Next week, YC’s first fall batch will present at Demo Day. Here is what will distinguish the top companies from the stragglers, based on my scores of meetings with YC companies over the years.
1) Top Tier. This elite group makes up 5-10% of the batch.
These companies have built a serious business in a very short period of time. They have significant revenue, typically $150,000 to $500,000 ARR.
You’ll see these guys raising $2 million at a $20-25 million post-money valuation. The rounds often wind up oversubscribed.
2) Mid Tier. This is the average YC startup, perhaps 60% of the batch. Expect to see revenue of $3-5,000 a month, often in pilots.
You’ll usually see these raising $2 million at a $20 million post-money valuation. The rounds do not usually oversubscribe.
3) Lower Tier. This final group of companies is struggling to sign customers. It represents perhaps 30% of the batch.
Expect to see zero revenue with these. They may have some Letters of Intent (LOI’s) or a rich pipeline, but cash is king, and they don’t have it yet.
You can pick these up at a $15 to $20 million cap. The round is unlikely to oversubscribe.
Even if a startup isn’t at the front of the pack on Demo Day, it can still be a huge success. No one can look at a brand new company and say for sure where it’s headed.
Why Investing in YC Companies Is Hard
Let’s take the average YC company at Demo Day. We’re talking about a startup with a couple thousand a month in revenue priced at a $20 million cap.
If you build an entire portfolio of these, it will be very hard to make money.
Assume a miracle happens and one of these startups hits a $1 billion valuation. You’ll be diluted by half along the way, giving you a 25x return.
A portfolio of early stage startups might contain 30-40 companies. So, that $1 billion outcome didn’t even return the fund. Meanwhile, most of the others are probably failing.
The fundamental problem for the investor is that these are pre-seed companies priced like late seed stage startups with $500,000-$1 million ARR.
How I Approach Investing at YC
That said, YC has a history of producing some of the best companies. I don’t want to exclude YC as a source of deals.
I pick off one or two excellent YC startups a year before Demo Day. I also invest in others a year or two after Demo Day, when their traction has caught up to their valuation.
This gives me a portfolio with a couple high priced deals balanced out by many cheaper ones in non-YC companies. My average entry price stays reasonable, at $9.7 million for companies averaging around $300k ARR throughout 2024.
Wrap-Up
YC does a ton of filtering for the investor. They also give their startups some of the best coaching on earth.
This valuable service isn’t free. Hence the higher valuations.
Like any luxury product, it’s okay to indulge from time to time — if you have the money.
Note: YC also admits many biotech and deep tech companies. Those companies have entirely different benchmarks and I don’t invest in those areas, so they are excluded from this analysis.
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