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Don't Over-Optimize Fundraising (ycombinator.com)
86 points by akharris 8 days ago | hide | past | web | favorite | 34 comments





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.


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.


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.


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.

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

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]


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.

> 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

Most early-stage raises lack the luxury of a competitive process. Bring able to trade concessions in terms for the win of a deal is a strong predictor for greater commercial sense. If someone can’t give away another point to fund their business, they may be in the wrong seat.


Globally or in Silicon Valley (and other tech hotspots)? It's common knowledge among experienced founders (or even just people who read a bunch of startup blogs) in Silicon Valley - that's why people raise "a round" of fundraising instead of just going to a single VC.

In areas that aren't startup hotspots I can certainly see that dynamic, but this is why people move to the Bay Area for fundraising.


It certainly does work both ways, but each player in a negotiation has a break point at which they walk away. You need to figure out what that is for you and for the other party.

The issue with founders who over-optimize in fundraising is that they are rarely working with a clear, frame worked goal in mind. It's often "I just want better!"

I understand this impulse. I've been there myself. I'm hoping to help people take a step back and consider the wider picture.


> Whenever an investor says "are you really going to quibble over 1%?" my instinctive reaction is "are you?"

My reaction is even stronger: "Yes, I am. 1% to you is .02% of your fund--it's a rounding error. 1% to me is real money."


That's absurd. 1 point of the company at a given stage might be 5-10% of the total investment that the VC makes (given that VCs typically shoot for 10-20% of the company).

The VC is doing, give or take, the same deal 10-20x in a portfolio. If you talk about that 1% becoming a norm, then it really moves the dial 5-10% on the total return for the VC.

A founding team should be owning 60-80% of the company after that transaction. Meaning, the 1% ownership difference is something like 1.3% of the founders' total return.

If you're going to try to do math on it, be fair and real.

Full disclosure: VC here.


You are optimizing for the fact that you need all your companies to give you this since you can't predict the single "hit" that will generate the vast majority of the value of your portfolio.

Founders are (or at least should be) optimizing for the fact that they are most likely to be a mediocre business that isn't going to cash out with a lottery ticket.


I actually agree (broadly) with your statement about founders.

As far as what the VC is optimizing for -- fair enough, I am only pointing out that saying the 1 point difference in, say, a 10 or 11 point equity stake is somehow actually only 0.2% to the VC isn't fair. It's a 10% difference in the VC's stake.


I agree with the other commenter that you need to avoid distributive negotiation on one scale (% ownership or price) because its outcome is inherently zero-sum. One way to resolve this, in addition to getting competing offers, is to add other elements into the negotiation so you’re no longer are negotiating on this one vector anymore. Try increasing liquidation preferences (or anything else that the invesor values more than you do) for example in exchange for the 1% percent. This way you end up with an integrative outcome: win-win situation.

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

I think the more salient point being made here is that too many founders try to over-optimize the quantitative aspects of the round. If you find yourself trying to negotiate for a 2% difference in dilution, you should probably see if there are other qualitative terms you can get instead. Use whatever negotiating leverage you have to adjust board structure/voting, founder re-vesting, and a million other less-flashy terms.

And in the scenarios, such as SAFEs, where the only real terms are $$$-related, just decide on a starting number you're comfortable with and don't stress about optimization.

VC's will often ask early on, "what are you raising at?" and just because they agree to that number, doesn't mean "oh darn, I should have asked for higher and let them negotiate me down."

As Michael Seibel said at one of our YC dinners, "during fundraising, don't try to make ninja moves because most of you are not fundraising ninjas." While yes I understand that 2% dilution every round over the lifetime of the company adds up, the advice for 98% of founders is that you will hurt your company (and therefore financial outcome) more than you will help if you try to make minor negotiations on price/dilution/valuation.


Totally agree. There's so much nuance to fundraising that isn't expressed here. Dilution is a critical aspect to raising capital: too much will ruin your ability to raise money in the future. Too little can result in a cancerous drag on growth by leeching away founder enthusiasm and time. It's really important to try and raise the right amount at the right time. I actually found this section more objectionable than the dilution comment since it encourages founders to raise money in drips and drabs. That's a great way to derail an early startup and give up far more equity than if you'd just raised a larger amount in one big, early round.

Optimizing a deal is absolutely, 100% what a startup should be doing, but you should be going for a globally optimal deal, not optimizing for just one attribute. Would you counsel a startup not to optimize for sales or user growth? Sales are literally the only other form of revenue for most startups and without users you have nothing. Just as with sales and user growth, however, juggling long-term and short-term needs is critical.


100% agreed.

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]


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.


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.


"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.


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.


Well, I think YC is pretty clear about the sorts of companies they aspire to invest in, e.g., Dropbox, AirBnB, etc. I also imagine quite a lot of the founders who apply to YC aren't aiming for "lifestyle" businesses, in particular since there are cheaper ways, from a dilution point of view, to raise the equivalent amount of capital (or alternatively, to bootstrap to early revenue and find alternative means to finance the business).

YC does indeed optimize for power law outcomes, but then again so does every venture investor (or at least, so should every venture investor).


Don't take gambling advice from the casino.

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

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

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.


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.

If I'm not mistaken, YC gets pro-rata as preferred shareholders, so their dilution is not any different from everyone else in that class.

Pro-rata doesn't mean what you are implying.

Pro-rata is in theory the right (but not the obligation) to buy back in, at the new price, to get back to your prior ownership level.

In practice however, pro-rata is a firmly stated polite request to the next round lead investor to let you do so. The real determinant of whether you get to use the pro-rata right is whether your next round lead investor is OK with it (and whether you want to try to block that next round).


Yes, I know. But if you want to tell YC they don't get their pro rata (or practically speaking, convince the founder to tussle with them over that), have fun. I've seen them not budge even when it makes the founder's life much harder as they struggle to balance the pretty typical ownership requirements of new money.

Good point, YC is a uniquely powerful market participant these days and has both the power and the breadth of portfolio to negotiate hard.

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.

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.




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