3 important questions every startup should answer during fundraising
It’s that time of year again, when a new cohort of talented, aspiring minds apply for entry to a highly selective institution of learning. College application season? Nope. Y Combinator application season. Now going into its 17th year, startups are applying now to join the ranks of over 3,500 companies that have gone through YC’s prestigious accelerator and achieved a combined valuation approaching $1 trillion dollars.
As I’ve written about previously, YC singlehandedly produces the investment volume of about 30 VC funds combined. Like the Dow Jones Industrial Average is for public stocks, YC is effectively an index on early stage startups. That means there’s a lot we can learn from how YC operates (what sectors they focus on, what regions they invest in, etc.) as their behavior is representative of the overall venture capital industry. For example, YC’s investment activity in Developer Tools startups mirrored the overall seed industry’s investment activity in that category, with a rise in Developer Tools companies both in YC and across the industry beginning in 2010, followed by a drop off in 2015, and then a rebound in 2017.
But just as important as what YC is investing in, is how YC invests. Like a college, YC asks companies to fill out a standard application that they use to screen which companies to back. An application that helps them assess founder qualities and business characteristics. Since YC is like a startup index, their application process — what they look for in companies they invest in — is perhaps also an index into what the VC industry looks for in companies too.
Can the written application that YC uses provide a glimpse into the unwritten application that other investors use? Can understanding what matters to YC help entrepreneurs understand what matters to investors elsewhere? Can studying the questions on the YC app help startups figure out the answers to communicating and pitching more effectively to investors in general?
The 3 most important questions
The YC application has 38 question fields to fill out. A lot of them are basic and procedural (company name, company location, how many founders, etc.), but many are also probing questions meant to assess a specific company characteristic or trait that YC believes is a determiner of future success.
From studying the app, there are 3 questions that stand out as the most interesting based on my time as an investor and entrepreneur. 3 questions important enough that they are asked multiple times within the YC application. The wording is different, but the intent behind those questions — the company traits that those separate questions are judging — is what’s the same.
I refer to those 3 traits as the 3 Ps: Proximity, Pace, and Potential. These are 3 things that investors care a lot about so whether you’re applying to YC or fundraising with a VC firm, the 3 Ps are important traits your startup pitch needs to showcase.
Investors gravitate towards founders who have worked in the industry they are targeting, lived through the problem they are solving, or built alternative solutions before that they are now going to improve on. That’s why there are so many examples of security companies built by CSOs, or DeFi apps built by crypto traders, or GenZ photo sharing apps built by college kids. Those entrepreneurs are all proximate to their market. And that’s why YC asks these two questions:
What these questions are trying to assess is the trait of Proximity. Are the founders proximate to the opportunity they are pursuing? Do they have a background that gives them insights, intuition, confidence, and credibility about their target market?
Proximity can often be the reason why a product finds market fit and is adopted, or a customer gains business value and is retained. That’s why YC and other investors try to assess founder Proximity during their diligence process because that inside knowledge and experience about a market can be the difference between company success or failure. And that’s why explaining your proximity is a must-do in any startup pitch.
The YC app has an entire section called “Progress” focused on company and product headway. Company milestones are obviously an important factor in investment decisions — the more a company has accomplished, the more valuable it likely is. But also of interest to investors beyond the achievements themselves, is how they were achieved. Or even more specifically how fast they were achieved, which is what YC is trying to find out with these next questions.
Pace is a virtue for any startup, and for early stage companies it may be their primary virtue. When you can’t outsize or out-resource the competition, you can still outrun them, and that speed of execution or Pace is what investors are looking for as an indicator of future success.
Not all milestones are judged equally because of Pace. 1 million MAUs or $1 million in ARR or 100k subscribers are all impressive accomplishments. But hitting those numbers in year 2 could be signs of a business that’s 10x bigger in a few years, whereas achieving the same milestones in year 5 might be signs of a business that’s plateaued.
It’s not just Pace in business metrics that matter. The company trait of Pace applies to product development, design updates, recruiting, closing customer leads, even responding to emails quickly. Pace ultimately suggests an operating advantage that a startup may have that can help them grow from a small company into a huge business. An advantage all entrepreneurs should highlight when communicating to investors.
Revenue is the ultimate scorecard for any startup as every for-profit business has to make money at some point. The YC app asks multiple questions about your company’s revenue, but the most interesting answer is not what your revenue is, but rather what your revenue could be.
Startup investing is a hits driven business. The top 10% of company investments drive 90% of returns meaning the best successes are huge, hit companies. And to even have a chance of building a hit company, the market opportunity the startup is pursuing has to be sufficiently large to begin with. A market whose Potential size is measured not in millions but in billions or even trillions of dollars.
Out of all the investment decision meetings I’ve been a part of over the years, the most common reason I’ve seen investors pass on a company is because of lack of size or Potential. They see a million dollar idea, but not a billion dollar idea. They see the Potential for a good company, but maybe not a great one. If you know your investor is looking for a hit, make sure to explain the company you are building has the Potential to become one.
Examples of the 3 Ps
At Gold House Ventures, the leading Asian and Pacific Islander-focused venture capital fund, we’ve invested in over 50 companies to date. During our many meetings with startups, the most memorable pitches were often when entrepreneurs highlighted one of the 3 Ps to describe their company.
Here are real world examples of the 3 Ps from the pitches of talented Gold House Ventures entrepreneurs we are honored to back:
- Proximity: Aerovect automates airport logistics with an advanced self driving system for luggage handlers and other ground support equipment. One cofounder is a Harvard computer scientist who worked in the aviation industry and is a licensed pilot. The other cofounder is a Harvard economist who studied aeronautics at MIT and has a deep understanding of airline economics. It’s hard to imagine a team more proximate to their market, with skills and intuition perfectly matched for this opportunity, than Raymond and Eugenio at Aerovect.
- Pace: Mercaso runs a B2B marketplace for SMBs to purchase the most comprehensive assortment of wholesale fast-moving consumer goods. The team went from idea to launch in just 2 months. And in their first year of operation, the business has grown 20% month-over-month and generated millions in sales, while also building a web and mobile ordering platform and operating their own fleet of trucks and micro-fulfillment center. The speed at which Mercaso moves their business forward with a small, lean team is truly remarkable and inspires confidence in what ambitious things they plan to achieve next.
- Potential: Vividly builds AI-powered tools and software to help food and beverage brands get the most out of their trade promotion. Over $1 trillion is spent annually on trade promotion, of which 60% is estimated to be money losing creating a huge need for efficiency improvements. Vividly is targeting the estimated $70 billion that CPG companies will spend next year on tools and services to better manage their trade promotion. It’s clear that Vividly has the potential to build a giant revenue business.
Regardless if you’re applying to YC or pitching to a VC, entrepreneurs should tell their own story about how they are Proximity to their market, show their rapid Pace of innovation and progress, and explain why the Potential opportunity they are pursuing is huge and important. Do that, and you may find the 3 Ps grabbing attention, sparking imagination, and getting people excited to invest.