to most people than subsequent millions. How
much more depends on the person. For founders who are younger or
more ambitious the utility function is flatter. Which is probably
part of the reason the founders of the most successful startups of
all tend to be on the young side.
[12]
More precisely, this is the case in the biggest winners, which
is where all the returns come from. A startup founder could pull
the same trick of enriching himself at the company's expense by
selling them overpriced components. But it wouldn't be worth it
for the founders of Google to do that. Only founders of failing
startups would even be tempted, but those are writeoffs from the
VCs' point of view anyway.
[13]
Acquisitions fall into two categories: those where the acquirer
wants the business, and those where the acquirer just wants the
employees. The latter type is sometimes called an HR acquisition.
Though nominally acquisitions and sometimes on a scale that has a
significant effect on the expected value calculation for potential
founders, HR acquisitions are viewed by acquirers as more akin to
hiring bonuses.
[14]
I once explained this to some founders who had recently arrived
from Russia. They found it novel that if you threatened a company
they'd pay a premium for you. "In Russia they just kill you," they
said, and they were only partly joking. Economically, the fact
that established companies can't simply eliminate new competitors
may be one of the most valuable aspects of the rule of law. And
so to the extent we see incumbents suppressing competitors via
regulations or patent suits, we should worry, not because it's a
departure from the rule of law per se but from what the rule of law
is aiming at.
Thanks to Sam Altman, Marc Andreessen, Paul Buchheit, Patrick
Collison, Jessica Livingston, Geoff Ralston, and Harj Taggar for
reading drafts of this.
|
Want to start a startup? Get funded by
Arabic Translation