
Don't Over-Optimize Fundraising - akharris
https://blog.ycombinator.com/dont-over-optimize-fundraising/
======
eximius
It seems to me that some of these points essentially suggest, 'hey, don't
worry about the details of your funding, they aren't that important to whether
you succeed. Just don't totally screw up on funding, focus on what you do with
it'.

And, hey, that might be true.

But it also seems to me that there is a conflict of interest here in several
of the main points.

> Founders who quibble over selling 18% or 20% of their company in a round
> have lost sight of what actually matters.

If each VC is getting that extra 2% of the company for free each round, that
adds up.

So maybe we should take these points with a grain of salt. They don't seem
obviously wrong to me (but I'm not an expert), but there _does_ seem to be a
conflict of interest in what they say and where it comes from.

~~~
Judgmentality
This is a tangent to the original article, but a reply specifically to your
comment on being "greedy" (by which I mean founders being sensitive to giving
up equity).

Whenever an investor says "are you really going to quibble over 1%?" my
instinctive reaction is "are you?" It goes both ways. Yes, 90% of a watermelon
is better than 100% of a grape. And obviously the investor's perspective for
an ROI and risk tolerance are different from the startup founder and it has to
be worth it for them. But it's so insanely selfish to paint the founder as
greedy when the investor is literally in the process of being a hypocrite.

I actually understand the investor's perspective and realize they have a
_completely_ different context with their own goals, risks, assessments,
etcetera and it's completely valid for them to have their own terms! I just
_despise_ when they frame the argument in such a tone-deaf manner. Yes, 1%
fucking matters, otherwise you wouldn't be asking for it.

~~~
nostrademons
Usually the answer to that is to get a competing term sheet. That way, the
answer to "Are you really going to quibble over 1%?" is "No, I'm not, I'm
going to go with the firm that gives me that 1% without quibbling."

This also underscores the importance of doing fundraising in parallel and
lining up as many offers as you can in a short period of time. If you're
negotiating 1:1 you've already lost; you can't actually get market price
unless you can make a market.

~~~
dataisfun
This might work to maximize price but it won't necessarily land you with the
best partners. The smartest, best money knows it and they make you pay for
their investment. Moreover, approaching fundraising as a transactional auction
in a quick sprint carries with it a bunch of "relationship debt." You're
signing on to someone (your investor) you can't fire for the duration of your
company's existence. Rushing into that might end up costing your company far
more than the marginal gain from a bidding war. Just my two cents.

~~~
pedalpete
This goes against point #2 that the investor for the most part doesn't matter.

~~~
dataisfun
Point #2 is so patently absurd its hard to take seriously. One, YC are
themselves investors, and as far as I know they don't position themselves as
causally inert in relation to a company's success / one of many
indistinguishable and arbitrary alternatives.

Two, I don't think you will find many entrepreneurs who'd claim indifference
around their investor choice. At the very least, this claim asks us to believe
there aren't terrible investors who cause damage, which runs contrary to both
common sense and history.

[edited]

~~~
dataisfun
Well, mea culpa. The piece does address the issue of bad investors. My main
beef is with the line, "in the end, while some investors are better than
others, none of them translate directly to success," which I don't think is a
credible claim, or at least warrants more evidence.

------
dataisfun
This article seems to be in some conflict to how YC operates, which is
designed around the demo day auction frenzy, where you might see valuation
caps rise overnight on a rolling basis (I've seen some almost comical leaps in
valuation in this regard), not to mention starting at prices in the $10-15M
range. The ones that clear at those prices, on average, don't have the
traction to justify it, which means the capital they get is often either
second tier or first-tier call options. The net result is the best companies
in the batch do just fine and because their prices, on average, were higher,
YC and the company benefit from reduced dilution. The rest of the batch is
then left with an inflated effective post-money that makes it harder for new
capital to finance, especially if it follows an average growth curve.

New money doesn't particularly care you raised post demo-day at $15M if they
think you're worth for example, at best, $12M now. It's a difficult
conversation to have with founders and it can result in completely unnecessary
pain around morale and optics. The worst loss is perversely invisible, as
smart money might de-prioritize pursuing these companies knowing they have to
work around the earlier mis-price. This is an opportunity cost that might not
be apparent to most.

This is all complicated by the fact that demo day is in fact, not the first
shot investors get at the companies in a batch. You might find that some of
the most exciting companies in a given batch have been almost fully subscribed
by the time demo day rolls around, as top tier firms don't wait till the
actual demo day. Obviously, YC can't nor should they proscribe meeting with
investors ahead of demo day, but this simply means access isn't as equally
distributed as the notion of demo day might suggest. It looks to some degree
like a second pass for folks without the network or access of a top-tier firm.

All this works great for YC, which, like every other fund in this world, makes
money off power law returns, but it comes at a cost.

[edited]

------
aiisahik
Don't over-optimize for the investor. If your startup lands in trouble, no
investor is going to dig you out of it.

What should you over-optimize for? Flexibility. Over-optimize for the ability
for your business to become a cashflow positive lifestyle business that is not
a 100M+ exit. That's actually what many many startups become.

YC won't tell you that because they over-optimize for world-changing binary
results.

~~~
rlucas
Agreed with a caveat (from a VC perspective, mind you).

99% (schematically) of new businesses should indeed optimize for flexibility.

But, if you judge yourself to have a real shot at the >> $100M exit, then
optimize for that path and foreclose the flexibility.

There's a real truth to the idea that you will be putting your all into any
business, so if you have one that really can create an entire career's worth
of wealth at once for you and your whole team, you should optimize for that.

If on the other hand your business doesn't have a realistic shot at that, stay
the hell away from VC. Waste of time and cash is king anyhow.

~~~
ablekh
_" There's a real truth to the idea that you will be putting your all into any
business, so if you have one that really can create an entire career's worth
of wealth at once for you and your whole team, you should optimize for that."_

That's the "truth" convenient for VCs. Even if a startup has a realistic shot
at >> $100M exit, it doesn't automatically mean that the founders should go
that route. It depends on their risk tolerance and particular circumstances.
If a startup could exit at $200M with a _much lower risk_ than them exiting at
$600M, some/many founders might prefer the former route. And that still would
be "an entire career's worth of wealth at once" for them and the whole team
(if the team is small enough), or pretty close to that, or simply just a very
very good outcome.

~~~
rlucas
I don't disagree with what you're saying schematically. I agree that there's a
lot of propaganda that serves the money machine, and that it's not suitable
for most founders.

I think the specific numbers you're providing are tricky, because generally,
getting to $200 M exit within, say, a decade, involves institutional funding
(VC, PE, "growth", whatever).

(As a relatively small non-Valley funder, I would generally also prefer to be
an investor in a company that exits at $200 M with a _much lower risk_ than a
$600 M exit, given that getting to $600 M might mean another $50-100 M in
late-stage, first-money-out, preference overhang capital.)

I think the real question usually has orders of magnitude difference here.
Internally-fundable businesses tend to opt for business models like services,
consulting, etc., since they can scale without a lot of invested equity. Hence
a lot of times you wind up growing a business semi-organically and end up
getting a 1-2x revenue multiple for a modest growth, modest gross-margin,
consulting type business. Or, if you do get a good SaaS operation going and
grow it organcially, you might find yourself faced with the late-arriving
roll-up play heavily funded by private equity, who will buy you at a 3-5x in
an attempt to consolidate the market and float it at a 6-10x.

And yes, if you as a founder have a 90% shot at $10 M in 10 years, vs. a 9%
shot at $100 M or a 0.9% shot at $1 B, most rational founders should and do
take the safe road. Stipulated :)

But in my experience and observation, getting over the hurdle of product-
market fit and a repeatable go to market strategy is what tends to kill
startups. If you get that PMF and GTM working, it often makes sense to fund
hypergrowth. If you don't, the company is walking dead anyway.

------
idlewords
Don't take gambling advice from the casino.

~~~
austenallred
YC's stake gets smaller if the founder gets more diluted, so YC's interests
are aligned with the founders'.

~~~
Judgmentality
While I completely agree YC is providing valuable advice, I do not find your
argument convincing. It reminds me of realtors supposedly being aligned with
home owners because they make more for a higher sale price, which is true but
it's completely ignoring effort. The homeowner has a much higher incentive to
put more effort into selling the home for the right price, whereas the realtor
has much more incentive to sell it faster.

[https://www.youtube.com/watch?v=pbFkw_roJqI](https://www.youtube.com/watch?v=pbFkw_roJqI)

This is not a perfect analogy for investors and founders, but it is an example
where supposedly incentives are aligned but in reality they might not be.
What's best for the investor is not necessarily what's best for the founder.

But again, in this case I do agree that YC is providing useful advice.

~~~
austenallred
I hear what you're saying, and that makes sense, but in this case YC has no
incentive to "churn and burn" through companies. In fact, given that they
_really_ make their money from multi-billion dollar exits, even a marginal
amount of dilution in those companies harms them greatly.

------
thoughtstheseus
For seed funding maybe it does not matter... but usually the options at that
stage are funding or no funding. For every other funding it does matter.

------
rlucas
TL;DR: optimize only for monotonically increasing, vanilla terms for 24 months
runway at a time.

As a VC and an entrepreneur, various times over the last 19 years, I will say
this to entrepreneurs in good faith:

1\. Your core competency is company building, not fundraising. (There are
exceptions, but you're not one of them.) Just get enough money to company-
build for the next 18-24 months on plan.

2\. The primary (only?) thing to optimize for in valuation is "monotonically
increasing over time." All of the pain (for founders, early investors, et al.)
is when you have flat-to-down rounds. That's when you REALLY get diluted, and
I don't mean like "geez 30% sucks" I mean like "let's build in a new 20%
option pool because then founders are now down to 5% each" kind of dilution.

3\. The other thing to optimize for is keep your overhang (liquidation
preferences) manageable. The bigger the prefs, and the bigger the post, the
worse your options are for an earlier founder-friendly exit.

4\. Finally, as a sandpaper-the-edges kind of thing, remember that terms tend
to get more investor-friendly over time, even for good (but not phenomenal)
performers. So all in all, choose smaller rounds and lower valuations
_provided you get vanilla terms_ (meaning no multiple prefs or strange
dividends etc.) because subsequent investors will insist on same-or-better
sweeteners, which can bite everyone down the stack.

5\. Really finally -- remember that for all of the seeming insider sharkiness
of VCs, they all have to see each other in polite company again. Meaning,
they're the devil you know. The real rapacious problem terms come from non-VC
participants who don't mind slashing and burning -- be most cautious of those.

