After YC acceptance, what are YC's expectations on exits? (unicorn vs. modest exit)

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danjos3ph

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To get accepted into YC, they want to see a path to becoming a unicorn ($1 billion+ valuation).

But after acceptance, what expectations does YC have? Do they pressure founders to become unicorns or are they okay with more modest exits?

Taking some examples: X years after investing $500k, say an exit would get them $2M back ($1.5M + their original $500k), a 4X multiple. If X is not too long, this is a good deal for them in terms of internal rate of return (IRR). As a benchmark, Angel investors get 25-30% IRR overall. Plugging in different X:
  • For X=5 years, a 4X multiple = 32% IRR (slightly above industry average result for an angel)
  • For X=3 years, a 4X multiple = 59% IRR (an excellent result for an angel investor)
  • For X=1.5 years, a 4X multiple = 152% IRR (an unreasonably high IRR; I think rivaling even their AirBnb investment)
What are their expectations after acceptance (especially for YC alum)? Would they go against you if you wanted more 'modest' exits?
 
@danjos3ph Been through YC. They don’t put pressure on you to do any of those things. It’s your company - you decide what’s best and how you want to run your ship - the partners just try to help you and provide their feedback in whatever direction you choose. They’re very pro-founder choice and don’t pressure you to do anything, and actually help you navigate the pressure you’ll get from your other investors. That said, the founders that get accepted into YC have typically very high ambitions (billion dollar company) already.

On the meta level of course they’re investors and exits make them money, but that’s never been the focus ever in my experience. Focus is on launching fast, the quest to find product market fit, and staying alive long enough to figure stuff out. So you could say that what they expect after acceptance is the same as what you are looking for - to help you get more traction so you can raise your seed round.

I’ve seen batchmates burn themselves out and partners recommend them take some time off to get themselves right. I’ve seen batchmates opt to go the aqui-hire route (and get nothing for YC in return) and they’ve been incredibly supportive. Honestly they’re probably the most founder-friendly investor out there, which is why alumni continue to apply again and again after their first go around.
 
@danjos3ph Really, what they expect is you to raise a seed round at the end of the program. And as the other commenter said, in the VC world, really only the 100x companies matter.

But also, you're building the company for you, not them. So shoot high, but if you have a chance for an acquisition, have your lawyers read the contracts closely (for stuff like liquidation preference etc.), and do the best decision for you.
 
@mousearts
Really, what they expect is you to raise a seed round at the end of the program.
Click to expand...

Thank you for your comment!

Do you have any direct or indirect experience you could share about where raising a seed round is the main expectation YC has? (e.g. going through YC, a friend went through it, online articles, etc.)
 
@danjos3ph Don't have a specific resource, but generally the expectation for venture backed startups is that you continually get to the next round of funding. So if you're currently a pre-seed company (which is what you are if your only source of funding is YC), then your next goal is to get a seed round. If you're a seed company, your goal is to get to series A, etc.

Therefore, the stated goal for almost every preseed company is to raise a seed round. The purpose of the demo day is to help you with that. But this is also consistent with the many YC founders I've talked with, and people who've done similar accelerators (Neo, PearX).

Between each round, you will try to increase your valuation by some large multiple. For example, if your preseed is at 5 million valuation, then you want your seed to be 20 - 30 million.

If your goal is to just 1.5x the size of your company and build it to a modest size, you should likely not take a priced round VC funding. The goal for VC-backed companies is to 10x their revenue and valuation over and over again.

EDIT: That being said, there's nothing in the YC terms that allow them to take the money back, or force you to raise a seed round. So that's why I say you can technically do what you want, it just wouldn't be what the vast majority of YC companies are doing or really what the purpose of YC is.
 
@danjos3ph 100x in 10 years.

Angels/accelerators participate in many more rounds of companies that ultimately fail than VCs who only invest in later stages (where a lot of bad startups have already been shaken out). To come out on top, they arguably need the winning exits more than anyone else in the ecosystem.

Investing is literally an asset class - angels/LPs don't care about what an individual company returns, they care about what the fund returns overall, and more importantly, what did the fund return compared to less risky asset classes. Startups are high risk, so your fund needs to outperform what your LPs would get by dumping their money into an index fund.

4Xing a 500k investment in 1.5 years is an awful result for YC. What are they going to do with $2m? Invest in 4 more companies and hope that one of them does slightly better?
 
@mormarw I suppose let me elaborate a bit. YC and other VC investors understand that exit multiples have a long-tailed distribution. For sure the top 2% of companies are important, but the next ~23% of companies are still making them money -- it's a distribution. So, even if it becomes clear that a company won't be a unicorn, an investor's incentive is still to increase a company's returns, even if it's moving them from a 2X return to a 4X return. It's not actually a "lose everything or win 100X" paradigm.

So, accepting only startups with large potential markets (a necessary condition to become a unicorn) really serves 2 purposes: (1) finding true unicorns and (2) improving expected returns for all startups, including the non-unicorns. But, after YC acceptance, how you treat those companies isn't necessarily to push for unicorns. Actually, to push every company to become a unicorn would likely bring you lower returns, since you'll sabotage exits that would otherwise still make you money.

4Xing a 500k investment in 1.5 years is an awful result for YC
Click to expand...

It's not clear to me why 4X in 1.5 years is bad. If your goal was to make the most money in 10 years, you should view these 2 scenarios approximately equal:
  • One 10,000X exit multiple after 10 years (151% IRR)
  • A 4X exit multiple after 1.5 years (152% IRR), repeated ~6.5 times sequentially
Where IRR = 100% * (ExitMultiple^(1/years) - 1)

Both will make you about the same amount of money. You can't force every company to be a unicorn, you have to allow them an exit that makes sense for that company. At least that's what I'd expect from a rational investor (this post-acceptance behavior is different than the pre-acceptance logic of requiring unicorn potential).
 
@danjos3ph YC founder here. Me and my partner were afraid of pressure, but everyone told us they are chill and founder friendly. That is super correct.

We didn’t want to go the VC route, and didn’t want to have them saying we needed to raise or do demo day. They didn’t pressure us to anything. We didn’t ever do demo day for our company, they told us we could do one at any batch if we wanted.

YCombinator behaves more like a business founder friend you can go to ask for tips, help, contacts or anything. Specially because your contacts are previous founders of exited companies. The community is where a lot of the good things come from.
 
@danjos3ph They don’t have any.

They expect to make all their returns from a handful of companies in the batch and know that most of the startups will give them negligible or 0 returns.

Any VC who isn’t expecting this doesn’t know wtf they’re doing.
 
@danjos3ph In general venture capital is an outlier business. While 4x return is good for you, it doesn't really cause the fund IRR to go up or down because the $500K is a small fraction of the total capital invested. To cause the IRR to actually go up or down you need outlier returns of 50-100X or higher. The 4X returns and zeros will balance over a larger portfolio set. If a portfolio of a large number of companies was able to consistently return a 4X in 3 years that would be exceptional but this doesn't actually happen.
 
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