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The Future of Startup Funding (paulgraham.com)
241 points by BenSchaechter on Aug 5, 2010 | hide | past | web | favorite | 91 comments

This is a really superb and thoughtful piece on the funding process. The only issue I would take is with the idea that funding terms will become standardized and the process routine. While, even as a lawyer, I would actually love to see this happen (we prosper right along with our startup clients and no one benefits from the waste that occurs with funding games), I have not seen this happen even as all sorts of standardized documents are now widely available to facilitate it. It can and does occur if the investors want to settle for terms protecting their basic interests but giving them no special advantages (what I call vanilla terms). That said, only the friendliest of investors will do this, and by "friendly," I mean in relation to the founders, and this usually means only friends and family or perhaps an individual angel or two that has a long history with one or more of the founders and wants above all other things to help promote the founders' interests. The rest of the angels, and most certainly the institutional ones (so-called "super angels") continue routinely to press for special advantages of one type or other. With special advantages come special terms and with this comes lawyer review, back-and-forth negotiations, and the like. In this sense, absent a huge shift in the balance of power toward founders, I don't see purely standardized documentation and routine processing becoming the order of the day anytime soon. Others may differ, and I may be wrong, but that's how I see this based on considerable day-to-day experience in this field. That said (for what it is worth), this is a brilliant essay that concisely encapsulates the important trends one will encounter in early-stage startup funding, and it should be widely disseminated to all who might have an interest in this field.

As the amounts invested in early stages get smaller, and some of the Series A rounds are replaced by angel rounds, there will be an economic incentive to move toward more standardized terms for these early rounds. The less money being invested at a given stage, the more conspicuous the lawyer fees for special terms will be.

How valuable are these non-vanilla terms to investors? Presumably you can get anyone to commit to vanilla terms for the right price. Then it's just a question of making big investors care less about these terms (e.g. by repeatedly demonstrating that investments can succeed without them), or taking more investments from people who put a lower premium on the terms (e.g. super angels).

A thoughtful analysis by a knowledgeable lawyer (Yokum Taku of WSGR) of various seed-stage terms and their use in standardized sets of financing documents appears here: http://www.startupcompanylawyer.com/2010/03/14/how-do-the-sa.... As appears from his useful chart comparing the various standard sets, investors (and lawyers) just have different ideas of what they regard as important for different types of investments.

Jason Mendelson, a well-known lawyer-turned-VC, took this further in a piece entitled "Why There Will Never Be a Standard Set of Seed Documents" (http://www.jasonmendelson.com/wp/archives/2010/03/why-there-...), in which he gets into more details about how people differ on what protections and terms to seek when making early-stage investments.

With respect to this this article, what would be helpful would be some links to actual convertible notes with caps and other provisions mentioned in his piece. Anybody have anything to share with the community?

I like the part at the end where he says that "employers are the main competitor to angel investors" -- that could be the beginning of a whole new essay...

Fundraising is still terribly distracting for startups. If you're a founder in the middle of raising a round, the round is the top idea in your mind, which means working on the company isn't. If a round takes 2 months to close, which is reasonably fast by present standards, that means 2 months during which the company is basically treading water. That's the worst thing a startup could do.

So if investors want to get the best deals, the way to do it will be to close faster. Investors don't need weeks to make up their minds anyway. We decide based on about 10 minutes of reading an application plus 10 minutes of in person interview, and we only regret about 10% of our decisions. If we can decide in 20 minutes, surely the next round of investors can decide in a couple days.

This 20 minute figure is missing the point. What matters here -- to founders at least -- isn't how much time YC spends on the startup. What matters is how long the startup spends on YC. I don't know how long the average group spends filling out the YC application form, but I'm sure it's quite a bit longer than 20 minutes.

(Back of the envelope calculation: Suppose a typical group spends 3 hours filling out investment-application paperwork per investor they're pitching; investors take 1 out of every 20 applicants; and a startup wants to take money from 5 investors. Then they've just spent 300 hours -- over a month -- filling out application forms, and it's probably going to be 2 months before they can focus on something other than raising money again.)

We thought about that, and we made a point of making the YC application something that would be to the advantage of startups to complete even if they never submitted it.

And conveniently for founders, there is a certain practice that's common among YC-like organizations that makes the cost of multiple applications low (e.g. http://www.ventures.io/apply).

I agree that the YC application is useful per se and not just as a route to funding -- in that respect it was a bad choice of example, but it was the example of funding application paperwork which people here are most familiar with.

But I still think that investors will need to compete not only on how quickly they can decide to fund a startup but also based on how much effort it takes to apply -- with the important difference that in the first case investors will notice if they lose ("sorry, you took too long to get back to us, and we've already got all the investors we need for this round") and in the second case investors will simply never see the deals.

(Back of the envelope calculation: Suppose a typical group spends 3 hours filling out investment-application paperwork per investor they're pitching; investors take 1 out of every 20 applicants; and a startup wants to take money from 5 investors. Then they've just spent 300 hours -- over a month -- filling out application forms, and it's probably going to be 2 months before they can focus on something other than raising money again.)

I don't think it makes sense to say that because investors take 1 out of every 20 applications, a given startup has to pitch 20 investors. The average might, but that isn't necessarily a meaningful number. Some will pitch 1, others will pitch 40 before giving up.

I think this will go down as one of PG's best and most predictive essays. It feels as if these changes are all just before the tipping point but close enough that they're going to happen; if they do, it'll be a huge positive for founders and the investors that adapt.

Can we Martin Luther this essay across Sand Hill Road?

Be more lenient on terms, let us raise less money at once but accumulate it over a few mini-rounds, and leave us to do what we do best.

Yep - he has a good 30,000 ft view of what's going on that most of us (myself included) can't really perceive, only privy to bits and pieces of it.

As always, PG's done a good job of writing a thought-provoking and highly readable essay. I'm hardly qualified to comment one way or another about the ins and outs of startup financing- I'm willing to assume that he's got the facts right on those aspects of the essay- but one part of the essay stuck out at me like a sore thumb: (talking about YCombinator's "competition" with employers)

<blockquote> Nearly all customers choose the competing product, a job. Why? Well, let's look at the product we're offering. An unbiased review would go something like this:

Starting a startup gives you more freedom and the opportunity to make a lot more money than a job, but it's also hard work and at times very stressful. </blockquote>

I'd say that this represents about 80% of an "unbiased review". The missing 20%? "... it's also hard work, and at times very stressful, <em>and the odds are very much against all of that hard work and stress paying off for you in any kind of direct, financial way.</em>"

I wouldn't put that in the product review because it's more a feature of the user than the product.

E.g. it wouldn't be accurate to say in a product review of running shoes "you are going to run slow in these shoes" even if on average that's what people did.

Who, considering working their first startup job, can possibly end up in an epistemic state of knowing that their hard work will pay off? How could you reasonably end up assigning a confidence of more than 50% without it being sheer naked Lake Wobegon effect and overconfidence? If no one can possibly get rid of this uncertainty, it ought to be part of the unbiased review.

In case I'm reading too much into this, am I right in think that you believe startups are _not_ risky?

If so, then that changes nearly everything that people understand about startups.

I'm saying that while there is a large random multiplier in everyone's outcome, the risk of total failure varies enormously with the founders. Some founders have a near 0% chance of total failure. Others (a larger number) have a near 100% chance. So while this means on average the change of a startup succeeding is 1/n, quoting that stat as part of the description of a startup would be misleading, because for a small number of people it's just not true, just as for a small number of fast runners it would not be true that they'd run slow in the shoes, whatever the average person did.

One of our axioms at Y Combinator is not to think of deal flow as a zero-sum game. Our main focus is to encourage more startups to happen, not to win a larger share of the existing stream.

When I read this it reminded me of the good things that Google does to make the internet easier and faster. It's self-interested -- the better the internet gets, the more people click on their ads -- but in an inclusive way: there are auxiliary benefits that accrue to a lot of third parties (like me, using Chrome right now). In YC's case, that would be the population of startup founders and anyone who benefits from the startups they found.

I like it when companies behave this way. Maybe there are degrees of self-interest and this is a more enlightened one. It's too much to expect companies to do good things irrespective of their self-interest, but not too much to expect the above, especially if it turns out that they end up making more money this way. Then others will have a narrow and greedy reason to go down a broader and more generous path.

Lest this seem like nothing much, it wasn't so long ago that people in this position thought primarily in terms of controlling and crushing. The difference may be one of degree, but it's not just rhetorical.

Using that heuristic, I'll predict a couple more things. One is that investors will increasingly be unable to wait for startups to have "traction" before they put in significant money.

To an outsider, this sounds like a small-scale version of the events that caused the Dot-com bubble: Investors race to fund ever-shorter rounds of companies that might someday be valuable, but have nothing right now but a sales pitch and a website. This arrangement would benefit a company like YCombinator, who seem to successfully fund companies based on little more than gut feel. But taking away "success as a predictor of success" from the VCs' playbook, would they have another strategy that beats random guessing? The Dot-com bubble suggests "no." Hopefully the small average investment really does turn the math on its head!

This is why it will be important as an investor to actually understand the business area that the startup is getting into. The problem with the dotcom bubble wasn't that there was pressure for investors to make a decision; the problem was that many investors put in their money without any clue as to even what the companies they were investing in actually did.

I think you miss the point, there's a massive gap between understanding a market and successfully capturing it.

Regardless of a VCs understanding of it, if the founders can't capitalize on it, but can talk the talk, it's gonna fail.

Some successful sales actually prove a basic level of competence. It also shows the founders have a whole host of other skills, they can run a basic company, have some sort of idea how to market let alone gain traction, there really is a market for the product rather than vague projections, etc.

There was more driving the Bubble than investors deciding early which startups to fund. For one thing there was another entire layer of guessing, as noob LPs poured money into venture funds created by noob VCs. That's not happening now. In fact the situation is the opposite; the VC business is contracting.

That's sort of the point: investors will need to know more than just how to evaluate pitches in order to make good investments. I'm not sure that there is a "strategy" to evaluate startups very early. What needs be done depends heavily on the situation. However, it seems that it is possible to beat random guessing.

Is this not an echo chamber of 'we're doing this so everyone should'?

Has YC actually made a lot of money yet? I ask because the web does not provide a definitive answer. I see a few YC companies doing well, but there's no 100 million dollar companies there, let alone billion dollar companies.

Given that YC had to raise money last round to fund companies, one wonders.

I have a lot of respect for pg and read everything he writes, but I'm asking out interest in the actual reality of the situation, it's hard to tell.

Our stock in the startups we've funded is worth a lot on paper. I've never tried to calculate how much. But I wouldn't be surprised if e.g. the Dropbox stock alone is worth more than we've invested to date.

The reason we raised money is that we've only been doing YC for 5 years (during the first of which we only funded 8 companies), and big exits usually take longer than that.

If you got a huge return from an early investment would you decline to raise another round and continue with your own funds?

Funding being one of the terrors I'm trying to avoid I have little knowledge in the field, good to hear you're doing so well!

Sounds like you're right and more people should be following this model, and will lose out if they don't!

I don't think it's fair to say the invaders usually win. In hindsight they appear to, because you don't remember the 10,000 startups that tried and failed for each one that succeeded. Broadcast.com was an invader in the same space as YouTube.

A big business would die of schizophrenia if they tried to fend off everything that attempted to disrupt them.

That's tangential to the point of the article though I suppose.

"Invaders" here is plural, and that's important. broadcast.com and youtube were on the same "side" of that particular battle. The invaders won, broadcast.com just doesn't benefit from that.

a) no because Yahoo shareholders sure don't feel like they've been on the winning side of that battle. Their investment in broadcast.com netted them -$3 billion.

b) that doesn't change the hindsight bias at all, it just shifts it from individual companies to individual industries. For instance the invaders in grocery retail have done very little.

a) The point here is not that all the invaders win, just that the companies that do win tend to be invaders rather than incumbents. If Hulu loses to YouTube, the fact that broadcast.com didn't amount to much is scant consolation.

b) Grocery retail is an established market. PG was talking about new markets: "The pattern here seems the same one we see when startups and established companies enter a new market."

a) no, once again, that's just an observational bias. You are thinking of the industries where the invaders win because you don't hear about the others. Invaders usually lose and are forgotten, but occasionally win and are remembered.

b) you're not an invader if it's in a new market. you're more of a pioneer then.

a) Yeah, that could be. Even if we limit discussion to the software/internet space, we could be ignoring all the small companies that created a new market then got crushed by Microsoft.

b) <shrug> PG chose the term, not me. The point is that you have a startup and an established company competing in a market that recently didn't exist. PG's point was that very often the startup wins. He may be wrong, but grocery retail is not a counter example.

If you take PG's essay one step further, it would seem there might also be a need for micro-investing in the same style that Kiva does micro-loans. Something that lets small fish invest in startups that need less than, say, $250k. Investments could have a lower limit of $5k for example, and most software startups might only need 10 or 20 investors at $5k a piece.

Diaspora received a great deal of funding on Kickstart, but Kickstart specifically says it is not meant for investing. I think there might be a niche between well-connected, wealthy angels and simply asking family and friends for seed money. This would also alleviate the choice between risking your relationships with all your friends and family just to generate seed money. If you have a business idea, there should be an option to raise money in an open market at any scale.

I think that's illegal--offering equity investment in small amounts to members of the public is legally a public offering of stock, which falls under the jurisdiction of lots of ugly federal regulations.

Angels exist because there's a big legal distinction between offering stock to ordinary people and offering stock to millionaires.

Thanks for pointing that out Phil. I'm not a lawyer, but I wouldn't call it illegal outright, as you say it may just require a fair amount of upfront legwork to arrange the structure of the service in a legal way. There do seem to be some exceptions the SEC offers, such as the below from their site. I agree it may be impossible to make it work after jumping through all the hoops, but if you succeeded all that red tape would make a decent barrier to entry for others.

From http://www.sec.gov/info/smallbus/qasbsec.htm#eod6

"Section 3(b) of the Securities Act authorizes the SEC to exempt from registration small securities offerings. By this authority, we created Regulation A, an exemption for public offerings not exceeding $5 million in any 12-month period. If you choose to rely on this exemption, your company must file an offering statement, consisting of a notification, offering circular, and exhibits, with the SEC for review. Regulation A offerings share many characteristics with registered offerings. For example, you must provide purchasers with an offering circular that is similar in content to a prospectus. Like registered offerings, the securities can be offered publicly and are not "restricted," meaning they are freely tradeable in the secondary market after the offering."

Also: http://www.sec.gov/answers/regd.htm

Any idea how Sprowtt was planning to get around the law if it is illegal?


"Much of the stress comes from dealing with investors."

Disagree here. Dealing with investors is a source of stress, but there are many reasons why startups are stressful. A friend put it this way: "As a startup founder, every day you're eating glass and staring into the abyss."

There is the stress of product-market fit, dealing with the fact that no one knows who you are or cares, endless hours, etc.

But the best startup founders, I think, do it because they simply can't do anything else.

While I hope that fundraising becoming more efficient will help create more great startups - I think the battle against cushy jobs at established companies is at the very, very beginning.

When you need the money, the stress from investors rises to the top.

Oops. I was supposed to review this but ended up being too busy fundraising.

Investors don't like trying to predict which startups will succeed, but increasingly they'll have to.

I'm puzzled because I thought investing successfully was all about doing exactly this.

I used to think that too when I was a founder, but currently, at least, most VCs and many angels tend to wait till they see a startup starting to take off, if they can. This works just as well as predicting, so long as they jump in before other investors.

Business has traditionally not needed outside funding. Funding has mostly come from revenue or from family. This angel/small scale investment is only neccessary because technology is changing so quickly and there are many opportunities at the moment. But this will end soon enough and the market will stabilize.

The few new things that startup then will not be worth having a lot of angels for.

That's false. Medieval trading voyages, which comprised a large part of economic activity at the time, were frequently paid for with investor money. Since the industrial revolution most new industries have been.

More things surely would have before, but there was no way for investors to ensure they weren't cheated by the managers skimming the profits. The reason venture funding worked for trading voyages was that when the ship returned, it was very hard to conceal what was in it.

The way railroads ensured that investors got paid was to fund themselves with bonds that paid a fixed rate. Managers were free to do what they wanted with the cash flow, but if they failed to make their bond payments they'd be in default.

Big and risky business has always been paid for by big money. Trading voyages were big business and were limited in the number available. There were not millions of ships setting sail everyday.

The risk and cost factor in websites is rapidly reducing. As the risk reduces, so will the need to go to people dedicated towards giving money. It will be easier to raise money locally and in your environment, as has been done for a long time.

In human society, it's my observation that there are two types of capital being raised:

-- Risky and big money: These is the type of money that gets raised from venture capitalists nowadays and from rich dudes back in the shipping days

-- Less risky and smaller money: This type of money is raised from savings, bank loans and borrowed from family.

Websites and many of these simple technology things are rapidly moving out of the first category and into the second category. Cost is dropping and risk is dropping. Things like robots or electric cars are now in the first category.

The volume of shipping varied at different times, but it was always a huge component of European economies. There were points in the preindustrial period when several percent of English workers were on ships at any given time. The percentage would have been higher in the Netherlands. And investing in shipping was definitely not limited to the high and mighty; ships were rarely owned outright, but were divided into shares, and I've read of shares as small as 1/64 of a ship.

That makes sense.

The first companies issuing tradable stock were shipping/trading companies. 1/64th shares seems to be about the size that would start to require some more sophistication.

It doesn't cost much to run a website, but it can still cost a lot to grow a business. Look at all the companies in the local space. Their limiting factor is how many sales reps they can hire; the company that raises $10 million beats the company that raises $1 million.

The same holds true for long-tail content generation. If you want to build a better Demand Media, you need to spend like they spend.

As transaction costs in general decline, it will make less and less sense to rely on friends and family, the way I don't rely on friends and family to make my shoes, even though shoes are (adjusted for inflation), much cheaper than they have been in the past.

Your "Two types of capital" division is arbitrary, both because you're turning a continuum into a binary decision, and because that's just one way to divide things. I could divide capital-raising businesses into those with limited scale and those with unlimited scale. There are more and more businesses with unlimited scale, and the optimal way to run such a business is to maximize risk, and to use someone else's capital to place bigger bets.

Actually, what you're saying seems true according to PG's own "meta-trend" of founders of web startups becoming more powerful. Founders would be most powerful when they only need to raise money from friends and family - as it continues to become cheaper to start such a startup, why shouldn't the angel industry contract just as the VC industry is doing now?

There's a lower bound on the cheapness: the living expenses of the founders and the people they hire. Few families could risk that amount of money on something as risky as a startup.

Is there an unfulfilled opportunity in creating bond-type instruments for investment in startups/businesses that may never get acquired or to the public market? Many founders don't want to exit, or don't intend to (37Signals would be a marquee example), but it is getting easier and easier to make some significant amount of revenue from smaller and smaller niches. It is just less likely, in those small niches, to create a big company, and there are a limited number of acquirers who can acquire successfully.

Perhaps. But the level of risk is so high that the bond would have to pay a very high coupon. But by perhaps bundling startups together the way they do for mortgages it could lower the risk level. We could have SBS's or Startup Backed Securities. Har.

This is not a bad idea. It might be a great one. Do you know anything about the logistics of getting something like this legally worked out? Presumably, there are some businesses who'd be okay with that very high coupon -- as the business model improves itself it could come down. It's a lot less risky that credit card and other personal debt, but it handles a niche that equity investments mostly can't touch. That's possibly trillions of dollars in an underserved market.

Coming from a family of entrepreneurs (in India), this seems empirically false to me, regardless of whether you count tech startups or regular 'small businesses'. Almost without exception, we've needed significant capital to start a business. Whether this came from a bank, a private investor, or existing family wealth has changed over time, but the need for it has not.

I'd actually argue the opposite. Business has traditionally needed outside funding, but the incredible cheapness of software startups is decreasing that need.

Finally, you say that investment "is only neccessary because technology is changing so quickly...but this will end soon enough." That definitely seems wrong. Technological change is accelerating.

Business always needs investment. These private investors you got investment from, did they know your family already?

What are people's thoughts on peer-to-peer startup funding? Is it ever going to happen?

By that I mean raising money with a larger number of smaller inputs from a marketplace or similar. Potentially still in exchange for equity though also possibly for debt or just belief, as with Kickstarter.

Diaspora and Kickstarter are a recent successful example, though that was something of a black swan event in my opinion.

I do think this type of exchange could solve some of the things founders dislike about raising money, but it certainly raises other problems.

I heard a while ago of a company called Sprowtt planning to do something like this, but researching again just now, they appear to have "hit the deadpool" http://www.crunchbase.com/company/sprowtt-marketplace

This is a question for pg and anyone else who can chip in:

I love the idea of a startup-controlled round and would definitely love to do my first round (coming soon hopefully) this way but... how exactly do I go about setting something like this up? Is there somewhere that explains how to do this or do I have no recourse but retaining a lawyer who has experience with this sort of deal (which I don't have the money for right now).

I'd love a nuts and bolts type answer if possible.

Or is this process even possible (yet) for a startup founder to lead?

This recently-posted article has a lot of details:


If you're going to take 10s to 100s of thousands of dollars from private investors, there's no getting around having a lawyer with experience in such deals.


That article appears to be generic SEO spablum with no relevance to angel investing/convertible debt. (For example, the word 'convertible' does not appear.) What's 'great' and relevant about it?

I suppose you're unfamiliar with Venture Hacks - it's the accepted HOWTO bible for startup entrepreneurs navigating the funding battlefield. They also do Angel List, which is the most important innovation in startup funding since YC.

So rather than downvote you, I wanted to explain why it's not SEO spam.

You don't have showdead on, I guess. He's actually replying to a dead response by martygood, not the link by gojomo.

Indeed, gojomo is not accusing gojomo of posting spam. Nor is gojomo unaware of VentureHacks, as it was gojomo who recommended the VentureHacks link in the first place. On the other hand, gojomo has some pretty whack views, and rarely respects the HN taboo against frivolity. So he deserves a dressing-down every once in a while, and I don't care if he downvotes me for this opinion.

This is a great article, Paul. I have one question, if you do not mind setting off on a tangent. You said that start-up investing is a seller's market now. Why is that? In general "a sellers market" would indicate that there a lot of investor money in comparison with startup opportunities.

Is it because there profitable exists which are bringing more money in? I have been following the news and while the number of buyouts seem to be increasing, many of them are at valuations which would not indicate much profit for the investors.

Also VCs keep telling me that they have trouble getting funds as their traditional institutional investors have soured on the VC investment class. So that would indicate something other than a seller's market.

Or do you think that because there is so much activity with start-ups, investors have already decided that some companies that have not yet reached an exit (e.g., Twitter, Foursquare) are defacto winners, so that there is an assumption of high profitability even without the exits.

Or do you think it is a sellers market because more money is going to silicon valley now that many of the wall street profit making schemes have stopped working.

Or is it possible that it only seems like a seller's market to you because Y-combinator is so successful and popular that investing in Y-combinator startups is indeed a seller's market, while this may not be the case overall.

Running Hackers and Founders, I've come aross a ton of young founders that have gotten seed rounds. And, a ton of them are hiring.

I think one reason for the trend is that a number of rich people have soured on the idea of paying someone at BigCo finance to manage their money for them in the stock market. A lot of portfolio's have recovered most of the losses from the past 2 years of stock market craziness, and a lot of them are seeing the benefit of diversifying their investments with angel investing.

Multiply that trend times 500 to 5000 millionaires in Silicon Valley, and you have a sellers market in angel investing. That is, there are a lot of angel investors looking for startups to invest in early.

It's clearly not just YC. I'm not sure what's happening. It could be the leading edge of a very uneven recovery. It could be a secular trend of more interest in investing in startups; i.e. a recovery from the previous crash. Or it could be due to the super-angels, who are more aggressive in early stage deals than VCs.

So question: in a rolling close with convertible notes, what happens if the startup neither gets a buy out offer nor raises another round of capital?

In any startup, if there's never an exit, the investors lose their money.

Thanks. It could also happen that the startup doesn't require more capital and is self sustaining. But doesn't get a buy out offer until after the convertible notes expire. In which case, the investor doesn't get to enjoy in the returns - he just gets his money back with some interest.

YC companies get a lot of publicity. And so their chances of raising another round of capital or getting bought out are very good. This is not the case with most startups. So a rolling close with convertible notes may not be the best option from investor point of view - no?

(With an equity deal, the startup can get an exit until it goes out of business. With a convertible notes deal, you have a fixed timeframe and you (as an early stage investor) lose out if the exit happens beyond that time period...

...So I thought one never did a convertible notes deal unless they knew there was a very very good chance of an exit within the specified time frame... am I missing something?

My point is - I don't see rolling closes with convertible notes getting too popular with most angels.)

The convertible note doesn't disappear. In the worst case it merely converts to stock at a pre-configured valuation.

If the startup starts making lots of revenue (just for argument's sake, I am not actually implying this happens with any noticeable frequency), wouldn't the investors get part of it, even without an exit?

A business certainly can raise private capital, become profitable and remain privately owned. It would be like investing in a public stock because you expect their dividend to grow.

I think there is an assumption the VC agreement is structured without any sharing of operating profits, but I'm not sure why it has to be this way... anyone care to enlighten?

If a profit sharing component was added to this model, you could significantly reduce investor risk, possibly offer better terms to founders and create an added incentive for finding businesses that have a monetizable product or service. Maybe YC is trying to avoid founders that bow to these constraints in favor of startups focusing purely on the product? There is nothing wrong with this, but it might just be delaying the inevitable; someone, somewhere will need to make a profit from it or the business will surely die.

I believe convertible notes still have some far-off due date, and they are accruing some nominal interest rate. So at some point, the money comes due if never converted (and the company is still in business).

If the company reaches a point where it will need no outside capital (nor pursue acquisition/IPO), it could have a 'round' that simply converts the debt to equity at some agreed-upon value. Then, perhaps, the original investors can at least start the capital-gains clock, collect dividends, sell shares on a private market, etc.

In a rolling round, is each investment negotiated at a different price? Or does the company sell X shares at Y price, first-come, first-served? The former sounds like a lot of work; the latter gives people an incentive to delay even more (they'll have made an investment with more information than the prior investors. And, of course, they'll have cash on hand in the interim.)

In most cases, where you're talking to investors simultaneously you do the note on the same terms for each investor.

The exception to this would be e.g. I intend to raise $150k, i get this amount of money in the bank and then more investors want to participate. I can bring them in but I could argue for a higher valuation since they're coming in once I have money in the bank i.e. at less risk than the investors who initially put in $150k and therefore deserve the lower valuation.

Other exceptions might be where an investor brings particular value that warrants a lower price e.g. you're working on payments and Max Levchin wants to invest

Rolling round is done with convertible notes. No valuation talks take place.

Convertible notes are loans that can be converted into equity if some predetermined event takes place (usually you raise another round of money or you get a buy out offer.)

You're not selling X shares at Y price. You're issuing a loan that may get converted into X shares. Every investor who gets these convertible notes usually will end up getting the same valuation in the future if the note converts to equity.

So with rolling round, you're just taking on debt. And you can take as much debt as you want to (unless you've added a clause in any of the notes that determines that you can't go over a certain amount of debt.)

Rolling round is done with convertible notes. No valuation talks take place.

that's not true, most of the convertible notes we're seeing include a valuation cap in them i.e. the investor never converts their debt at a valuation higher than the cap. the cap addresses the main criticism of convertible notes, namely they misalign the incentives of the founders (who want a high valuation for their next funding event) and investors (who want a lower valuation for the next round so they get more stock).

I think it'd be great if YC published a standard note that has the cap (with both a dollar and percentage) that accommodated rolling closes like y'all did for the Series AA docs. Given that this is now the new hotness, it'd make seed investing even more efficient, especially for startups outside the Valley who may not have relationships with up-to-the-minute legal help.

You're right; we'll do that.

OT: That's weird, I didn't see this and just posted a dup - http://news.ycombinator.com/item?id=1579024 - but it didn't get caught. The only difference seems to be in the www in the url.

The dupe detection is a simple string comparison. Any character differences will allow the dupe to be posted - even differences like trailing slashes.

Some angel groups have some steep fees just to pitch and luckily there is counter movement to that. I hope with the shift towards more angel investment in the long run that this attitude of paying a high fee for presenting is not getting to a norm.

Don't worry, that custom is already so dead that I forgot to even mention it. I don't think any YC-funded startup has ever paid to pitch one of these groups.

Could someone please guide me towards a "startup funding 101" resource that explains what all this means? Ideally something that walks you through the process instead of just defining the vocabulary. I've searched but I haven't found anything good.

series A rounds, additional rounds of funding, fixed size rounds, convertible notes, changes in valuation, stock dilution, etc.

"it's usually the invaders who win." Let's aim, launch & invade!

May I suggest the use of the word archangel instead of super-angel?

I think there's a missing word in this sentence: "What I'm saying is that the kind of help that matters, you may not have to be a board member to give."

The essay makes sense as far as it goes, but if it's true, there's going to be a change in both board of directors and advisors as well.

This sounds wonderful, but a bit too much wistful thinking.

I think that adding more VCs and Angels to the ecosystem would actually make me less likely to consider raising money.

The first year of a startup can be incredibly cheap. Cheap enough that you simply don't need any outside cash to make it happen. For me, the only reason I'd ever consider taking VC if for the side benefits that come along with the money.

When you have an entity like YCombinator backing your thing, you get a huge boost from their connections (and the fact that they're inclined to use those connections for your benefit). That's orders of magnitude more valuable than the lousy six grand they give you, and if I could get that help without the money attached or the requirement to move to the bay area, I'd jump at it for my latest project.

Now imagine the scenario with Random No-Name Angel with $100k to give you. All you get out of that deal is money. No influence. No guaranteed TechCrunching, no introductions to Important People, no Inc Magazine cover story about you and the latest crop of young entrepreneurs. Unless you actually need money (which if you're smart, you shouldn't), there's just no advantage there.

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