Business modelsStartup general interest

Y Combinator growth benchmark

By October 8, 2012 2 Comments

Back in September Y Combinator founder Paul Graham wrote an essay about growth. The central point of his essay is that startups are all about growth and that is the one thing they measure at Y Combinator. According to Paul most startups should look at revenue growth, but active users is a good proxy for companies that aren’t charging their customers (yet).

Because the Y Combinator program is short (3 months) they measure growth weekly. Here are the benchmarks:

A good growth rate during YC is 5-7% a week. If you can hit 10% a week you’re doing exceptionally well. If you can only manage 1%, it’s a sign you haven’t yet figured out what you’re doing.

Paul goes on to point out that growth is exponential and that small differences in the weekly percentage growth rate have a surprisingly big impact on where a company ends up after a year or two:

A company that grows at 1% a week will grow 1.7x a year, whereas a company that grows at 5% a week will grow 12.6x. A company making $1000 a month (a typical number early in YC) and growing at 1% a week will 4 years later be making $7900 a month, which is less than a good programmer makes in salary in Silicon Valley. A startup that grows at 5% a week will in 4 years be making $25 million a month.

I share the view that growth is critical, and that without very high growth rates early on a business will never grow big. Growth is the main driver of value in our companies and it is what makes them exciting to IPO investors and acquirers. I disagree that growth should be the sole focus though. In practice most businesses are cash constrained and have to optimise the trade off between investing in growth and running out of cash – so they focus on growth AND operational efficiency. The unknown variable here of course is the ability to raise more money, and there may be a difference between what Paul is saying and what I’m saying purely because Y Combinator companies growing at 5% per week are always able to raise capital and therefore can focus on growth knowing that if they hit their growth target they will never run out of capital.

Most companies aren’t so lucky. They need to maximise for growth whilst either getting to profitability within their existing resources or maximise for increase in valuation at the next round by thinking of the milestones they can hit before running out of cash. Many of those milestones will be growth oriented, but they often centre on hitting round numbers – e.g. $10k or $100k per month in revenues or 1m active users. Hitting these milestones takes time and growing faster but running out of cash before they are reached may not be the best strategy.

(Paul arguably covers this point when he says that entrepreneurs should look forward to make sure that growth can be maintained, and stopping growing because cash has run out would definitely be a failure to look forward. I wanted to make it more explicit.)

Finally there is sustainable growth and unsustainable growth. That may not matter much when companies are just getting going in Y Combinator but it is critical as a business grows. The classic case of unsustainable growth is where each customer costs more to acquire than his or her life time value. It is mostly ecommerce companies I’ve seen suffering from this problem. To maximise growth in the early days they spend a lot of money on marketing and sometimes lower prices to attract users. Impressive revenue growth follows, but losses rise at an equally rapid rate, and the company has to raise more money to keep growing. To show that the company will make profits in the end management produce models that assume metrics like gross margin, customer repeat rates, and customer acquisition costs will improve going forward. Sometimes investors are convinced. Sometimes not. The standout example of this sort of thinking recently was Groupon which convinced investors at its IPO that their customers were very loyal and that they could at any point become profitable by halting spend to acquire new customers. Many potential investors chose to stay on the side lines because they didn’t believe the assumption about customer loyalty and feared the company was structurally unprofitable and growing unsustainably.