How Investors Think About Ideas - Wufoo Cofounder Kevin Hale

Hi, my name's Kevin Hale. I'm a partner here at Y Combinator. A lot of founders ask me, "How do I know if my idea is going to be interesting to an investor?" So today I'm going to talk about how investors think about ideas.

Every startup idea usually is composed of three parts: there's the problem, there's the solution, and then there's an insight. These are usually the things I'm looking for the most. The most common problem that a lot of founders make is that they start here at the solution. This ends up being the thing that I'm always looking out for because it creates the situation we call at YC "a solution in search of a problem."

This is usually one of the biggest mistakes that a lot of founders make. They say, "I'm interested in some really cool tool or technique or trend, like I'm interested in machine learning or I'm interested in the blockchain." What they try to say is, "I want to do this thing," and then they try to then start at the solution, and eventually try to shoehorn a problem. Maybe they don't even end up having an insight.

The best way to actually create a startup is to start with a problem. Once I understand what the problem is, I have a good understanding when I'm looking at an idea of who the customer is and also how big the potential market is. There's kind of an easy formula for figuring this out. What I'm trying to imagine is, "What would it take for this company to be a billion-dollar business?"

You can usually do this with a math formula. A really quick shorthand is to try to figure out, "Okay, what is it going to take for this company to make 100 million dollars a year?" If let's just assume that a valuation of a billion dollars is going to be 10x the multiple of revenue, the question becomes, "Okay, what do I have to fill out on the other side of this equation to get to this number?"

It's always going to be the price that I charge for this product. Let's say it's a consumer product where the lifetime value is like a hundred dollars. Then the answer is, I need 1 million users or customers in order to get to this idea. Now, as soon as I think about this equation, I start thinking about these two things: one, do I believe that people will pay for a hundred dollars? And two, do I believe that there's a million people out here who will pay this amount?

It really becomes one of these questions. I start here and then I have to think about, "Okay, what do I have to believe for this equation to be true?" There are four types of beliefs that I've been thinking about. At any given time, I'm thinking about what do I have to believe about the founders for this to be true? What do I have to believe about the market for this to be true? What do I have to believe about the product for this to be true? And what do I have to believe about their acquisition strategy for it to be true?

This is something that you typically see in like a consumer startup. Down the road, you might see other values where it's 10k and 100k. So at these prices, now we're getting into, are they small businesses, these are luxury items, etc. Then I'm thinking, "Okay, what does the customer segment look like?" These will change. I'm likely to sort of 100k, 10k, and then 1k.

Now, I'm trying to figure out, like, have they figured out how to find these people? Do I believe that they can ask for these prices? So this question I'm looking at the founders is, "What do I believe about the founder? Can they sell a product worth $100,000? Does the market support this kind of product?" That usually means that if someone's paying this, they're thinking the value of the product is worth many multiples of this; therefore, that's why they're willing to pay it.

The product usually is that the product just works as a default. But sometimes it's like, "I built the product that's 10x did something like this." Could that happen? Acquisition is one of the big ones that usually I'll end up asking a ton of questions to verify. Has this person figured out understanding their costs? Do they understand how to get customers? Do they understand how to get them profitably, etc.?

The thing about these four things I need to believe in order to believe that this equation is true is there's two types of beliefs: there's the default belief and then there's probably something I call the special sauce. Let's say I'm talking to a biotech startup. The default belief is that they can make whatever things that they can build or create or sell to, whether it's a pharma company or, like, the customers, etc.

Like them being able to build it is the default. I actually do not spend a lot of time trying to figure out if founders can do that. There are some basic threshold things, but to me, it's like if they can't even do that, they'll never get off the ground. Usually, the trick to getting to a billion-dollar company is that the haves have something else.

So the extra things, let's say for a biotech firm, are: are they good at storytelling? Are they going to be able to tell the story of their company and explain whatever it is that they make in a way that investors will give them a lot of money to either get through FDA approval or to bring their product to market, etc.?

That is usually things that I need to believe in because if I believe that these biotech founders are not able to communicate well and don't have good social skills, then to me, I feel like they don't have what it takes to fill in this equation and become a billion-dollar company.

So when you're thinking about your ideas and trying to figure out which ones to work on, try to think about starting with the problem and figure out what it would take for it to be a billion-dollar company. Then ask yourself what are the things that you'd have to believe in four categories: yourself as a team or founders, the market, the product, and the acquisition strategy.

If I believe those four things and that you have proof of making that happen, that will get an investor interested in you.