Y-Combinator's Framework: How Much Traction Is Needed To Raise Funding? | VC Jobs
Focus on PMDF & Not Just PMF, Circle’s Founders' Views on Startup Valuation
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Deep Dive: Y-Combinator's Framework: How Much Traction Is Needed To Raise Funding?
Quick Dive:
MVP is Over. You Need to Think About MVE.
Steve Jobs: 'The Half-Truth of First-Mover Advantage'
A Simple Framework for Pitching the 'Use of Funds' Slide to Investors.
What's Better Than Product Market Fit (PMF)? It's Product Market Distribution Fit (PMDF)
Circle’s Founder, Sid Yadav’s Views on Startup Valuation
Major News: Alphabet Likely To Buy Hubspot For $30 Billion, Neuralink Implant Malfunctioned, OpenAI Plans To Launch Google Search Competitor & Mistral AI Raising $600 Million.
Best Tweet Of This Week On Startups, VC & AI.
VC Jobs & Internships: From Scout to Partner.
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TODAY’S DEEP DIVE
Y-Combinator's Framework: How Much Traction Is Needed To Raise Funding?
“Can I raise funding based on an idea without building any product?" This is a common question among founders. My answer is always "Yes, you can." However, you need to tick off certain criteria that can convince investors of your idea's potential, even without a built product. Many founders make the mistake of underestimating this aspect.
If you’re a regular reader of this newsletter, previously I shared - "For some founders, having a compelling idea and reputation is enough, but for most, they need a combination of idea, market understanding, traction, and a strong team." Most founders get confused about how much traction is enough and whether they need to build a product to gain traction. In today's write-up, we'll dive into these questions using the Y-Combinator framework.
Some startups like Asana, Zillow, Reddit, Wufuu, and Zenefits managed to raise millions of dollars from leading investors like Y Combinator based solely on their ideas, without having written a single line of code or built a product. What made them stand out and secure funding even without a built product?
The key differentiator lies in answering this simple question: What makes a startup different from other businesses? A startup is a company designed or created to grow rapidly. If you're not building a company that can scale very, very quickly, then you're essentially building a small business, which is not inherently wrong. However, investors are typically not interested in such companies.
So — the first question you should ask yourself:
Is your company growing or more scalable?
If the answer is yes, you need to have evidence for this because early-stage investors want something that can show that your company has the potential to scale. All companies that raised successful funding at the idea stage have evidence, and this evidence is not just a ton of traction or million-dollar revenue. So what it is?
Before diving into this specific question, founders need to understand the mindset of investors. How do investors approach and evaluate pitches?
They always think about how this startup will be worth billions of dollars and what’s the conviction for this.They think of all the reasons why this startup should succeed, and sometimes even before building the startup, investors can predict the potential path of that company.
In simple words, you have to show the investors a conviction that your company will do well (with or without traction). However, most of the founders failed in this approach. So how can you successfully convince investors?
Investors always think about startup ideas in three parts -
Problem: It’s the setting for a particular company that allows it to be able to grow quickly.
Solution: The experiment that the founder is running within those conditions for it to grow quickly….
Insight: Why the thing that founders trying to experiment is going to end up successful?
Let’s deep dive into each of these to understand how can you build something that aligns with these terms.
Problem
Founders should solve the problem which is -
Popular: A lot of people have the problem. You should avoid problems that there’s a small number of people.
Growing: Find the problem which is growing i.e. a large number of people will face problems in the coming time.
Urgent: that needs to be solved very very quickly
Expensive To Solve: if you’re able to solve it then you can charge a lot of money for potential
Mandatory: problems that are mandatory right so therefore it’s like ah people have this problem and they have to solve it
Frequent: over and over again (super important) — people are gonna encounter over and over and over again and often in a frequent time interval
This doesn’t mean your startup should follow all these criteria. Generally, A successful startup has one of the aspects in their problem and even some have multiple aspects. So if your company is not growing or someone is not excited about your problem that means your startup is not having any of these aspects.
But out of all these aspects, the most important thing successful startups have is Frequency. Most investors like this type of idea as it gives people a lot of opportunities to convert and grow exponentially.
So overall the ideal problem (which is VC hackable) looks like this -
Millions of people have the problem.
The market is growing by 20% per year.
The problem is solvable right now, immediately.
Problem that costs a billion dollars to solve or some billion-dollar TA
The problem is where the law has changed like the healthcare sector boomed when affordable healthcare came into act
problem which needs to be solved multiple times in a day. Example -facebook or slack.
Solution
One of the advice for the solution is — “Don’t Start Here.” What does it mean?
While building a product, most of the founders start with the solution first and then move toward the problem.
For example — most of the founders get excited about a particular technology like blockchain or AI and they think that they want to build something but the question is what kind of problem do they solve? Generally, they just forced themselves to shoehorn the particular tech into the problem. And investors hate this approach.
Most investors look for a startup which is PSOP - Problem in Search of a Solution. Investors typically want to see that a startup has identified a real problem or pain point that customers are experiencing, and is then working to develop a solution to that problem.
So, Founders should aim that “I am going to solve this problem — whatever it takes!”
If you are using the Solution In Search of a Problem approach — your startup never going to grow efficiently and if you want your startup to grow efficiently — use the SISP approach.
The last and most important thing — Insights?
What are the reasons — why this solution is going to work out? What are those insights? What’s your unfair advantage? Investors always want to know these things from founders. So during the idea presentation founder should focus on their unfair advantage over the others and why they can win in the market.
Just remember that the unfair advantage should be related to growth.
If not then investors not going to invest in your business. Most of the founders just say that they are solving this problem without explaining why they can win the market or talking about unfair advantage. So how can you explain about your unfair advantage -
So there are five different types of unfair advantage
As a startup, You need to have at least one. If you look at successful startups you will find that they have multiple unfair advantages which lead them to achieve that successful startup tag. As a founder, just ask yourself about these five unfair advantages,
Founder Advantage: Are you among the top experts in the world in solving this problem? If not, it’s a weak advantage.
Market Advantage: Is your market growing at least 20% a year? This sets a trend for automatic growth.
Product Advantage: Is your product 10x better than the competition? Clear differentiation is crucial.
Acquisition Advantage: Can your startup grow without relying on paid acquisition? Word-of-mouth is a powerful channel.
Many entrepreneurs believe that demonstrating a successful track record in paid advertising through platforms like Facebook, Twitter, or Google Ads, along with presenting detailed metrics such as Customer Acquisition Cost (CAC) and Customer Lifetime Value (LTV), can prove the sustainability of their acquisition model. However, it’s crucial to understand that relying solely on paid acquisition can be risky.
If your company’s growth strategy heavily depends on paid advertising, it’s a vulnerable position to be in. As your popularity surges and revenues reach substantial figures, you’ll inevitably attract fierce competition. Think of it as becoming a significant player in a game where newcomers constantly join, making it harder to maintain your edge.
A prime example of this scenario is evident in companies where most of their early growth was fueled by paid acquisitions. Over time, this advantage eroded as the market became saturated, leaving them with limited room for further expansion.
The key is to explore acquisition channels that require little to no financial investment. The most potent and sustainable growth often comes from word-of-mouth referrals. Cultivating a product or service that people naturally want to talk about and share with others can be a game-changer.
In the initial stages of your startup, when funds are tight, focusing on methods that don’t require a significant financial outlay is not just a necessity; it’s a strategic advantage.
This is why startup advisors often stress the importance of doing things that don’t scale at the beginning. It’s about finding creative, low-cost, or preferably, no-cost strategies to grow your business organically.
In essence, the real advantage lies in discovering avenues of growth that are inherently free. These organic methods not only conserve your resources but also pave the way for sustainable, long-term success.
5. Monopoly Advantage: Does your company become stronger and harder to defeat as it grows? Think network effects or winner-takes-all scenarios.
The concept of having a monopoly in the business world isn’t about the traditional board game with a monocle-wearing tycoon.
It’s about whether, as your company grows, it becomes increasingly challenging for competitors to defeat you. In essence, do you get stronger as you expand?
Companies with network effects in marketplaces exemplify this phenomenon. In these winner-takes-all scenarios, one company tends to dominate. Network effects mean that as my network within the platform grows, so does the strength of my company. The value of the product or service escalates in tandem with the expanding user base.
Just remember that every investor has their approach but these fundamental things stay the same across startup investing. So if your startup satisfies these three terms on problem, solution and insights basis, no one can stop you from raising money based on an Idea….
You can also check these sources by Y-Combinator: Kavin Hale
QUICK DIVES
1. MVP is Over. You Need to Think About MVE.
(Hint: V isn’t for viable — it’s for valuable)
Most startups fail because first-time founders either under-invest and create something untested based on gut instinct, or over-invest without validating if it provides value.
The crucial question is not "how can I solve this problem?" but "how can I create a valuable experience that people desperately need and will pay for?"
The example of Thomas Edison's light bulb invention highlights this - existing bulbs were viable but not valuable as they didn't last long. Edison focused on creating a Minimum Valuable Experience (MVE) by making affordable, durable bulbs that provided the illumination people craved.
To identify an MVE, use the A.C.T. framework:
Audience - Deeply understand your ideal customer segment, their behaviours, goals, and what they seek.
Communication - Craft messaging using language and formats that resonate with your audience.
Touchpoints - Design triggers and channels to move your audience to action effectively.
The startup Webflow exemplifies mastering A.C.T. The founders envisioned empowering designers through no-code web design. They intimately knew this audience, positioned Webflow's unique value and gained explosive traction via platforms like Hacker News. Though facing numerous setbacks, their clarity of vision and customer focus ultimately led to billions in valuation.
Startups must relentlessly pursue creating meaningful experiences, not just viable products. Continuously adapt based on audience feedback. Success stems from this laser focus on delivering an MVE that genuinely improves customers' lives in ways they'll pay for. Must recommend reading this article by Pete Sena.
2. Steve Jobs: 'The Half-Truth of First-Mover Advantage'
Being first in the market is often seen as a competitive advantage, but how real is this competitive advantage? For example, do you have to be first – new product, new service, new market, etc?
Moving quickly and striving to establish your business as the ‘go-to’ product/solution in a new market (or niche) sounds like a competitive advantage, but the reality is often very different.
What History Taught Us
If you study any new industry or market, you will find that most pioneers didn’t build truly great products/services/companies, incumbents did!
For Example
Apple was relatively late to the smartphone market. Blackberry, Nokia, and Windows had at least five years of a head start on the first iPhone – released in 2007. Note: By 2009, the iPhone surpassed Blackberry sales.
White Castle had over a decade head start on most hamburger chains but failed to capitalize on it – leaving Ray Kroc and McDonalds to revolutionize the fast-food industry.
Chrysler, Ford, GM, Honda, Nissan, and Toyota all released an electric car in the early 1990s. Tesla didn’t release its first car (Roadster) until 2005. A decade after traditional automakers already had their electric cars on the road.
Facebook was not the first social media site, Six Degrees was in 1997. Facebook didn’t launch until 2004.
When Compaq released their “portable” PC (laptop), there were at least 15 other offerings at the time, but theirs was the first to run software built for IBM.
We can list examples of companies failing to take advantage of being first in the market. Some will argue that timing is the main reason why so many pioneers failed to dominate the market.
Timing Is Definitely An Important Factor, But It Is Not The Core Reason – Execution Is. More specifically, excellent product/service execution and great marketing execution.
Steve Jobs’s iPhone, for instance, didn’t become a huge success because it was the first smartphone, but because of excellent product execution (an industry-first 3.5-inch touch-sensitive screen) and extensive marketing to promote it.
On the marketing side, it started with a promise from Steve Jobs, “A device that will deliver all the features of iPods as well as the smartphone.” Creating a lot of excitement well before the first-generation iPhone was revealed to the masses.
The next logical step for Apple was to reach out to influencers (e.g., reporters, reviewers, experts, etc.) to critique the new iPhone. Unsurprisingly, most publications and reviews were favourable, describing the first iPhone as a “breakthrough” device.
So it was all down to a great device? No.
While it had a great design, the iPhone had many adaptation challenges that marketing had to overcome. For example, it had a substantial price tag of $499-$599. At that time, higher than most of its competitors.
Second, customers had to sign up for a two-year contract with AT&T (using a slower EDGE network and not 3G which was faster and available at the time).
While acknowledging these challenges, Apple’s marketing team focused on its unique selling proposition – an industry-first 3.5-inch touch-sensitive screen. As is the case with any significant product launch from Apple, marketing had a healthy budget for television, print, and web ads.
Lessons Learned
Of course, your business doesn’t have Apple’s resources, but that’s not the key takeaway.
The lesson to learn is that execution (product + marketing) is far more important than being the first to the market.
In many ways, your organization is better off entering the market second, third, or even fourth. Why? A road to new markets (innovative products/services) is paved with mistakes and lessons learned. Expensive lessons that your company can avoid if you pay attention.
For example, being first to the market means educating potential customers on the new product/service – a very time-consuming and expensive marketing exercise. Let the pioneers do that for you.
3. A Simple Framework for Pitching the 'Use of Funds' Slide to Investors.
You’re running a startup and you’re going to raise money to accomplish something. Makes sense. What doesn’t make any sense at all is how many founders seem to be shy about sharing the details of the plan.
A lot of the due diligence process is going to be focused on figuring out whether you are a competent, believable founder and showing that you have a detailed plan and vision for what’s going to happen over the next period.
Put differently:
If Investors are going to invest $2 million into your startup, they want to know what that money buys them, in terms of progress for your company.
Ideally, your company has an operating plan as part of the pitch deck, which goes into detail about what is going to happen between this and the next funding round.
On the “ask” slide, however, you have the opportunity to summarize in three or four bullet points what you’re going to do with the money. Typically, you’re going to want to include product, traction, market validation and key hire milestones.
Product — What product milestones do you need to hit to raise the next tranche of money? In particular, this includes beta or full product launches, major feature sets in the product pipeline or integrations with partners.
Traction — What business metrics do you need to achieve to raise more money? How many units do you have to sell, how many subscribers do you need, how many customers do you want? Other metrics may also be helpful here — your net promoter score (NPS), monthly active users, etc.
Market validation — What can you do to prove that there’s a real market out there willing to pay for the product or service you are peddling?
Key hires — To reach the above goals, you probably need to hire. How many people do you need to hire? When?
Each of these goals should be SMART: specific, measurable, achievable, relevant and time-based. Poor goals are vague: “Improve marketing,” or “Get more customers” or “Add features to our product.”
Examples of great SMART goals:
“By May 2025, we need 2,000 paying customers on our recurring subscription model.”
“In the next six months, we need to reduce our customer acquisition cost by 20%.”
“Our B2B sales need to improve, so by July we are aiming to hire an experienced VP of sales who can help shape our sales processes.”
Be. Specific.
4. What's Better Than Product Market Fit (PMF)? It's Product Market Distribution Fit (PMDF)
Having a great product is useless unless you also have the right channels to sell it through. This is particularly true with some sorts of businesses — a winery, for example, will never get to scale unless the product is carried by one of the large distributors (with alcohol, the 3-tier distribution system is mandated by law). Medical products are also controlled by a few large distributors. Or if you’re a startup selling a mobile app, your distribution relies completely on the iOS and Android app stores. You’ll never make it if you don’t optimize your presence in that sales channel.
Startup with better distribution usually beat a better product so investing early in sales and marketing will help you achieve your business goals.
Today, of course, many companies sell directly online instead of through traditional resellers or retail stores. And yet distribution still matters — putting your product on Amazon will get you 1,000 the distribution you could ever get on your standalone website. And Amazon charges a toll for that.
So all of this boils down to the one equation: CAC < LTV (Customer Acquisition Cost < Life Time Value). If you don’t have efficient distribution then your Customer Acquisition Cost will be too high. And if you have to pay a toll to get distribution then the Lifetime Value of a customer will be lower. But Distribution ain’t cheap.
If you are aware of this - Apple decided to stop selling through retailers and open their own branded stores instead. It was a dicey move because they were giving up the distribution of Best Buy, Circuit City, and all the rest.
But Steve Jobs said, “We sell a premium product and we need to take control of the customer experience to get the premium price”. So in essence he went from a low-cost low-margin distribution model to a high-cost high-margin distribution model. And this decision worked out well.
Licensing can also be a way to get distribution. A famous case study from history is consumer videotape systems. Betamax, owned by Sony, was the superior product. But VHS, the competitive system owned by JVC, ended up winning because JVC got distribution by licensing VHS to all the other companies making video players. One of the examples is when Google first released the Android operating system, Apple had a big lead with iOS. Google decided to distribute Android by licensing it to other smartphone companies (so that Google would get the search traffic). Today the worldwide market share is 73% Android and 27% iOS. Distribution matters.
The point of all this is that while entrepreneurs are working hard to get Product/Market Fit, they should also be experimenting with various distribution channels. The laws of economics say that your startup will fail if you don’t get to CAC < LTV, and ultimately the driver for that is Product/Market/Channel Fit.
5. Circle’s Founder, Sid Yadav’s Views on Startup Valuation
Sid grew his startup Circle (an all-in-one community platform) from 0 to $20m+ ARR in 4 years. The last financing was at a $250m valuation a year ago and has nearly doubled all metrics in the past year. He shared that a lot of people often ask him how much Circle is worth today.
After talking to some of the world’s most successful founders and digesting countless material about startup valuations, here’s what Sid thinks about startup valuation:
“A valuation is a number an investor or acquirer comes up with based on analyzing your discounted future cashflows, while the price is a number buyers and sellers agree to act on.
Your price is not necessarily your valuation, since the former is influenced by market dynamics — demand and supply.
If you’re a private company, the valuation is what you want to pay attention to, since the only way for you to gauge the true price would be to have buyers and sellers transacting in the public market.
I like to put myself in the shoes of a potential investor or acquirer.
When they value Circle, they’ll typically look at:
the size of our business today
the growth rate
our market size way out in the future
our ability to serve that market with valuable products
our ability to capture and sustain some of that value for ourselves
macro trends with inflation and interest rates
It’s too late to change #1 and we don’t control #6, but #2-5 are completely in our control. No excuses.
That’s the theory. Here’s a more concrete answer:
A quick heuristic investors use to value fast-growing SaaS companies is a multiple on ARR (annual recurring revenue).
Given the day, my valuation of Circle varies between 10x to 25x our ARR.
On most days in the past 12 months, it’s been closer to 25x — because we truly have a lot going for us compared to other startups on our scale. If a major new prospect investor were to evaluate us for a transaction, I’d typically offer to send them all 50 of my monthly investor updates to back this up.
Once in a blue moon, I get as pessimistic and tell myself that Circle is likely worth a lot less than 25x our ARR.
But I also remind myself that it’s mostly in my control to act on this. It’s my fiduciary duty to maximize shareholder value, so we must.
If we aren’t moving fast enough, we can fix those bottlenecks today. If we’re scaling on the wrong foundations, we can pause and reflect on our fundamentals today. If we aren’t thinking big enough about our market opportunity, we can expand our imagination today.
If a key hire isn’t working out, we can make a performance plan for them today.
Valuations are slightly subjective with some objective grounding, entirely dynamic, and always in flux. They’re a guess at what reality could be, and the subject’s lens matters more than people think.
The key is to treat them as not just a number someone else decided for you, but an intuition you act on. And remember the quote: if you don’t deal with reality, reality will deal with you.”
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THIS WEEK’S NEWS RECAP
Major News In VC, Startup Funding & Tech
A US jury ordered Microsoft to pay $242 million to IPA Technologies for infringing a patent related to voice recognition technology used in Cortana. More Here
Apple is reportedly close to reaching an agreement with OpenAI to integrate ChatGPT features into its upcoming iOS 18 operating system for iPhones. More Here
OpenAI prepares to unveil its AI-based search tool, poised to rival Google and Perplexity. More Here
Google, under its parent company Alphabet, is contesting a $17 billion lawsuit in the UK over alleged anticompetitive practices in the online advertising market. More Here
Neuralink's brain implant chip in their first human patient had some problems a few weeks after surgery. More Here
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TWEET OF THIS WEEK
Best Tweet I Saw This Week
“The bigger the words, the dumber the ideas” Do you agree with Paul Graham's words? Feel free to share in the comments.
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🧐 Some Tips To Break Into VC:
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Sourcing
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How do you move the needle for a firm in at least one of these? If you don’t, it’s hard to make the case to get a role.”
(Shared By Harry Stebbings)
Not getting any VC Summer internships? Here's How to Level Up Your Summer
Work at a startup: Gain firsthand experience and understand the challenges entrepreneurs face, building empathy for future founders you may fund as a VC.
Start your own startup: Building something from the ground up demonstrates entrepreneurial passion and provides invaluable insights into the challenges and rewards of entrepreneurship, making you a better VC candidate and enabling you to better support founders.
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Great Read.