377 startups and the largest Demo Day ever — How Y Combinator is super-sizing its startup school to become a global unicorn factory

An awkward tension hung in the warehouse air as Michael Seibel stood on a small stage and stared at a sea of faces.

The space was sparsely decorated, with bright orange walls and carpet, but the room was packed with founders from the 193 companies going through Y Combinator's vaunted startup accelerator program that summer of 2019.

 

"OK, let's get this out of the way," Seibel said, according to one of the founders in the room that day. "How many of you have been reached out to by Sequoia?"

The founders shifted uncomfortably in their white plastic chairs at the mention of the venture-capital firm, before two-thirds put up their hands.

"You thought you were pretty special?" Seibel said, scanning the room. "You're not."

Word had gotten back to Seibel, a partner at Y Combinator, that some of the founders were thinking about doing something that was tacitly forbidden: raising money before Demo Day, the official fundraising event.

 

Demo Day is supposed to be the first time that anyone in Silicon Valley sees or hears what Y Combinator's newest batch of companies has been working on — a curtain-raising moment that's part of the pageantry and mystique that's made YC, as it's commonly referred to, Silicon Valley's most famous startup accelerator.

The three-month program — part startup school, part mentorship — has produced smash hits like $96 billion Airbnb and $95 billion Stripe. For venture-capital firms looking for an edge, seducing a fledgling YC startup with a check before Demo Day is an easy way to get a jump on the competition.

But the flouting of rules that Seibel called out in 2019 points to a transformation underway at YC, which recently celebrated its 16th birthday: The camaraderie, mentorship, and traditions that once defined the YC experience, and in which some of its biggest hits were forged, have all but disappeared.

Instead of being a place where an aspiring tech mogul might bump into a billionaire tech CEO in the halls, today's program is more akin to a diploma factory, cycling through ever larger groups of founders and their fledgling startups. The switch to a virtual format due to COVID-19 has exacerbated the transformation.

Founders going through the program live all around the world, and it has ballooned to more than 300 companies in a single batch — a scale that's raised questions among YC alumni, investors, and up-and-coming entrepreneurs about whether the program is still the elite training ground and badge of honor it once was.

 

"YC allowed me to fundraise more quickly than I could have on my own, and that's really it," said Shadiah Sigala, who joined YC's summer 2018 class to launch her second startup, Kinside. Tensions within YC's clubby alumni ranks that spilled into view this summer and friction with some of the venture-capital firms that work with YC also hint at the strains that have come with its growth.

You don't have those moments where you're just, you know, drinking coffee and you randomly talk and meet people

Those challenges are likely to become greater as President Geoff Ralston leads the firm further beyond its roots, packaging YC's magic startup formula into something that can be offered to a wider market. With Silicon Valley know-how in high demand, Y Combinator is one of the organizations best positioned to fill the void — if its product can scale.

 

"I don't think we're funding all the companies that we can fund," Ralston said in an interview with Insider. "There are an extraordinary number of good entrepreneurs around the US, around different demographics, that we can push into."

 

More global, less money, fewer 'moments'

 

Manuel Rodriguez Dao and the cofounders of the online-marketplace startup Meru applied to YC three times before getting accepted in January.

After applying late, they got the acceptance call one day before the program started. The remote format meant the founders could participate without the logistical challenge of leaving their employees in Mexico and China.

"I think if we would have to go to San Francisco, maybe we wouldn't have considered doing the program," Dao said.

Meru was one of 346 companies accepted for winter 2021, which ended in March — Y Combinator's largest batch ever at the time. Over half were based outside the US. With the coronavirus pandemic raging, the founders attended their weekly lectures virtually and met with their YC partners over video.

The online curriculum involves all the same lessons and advice on startup essentials like building a pitch deck and fundraising a seed round. Dao, one of over 50 YC participants and alumni Insider spoke to for this story, described the experience in positive terms and credited it with helping him improve parts of his business such as customer service.

But he acknowledged that the online program lacked some of the fellowship and spontaneous benefits he had heard about from earlier classes.

"You don't have those moments where you're just, you know, drinking coffee and you randomly talk and meet people," Dao said. "It's much more scheduled."

 

As the format has switched, so have YC's terms. While startups in recent years received $150,000 in funding from YC in exchange for giving the accelerator 7% of their equity, startups in the fully online classes got just $125,000 for the same equity cut. YC also reduced its pro-rata rights, which allows the firm to invest in a startup's later funding rounds, to 4%.

The smaller checks have freed up money to invest in as many as 3,000 more companies, according to YC. That combined with the all-virtual format means YC is opening the doors to a broader, more diverse group of entrepreneurs than in the past and improving its odds of finding the next Airbnb. The summer 2021 batch of startups, which will present to outside investors during Demo Day this week, was the third conducted entirely online, and so far there are no plans to go back to being fully in person.

 

There's value in being in Silicon Valley, Ralston said. "There's something in the air and the water and the philosophy, the psychology of Silicon Valley that bleeds over into companies and is really useful," he said. But not everyone has the ability to move there for three months, and YC's experience working with startups remotely during the pandemic has made clear that that's OK.

Eventually, he said, Y Combinator's program will evolve into a mix of virtual offerings and some in-person events for those in Silicon Valley. But YC disputes any notion of it being a diploma mill, pointing to an acceptance rate of less than 2%. Even before the pandemic and the shift to the virtual format, YC was taking steps to ensure that the increasing number of startups didn't detract from the program by dividing batches into groups of 100.

 

"Are you the guy that invented Gmail?"

 

Today's screen-based experience is in some ways unrecognizable from the program's early days, when young founders regularly gathered with Paul Graham, YC's creator, for a home-cooked dinner of rice and beans on Tuesday nights.

The initial YC class, in the summer of 2005, consisted of just 10 startups working out of a squat, gray concrete-brick house in Cambridge, Massachusetts. Graham, or "PG," held a guru-like status among techies thanks to his popular blogs and a book of essays called "Hackers & Painters," which cast Silicon Valley as "an intellectual Wild West." And he had street cred, having sold an e-commerce startup to Yahoo for $50 million in the '90s.

It was a formative and career-defining experience for many of the first enrollees, including Alexis Ohanian and Steve Huffman, the founders of Reddit. They would go on to sell the company for millions of dollars about a year later, marking the first exit for YC's experimental investment model.

 

YC's four cofounders — Graham; his girlfriend at the time, Jessica Livingston; Trevor Blackwell; and Robert Tappan Morris — ran the entire program themselves in those days, eventually relocating to California. For startups, the experience was personal, immersive, and intense.

"All of the founders that were there were roughly all the same age. Everyone was growing in the same direction with their companies," said Jeff Morin, who did the summer 2008 batch with his company Anyvite. "Everyone was rooting for each other and helping each other out, providing advice and guidance if they could."

 

Even as class sizes grew, reaching 84 startups in the summer 2012 batch, and as YC brought on more partners, including Sam Altman, a 2005 alumnus, the YC experience was defined by personal interactions and coaching.

Founders frequently rented houses with their teammates or other companies, coding from the living rooms of mid-century California starter homes. The more adventurous commuted from San Francisco, where dozens of YC founders and alumni took over a 12-story building in North Beach dubbed the "Y-scraper."

 

For Jason Tan, a cofounder of Sift, the interactions with partners were invaluable. Shortly after starting the program, Tan looked at other startups in his cohort, including the lyric-annotation website Genius and the food-delivery app Caviar, and decided his anti-fraud startup was too boring. Tan and his cofounder wanted to pivot to something sexier, like a consumer app. They got into a heated debate with Altman, who was convinced that anti-fraud software was a better business.

At one point Altman left the room and returned a few minutes later with Graham, in his trademark khaki shorts, who stood and listened to the founders before delivering his verdict.

"Well, if you guys want to drive off a cliff, go for it," Graham said. "This is why we invest in 63 companies every summer."

Ten years later, Sift's anti-fraud business has raised $157 million from investors, and the company is worth $1 billion. Graham's instincts were "spot-on," Tan said.

Graham "wasn't always right, but he was usually right," said George Deglin, who went through the program with OneSignal in summer 2011. "And I think everyone appreciated him for being really direct."

 

The ability to learn from and meet legendary tech figures was another reason founders were willing to give up 7% of their company to join YC. The program regularly hosted founders like Twitter's Ev Williams, Facebook's Mark Zuckerberg, and, later, the cofounders of Airbnb, who stopped by YC's headquarters for in-person talks. Many of those guest-speaker talks have migrated online during the pandemic (Airbnb's founders have never missed a year, Ralston said), preserving an important, if not quite as memorable, aspect of the YC experience.

 

When Brian Fioca went through the program in 2008, he and his wife went to a party at Graham and Livingston's house. His wife, an artist, walked up to Graham and started chatting.

"Are you the guy that invented Gmail?" she asked. She was thinking of Paul Buchheit, a YC partner at the time.

"No, but he's here," Graham answered. "I can do an impression of him if you want."

 

Favorites and funding deals

 

Nearly all the startups Insider spoke with said they found their YC experience valuable. But a recurring criticism was that not all startups were treated equally. Each crop quickly divides into two unspoken camps: those that are deemed to be on a surefire path of success, and those that aren't.

"A lot of attention of YC partners was directed toward those companies that are obviously going to be amazingly successful," said one founder from summer 2014, who asked to remain anonymous but whose identity is known to Insider. "That came at the expense of all of the other companies."

The founders that needed the most help and hand-holding were often the ones left to flounder, the person said. Those disparities risk becoming more pronounced with more startups participating remotely and fewer opportunities for spontaneous run-ins with YC's power brokers.

 

"I definitely got that vibe that there are favorites," said Trent Hedge, a cofounder of Atmos, which participated in the summer 2020 program. Hedge didn't describe any founders getting inferior or insufficient attention, and he gave YC high marks, even in the online-only format. But his comments speak to the importance of forging strong relationships.  "You only need one partner who agrees, who vouches for you, will typically favor you through the whole process. Typically they will determine their top one to three companies," he said.

The perception of favorites underscores the challenges ahead for Ralston, the third president in YC's history. (Graham stepped back from day-to-day involvement in 2014, and Altman left entirely after moving to the chairman role in 2019.)

Graham still keeps in touch with Ralston and has a financial stake in YC. In an email to Insider, Graham endorsed the supersized strategy, saying that "YC doesn't have to degrade as much as most things would when growing 50x, because it's completely parallelizable."

Graham acknowledged that the virtual format of the program was a risk in terms of quality, but he said the benefit of bringing YC to founders outside the US might make the trade-off worthwhile.

 

"Arguably startups have a better experience now than they had in the beginning, because in the beginning few investors took YC startups seriously, whereas now the YC brand gives them some level of credibility automatically. So if founders get the same amount of attention from partners plus investors take them more seriously, they're better off," Graham wrote. And, he added, "the food is much better than when I was cooking it."

There are some encouraging signs. As of July, the top companies in the summer 2020 batch had an average return on capital of 1.65x, and the top companies in the winter 2021 batch had an average return on capital of 1.5x, according to a summary sent to investors in the Pioneer Fund, a syndicate of mostly YC alumni that invests in a selection of the top companies of YC batches. This means that after Pioneer invested, those young companies became an average of 1.5 times as valuable. (The multiple is based on changes to the average valuation after the Pioneer Fund's initial seed investment.)

 

A lot of times the market valuation for YC companies is not justifying what value has been created

By comparison, the top companies in the winter 2018 batch had an average return on capital of about 1.35x after one year and just over 1x after three months. The winter 2018 companies are now valued at an average multiple of about 5.1x, according to the summary. That includes Shogun, which was recently valued at $575 million, for a return on capital to the fund of 57x.

The real test will come in the years ahead, as it becomes clearer how many in the cohort survive and thrive and whether any of the all-virtual graduates evolve into billion-dollar unicorns. Some VCs already see fast-rising valuations of fledgling YC startups as more of a product of good marketing than demonstrable merit.

"I feel that a lot of times the market valuation for YC companies is not justifying what value has been created," Heather Hartnett, a founding partner at Human Ventures, told Insider.

"They've done a good job scaling," Hartnett said. "But they definitely are not a high-touch platform anymore, where they were before."

 

Another prominent early-stage VC was blunt: "I don't give a rat's ass if you went to YC."

Some VCs bristle at the accelerator's involvement in funding deals. Two VC investors who wished to remain anonymous told Insider they had firsthand experience with YC holding up funding deals, using its 7% stake and pro-rata rights in startups as leverage to dictate terms favorable to YC.

"There is always an arm wrestle that happens in a hot Series A," said Ian Rountree, a Cantos Ventures partner, "but in many cases," YC acts as if it's "in opposition to the new investor."

"And the founders can be collateral damage," he said.

 

Ralston dismissed the criticism as disingenuous. "You know, pro rata is a right. It's called a right," he said. "And we have a fiduciary duty to our investors to take them," adding that in some cases, YC is willing to reduce its pro rata  in hot funding deals to "make that not a problem."

 

Barred from the community

 

Every day, thousands of founders who earned their wings through YC converge on Bookface, a special members-only social network where insiders share everything from hiring references and business advice to exclusive investing opportunities in startups.

Bookface operates under a strict code of confidentiality. But as YC has grown, the program has lost some of its ability to control what people in its community do or say, causing a couple of bitter, high-profile disputes this summer. The episodes resulted in YC kicking two alumni out of the network, leaving an embarrassing blemish on something YC has long touted as one of its perks.

Katia Damer, the CEO of Prolific, a 2019 alumna who was one of the banished founders, blasted YC on Twitter. "At this point YC are literally self-sabotaging. One way to make your own organisation fail," Damer tweeted.

YC justified the expulsions on the grounds that the alumni violated its rules by publicly sharing discussions that had taken place on Bookface. Those rules, like the strictures on raising money before Demo Day, are increasingly colliding with the realities of an organization that's evolved significantly since their creation.

 

Like many of the startups it has advised over the years, Y Combinator may need to make some adjustments if it wants to realize its dreams.

 

 

Source: https://www.businessinsider.com/inside-y-combinator-growth-spurt-51-startup-founders-biggest-changes-2021-8

 

 

Other news