On seed-stage startup traction (and why to ignore it)

I’ve had the privilege of investing in 300+ Y Combinator startups over my career and looked at many thousands more. Over the years, I’ve learned that one of the trickiest things about seed-stage investing is separating “signal” from “noise”. Every company, team, idea, product, and market is unique and exciting, but a good VC has to know what information to pay attention to and what to ignore when making their investment decisions.

At Rebel Fund, we’ve taken a very data-driven and scientific approach to separating signal and noise when looking at YC startups. We’ve invested millions of dollars into developing the world’s most comprehensive database of YC startups and founders outside of YC itself, now tracking hundreds of variables on each company and millions of data points overall. We’ve used this data to train our proprietary Rebel Theorem 3.0 machine learning algorithm, which scores every new YC startup in terms of its likelihood of having a successful outcome.

When making our investment decisions, most VCs look at some combination of the same aspects of each company: team, product, market, traction, timing, competition, and defensibility. At Rebel, we pay attention to all of these things at different stages of our due diligence process, but focus our algorithm most heavily on characteristics (or in data science speak “features”) related to the founders themselves. This is because product ideas can and often do pivot over time, markets rapidly evolve, traction can wane, competitors come and go… but the founders are usually a constant and have a huge impact on the fate of an early-stage startup.

However, many seed-stage investors prefer to focus on the more easily quantifiable aspects of a startup when making their investment decisions, like revenue traction or monthly growth rate, probably because it feels more comfortable to base a high-stakes investment decision on something ‘hard’ like numbers vs something ‘soft’ like team quality. This may be why almost every YC startup has an “up and to the right” chart in their pitch deck, showing how their revenue is growing like crazy (though often with just a few weeks or months worth of history).

This begs a very important question, which I hope to anwer in this post: From an investor standpoint, how much does early traction really matter in seed-stage startups?

I asked this question to several YC partners I know, since arguably no one in the world is in a better position to pattern-match how much early startup traction predicts their long-term success. Shockingly, I found no consensus whatsoever. Some partners felt it was super important, others felt it doesn’t matter at all, and others felt it matters but with certain qualifiers, like only above a certain revenue threshold, or only in the sense that it shows founders have hustle or sales skills.

I found it curious there’s an aspect of seed-stage startups that investors seem to care about very deeply, yet even YC partners can’t seem to agree whether it actually matters.

So, I did what any tech nerd armed with a massive database and top-notch data science team would do — set out to answer this question quantitatively.

Rebel has been collecting early traction metrics on YC startups at Demo Day since early 2022 (I wish we had started earlier¹). Here are the ones we determined most relevant for this analysis:

Demo MRR — The monthly recurring revenue (MRR) reported by startups at Demo Day. When revenue was reported weekly or annualized, we standardize it to monthly.

Demo Monthly Growth Rate — The month-over-month (MoM) growth rate reported by startups at Demo Day. When reported weekly or annualized, we also standardize it to monthly.

Demo Total LOI — The total dollar amount of revenue pre-committed to startups via a letter of intent (LOI) as reported at Demo Day. These are non-binding commitment letters, typically used by capital-intensive startups to show market interest in their product ahead of commercializing it.

Demo Annualized GMV — The annualized gross merchandise volume (GMV) reported by startups at Demo Day. This metric is typically used by marketplace startups to show the value of products or services passing through their platform.

Of course, not all of these metrics are reported or even relevant to all startups, but we still had thousands of data points to work with.

We then compared these early traction metrics to an internal metric we use called Latest Inferred Valuation Final, which is our best estimate of the latest valuation of each startup, based on a proprietary formula we developed incorporating various internal and external data sources.

Our data analyst then ran a correlation analysis to see how well these early traction metrics correlate with companies’ latest valuation. If indeed strong early traction is highly correlated (and plausibly predictive) of startup success, then we’d expect to see high correlation coefficients between at least some of these traction metrics and latest inferred valuations.

Below are correlation heatmaps our data analyst produced, using both the Spearman and Pearson methods (explaining these goes beyond the scope of this post). Here are some correlation strength guidelines for context:

• 0.00 to ±0.10: Negligible correlation (no meaningful relationship)
• ±0.10 to ±0.30: Weak correlation (small, but noticeable relationship)
• ±0.30 to ±0.50: Moderate correlation (clear relationship, but not strong)
• ±0.50 to ±1.00: Strong correlation (variables are strongly associated)
• ±0.70 to ±1.00: Very strong correlation

As you’ll see, there is a weak to negligible correlation between any of these traction metrics and latest company valuations.

The only metric that makes a decent showing is Demo Total LOI, but I suspect that’s because LOIs are collected by capital-intensive startups (like hardware companies) that tend to raise at higher valuations by nature.

The implication is all of those “up and to the right” growth charts in YC startup pitch decks are mostly just noise from an investor perspective. This would also explain why the YC partners I spoke with had such wildly different opinions on whether early YC startup traction really matters.

This seems counter-intuitive, since isn’t the #1 job of every startup to grow?

It is indeed, but there’s a big difference between post-PMF (product-market fit) growth and initial pre-PMF growth just a few weeks or months after going live. The former is a vital prerequisite of a successful startup, and growth-stage investors should pay attention to it. However the latter is signal-poor and frankly easily manipulable by founders — it’s not hard to engineer a few weeks or months of growth by pumping up paid SEO or turning all your attention to sales ahead of Demo Day².

Even with this blog post in the wild, I’m sure that YC founders will continue to ramp up their sales ahead of Demo Day and investors will continue to swoon over their steep early growth curves. Savvy investors beware though… early traction in seed-stage startups is mostly just window dressing, so best to focus on the ‘soft’ stuff 👍🏻

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¹I know ~3 years is a relatively short amount of time to judge the success of a startup, but it’s all we can do based on our data. It’s probably enough for this analysis anyway, since if early and sustained growth was the reason for a startup’s success, we’d likely see valuation markups pretty quickly.

²From a founder perspective I think early traction still matters, because it forces them to speak with customers, deeply understand their target market, and evolve their product enough to earn real revenue dollars. And if it helps you raise capital, go for it!