Understanding Key Startup Terminology and Concepts

Dalton explains essential startup terminology, emphasizing the importance of product viability and understanding financial metrics.

### Understanding Key Startup Terminology: Insights from Dalton at Y Combinator
* 📦 The term MVP, or **minimum viable product**, refers to a product that must be **useful enough to serve a purpose for customers**, emphasizing that it must be **viable and not just a simple, non-functional creation**.
* 💰 Venture Capital, often referred to as VC, involves investing small amounts of money in startups with the hope that a few will **become very successful**, offsetting the risks of the majority that may **fail**.
* 👼 An angel investor is typically an individual investing their **personal funds** into early-stage companies, often as a **side project**, with **smaller investments** compared to traditional VCs.
* 💸 Profitability is defined as **making more money than is spent**, and it’s crucial to **monitor profit margins** as a startup grows, with successful examples like Google highlighting the **importance of high margins at scale**.
* 🔥 Burn rate indicates how much money a company spends monthly, and it’s vital for founders to **keep track of this metric to avoid running out of funds** despite potential revenue.
* 💵 A seed round is generally the **first significant amount of money raised** by a startup, which can vary widely in size and structure, unlike later rounds like Series A, B, or C, which typically involve **lead investors**.
* 📈 Product-market fit (PMF) occurs when a startup's product **resonates with users**, shifting the focus from **finding customers to scaling the business**, highlighting the different priorities before and after achieving PMF.
* 🚀 Bootstrapping involves starting a company without external funding, relying solely on **personal funds or revenue**, which grants the founder **complete control over the business's direction and growth**.

[Music] Hi there, my name is Dalton. I'm a managing partner at Y Combinator, and I'd like to talk to you about some startup terminology today. All right, so I'm going to go through some terms that are common in startup land and give you some more details and define it. Okay, let's talk about the term MVP or minimum viable product. So, let's be specific. The keyword here is viable. A product that doesn't work at all and is useless to everyone is not viable. And so, when you're thinking about what is an MVP or how should I build my MVP, it has to be useful enough to serve some kind of purpose for the customer. Again, that's that viable word. And so, it doesn't just mean a simple product that you built that doesn't do anything. It's got to be useful to someone for it to be viable. And so, remember this next time you're thinking about what should go in an MVP. The next term I'd like to talk about is

the term Venture Capital. Sometimes, the people that work in the Venture Capital industry are referred to as VCs. The way Venture Capital works is they invest a small amount of money to buy equity in startup companies with the hope that enough of those companies become very large to return the original investment that they made. They're also comfortable taking more risk than you would take in a traditional investment. It's often the case that the majority of a Venture Capital portfolio does not succeed, but the investments in the really big successful companies pay for everything. So, for instance, imagine you were an early investor in a company like Google or Apple or Facebook. That small investment ended up being worth so much. It was worth taking the risk when those were tiny unprofitable companies. And so, the way to think about venture capital is it's an industry that's looking for businesses that may be risky but could be very huge if they're successful. Is I understand the original Venture Capital was in the whaling industry. The way it worked is when

people uh would go out to hunt whales. A lot of times, the ventures would fail um, and so the people that needed money to start a ship needed to raise money from investors. The way they did a portfolio was they would invest in multiple ships in the hope that if one of them was successful in capturing the whale, it would pay for all the failed expeditions. I'd like to define what an angel investor is uh. No, that's not someone that is angelic. It's a type of venture capital investor that is investing usually their own personal money, not out of a VC fund. And they tend to be the earliest stage investor in a company. They also tend to write smaller checks, say $20,000 or $50,000 or something like that, and they tend to do it not as a full-time job. It'll be a hobby or a side project uh. They might be running a company, they might be retired. There's no qualification to be an angel investor. It's usually just someone that has money, and so you'll see just a wide

a wide type of people that do this, and the thing they have in common is they just writing personal checks into small startups, and they're doing it not as a full-time job. So, that's the best definition of an angel investor. Okay, another term in startups that I'd like to define is profitability. And look, there's some pretty obvious definitions of profitability, which is just you make more money every month than you spend, and that's a pretty good definition. But to add a little bit more to it, it's good to think about if a business, as it grows bigger and bigger, either has stable profit margins or if the profit margins increase or decrease. It's common to have a startup that at a very small scale might not be making money, but as it gets bigger and bigger, the profit margins increase. It's good to think about if you're starting a startup or if you're working at a startup, how your margins, i.e., the difference between how much you're making and how much you're spending, change as your company grows.

bigger and bigger, and what I'd be looking for is at scale, the profit margins are pretty good, and there's a clear way you make more and more money. To give you an example, something like Google. Google did not make any revenue for its first few years of existence, but the profit margins on online advertising are very high. And so, once Google turned on their monetization engine, they started to make an enormous amount of money. They are very profitable. You can look them up; they're publicly traded. And so, that's a great example of a company that initially was not making money, was not profitable, but was able to have an incredibly attractive business at scale once they turned on the monetization engine. And so, that's the kind of profitability engine you should be looking for as a startup founder too. Next, I'd like to talk about burn rate. Burn rate is how much money at the end of the month has been burned by your company or how much your bank account has gone down. So hypothetically

if you had a million dollars in the bank and at the end of the month you had $900,000 in the bank, your burn rate would be $100,000. As a startup founder, it is critical to watch your burn rate. You may be making money in some ways; you may have a lot of topline revenue, but if you're burning money every month, you might go out of business. And so, it's great as a startup founder to think hard about where the money is going and to pay careful attention to the bank account balance and make sure that your burn rate does not get out of control. Not paying attention to this is harmful to your startup's health. Next, I'd like to define a seed round. There's not a technical definition of what exactly is or isn't a seed round, so let me give an example. Say someone raises $300,000 on a SAFE. You could call that a seed round. Say that there's some crazy company that's founded by celebrities, and they raise $100 million on a billion.

dollar valuation. Sometimes they refer to that as a seed round. And so, because of this big variability, it's sometimes hard to tell exactly what is and isn't a seed round. U for the sake of argument, here's my suggestion. A seed round is usually the first amount of money that a new startup raises of any consequence. And so, usually when you begin a company and you raise the first amount of money and you say, Okay, we're done raising money, whatever amount of money it is that you raised, you would refer to as a seed round. In addition to other fundraising terms you may have heard of, a series A or a series B or a series C. Um, the difference between one of those rounds and a seed round. For one, it is often the case, but not always, that in a series A, B, or C, a lead investor is involved. You also may be giving a board seat to that person. It's also the case that it traditionally, uh, the lead investor gets a significant ownership percentage. So, for instance, traditionally in a series A, the lead investor might get something

like a 20% ownership in a seed round. Anything goes. It could be that it's entirely composed of 50k checks, and there is no lead investor, right? It's a very wide definition, but with a, there's usually one primary lead investor that leads the Series A, to use the terminology. And the same thing goes with Series B and C for startups that have been around a while. And when you keep raising a new round, you tend to give it a new name. And again, traditionally, you just keep incrementing the letters in the alphabet. And so you'll sometimes see companies that are like a Series E or a Series G or a Series H. I think I've definitely seen that before. What are the normal valuations for these? I don't know. It's a wide range. And so you can't just look at what the round letter is. You also want to look at what the valuation is. Next, I'd like to define product-market fit or PMF. Product-market fit is

something we talk about a lot at Y Combinator, and it's one of those terms where people talk about it so much you might think you know what it means, but the actual definition is a little bit tricky, and there's not actually a scientific explanation of it. A good way to think about product-market fit is when you've built something, and people are using it, and they like it a lot, and your biggest issue is no longer trying to define what people want or trying to make something people want. It's to start to be in growth mode and serve as many people as you can. Okay, and so one way to think about product-market fit when you're a founder is that needing to get more customers is not your biggest problem. You probably have other problems like scaling or like performance, like sales. You have all these other problems versus most startups when they first start do not have product-market fit. Essentially, all of them do not have product-market fit, and what this means is they may build something, they may have some assumptions about what

customers want, but they don't have any customers, or they haven't worked with enough customers to really figure out if it's serving their needs properly. Startups in the pre-product market fit stage are just spending all their time trying to test their assumptions, trying to build, trying to design, trying to talk to customers to really zero in on what these customers want. From our perspective, there's just a very different set of priorities when you're pre-product market fit versus post-product market fit. When you're pre-product market fit, all you should be worried about is finding product market fit. When you're post-product market fit, your job is to stay in that state, to keep product market fit, and to grow and scale to the best of your ability. It's good for you as a founder to realize that the tactics and priorities you should have are very different depending on which of these two modes you're in. I'd like to define the term bootstrapping. Bootstrapping is when you start a

company, and you do not raise any Venture Capital. You just use your own personal funds or the revenue from the business to get off the ground. So, for instance, if you were to start a new company that built an iPhone app, and you didn't raise any venture capital, and you just launched it on the App Store and started making lots of Revenue and built a successful company, you would call that a bootstrapping situation. You would say you are a bootstrapper because you didn't raise any money to do it. One of the reasons it's a great option is it's entirely within your control. You don't need the approval of investors to go bootstrap a company. It's also a good option if you're doing something that is not traditionally a venture business, a venture-scale business, which is something that could grow really, really big, really, really fast. Bootstrapping is a much, much better option for businesses that you expect to get to 5 to 10 million a year in Revenue, something like that, and to probably not grow beyond that. Bootstrapping is a great option.

convertible note in the context of startups is a financial instrument whereby an investor gives a startup money, and they sign a piece of paper. You should read carefully what this piece of paper says. In the case of a convertible note, it is a debt-like instrument. There are usually terms in a convertible note by which you would pay some amount of interest, or you might need to pay the investor back. And so, it's your job as a founder to read the fine print very carefully. An alternative to a convertible note is something called a safe note. A safe, also known as a simple agreement for future equity, is a financial instrument that was actually initially created by Y Combinator, specifically Carolyn Levy. And it is an alternative to a convertible note if you're raising as a startup founder, and you are not doing a priced round and selling preferred equity. A safe is a great option to quickly close money in a seed round ahead of when you would raise a Series A at a future date. If you're thinking about whether or not to raise

on a convertible note or a safe. I would encourage you to read carefully the fine print and understand the pros and cons of each. The advantage of a safe is that there are just fewer terms to worry about, as well as different rights, fewer rights in a convertible note, and so that's often very useful to startup founders. Equity is ownership in a startup company. Equity would refer to what percentage of that would add up to 100% of the company that a founder, employee, or investor would own. If you work at a startup, you may not directly get equity; you may get stock options, which are basically a right to, in the future, execute on the stock options to receive equity at that point in the future. And so, it's important for you, in the fine print, as both a founder, a startup employee, or an investor, to read the fine print and understand if you are getting stock options or if you're getting equity directly, or if you're investing in a safe, or you're investing in a convertible note, or some other

instrument always read the fine print and understand exactly what you are buying. Buying and selling Tam or total addressable Market is a term that you would hear a lot um in the land of startups. What it usually refers to is hypothetically if 100% of the potential customers of your product all purchase your product, how much money would you be making. No one actually would get to 100% of their Tam, it's more of just a thought experiment for how big the market could possibly be. So for instance, if you were trying to establish the Tam of something like a Tesla or a car manufacturer, you would look at how many total cars people buy across the world and that would be the total addressable market. And you would make an estimate of how many of the cars could be sold by Tesla. One um interesting point about Tam calculations is they can be wrong, they can underestimate how big the market could be. Again to give you an example, when Tesla first started, the total addressable market for electric cars was tiny and so you had to believe they the

market for electric cars would grow and be so big it would take over and be effectively the market for all cars. For the Tam to seem sufficiently big, in addition for a company like Uber when they first started, the total addressable market for taxis or for car services was quite small. But Uber dramatically increased the size of the market because they created a better user experience and they encouraged people to start taking ride-sharing that didn't before. And so this led to the initial Tam seeming much, much smaller than it ended up being. And so think of Tam as sort of just a potentially helpful thought experiment versus something that is set in stone. Great products tend to grow The Tam. Next, I'd like to define valuation. Valuation is a term that people in startup land talk about a lot. What it usually refers to is what valuation the last investor invested at. And so say there was a company that raised $2 million on a $20 million post-money safe. The valuation would be $20 million. The thing about valuation is it

doesn't actually mean there are always buyers and sellers. This doesn't work like the stock market. In the stock market, the stock price is the valuation, and anyone could go and publicly trade the stock at whatever their current market price is. With startup companies, they are privately held. There's not really a liquid market, and so it's best to think of valuation as just some measure of how it might be valued by some folks versus a true measure of how much that startup would be worth if it were to sell that day or if it were to go public that day. Often, you might have noticed that startups with high valuations don't always succeed, and so just think of it as a helpful term but not necessarily always accurate. Next, I'd like to define an IPO or initial public offering. An IPO is a company that is privately held, i.e., it is owned by its investors or its founders or its employees, and it issues shares or it sells shares to the public markets. The public markets are things like NASDAQ or the New York Stock Exchange or

other you know public exchanges like that, and anyone in the public that has some kind of stock brokerage account can buy some of those shares. The reason IPOs are important to startups is it's often a way for their employees, or their founders, or their investors to be able to realize money from the companies they have built. And it's also a great sign that the company is doing well. This isn't always the case, but IPO is the big goal that a company is financially mature, that it is growing well, and has built something of enduring value. Next, I'd like to define ARR, or annual recurring revenue. You will hear this term thrown around all the time in startup land, and let's break it down. Annual means every year. Here, recurring means the customers are either in some sort of subscription that auto-renews, or they've signed contracts that renew in some way. The third R is revenue, which should be obvious. That's just revenue. And so, the way to think about this is say you have a company, and you

have 10 customers that have each signed yearly contracts for $100,000 a piece that renew yearly. If you have 10 $100,000 contracts that renew yearly, that would be a million dollars of ARR. And so, the important thing here, if you're going to use this term, is to understand recurring is important. And so, make sure if you're reporting, if you're telling an investor you have ARR, make sure it actually recurs. And it also is best if it recurs on an annual basis. If you're quoting ARR, traditionally, if you're billing people on a monthly basis, you would quote MRR or monthly recurring revenue. And so, say it's a subscription to ChatGPT or something like that that renews monthly, you would more commonly see that revenue reported as MRR, monthly recurring revenue, versus ARR, which is more traditionally companies that bill once a year. All right, that was startup terminology with Dalton. I went through a number of terms you may have heard before, and I'll be sure to define more.

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Y Combinator

MVP, or minimum viable product, refers to a product that is useful enough to serve a purpose for the customer, not just a simple or useless offering.

Venture capital involves investing a small amount of money in startup companies, taking on more risk in the hope of funding a few that become very successful.

Angel investors are individuals who invest their personal money in early-stage startups, often as a side project, and they typically write smaller checks.

Profit margins can be highly attractive at scale, as demonstrated by Google's success after turning on their monetization engine.

Monitoring burn rate is crucial for startup founders, as excessive spending can lead to financial trouble.

A seed round is typically the first significant amount of money raised by a new startup, with variability in its definition, while later rounds (A, B, C) often involve a lead investor and significant ownership percentage.

Understanding Startup Funding and Product-Market Fit

Startup funding rounds vary, with seed rounds often having a wide definition and no lead investor.

As startups grow, they incrementally raise new rounds, leading to labels like Series E or G.

Product-market fit is crucial for startups, indicating when they have satisfied customer needs and can focus on growth, while pre-product market fit involves testing assumptions and finding the right product for customers.

Bootstrapping and Funding Options for Startups

Bootstrapping refers to starting a company using personal funds or business revenue, without raising venture capital.

It's a great option for businesses expecting to generate $5 to $10 million in annual revenue, as it offers full control to the founder.

Convertible notes and safe notes are financial instruments for raising startup funding, with safe notes offering fewer terms and rights, making them a popular alternative.

Understanding TAM, Valuation, and IPOs in Startups

TAM (Total Addressable Market) refers to the hypothetical revenue a company would make if 100% of potential customers purchased its product, serving as a thought experiment for market size.

TAM calculations can underestimate market potential, as seen with companies like Tesla and Uber, which dramatically grew their markets.

Valuation in startups refers to the investment price set by the last investor, but it doesn't guarantee a liquid market or accurate measure of the company's worth.

An IPO (Initial Public Offering) is when a privately held company sells shares to the public, aiming to raise capital and expand its ownership.

IPOs are crucial for startups as they provide a way for founders, employees, and investors to realize financial returns and indicate the company's success.

Annual Recurring Revenue (ARR) refers to the revenue generated from customers on a yearly basis through auto-renewing subscriptions or contracts.

If a company bills customers monthly, the revenue is typically reported as Monthly Recurring Revenue (MRR) instead of ARR.