So if you're wondering whether you should apply, the answer is yes. Even (especially?) if you get rejected.
We're sorry to say we couldn't accept your proposal for funding. Please don't take it personally. The applications we receive get better every funding cycle, and since there's a limit on the number of startups we can interview in person, we had to turn away a lot of genuinely promising groups.
Another reason you shouldn't take this personally is that we know we make lots of mistakes. It's alarming how often the last group to make it over the threshold for interviews ends up being one that we fund. That means there are surely other good groups that fall just below the threshold and that we miss even interviewing.
http://ycombinator.com/whynot.html
We're trying to get better at this, but it's practically certain that groups we rejected will go on to create successful startups. If you do, we'd appreciate it if you'd send us an email telling us about it; we want to learn from our mistakes.
Y Combinator Staff
The trick of accepting the dilution of YC is to make estimates of whether the idea could 7% become larger/better. Or (more easy to understand) whether the effect of YC on all the components of P(small) could accumulate to more than 7% of P(small).
If your probability of success increases as a function of your investors, for instance, YC easily earns its 7% just due to pure signalling effect. If you're looking to get better hires, then the YC seal-of-approval could easily elevate you into the 'A-Class' of hires that everyone insists makes the difference. Of course, there are a lot of other factors : but scoring a total of +7% on them overall is all that should determine whether to choose a place with YC (supposing that you've been accepted).
Just my 2c.