Reflections On YCombinator Demo Day: How The Seed Market Has Changed

Earlier this week, I attended the Spring YCombinator Demo Day. I’ve been attending for six years now. Each time, I’m impressed by the intelligence, ambition and the polish of the founders presenting companies only a few weeks or months old.

As I listened to the pitches, I wondered if the types of startups founders decide to build at YC has changed over time and whether those trends are lagging or leading indicators of the market as a whole. At each Demo Day, the YC team provides investors a list of all the companies pitching and I’ve kept a few. To get a sense of the broader trends in YC companies, I’ve compared the Winter 2012 class and the Spring 2014 class by sector (consumer v. enterprise), segment (ecommerce, education, social, gaming, delivery) and by revenue model (subscription, ads, transactional).

These are the trends I observed in the data:

Mild shift toward enterprise: In 2012, 48% of YC startups were enterprise. In 2014, enterprise startups were 57% of the class.

Within enterprise, there has been a shift toward industry specific Software-as-a-Service (vertical SaaS) at the expense of horizontal SaaS. Vertical SaaS startups comprised 29% of the 2012 enterprise companies and 40% of the 2014 class. To make this idea more concrete, here are two examples. VidPresso provides software to the TV broadcast industry and is an example of vertical SaaS. ZenPayoll, a provider of payroll services, serves many different types of businesses and is a horizontal SaaS company.

Platforms-as-a-Service, which enable developers to build and scale applications (Heroku), have also seen a decline in numbers. In 2012, there were 5 PaaS companies while in 2014, I counted 2. Shifting to consumer, social apps have fallen from 24% of consumer startups to 15% at the most recent demo day. Unlike the 2012 class, there were no gaming companies in 2014. Food delivery companies, education companies and consumer market places have cropped up in their place.

As for revenue models, subscription remains dominant. 53% of 2012 YC companies chose this revenue model and 56% chose it in 2014.

Also notable is a marked increase in the number of non-profits. The 2014 class graduated 6 of them, up from zero in 2012.

All in all, YC startups do seem to be shifting with the market and/or YC partners are screening for startups that are more reflective of the environment. The shifts toward vertical SaaS and away from social and gaming apparent in this class are consistent with the patterns I’m seeing in the fund raising market. Unfortunately, the data isn’t able to tell us who is setting the trend. In any case, I’ll be tracking these trends in the future and hope to be able to draw more conclusions over time.


ThredUp: Leveraging Data to Understand Customers

ThredUp, the leading online resale marketplace for women’s and children’s fashion, has gathered interesting data points on its customers’ shopping trends. Here’s a quick look.

Ever wonder which clothes in your closet might fetch the most money? Or in which cities people shop the most for “practically new” shoes and dresses? Or which clothing brands hold their value the most? These are the kinds of juicy shopping tidbits you will find in thredUp’s Second Annual Resale Report. Founded in 2009, the fast-growing company has seen it all when it comes to fashion trends—and is willing to dish. Here are just some of the most interesting insights from 2013:

Of the 10,000 U.S. cities embracing the online fashion resale marketplace, residents in San Francisco, Brooklyn, Seattle, Chicago, Houston, Miami and Los Angeles are among the most enthusiastic. Indeed, shoppers from the top 10 cities collectively saved almost $1.8 million buying and selling clothes on thredUp in 2013.

What were these folks buying, you might ask? The fastest-selling brands for women include Burberry, Coach, Gucci, Toms, and True Religion. For kids, Zara, Crocks, Patagonia, Ralph Lauren and Matilda Jane were among the hottest. These brands, part of the more than 20,000 sold on the site, typically sell out within hours of being listed.

Of course, much of what you buy depends on where you live. thredUp checked that out and found some interesting—and surprising—results. For instance, Weston, FL residents bought up the most activewear clothing. The most shoe-obsessed population seems to hale from Lancaster, PA. Preppy clothing is biggest in Fontana, CA while formal wear is more the norm in Pleasant Shade, TN. Who buys the most designer brands? That honor goes to the fashionable people of Brooklyn, NY, who purchased more pieces by the likes of Stuart Weitzman, Missoni and Dolce & Gabbana than anyone else.

With savings of up to 90% off retail, the online resale marketplace is growing fast. In 2013, stripes, florals and plaids were the best-selling patterns. Wonder what they will be in 2014?


The Four Key Steps In Startup Fund Raising Processes

Raising capital from venture capitalists at any stage can seem like a very strange, ambiguous and amorphous process. I’ve written about the way Redpoint diligences/researches a startup and its market and what questions we tend to ask at each stage. In this post, I’ll focus on the process from entrepreneur’s point of view.

When raising capital, entrepreneurs will see potential investors move through four phases of investment decision-making process: screening, socialization, diligence, and decision. I’ve drawn a schematic that illustrates this evolution above. The chart also shows a line indicating the progression from one step to the next, using data from my own investment funnels.

Screening: the first call and/or first meeting. The screening step can include associates, principals and/or one or two partners. In this phase, investors are evaluating the risks of the investment, the market size, and the industry, to determine if it’s a fit with their fund size and investment goals. Looking at my CRM data, roughly 15% of startups continue onto the next stage.

Socialization: excited by a startup’s pitch and prospects, the partner/team who met with the company will share their knowledge with other members of the firm. VCs typically ask for second meetings during socialization. In second meetings, founders repeat the pitch to a broader group within the firm, though typically not the entirety of the partnership. If the deal team resonates with the founders and the opportunity and vice-versa, the deal team begins diligence. Again, about 15% of startups move onto diligence.

Diligence: the deal team begins researching the opportunity and share their findings with the broader partnership. This includes evaluating the team, the market, product roadmap and sales pipeline. Behind the scenes, VCs call contacts in industry to refine their point of view. As the research progresses, VCs will often volley questions back to the startup, seeking clarification. Typically, the diligence process is focused on a few key questions like market size, defensibility, regulatory risk, or competition. Increasingly, investors and founders discuss deal structure and outline deal terms at this stage. After diligence, about 10% of startups continue to the final “Partner Meeting,” a meeting of all the partners in a venture firm, or the entirety of the VC’s investment committee.

Decision: This the “Partner Meeting.” Beforehand, the deal team briefs the partnership on all the diligence materials, key questions, and deal terms. Founders pitch the entire partnership. After the meeting, all the partners debrief on the opportunity. Some firms provide deal teams latitude to make decisions on their own; others have implemented rigid voting processes to seek approval for investment. Granted approval and with a term sheet in hand, VCs then must convince an entrepreneur to sign their term sheet and partner with them. In the past 2 years, I’ve been lucky to invest in three companies (Axial, Electric Imp and Looker), for a success rate of 6% in this stage, or 0.2% throughout the process.

For founders, it’s important to understand where they are in the process with investors for two reasons. First, so as not to misjudge the finish line either by running out of capital in the midst of a process or presume success at too early a stage. Second, to build auction pressure in financings to create negotiating leverage on terms. Keeping VCs in stride with each other is one tactic to accomplish this goal.

The first part to ensuring a successful fund raising process is understanding the milestones. But ideally, after this process is completed, a founding team and an investor have built a strong and mutually beneficial relationship that will last many years and throughout the company’s ups and downs.


Why Startups Face Increasing Competition In Raising Series As And Bs

Has it become harder to raise money? is a question I hear all the time. On one hand, the total dollars invested by VCs is relatively flat at just under $30B per year, according to the NVCA. On the other hand, the stories of difficulty raising series As and Bs have become a steady drumbeat.

To get some sense of the patterns, I analyzed 917 companies from seed through Series B over the past 14 years, using Crunchbase data. I’ve divided the companies into cohorts by the year they raised their seed investment. Click on the charts to view interactive ones.

The chart shows the narrow funnel seed stage companies must pass through to raise a series A. There are three observations we can make from the chart. First, the number of seed investments in the Crunchbase data has increased by 4x in 4 years. Some of this growth is better data recording, but I suspect the majority of the growth is driven by increased seed investments. Second, the total number of Series As has also increased, but it’s hard to say whether that’s data accuracy or ground-truth. Third, the total number of Series Bs is remaining relatively constant, even for the newer cohorts, like the 2012 class.

Across all these cohorts, the mean success rate to raise an A after a Seed is 27%, to raise a B after an A is 35%, and the whole way through the funnel, Seed to B, is 11.5%. Said another way, only 12% of companies who raise a Seed will raise a B.

If you’re wondering how these trends have changed over time, this next chart will answer that question for you. The x-axis shows calendar year and the y-axis shows the % of companies that raised a round. The blue line shows the percentage of companies raising an A after a seed; the orange line shows the percent of post-Series A companies raising a B; the green line shows the percent of post-Seed companies who have run the gauntlet successfully to raise a Series B. The secular decline in all of these ratios screams of increased competition.

According to analysis by my partner Jamie Davidson on typical periods between financings peaks around 9 months so the follow on rates for Series Bs should be accurate up until the 2011 class, which gives these startups more than 2 years to raise their B. Data from 2012 and 2013 will show lower success rates because most of these companies won’t be mature enough to be in the market for a B.

Despite the noisy data, it’s reasonable to conclude the financing market has become more competitive, driven by an increase in the total number of startups raising seed capital and a relatively constant inflow of capital into venture capital.

Originally posted on Tomasz’s personal blog, here.


The Mininum Size Seed Round To Maximize Series A Follow On Investment

How large of a seed round should founders raise to maximize their chances of raising a Series A? Smaller seed rounds are simpler and faster to raise because they typically require fewer investors. They may also require less dilution because of the smaller investment size. On the other hand, to raise a Series A, the startup needs enough runway to hire a team and prove certain milestones to Series A investors.

Using Crunchbase data from 2005 to 2012, I’ve plotted the follow-on rates by size of seed investment quintiles across 2906 companies in that period. Startups who raised $300k or less in their seed raised Series As about 12% of the time. Founders who raised between $300k and $600k doubled their odds of raising an A to better than 24%, and those who raised between $600k and $900k increased the probability an additional 50%, reaching 33%. After that point, the marginal capital demonstrates diminishing returns.

The data indicates that larger seed rounds substantially increase the odds of raising a Series A. This could be due to a number of reasons. First, founders with larger seed rounds benefit from more time to establish product market fit. Second, the additional capital enables seed stage startups to be more aggressive ramping the business either through marketing efforts, recruiting efforts or other tactics. Third, larger seed rounds likely have one or two institutional investors who have invested the substantial majority of the round, and given their larger fund sizes are willing and able to lead the Series A.

More runway implies better odds of success.

Originally posted on Tomasz’s personal blog, here.


Do Larger Seed Rounds Lead To Bigger Series As?

In What’s Up with the Series A, Nikhil Basu Trivedi documents the bifurcation in the Series A market. While there are a handful of startups that raise blockbuster Series As of greater than $10M, the average Series A investment size remains relatively constant over the past 6 years just around $5.3M for US technology companies according to Crunchbase data[1].

After reading his post, I wondered if a big seed round is a leading indicator of a big series A. In other words, would larger seed rounds provide enough negotiating leverage in fundraising conversations to bolster average check sizes and increase pre-money valuations?

Let’s go to the data. Below is a chart of 726 startups who raised a seed and a follow-on Series A anytime from 2005-2013. The x-axis is the size of the seed round in $k and the y-axis is the size of the Series A in $M. Each dot represents one startup.

There isn’t a clear pattern within the data but we can make three important observations. First, Series As rarely exceed $10M for companies with seed stage financing and the distribution of these financings tends to be relatively independent of seed investment size. Second, in the top right, we see a cluster of large-seed and large Series A companies, but the sample size is quite small, only 4. Third, the correlation between the size of the seed round and the size of the Series A is tenuous at about 0.25 R2. I can’t argue larger seed rounds precede larger As.

But, there is a nugget of useful insight in the data. Below I’ve charted the distribution of seed investments by size on the left, and the distribution of Series A investmens by size on the right. They are quite different.

Seed investments are uniformly distributed, but Series A investments follow a power-law distribution. Fundraising is never simple or easy, but there is a marked difference in the difficulty of raising a large seed compared to large A. Roughly 18% of startups in this data set raised a $1.5M+ series seed, but fewer than 8.5% of these startups raised a Series A of greater than $10M.

Said another way, there is 3x more capital available for sub-$10M Series As than for greater than $10M As. In contrast, the amount of capital invested in seeds greater than $1M is about twice as big compared to small seeds, which is quite likely an artifact of the rise of the dedicated seed fund and traditional VCs’ entry into the seed market.

All in all, larger seeds may not have a strong effect on the size of the Series A a startup can raise. But, at least at this point in the market, it’s becoming easier for founders to raise substantial seed rounds.

[1] The numbers I’m using here differ from Nikhil’s because in addition to geography, I filtered the industry to tech companies, which seem to garner larger investments than the average Series A.


*Originally posted on Tomasz’s personal blog, here.


The Best Times of Year to Raise Capital for Your Startup

Aside from a startup’s internal considerations about the right time to raise money, founders should weigh the seasonality of the fund raising market when planning their raise. There’s a rule of thumb batted around the valley that the worst times to raise capital are in the dog-days of summer and after Thanksgiving. As it turns out, this aphorism is only a half-truth.

Below is a chart of the dollars VCs have invested by month of year. I’m using Crunchbase data since 2005 for tech companies in the US. There are a few notable trends in the data.

First, the impact of the summer is evident. The slowest month for investments during the year September. I’d estimate there are a few weeks latency in the data between when the investment commitment is made and the investment is disclosed. The legal diligence process of about 3-4 weeks that typically follows signing a term sheet introduces this lag.

Second, setting aside the slowdown in summer, VCs invest more and more as the year progresses. It’s not crazy to draw a parallel between this trend and the patterns quota attainment for salespeople in which the majority of sales arrive in the last two weeks of a quarter. VCs aim to invest a certain amount of dollars and/or in a certain number of companies each year. The later in the year, the greater the time pressure, the better the motivation.

Third, the difference from the best month, December, to the worst month, January, is substantial: a 75% delta in the total dollars invested and 50% increase in the number of investments. These differences are statistically significant with greater than 95% confidence, so seasonality quite clearly exists.

This analysis raises another question: is there an optimal time of year to maximize the size of an investment and presumably pre-money valuation?

The data shows the average investment size spikes in August and December, both of which have over the past nine years, generated 15% larger rounds. The difference is statistically significant with greater than 90% confidence.

Assuming a three month fundraising process, the best times of year to start a financing process is in September, targeting a December close, when investment sizes are 15% larger than average and investment volumes are 50% larger. Starting a raise in May is the second best choice. While the average investment sizes are identical to December, investment pace is much slower, hence a bit riskier.

*Originally posted on Tomasz’s personal blog, here.


What the Nest Acquisition Means for the Internet of Things

As recently as six months ago, it was easy to disregard the Internet of Things (IoT) as just a theoretical market that Cisco measured in the trillions, but whose potential never seemed to materialize. That’s all changing.

The past year ushered in a new era for the Internet of Things for three reasons. First, venture capitalists invested nearly $1B of capital in the IoT in 2013, more than 3% of all VC investments by dollars. Second, the sector witnessed its first IPO, Control4. And third, Nest’s sale to Google last week set the high water mark for IoT acquisitions, measured at more than $3B, firmly establishing the category as a strategic imperative for the world’s largest technology companies.

The IoT momentum generated in 2013 will only continue to grow, as the number of connected device startups and products compounds, each looking to satisfy an unmet consumer want or enterprise need. By 2017, each consumer will have 5 connected devices, more than double today’s per capita figure and potentially doubling the total revenue of the hardware market.

To realize the true potential of the IoT dream, the development of connected devices must be made simpler and easier. In addition, all of these billions of new devices will need to communicate with each other, seamlessly.

That’s why I’m so excited about the future for IoT companies like Electric Imp. In the same way Amazon Web Services advanced online storage and computing infrastructure, Electric Imp frees innovators to focus on the things they do best – build great products. No longer do companies have to create back-end infrastructure and worry about connectivity, scalability and compatibility – they can focus on the design and differentiation of their product.

2013 was just the beginning for the IoT. With billions of new devices and innumerable new uses for them, our world will change dramatically over the next decade, fueled by the innovation of entrepreneurs building novel connected products.

Originally posted on our portfolio company, Electric Imp’s, blog, here.


The Two Key Skill Sets Startups Must Develop To Grow


In “Why Winning Streaks End”, Rosabeth Kantar, a professor at HBS, explains the key to maintaining momentum in any company is maintaining the discipline of every day processes. Similarly, Atul Gawande’s book Better echoes this idea. For surgeons, the best way to keep patients safe and healthy is ticking through a checklist before each surgery.

As I’ve watched a handful of startups grow, the pattern I see emerging from most of them is their ability to persistently transform chaos into process. And then continuously improve the way they do things.

At the beginning, each of these companies pursued product development with something akin to Lean Startup Method. The founders identified a problem, spoke with customers and quickly iterated their solution into products the market would buy.

After the prototypes were built, the founders needed more help building the product and developed a process to hire engineers to grow the development team. Next, these companiess shifted into sales and marketing mode, pitching and selling potential customers. In so doing, they defined and refined their go-to-market process. When the customer acquisition methods were somewhat in place, these startup created a third process to recruit salespeople and build a marketing organization. And so on for customer support, sales operations, human resources, finance and every other key activity of a business.

Once in place, these processes can’t remain static. Processes must stay relevant and productive through persistent improvement. This means using software to instrument processes, charging team leaders with the responsibilities to create new ways of doing things and pushing the company towards rapid improvement.

For some, the word process has a strongly negative connotation. It’s probably because we often notice the processes that don’t work: the line at the DMV, the vacation time approval or airplane boarding. While those may need some work, we shouldn’t simply throw the baby out with the bathwater and pan all processes.

Code check-in regimens, hiring procedures, OKR setting routines, annual reviews – all of these work and to great benefit of the employees, teams and company. What was Zynga’s Playbook for launching games if not a list of proprietary processes?

Broadly speaking, I think this means startups need two skill sets as they grow: the ability to design processes and the ability to maintain/improve/destroy processes as the business evolves.


*Originally posted by Tomasz on his personal blog, here.


Why Quotas Aren’t the Most Important Number for Startup Sales Teams

I’ll never forget the first time I was assigned a sales quota. I was six months into a sales role at Google in which I on-boarded and managed the accounts of social networks running AdSense ads. Our key metric was customer satisfaction and retention. After a few months, I was starting to get into a groove. And then, our team was assigned a new manager who put the team on a quota, sending me into a tailspin.

I was daunted by the quota. I asked myself if I might ever be able to hit the number and doubted that I could. I fell into a crisis of confidence. How would I add $X of additional revenue this year?

I remembered my quota trauma while reading an article by Jason Jordan, a sales management training consultant, who wrote about the three kinds metrics that matter for sales teams: Business Results, Sales Metrics and Sales Activities.

Business Results are the revenue growth figures for a company at the highest level. Sales Objectives are the goals of each sales team: acquiring brand-name customers, growing customer accounts or hitting a quota. Sales Activities are outbound sales calls, writing account plans and qualifying leads.

Jordan makes a great point in his post, that the only type of metric sales teams can effect are the tactical Sales Activities. Unfortunately, most sales teams only focus measure Sales Metrics, so it’s challenging to diagnose why salespeople miss quota.

He argues sales managers should focus their sales teams on Sales Activities and measure those leading indicators in addition to Sales Metrics which are lagging indicators of success. In my interpretation, that means sales managers ought to set a quota, and in addition, outline a general plan (total number of calls, target sales sizes, conversion rates) for how to accomplish that quota. This enables the sales team to understand how they are tracking towards the Sales Metrics and allows them to diagnose where the sales funnels might be under or over-performing.

I’m sure the most successful sales teams have instrumented the Sales Activity metrics Jordan talks about, because it’s a very logical thing to do: dig deeper into the sales process to understand how to improve it. But I wish I had read Jordan’s post all those years ago.


*Originally posted on Tomasz’s personal blog, here.