September 2012

A startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup.

Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of "exit."

The only essential thing is growth.

Everything else we associate with startups follows from growth.

If you want to start one it's important to understand that.

Startups are so hard that you can't be pointed off to the side and hope to succeed.

You have to know that growth is what you're after.

The good news is, if you get growth, everything else tends to fall into place.

Which means you can use growth like a compass to make almost every decision you face.

A startup is a company designed to grow fast. Being newly founded, working on technology, taking venture funding, having an "exit" — none of that is essential. The only essential thing is growth; everything else follows from it.

You have to know that growth is what you're after — startups are too hard to succeed at while pointed off to the side. If you get growth, everything else tends to fall into place. You can use growth like a compass to make almost every decision.

A startup is a company designed to grow fast; the only essential thing is growth, and everything else we associate with startups follows from it.

Redwoods

Let's start with a distinction that should be obvious but is often overlooked: not every newly founded company is a startup.

Millions of companies are started every year in the US.

Only a tiny fraction are startups.

Most are service businesses — restaurants, barbershops, plumbers, and so on.

These are not startups, except in a few unusual cases.

A barbershop isn't designed to grow fast. Whereas a search engine, for example, is.

When I say startups are designed to grow fast, I mean it in two senses.

Partly I mean designed in the sense of intended, because most startups fail.

But I also mean startups are different by nature, in the same way a redwood seedling has a different destiny from a bean sprout.

That difference is why there's a distinct word, "startup," for companies designed to grow fast. If all companies were essentially similar, but some through luck or the efforts of their founders ended up growing very fast, we wouldn't need a separate word.

We could just talk about super-successful companies and less successful ones.

But in fact startups do have a different sort of DNA from other businesses.

Google is not just a barbershop whose founders were unusually lucky and hard-working.

Google was different from the beginning.

To grow rapidly, you need to make something you can sell to a big market.

That's the difference between Google and a barbershop.

A barbershop doesn't scale.

For a company to grow really big, it must (a) make something lots of people want, and (b) reach and serve all those people.

Barbershops are doing fine in the (a) department.

Almost everyone needs their hair cut.

The problem for a barbershop, as for any retail establishment, is (b).

A barbershop serves customers in person, and few will travel far for a haircut.

And even if they did, the barbershop couldn't accomodate them. [1]

Writing software is a great way to solve (b), but you can still end up constrained in (a).

If you write software to teach Tibetan to Hungarian speakers, you'll be able to reach most of the people who want it, but there won't be many of them.

If you make software to teach English to Chinese speakers, however, you're in startup territory.

Most businesses are tightly constrained in (a) or (b).

The distinctive feature of successful startups is that they're not.

Not every newly founded company is a startup. Of the millions started each year in the US, only a tiny fraction are. Most are service businesses — restaurants, barbershops, plumbers. A barbershop isn't designed to grow fast; a search engine is.

I mean designed in two senses: intended, because most startups fail, but also different by nature — the way a redwood seedling has a different destiny from a bean sprout. That's why we have a separate word: if companies were merely similar but some got lucky, we wouldn't need one. Startups have a different sort of DNA. Google was not a lucky barbershop; Google was different from the beginning.

To grow rapidly, you need to make something you can sell to a big market — the difference between Google and a barbershop. A barbershop doesn't scale. To grow really big a company must (a) make something lots of people want, and (b) reach and serve all of them. Barbershops are fine on (a) — everyone needs a haircut — but fail on (b): they serve customers in person, and few will travel far.

Software solves (b) but can leave you constrained in (a). Teach Tibetan to Hungarian speakers and you reach everyone who wants it, but there won't be many; teach English to Chinese speakers and you're in startup territory. Successful startups are constrained in neither.

Not every new company is a startup; startups are designed by nature to grow fast, which means making something a big market wants and being able to reach all of them.

Ideas

It might seem that it would always be better to start a startup than an ordinary business.

If you're going to start a company, why not start the type with the most potential?

The catch is that this is a (fairly) efficient market.

If you write software to teach Tibetan to Hungarians, you won't have much competition.

If you write software to teach English to Chinese speakers, you'll face ferocious competition, precisely because that's such a larger prize. [2]

The constraints that limit ordinary companies also protect them.

That's the tradeoff.

If you start a barbershop, you only have to compete with other local barbers.

If you start a search engine you have to compete with the whole world.

The most important thing that the constraints on a normal business protect it from is not competition, however, but the difficulty of coming up with new ideas.

If you open a bar in a particular neighborhood, as well as limiting your potential and protecting you from competitors, that geographic constraint also helps define your company.

Bar + neighborhood is a sufficient idea for a small business.

Similarly for companies constrained in (a).

Your niche both protects and defines you.

Whereas if you want to start a startup, you're probably going to have to think of something fairly novel.

A startup has to make something it can deliver to a large market, and ideas of that type are so valuable that all the obvious ones are already taken.

That space of ideas has been so thoroughly picked over that a startup generally has to work on something everyone else has overlooked.

I was going to write that one has to make a conscious effort to find ideas everyone else has overlooked.

But that's not how most startups get started.

Usually successful startups happen because the founders are sufficiently different from other people that ideas few others can see seem obvious to them.

Perhaps later they step back and notice they've found an idea in everyone else's blind spot, and from that point make a deliberate effort to stay there. [3] But at the moment when successful startups get started, much of the innovation is unconscious.

What's different about successful founders is that they can see different problems. It's a particularly good combination both to be good at technology and to face problems that can be solved by it, because technology changes so rapidly that formerly bad ideas often become good without anyone noticing.

Steve Wozniak's problem was that he wanted his own computer.

That was an unusual problem to have in 1975.

But technological change was about to make it a much more common one.

Because he not only wanted a computer but knew how to build them, Wozniak was able to make himself one.

And the problem he solved for himself became one that Apple solved for millions of people in the coming years.

But by the time it was obvious to ordinary people that this was a big market, Apple was already established.

Google has similar origins.

Larry Page and Sergey Brin wanted to search the web.

But unlike most people they had the technical expertise both to notice that existing search engines were not as good as they could be, and to know how to improve them.

Over the next few years their problem became everyone's problem, as the web grew to a size where you didn't have to be a picky search expert to notice the old algorithms weren't good enough.

But as happened with Apple, by the time everyone else realized how important search was, Google was entrenched.

That's one connection between startup ideas and technology.

Rapid change in one area uncovers big, soluble problems in other areas.

Sometimes the changes are advances, and what they change is solubility.

That was the kind of change that yielded Apple; advances in chip technology finally let Steve Wozniak design a computer he could afford.

But in Google's case the most important change was the growth of the web.

What changed there was not solubility but bigness.

The other connection between startups and technology is that startups create new ways of doing things, and new ways of doing things are, in the broader sense of the word, new technology.

When a startup both begins with an idea exposed by technological change and makes a product consisting of technology in the narrower sense (what used to be called "high technology"), it's easy to conflate the two.

But the two connections are distinct and in principle one could start a startup that was neither driven by technological change, nor whose product consisted of technology except in the broader sense. [4]

Why not always start a startup, the type with the most potential? Because this is a fairly efficient market. Teach Tibetan to Hungarians and you'll have little competition; teach English to Chinese speakers and you'll face ferocious competition, precisely because the prize is larger.

The constraints that limit ordinary companies also protect them — start a barbershop and you compete only with local barbers, not the whole world. But the most important thing they protect a business from is not competition; it's the difficulty of coming up with new ideas. Bar + neighborhood is a sufficient idea for a small business: your niche both protects and defines you.

A startup must think of something novel — deliverable to a large market, where the obvious ideas are already taken — so it works on what everyone else has overlooked. You'd think this takes conscious effort, but usually founders are simply different enough that ideas few can see seem obvious to them. At the moment of founding, much of the innovation is unconscious.

What's different about successful founders is that they see different problems. Being good at technology while facing problems it can solve is powerful, because technology changes so fast that formerly bad ideas quietly become good. Steve Wozniak wanted his own computer — an unusual problem in 1975, but one change was about to make common. Because he could build one, he did, and Apple later solved it for millions, established before the market was obvious.

Google has similar origins. Page and Brin wanted to search the web, and unlike most had the expertise to see existing engines weren't good enough and improve them. Their problem became everyone's as the web outgrew the old algorithms — and as with Apple, by the time everyone realized how important search was, Google was entrenched.

That's one connection between ideas and technology: rapid change uncovers big, soluble problems elsewhere. Sometimes what changes is solubility — chip advances finally let Wozniak afford a computer; in Google's case it was bigness, the growth of the web. The other connection is that startups create new ways of doing things, themselves new technology in the broader sense. The two are easy to conflate but distinct, and in principle a startup could involve neither.

Startups must work on novel ideas because the obvious large-market ones are taken; the best founders see problems others can't, often ones technological change has just made soluble or big.

Rate

How fast does a company have to grow to be considered a startup?

There's no precise answer to that.

"Startup" is a pole, not a threshold.

Starting one is at first no more than a declaration of one's ambitions.

You're committing not just to starting a company, but to starting a fast growing one, and you're thus committing to search for one of the rare ideas of that type.

But at first you have no more than commitment.

Starting a startup is like being an actor in that respect.

"Actor" too is a pole rather than a threshold.

At the beginning of his career, an actor is a waiter who goes to auditions.

Getting work makes him a successful actor, but he doesn't only become an actor when he's successful.

So the real question is not what growth rate makes a company a startup, but what growth rate successful startups tend to have.

For founders that's more than a theoretical question, because it's equivalent to asking if they're on the right path.

The growth of a successful startup usually has three phases:

There's an initial period of slow or no growth while the startup tries to figure out what it's doing.

As the startup figures out how to make something lots of people want and how to reach those people, there's a period of rapid growth.

Eventually a successful startup will grow into a big company.

Growth will slow, partly due to internal limits and partly because the company is starting to bump up against the limits of the markets it serves. [5]

Together these three phases produce an S-curve.

The phase whose growth defines the startup is the second one, the ascent.

Its length and slope determine how big the company will be.

The slope is the company's growth rate.

If there's one number every founder should always know, it's the company's growth rate.

That's the measure of a startup.

If you don't know that number, you don't even know if you're doing well or badly.

When I first meet founders and ask what their growth rate is, sometimes they tell me "we get about a hundred new customers a month."

That's not a rate.

What matters is not the absolute number of new customers, but the ratio of new customers to existing ones.

If you're really getting a constant number of new customers every month, you're in trouble, because that means your growth rate is decreasing.

During Y Combinator we measure growth rate per week, partly because there is so little time before Demo Day, and partly because startups early on need frequent feedback from their users to tweak what they're doing. [6]

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.

The best thing to measure the growth rate of is revenue.

The next best, for startups that aren't charging initially, is active users.

That's a reasonable proxy for revenue growth because whenever the startup does start trying to make money, their revenues will probably be a constant multiple of active users. [7]

How fast must a company grow to count as a startup? There's no precise answer. "Startup" is a pole, not a threshold. Starting one is at first just a declaration of ambition — a commitment to build a fast-growing company and search for one of those rare ideas.

It's like being an actor: at the start of his career an actor is a waiter who goes to auditions, but he doesn't only become an actor when he succeeds. So the real question is not what rate makes a company a startup, but what rate successful startups have — for founders, equivalent to asking whether they're on the right path.

A successful startup's growth usually has three phases: slow growth while it figures out what it's doing; rapid growth once it knows how to make something wanted and reach people; and a slowing as it hits internal and market limits. These produce an S-curve, and the defining phase is the second, the ascent — its length and slope determine how big the company gets.

The slope is the growth rate. If there's one number every founder should always know, it's that — the measure of a startup. Without it you don't even know whether you're doing well or badly.

"About a hundred new customers a month" is not a rate. What matters isn't the absolute number of new customers but the ratio of new to existing ones — a constant number every month means your growth rate is decreasing.

During YC we measure growth per week, because there's little time before Demo Day and startups need frequent feedback. A good rate is 5-7% a week; 10% is exceptional; 1% means you haven't figured it out yet.

Best to measure revenue; next best, for startups not yet charging, active users — a reasonable proxy for revenue growth.

"Startup" is a pole, not a threshold; the question is what growth rate successful startups have. A good rate during YC is 5-7% a week, and it's the one number every founder must know.

Compass

We usually advise startups to pick a growth rate they think they can hit, and then just try to hit it every week.

The key word here is "just." If they decide to grow at 7% a week and they hit that number, they're successful for that week.

There's nothing more they need to do.

But if they don't hit it, they've failed in the only thing that mattered, and should be correspondingly alarmed.

Programmers will recognize what we're doing here.

We're turning starting a startup into an optimization problem.

And anyone who has tried optimizing code knows how wonderfully effective that sort of narrow focus can be.

Optimizing code means taking an existing program and changing it to use less of something, usually time or memory.

You don't have to think about what the program should do, just make it faster.

For most programmers this is very satisfying work.

The narrow focus makes it a sort of puzzle, and you're generally surprised how fast you can solve it.

Focusing on hitting a growth rate reduces the otherwise bewilderingly multifarious problem of starting a startup to a single problem.

You can use that target growth rate to make all your decisions for you; anything that gets you the growth you need is ipso facto right.

Should you spend two days at a conference?

Should you hire another programmer?

Should you focus more on marketing?

Should you spend time courting some big customer?

Should you add x feature?

Whatever gets you your target growth rate. [8]

Judging yourself by weekly growth doesn't mean you can look no more than a week ahead.

Once you experience the pain of missing your target one week (it was the only thing that mattered, and you failed at it), you become interested in anything that could spare you such pain in the future.

So you'll be willing for example to hire another programmer, who won't contribute to this week's growth but perhaps in a month will have implemented some new feature that will get you more users.

But only if (a) the distraction of hiring someone won't make you miss your numbers in the short term, and (b) you're sufficiently worried about whether you can keep hitting your numbers without hiring someone new.

It's not that you don't think about the future, just that you think about it no more than necessary.

In theory this sort of hill-climbing could get a startup into trouble.

They could end up on a local maximum.

But in practice that never happens.

Having to hit a growth number every week forces founders to act, and acting versus not acting is the high bit of succeeding.

Nine times out of ten, sitting around strategizing is just a form of procrastination.

Whereas founders' intuitions about which hill to climb are usually better than they realize.

Plus the maxima in the space of startup ideas are not spiky and isolated.

Most fairly good ideas are adjacent to even better ones.

The fascinating thing about optimizing for growth is that it can actually discover startup ideas.

You can use the need for growth as a form of evolutionary pressure.

If you start out with some initial plan and modify it as necessary to keep hitting, say, 10% weekly growth, you may end up with a quite different company than you meant to start.

But anything that grows consistently at 10% a week is almost certainly a better idea than you started with.

There's a parallel here to small businesses.

Just as the constraint of being located in a particular neighborhood helps define a bar, the constraint of growing at a certain rate can help define a startup.

You'll generally do best to follow that constraint wherever it leads rather than being influenced by some initial vision, just as a scientist is better off following the truth wherever it leads rather than being influenced by what he wishes were the case.

When Richard Feynman said that the imagination of nature was greater than the imagination of man, he meant that if you just keep following the truth you'll discover cooler things than you could ever have made up.

For startups, growth is a constraint much like truth.

Every successful startup is at least partly a product of the imagination of growth. [9]

We advise startups to pick a growth rate they can hit and just hit it every week. The key word is "just." Hit 7% and you've succeeded for that week. Miss it and you've failed at the only thing that mattered, and should be correspondingly alarmed.

Programmers will recognize this: we're turning starting a startup into an optimization problem, and that narrow focus is wonderfully effective. Just as optimizing code means making a program faster without deciding what it should do, a growth target reduces the bewilderingly multifarious problem of starting a startup to one: anything that gets you the growth you need is ipso facto right. A conference, another programmer, more marketing? Whatever gets you your target growth rate.

This doesn't mean looking only a week ahead. Once you feel the pain of missing your target, you'll do anything to spare yourself it in future — but you think about the future no more than necessary.

In theory this hill-climbing could strand you on a local maximum, but in practice it never happens. Having to hit a number weekly forces founders to act, and acting versus not acting is the high bit of succeeding; strategizing is usually just procrastination. Founders' intuitions about which hill to climb are better than they realize, and most good ideas are adjacent to even better ones.

Optimizing for growth can actually discover startup ideas. Use the need for growth as evolutionary pressure: modify your plan to keep hitting 10% a week and you may end up with a quite different — and almost certainly better — company than you started with.

Just as a neighborhood helps define a bar, a growth rate can help define a startup. Follow that constraint wherever it leads rather than your initial vision, like a scientist following the truth. When Feynman said nature's imagination exceeds man's, he meant the truth turns up cooler things than you could invent. For startups, growth is a constraint like truth.

Turn the startup into an optimization problem: pick a weekly growth rate and just hit it. That single target makes your decisions for you and can even evolve a better idea than you started with.

Value

It's hard to find something that grows consistently at several percent a week, but if you do you may have found something surprisingly valuable.

If we project forward we see why.

weeklyyearly 1%1.7x 2%2.8x 5%12.6x 7%33.7x 10%142.0x

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. [10]

Our ancestors must rarely have encountered cases of exponential growth, because our intuitions are no guide here.

What happens to fast growing startups tends to surprise even the founders.

Small variations in growth rate produce qualitatively different outcomes.

That's why there's a separate word for startups, and why startups do things that ordinary companies don't, like raising money and getting acquired.

And, strangely enough, it's also why they fail so frequently.

Considering how valuable a successful startup can become, anyone familiar with the concept of expected value would be surprised if the failure rate weren't high.

If a successful startup could make a founder $100 million, then even if the chance of succeeding were only 1%, the expected value of starting one would be $1 million.

And the probability of a group of sufficiently smart and determined founders succeeding on that scale might be significantly over 1%.

For the right people — e.g. the young Bill Gates — the probability might be 20% or even 50%.

So it's not surprising that so many want to take a shot at it.

In an efficient market, the number of failed startups should be proportionate to the size of the successes.

And since the latter is huge the former should be too. [11]

What this means is that at any given time, the great majority of startups will be working on something that's never going to go anywhere, and yet glorifying their doomed efforts with the grandiose title of "startup."

This doesn't bother me.

It's the same with other high-beta vocations, like being an actor or a novelist. I've long since gotten used to it.

But it seems to bother a lot of people, particularly those who've started ordinary businesses.

Many are annoyed that these so-called startups get all the attention, when hardly any of them will amount to anything.

If they stepped back and looked at the whole picture they might be less indignant.

The mistake they're making is that by basing their opinions on anecdotal evidence they're implicitly judging by the median rather than the average.

If you judge by the median startup, the whole concept of a startup seems like a fraud.

You have to invent a bubble to explain why founders want to start them or investors want to fund them.

But it's a mistake to use the median in a domain with so much variation.

If you look at the average outcome rather than the median, you can understand why investors like them, and why, if they aren't median people, it's a rational choice for founders to start them.

Something growing at several percent a week is hard to find but may be surprisingly valuable. A company growing 1% a week grows 1.7x a year; at 5%, 12.6x. The same $1000-a-month company would, four years later, make $7900 at 1% — less than a programmer's salary — but $25 million a month at 5%.

Our ancestors rarely encountered exponential growth, so our intuitions are no guide; what happens to fast-growing startups surprises even the founders. Small variations in growth rate produce qualitatively different outcomes — which is why there's a separate word for startups, why they raise money and get acquired, and, strangely enough, why they fail so frequently.

Anyone who understood expected value would expect a high failure rate. If success makes a founder $100 million, even a 1% chance gives an expected value of $1 million — and for the right people, like the young Bill Gates, the probability might be 20% or 50%. In an efficient market the failures are proportionate to the successes, and since those are huge, so are the failures.

What this means is that at any given time, the great majority of startups will be working on something that's never going to go anywhere, and yet glorifying their doomed efforts with the grandiose title of "startup."

This doesn't bother me — it's the same with other high-beta vocations. But it bothers people who've started ordinary businesses, annoyed these so-called startups get the attention when hardly any will amount to anything.

Their mistake is judging by the median rather than the average. By the median startup the whole concept looks like a fraud you need a bubble to explain. But the median misleads in a domain with so much variation; by the average you see why investors fund startups and why founding one is rational.

Small variations in weekly growth produce qualitatively different outcomes, which is why startups are valuable, why they fail so often, and why you must judge them by the average, not the median.

Deals

Why do investors like startups so much?

Why are they so hot to invest in photo-sharing apps, rather than solid money-making businesses?

Not only for the obvious reason.

The test of any investment is the ratio of return to risk.

Startups pass that test because although they're appallingly risky, the returns when they do succeed are so high.

But that's not the only reason investors like startups.

An ordinary slower-growing business might have just as good a ratio of return to risk, if both were lower.

So why are VCs interested only in high-growth companies?

The reason is that they get paid by getting their capital back, ideally after the startup IPOs, or failing that when it's acquired.

The other way to get returns from an investment is in the form of dividends.

Why isn't there a parallel VC industry that invests in ordinary companies in return for a percentage of their profits?

Because it's too easy for people who control a private company to funnel its revenues to themselves (e.g. by buying overpriced components from a supplier they control) while making it look like the company is making little profit.

Anyone who invested in private companies in return for dividends would have to pay close attention to their books.

The reason VCs like to invest in startups is not simply the returns, but also because such investments are so easy to oversee.

The founders can't enrich themselves without also enriching the investors. [12]

Why do founders want to take the VCs' money?

Growth, again.

The constraint between good ideas and growth operates in both directions.

It's not merely that you need a scalable idea to grow.

If you have such an idea and don't grow fast enough, competitors will.

Growing too slowly is particularly dangerous in a business with network effects, which the best startups usually have to some degree.

Almost every company needs some amount of funding to get started.

But startups often raise money even when they are or could be profitable.

It might seem foolish to sell stock in a profitable company for less than you think it will later be worth, but it's no more foolish than buying insurance.

Fundamentally that's how the most successful startups view fundraising.

They could grow the company on its own revenues, but the extra money and help supplied by VCs will let them grow even faster.

Raising money lets you choose your growth rate.

Money to grow faster is always at the command of the most successful startups, because the VCs need them more than they need the VCs.

A profitable startup could if it wanted just grow on its own revenues.

Growing slower might be slightly dangerous, but chances are it wouldn't kill them.

Whereas VCs need to invest in startups, and in particular the most successful startups, or they'll be out of business.

Which means that any sufficiently promising startup will be offered money on terms they'd be crazy to refuse.

And yet because of the scale of the successes in the startup business, VCs can still make money from such investments.

You'd have to be crazy to believe your company was going to become as valuable as a high growth rate can make it, but some do.

Pretty much every successful startup will get acquisition offers too.

Why?

What is it about startups that makes other companies want to buy them? [13]

Fundamentally the same thing that makes everyone else want the stock of successful startups: a rapidly growing company is valuable.

It's a good thing eBay bought Paypal, for example, because Paypal is now responsible for 43% of their sales and probably more of their growth.

But acquirers have an additional reason to want startups.

A rapidly growing company is not merely valuable, but dangerous.

If it keeps expanding, it might expand into the acquirer's own territory.

Most product acquisitions have some component of fear.

Even if an acquirer isn't threatened by the startup itself, they might be alarmed at the thought of what a competitor could do with it.

And because startups are in this sense doubly valuable to acquirers, acquirers will often pay more than an ordinary investor would. [14]

Why do investors like startups so much? Not only for the obvious reason. The test of any investment is the ratio of return to risk, and startups pass because, though appallingly risky, the returns when they succeed are so high.

But an ordinary business might have just as good a ratio, if both were lower. VCs want high growth because they get paid by getting their capital back, after an IPO or acquisition. The other route, dividends, has no parallel VC industry, because people who control a private company can too easily funnel its revenues to themselves. The real draw is that startups are easy to oversee: founders can't enrich themselves without enriching the investors.

Why do founders take the money? Growth, again. The constraint runs both ways: if you have a scalable idea and don't grow fast enough, competitors will — especially dangerous in a business with network effects.

Startups often raise money even when profitable. Selling stock cheap in a profitable company seems foolish, but it's no more foolish than buying insurance: they could grow on their own revenues, but VC money lets them grow faster. Raising money lets you choose your growth rate.

That money is always available to the most successful startups, because the VCs need them more than they need the VCs. A profitable startup could grow on its own, slower but surviving — but VCs must invest in the most successful or go out of business. So any promising startup is offered terms it would be crazy to refuse, and the scale of the successes still makes the VCs money.

Pretty much every successful startup gets acquisition offers too. Why? The same thing that makes everyone want their stock: a rapidly growing company is valuable. It was good eBay bought PayPal — now 43% of their sales and probably more of their growth.

But acquirers have an additional reason. A rapidly growing company is not merely valuable but dangerous: it might expand into the acquirer's territory. Most product acquisitions have some component of fear — even an unthreatened acquirer worries what a competitor could do with it. Doubly valuable this way, startups command a premium.

Investors like startups because their returns are huge and easy to oversee; founders take the money, and accept acquisition offers, because growth makes a fast-growing company both valuable and dangerous.

Understand

The combination of founders, investors, and acquirers forms a natural ecosystem.

It works so well that those who don't understand it are driven to invent conspiracy theories to explain how neatly things sometimes turn out.

Just as our ancestors did to explain the apparently too neat workings of the natural world.

But there is no secret cabal making it all work.

If you start from the mistaken assumption that Instagram was worthless, you have to invent a secret boss to force Mark Zuckerberg to buy it.

To anyone who knows Mark Zuckerberg, that is the reductio ad absurdum of the initial assumption.

The reason he bought Instagram was that it was valuable and dangerous, and what made it so was growth.

If you want to understand startups, understand growth.

Growth drives everything in this world.

Growth is why startups usually work on technology — because ideas for fast growing companies are so rare that the best way to find new ones is to discover those recently made viable by change, and technology is the best source of rapid change.

Growth is why it's a rational choice economically for so many founders to try starting a startup: growth makes the successful companies so valuable that the expected value is high even though the risk is too.

Growth is why VCs want to invest in startups: not just because the returns are high but also because generating returns from capital gains is easier to manage than generating returns from dividends.

Growth explains why the most successful startups take VC money even if they don't need to: it lets them choose their growth rate.

And growth explains why successful startups almost invariably get acquisition offers.

To acquirers a fast-growing company is not merely valuable but dangerous too.

It's not just that if you want to succeed in some domain, you have to understand the forces driving it.

Understanding growth is what starting a startup consists of.

What you're really doing (and to the dismay of some observers, all you're really doing) when you start a startup is committing to solve a harder type of problem than ordinary businesses do.

You're committing to search for one of the rare ideas that generates rapid growth.

Because these ideas are so valuable, finding one is hard.

The startup is the embodiment of your discoveries so far.

Starting a startup is thus very much like deciding to be a research scientist: you're not committing to solve any specific problem; you don't know for sure which problems are soluble; but you're committing to try to discover something no one knew before.

A startup founder is in effect an economic research scientist. Most don't discover anything that remarkable, but some discover relativity.

Founders, investors, and acquirers form a natural ecosystem that works so well that those who don't understand it invent conspiracy theories, just as our ancestors did for the natural world. But there is no secret cabal. Assume Instagram was worthless and you have to invent a secret boss forcing Mark Zuckerberg to buy it. He bought it because it was valuable and dangerous, and growth made it so.

If you want to understand startups, understand growth. It's why startups work on technology, the best source of the change that exposes rare fast-growth ideas; why founding one is economically rational despite the risk; why VCs invest, since capital gains beat dividends; why the successful take money they don't need; and why they get acquisition offers, being valuable and dangerous to acquirers.

Understanding growth is what starting a startup consists of. What you're really doing is committing to search for one of the rare, valuable ideas that generate rapid growth; the startup is the embodiment of your discoveries so far. It's like deciding to be a research scientist: you commit to discover something no one knew before. A startup founder is in effect an economic research scientist. Most don't discover anything remarkable, but some discover relativity.

Founders, investors, and acquirers form a natural ecosystem driven by growth. Understanding growth is what starting a startup consists of — like deciding to be a research scientist.

Notes

[1] Strictly speaking it's not lots of customers you need but a big market, meaning a high product of number of customers times how much they'll pay. But it's dangerous to have too few customers even if they pay a lot, or the power that individual customers have over you could turn you into a de facto consulting firm. So whatever market you're in, you'll usually do best to err on the side of making the broadest type of product for it.

[2] One year at Startup School David Heinemeier Hansson encouraged programmers who wanted to start businesses to use a restaurant as a model. What he meant, I believe, is that it's fine to start software companies constrained in (a) in the same way a restaurant is constrained in (b). I agree. Most people should not try to start startups.

[3] That sort of stepping back is one of the things we focus on at Y Combinator. It's common for founders to have discovered something intuitively without understanding all its implications. That's probably true of the biggest discoveries in any field.

[4] I got it wrong in "How to Make Wealth" [blocked] when I said that a startup was a small company that takes on a hard technical problem. That is the most common recipe but not the only one.

[5] In principle companies aren't limited by the size of the markets they serve, because they could just expand into new markets. But there seem to be limits on the ability of big companies to do that. Which means the slowdown that comes from bumping up against the limits of one's markets is ultimately just another way in which internal limits are expressed.

It may be that some of these limits could be overcome by changing the shape of the organization — specifically by sharding it.

[6] This is, obviously, only for startups that have already launched or can launch during YC. A startup building a new database will probably not do that. On the other hand, launching something small and then using growth rate as evolutionary pressure is such a valuable technique that any company that could start this way probably should.

[7] If the startup is taking the Facebook/Twitter route and building something they hope will be very popular but from which they don't yet have a definite plan to make money, the growth rate has to be higher, even though it's a proxy for revenue growth, because such companies need huge numbers of users to succeed at all.

Beware too of the edge case where something spreads rapidly but the churn is high as well, so that you have good net growth till you run through all the potential users, at which point it suddenly stops.

[8] Within YC when we say it's ipso facto right to do whatever gets you growth, it's implicit that this excludes trickery like buying users for more than their lifetime value, counting users as active when they're really not, bleeding out invites at a regularly increasing rate to manufacture a perfect growth curve, etc. Even if you were able to fool investors with such tricks, you'd ultimately be hurting yourself, because you're throwing off your own compass.

[9] Which is why it's such a dangerous mistake to believe that successful startups are simply the embodiment of some brilliant initial idea. What you're looking for initially is not so much a great idea as an idea that could evolve into a great one. The danger is that promising ideas are not merely blurry versions of great ones. They're often different in kind, because the early adopters you evolve the idea upon have different needs from the rest of the market. For example, the idea that evolves into Facebook isn't merely a subset of Facebook; the idea that evolves into Facebook is a site for Harvard undergrads.

[10] What if a company grew at 1.7x a year for a really long time? Could it not grow just as big as any successful startup? In principle yes, of course. If our hypothetical company making $1000 a month grew at 1% a week for 19 years, it would grow as big as a company growing at 5% a week for 4 years. But while such trajectories may be common in, say, real estate development, you don't see them much in the technology business. In technology, companies that grow slowly tend not to grow as big.

[11] Any expected value calculation varies from person to person depending on their utility function for money. I.e. the first million is worth more to most people than subsequent millions. How much more depends on the person. For founders who are younger or more ambitious the utility function is flatter. Which is probably part of the reason the founders of the most successful startups of all tend to be on the young side.

[12] More precisely, this is the case in the biggest winners, which is where all the returns come from. A startup founder could pull the same trick of enriching himself at the company's expense by selling them overpriced components. But it wouldn't be worth it for the founders of Google to do that. Only founders of failing startups would even be tempted, but those are writeoffs from the VCs' point of view anyway.

[13] Acquisitions fall into two categories: those where the acquirer wants the business, and those where the acquirer just wants the employees. The latter type is sometimes called an HR acquisition. Though nominally acquisitions and sometimes on a scale that has a significant effect on the expected value calculation for potential founders, HR acquisitions are viewed by acquirers as more akin to hiring bonuses.

[14] I once explained this to some founders who had recently arrived from Russia. They found it novel that if you threatened a company they'd pay a premium for you. "In Russia they just kill you," they said, and they were only partly joking. Economically, the fact that established companies can't simply eliminate new competitors may be one of the most valuable aspects of the rule of law. And so to the extent we see incumbents suppressing competitors via regulations or patent suits, we should worry, not because it's a departure from the rule of law per se but from what the rule of law is aiming at.

Thanks to Sam Altman, Marc Andreessen, Paul Buchheit, Patrick Collison, Jessica Livingston, Geoff Ralston, and Harj Taggar for reading drafts of this.

[1] What you need is a big market — customers times what they'll pay — not just lots of customers; too few, even paying a lot, can turn you into a de facto consulting firm.

[4] I got it wrong in "How to Make Wealth" [blocked] when I called a startup a small company taking on a hard technical problem. That's the most common recipe, but not the only one.

[7] A startup on the Facebook/Twitter route — popular but no revenue plan — needs a higher growth rate, since it needs huge user numbers to succeed at all.

[9] It's dangerous to believe successful startups embody some brilliant initial idea. You want not a great idea but one that could evolve into a great one — and promising ideas often differ in kind, because early adopters have different needs. The idea that evolves into Facebook is a site for Harvard undergrads.

[11] Expected-value calculations vary by person, since the first million is worth more than later ones. For younger or more ambitious founders the utility function is flatter — probably part of why the most successful founders tend to be young.

[14] Founders newly arrived from Russia found it novel that threatening a company makes it pay a premium for you. "In Russia they just kill you," they said, only partly joking. That established companies can't simply eliminate competitors may be one of the most valuable aspects of the rule of law.

Notes elaborate the argument: what you need is a big market not just many customers; growth as evolutionary pressure; the young-founder utility function; and why the rule of law matters to startups.