Incidentally, this is the actual advice we give startups about fundraising at YC. This batch I finally wrote it all down, and the s2013 startups used it when raising money.
"I don't know of a single VC investment that began with an associate cold-emailing a startup."
I can vouch from personal knowledge that this has happened a number of times at a number of different European VCs, and at least once with a major US VC in the last year.
I'm guessing it's far less common for YC startups because YC startups have demo day which essentially initiates the process. They also have a strong network because of YC so it's much easier for a VC to get a warm intro to any YC startup.
It may just be a Europe vs US thing but I'd be surprised if it didn't happen frequently in the US as well especially at less well connected startups.
Certainly referrals have significant value but most major VCs will be able to use their network to get references on pretty much any startup in any case.
I read "associate" as the more important part of that sentence than "cold-emailing." So, just to clarify, you're talking about a cold email from an associate vs. a partner?
I interpret it as distinct - the junior employee. He refers to the partners subsequently, though still advising to delay (rather than skip) the meeting.
If you get cold-emailed by an associate at a VC firm, you shouldn't meet even if you are in fundraising mode. Deals don't happen that way. [5] But even if you get an email from a partner you should try to delay meeting till you're in fundraising mode.
And from the footnotes:
[5] Associates at VC firms regularly cold email startups. Naive founders think "Wow, a VC is interested in us!" But an associate is not a VC. They have no decision-making power. And while they may introduce startups they like to partners at their firm, the partners discriminate against deals that come to them this way. I don't know of a single VC investment that began with an associate cold-emailing a startup. If you want to approach a specific firm, get an intro to a partner from someone they respect.
It's ok to talk to an associate if you get an intro to a VC firm or they see you at a Demo Day and they begin by having an associate vet you. That's not a promising lead and should therefore get low priority, but it's not as completely worthless as a cold email.
Because the title "associate" has gotten a bad reputation, a few VC firms have started to give their associates the title "partner," which can make things very confusing. If you're a YC startup you can ask us who's who; otherwise you may have to do some research online. There may be a special title for actual partners. If someone speaks for the firm in the press or a blog on the firm's site, they're probably a real partner. If they're on boards of directors they're probably a real partner.
There are titles between "associate" and "partner," including "principal" and "venture partner." The meanings of these titles vary too much to generalize.
we need to combine individual experiences and create a curated tabular list of investors classified by different dimensions in pg's great article. such a list combined with this article would be the ultimate cheatsheet for fundraising.
The main problem with such a list is that the experience with an investor is very subjective and you need to get a lot more information about the said situation in order to assess what really happened there.
I imagine people will likely contribute to such a list only if they are anonymous (The bay area is very small and you don't want to upset investors).
It kind of reminds me of thefunded.com where I find little value in the reviews since I have no idea who's behind it and what was the situation that led the entrepreneurs to leave that review.
Where can it be very valuable? When you have a small network of peers who trust each other (an accelerator for example) and are willing to share more details on the interaction with the investor (and could possibly take a call if needed).
I also believe that YC has a secret list of all of the investors with some comments from the staff (I also know that startups are asked to give some feedback on interaction with investors - that list is probably a curation of the feedback given).
When dealing with an investor I always ask them to provide me with 2 references: 1 entrepreneur they backed who is doing well and 1 entrepreneur who is not doing so well (that helps me understand if the investor is helpful when things are not going so well and believe me there will be some point when things will be a train wreck).
Additionally I always end up pinging my network and doing some backchannel references on the investors knowing that the references they are providing me are probably curated.
That is an excellent idea and barring a pile of non-disclosure agreements I could see a lot of people contributing to this.
Deal details with investor names attached are not likely to materialize until long after the fact and even then someone is breaking a promise, which professionals with ties to VCs are not going to do. Founders could technically get away with this, especially if a deal fell through but this world operates largely on reputation and such a thing could easily pop up at a moment when you really don't need it later on.
Crunchbase has quite a wealth of info in it, as does duedil.com , those you could use to get an idea of who is on the other side of the table as well as google. The best source of info for a company looking for funding from 'party x' is to go and find out who else 'party x' has invested in and then to see if there are connections that can be sounded out off the record as well as companies that 'party x' was going to invest in but where the deal fell through (this is a lot harder to come by though).
You should absolutely do this, always speak to founders of companies who've raised money from a given investor before taking money from them. You can also ask investors about other investors (as in "have you co-invested with X before, would you ?").
Considering that this essay will be read for years, maybe you might like to fix this little typo: "If you're in a wizard at fundraising". Edited: "equity round valuation might me". PS By the way, thank you so much for all this incredibly valuable free advice!
Thank you for posting this advice in a clear cut manner. As someone looking to raise money, but not currently residing in the valley, a thorough map to guide my thoughts and presentation development before venturing out into the West Coast VC waters is amazingly helpful.
> Since phase 2 prices vary at most 10x and the big successes generate returns of at least 100x, investors should pick startups entirely based on their estimate of the probability that the company will be a big success and hardly at all on price.
Can someone explain the reasoning here? Investing at a lower valuation means that for the same money in, the investor gets a higher cut of any payout, right? If an investor judges your company to have a 1% chance of ending up worth $100m and a 99% chance of it ending up at $0m, then they should be willing to invest if the valuation is << $1m and not if the valuation is >> $1m. Or not?
In practice few to zero investors make money that way. All the money in startup investing is in the big hits. Which means the way to make money as a investor is to try to invest in the companies you think will be big hits, and pay whatever the price happens to be.
What do you mean they don't make money that way? Do you just mean that $100m isn't a hit? If that's all you mean, change that number to $1b or $10b or one hundred... billion dollars (pinky to lip). But I think what you mean is that investors make money by finding companies that are grossly undervalued, to the point that an order of magnitude change in valuation shouldn't affect the decision. I'm still skeptical of this claim. How many companies valued at $10m do you think have a 10% chance of ending up at $1b+?
Almost all phase 2 startups will be worth zero, or nearly zero. Some will be worth $BIGNUM. If you invest in the latter, you will be rich irrespective of whether you invested at a valuation of $BIGNUM/100 or $BIGNUM/200. If you invest in the former, you will not be rich.
Moreover, whatever money you make on any startups that do not make $BIGNUM is rounding error by comparison.
Your questions are interesting, because (outside of the startup world) they are based on sound logic. The basic rules of expected value don't apply to startups, because the present value is not a good predictor of future value. Some people are good at predicting the outcome (success vs failure), but nobody can get the number right ($10m vs $1b). Any investor who lets marginal changes in valuation influence his decision is essentially calculating a probability using a random number.
> The basic rules of expected value don't apply to startups
If you'd reword that as "the basic rules of expected value are difficult to apply to startups", there'd be some chance it was true :).
And yet, difficult as it may be to apply, expected value is the framework to rationally make a decision about low probability / high payoff investments. Of course, if YCombinator is already invested at an early stage (note: when the valuation is quite low), I can understand why pg wouldn't care too much about the later stage valuations. If you look at what's best for YC, it's first and foremost that companies get the money they need to succeed (an incentive aligned with the founders and any investors) but probably also that the valuations (after their own investment) be as high as possible so that more of the pie remains for later investments. This latter incentive is clearly not aligned with investors and as an investor I'd take the advice to disregard valuation with a big grain of salt.
Excerpt: "To a first approximation, a VC portfolio will only make money if your best company investment ends up being worth more than your whole fund." This is the big hit, and VC's are trying to optimize their chances of getting one of these. That's different from trying to precisely calculate expected return. As long as you've found it, it won't matter if you paid a bit too much.
> Since phase 2 prices vary at most 10x and the big successes generate returns of at least 100x, investors should pick startups entirely based on their estimate of the probability that the company will be a big success and hardly at all on price.
To give concrete numbers to pgs statement:
Pick 2 hypothetical startups: A and B. A will go on to be a 10 billion dollar company and B will be a 100 million dollar company. Now, valuations at round B series vary from say $40 million to $400 million (as pg said 10x). Note: they arent yet worth what they will be worth later. Now, say you take a 20% equity cut for the round and there is no dilution between this and when they go public (just a simplifying assumption). At the end, the 20% equity is worth either 200 million dollars for A or 20 million for B. The difference in profit is 180 million dollars; much more than any additional amount you would have paid to get in on a higher valuation. Therefore, if you believe the company to be of the A type, you will pay that 20% of a higher valuation.
> pay whatever the price happens to be.
This is what pg means: the difference in profit between A and B was 180 million dollars which far exceeds the difference in cost in investing in the two. This makes the investors rather price insensitive IF they think that you are in the A category. The reason that investors have the mental model of assigning to categories rather than guessing the percent chance of success is that they know often they guess wrong. There are simply too many variables to create any sort of accurate chance of success.
> Therefore, if you believe the company to be of the A type ...
That's the problem I have with this line of thinking. An investor doesn't "believe" it to be type A. An investor gambles that it's going to be type A. Reasoning after the fact that you should have been willing to spend more on the winner, without accounting for probabilities, is flawed reasoning. If anyone could see five years ago that the company was certainly going to be worth $10b today, then it would have been worth $10b five years ago (after adjusting for inflation). If no one else could see it but you, and yet you were somehow certain, then sure, but that's not typically the situation.
[Before continuing, let me point out that you flubbed the math: 20% of $10b is $2b, not $200m. The difference between A and B equity is $1.98b, not $180m. This wasn't particularly important to your point, but since I am continuing this example I thought it might avoid confusion to note the error.]
Since most people generally prefer frequentist reasoning, here's another try. Suppose you invested in 100 companies, one of which was company A and the other 99 of which failed. If you invested at 20% in all 100 companies valued at $40m each, then you've spent $800m and have $2b in equity. If you invested in those same companies at $400m valuation each, then you spent $8b for that same equity of $2b.
> without accounting for probabilities, is flawed reasoning.
This is the problem. It is rather illogical to believe that one can come up with an accurate probability of success for a given company given the multitude of variables both known and unknown. For example, AirBnB was thought to be not only bad, but a terrible idea initially yet it is one of the biggest winners in all of the YC batches. What probability of success did investors give it? Think of it from the point of view of an investor who passed up on AirBnB. How much do you think that these probabilities that you come up with mean when you know how bad you are at deciding whether to invest at all.
Who says the probabilities are going to be accurate? The point is that it's better to guess at probabilities for outcomes and then calculate than it is to blind guess at valuations. Presumably, YC will be in a better position than most to estimate the probabilities.
It may be worth pointing out that pg could have some interest in what's being said here, though I don't by any means think that's his motive. Since YC takes equity before stage 2, it's much better for YC if investors over-invest in startups, since that'll improve their chances of winning.
I actually think he's more likely to simply care a lot about making life better for founders, though. He may care about investors too, but I warrant it's less.
Thanks Paul for taking the time to share this wisdom outside the YC Collective. These words will have long lasting, positive effects on the ecosystem. Much appreciated.
I like "We'll succeed no matter what, but raising money will help us do it faster."
I think this is a great universal negotiating technique. It's also useful for job hunting. Once you have time on your side (cash flow) you can afford to walk away from suboptimal deals.
From my experience, one of the most important realizations of fundraising is that it's an enormous mind game.
The hardest part of fundraising was getting the startup to a point where I actually believed in it. When I looked at our projections and where the company could go, I was no longer thinking, "Yeah, if a miracle happens," but rather, "It'll be hard, but I really, really think we can do that. We just need some help to get there."
Fundraising was a relative cakewalk when I was no longer selling investors on our company; I was explaining to investors that we were taking off, and asking them if they'd like to jump on board.
I believe that making that mental transition (to believing in your company) impacts the way you approach other areas of your business as well (not just fundraising).
For instance, when courting a large potential client or partner, your confidence goes up and you are not selling, so much as explaining. People pick up on this, and your results will show it. Plus, it just plain feels better when you really believe in your company's potential vs. merely hoping.
When you talk to women your m.o. should be breadth-first search, weighted by expected value. You should always talk to women in parallel rather than serially. You can't afford the time it takes to talk to women serially, plus if you only talk to one woman at a time, they don't have the pressure of other women to make them act. But you shouldn't pay the same attention to every woman, because some are more promising prospects than others. The optimal solution is to talk to all potential women in parallel, but give higher priority to the more promising ones.
The analogy to dating is problematic. Such a strategy is indeed effective for dating, but feels mercenary or even sociopathic to most people. Making the analogy raises moral issues that aren't relevant to fundraising.
Every human interaction is just analogous to dating, because human interactions are based on interest and the whole thing is called social dynamics. Be high value and wanted and everybody wants you, be desperate and low value and nobody wants you.
In dating, it is sexual interest, in business, it is monetary interest , the underlying principles are the exact same.
Essentially, they lead you on. They seem like they're about to invest right up till the moment they say no. If they even say no. Some of the worse ones never actually do say no; they just stop replying to your emails.
I've never sought investment, but I always really disliked it when companies broke communication off after an interview or application without a firm rejection.
On the otherhand, I think I prefer diminishing communication when it comes to dating. I don't treat dating like an application process. Most of the time when I talk to a woman, I'm not trying to ascertain her suitability as a mate, rather, I'm just trying to make my day/evening a little more enjoyable by having a conversation. Sometimes those conversations turn into something else, sometimes they don't. If I text someone after getting there number, I think I'd much rather prefer no response (I get what that means) to some sort of direct rejection.
PG makes the comparison explicit later in the essay:
"There are many analogies between fundraising and dating, and this is one of the strongest. No one wants you if you seem desperate. And the best way not to seem desperate is not to be desperate. That's one reason we urge startups during YC to keep expenses low and to try to make it to ramen profitability before Demo Day. Though it sounds slightly paradoxical, if you want to raise money, the best thing you can do is get yourself to the point where you don't need to."
You'll notice a common theme in this (excellent) piece: it's for startups that have some reason to believe they can actually raise a bunch of money. Startups who have either sufficient demonstrable talent behind them, are growing in some interesting way, or some other form of validation.
If you can't find some confidence that you're in that group, find a way to delay fundraising: keep your job, do consulting, work on alternate revenue streams, whatever, because fundraising when you're no in the group the bulk of this article applies to - trying to fundraise is hell. Not just hell like "it's really, really hard and frustrating" but hell like you could actually lose yourself in it, like you could actually get destroyed by it.
He's done a great job of explaining this in the past - just making sure to clear it up. The worst thing in raising money is realizing you're not there yet - because NOBODY will tell you that, especially not investors.
I'd strongly recommend having a presentation in the pitch meeting. It helps control the flow of the meeting and ensure you cover all the important points.
My favorite thing about these essays, is summarized by PG's remark in this one: "sorry, we think you're great, but PG said startups shouldn't ___, and since we're new to fundraising, we feel like we have to play it safe."
The card it gives to inexperienced players. This whole thing feels like a way to even out the information asymmetry inherent in these transactions.
Unsurprisingly, excellent advice phrased as succinctly as it could be for such an enormous topic.
I'm glad Paul Graham think that decks are on the way out, because they're a ludicrous (or at least inefficient) way of understanding what a startup does. If you have a product, show me that. If you have financials, show me those. Otherwise it becomes a competition to see which companies can dedicate their design resources to make the prettiest deck, and which investors can do the math on your '30% growth' number to figure out that you're growing from 3 to 4 users.
The advice about valuation is also great. I listened in on a conversation with very smart founders who are used to optimizing things, and they were super concerned about having a great pre-money valuation. It's tempting to focus on it because it's your only benchmark at a really stressful stage, but if things go badly it won't matter, and if things go really well it... won't matter either.
Another problem with emailing decks is that investors read them and decide, without much feedback to the founders. When founders can talk through the deck interactively with investors, they can learn which parts work and which don't, and what questions are unanswered.
I think showing the product alone works well only if the investor is in the target audience. I just met with an entrepreneur who has what I believe is a great product, but the investors he has talked with so far are just not going to be users of it.
In his case, I think having a couple of slides to help demonstrate the problem is very helpful. Otherwise there isn't a sufficient aha moment when he gets to the solution.
Certainly the business case is important to lay out, especially in the case you describe. Many decks don't do that though - they don't stand alone without a verbal pitch. They lack context and sometimes even topic headings.
I've seen many decks that have a page with a heading like "Opportunity" and a number (along with the obligatory graph going up and to the right). What is that? Competitor sales? Expected market share? Entire market size? Even if the investor is watching you pitch out loud, they may refer back to the deck and find they have forgotten what you said about that slide.
I'm sure I'm not the only one thinking back on some long-ago startup and thinking, "Oh! Those assholes! I knew it!"
Not that what PG says here is exactly news to me at this point, but his wide experience and resulting confidence is fantastic confirmation of things that I now know to suspect, but at the time seemed so reasonable. Oh, you don't lead? Oh, you want to see just a little more progress? Well of course you do. And I, earnest nerd, took them at their word.
This is interesting and contradicts a bit of "disrupt" meme:
"You can't trust your intuitions. I'm going to give you a set of rules here that will get you through this process if anything will. At certain moments you'll be tempted to ignore them. So rule number zero is: these rules exist for a reason. You wouldn't need a rule to keep you going in one direction if there weren't powerful forces pushing you in another."
What this seems to be saying (to young people) is "it's ok to ignore what other older more experienced people say (or what established practices are) and try to disrupt in those situations because the guidelines and experience they have is bogus but I am telling you that my rules are right so just trust me".
Your intuitions != what older more experience people say
pg and YC has more qualified investing experience than probably any other "experienced person" you could talk to. When you are doing a startup, it's generally a good idea to focus on innovating in your core area of expertise - which would be some combination of product/market/technology - and take the best practices of all the other areas, like financing.
I'm not talking about what PG or YC recommends with regards to investing.
I'm talking about the general idea that if anyone else said something like this and asked for blanket trust:
"you can't trust your intuition....rule number zero is: these rules exist for a reason"
Well those other people of course can't be trusted like PG and what they say doesn't matter as much. So if a person with 30 years in the taxi industry said to you "trust me these things are for a reason" and you saw he was as accomplished in what he did as PG would you just "trust him" or would you dig a little deeper?
Interesting but expected that I would get downvoted for stating an opinion on something I said "what this seems to be saying". In a classroom would a teacher takes points off for stating a thought like that?
Quite frankly I don't know why it's so necessary to walk on eggshells when stating a thought that seems to question what PG may say.
Much of "disrupt" goes against a pattern of previously accepted behavior that others have questioned.
I had to reread your original comment a couple of times to get what you were saying. I think you might be getting down-voted because of writing style and confusion more than anything else.
I agree that if my my writing style is not good, and adds to confusion, then that is something that I need to work on.
But I sometimes feel that there is a definite emotionality involved when people hit the vote button and people jump to a quick conclusion depending on either the particular subject or the person who the commenter is making their thoughts known on. It seems that when discussing these "protected" individuals or subjects you have to take extra care to say things in a way to protect against downvotes. And sometimes that is just not worth the effort so you don't say anything.
> But I sometimes feel that there is a definite emotionality involved when people hit the vote button and people jump to a quick conclusion depending on either the particular subject or the person who the commenter is making their thoughts known on.
I agree with everything you said, although, per my other comment, I think it was you who "jump[ed] to a quick conclusion" in this case. :)
Though I speak with the tongues of men and of angels, and have not charity, I am become as sounding brass, or a tinkling cymbal. And though I have the gift of prophecy, and understand all mysteries and all knowledge, and though I have all faith, so that I could remove mountains, but have not love, I am nothing.
These aren't universal, unqualified rules and I don't understand why you're trying to generalize them beyond fundraising. To use a different and perhaps silly example, I'd be more inclined to trust my intuition with respect to dog kennels than, say, medical or legal advice.
I think pg is saying that fundraising is more like medical or legal advice and less like dog kennels. He's not making a blanket statement about trusting people with prior experience.
If you want to make this more mathy, imagine there some function
I(s) = amount I should trust my intuition in situation s
pg is writing about what happens when "s_1 = I'm fundraising for the first time," but you're trying to rebut his point as if he were writing about what happens when "s_2 = I'm talking to someone more experienced than myself." There are three possibilities: pg believes I(s_1) = I(s_2), you're misunderstanding pg, or pg is contradicting himself.
You're arguing that since pg believes I(s_1) != I(s_2) (as evidenced by his previous writings) then pg must be contradicting himself. The correct line of reasoning is actually "If pg believes I(s_1) != I(s_2) then either pg is contradicting himself or I'm misunderstanding pg."
Given pg's generally fastidious nature with respect to these things, I'd say the prior odds of pg contradicting himself are much lower than you simply misunderstanding him. At the very least this is what most folks believe, so when you jump to the conclusion that pg is contradicting himself you come off as an uncharitable little troll. First stop on the troll tour: Downvote City. :D
Putting on my teacher hat for a second, when you smell a contradiction like that it's often a sign you're misunderstanding something. Rather than point out the apparent contradiction and go all j'accuse on the author, it's more useful to stop and ask yourself, "Assuming the author is intelligent enough to spot a contradiction like this, is there a way to understand what they wrote in a way that isn't contradictory?"
There's really no downside to doing this, even if there is a contradiction. At the very least you'll have developed a more robust argument. Often you'll end up with a way to express the author's argument more clearly than the author did in the first place, since you're probably not the only one confused in the same way. What's more, if there actually is a contradiction, folks will be more inclined to believe you when you demonstrate you've gone out of your way to try to understand the author.
"This is interesting and contradicts a bit of "disrupt" meme:"
If I was trying to rebut his point I would have stated that I thought he was wrong "and here is why" which is not what I did, did I?
With medical and legal advice by the way, it's highly likely that you if you talk to 10 professionals, (as the saying goes) you might very well get 10 different opinions.
"I'd say the prior odds of pg contradicting himself "
I didn't say PG contradicted himself at all. I said what he was saying contradicts the "disrupt" meme (if you want to call it that).
"Rather than point out the apparent contradiction and go all j'accuse on the author"
How does what I said in any way rise to the level of this:
Fair enough. I ask you forgive me for my incorrect interpretation. Here's what you wrote:
>"You can't trust your intuitions. I'm going to give you a set of rules here that will get you through this process if anything will. At certain moments you'll be tempted to ignore them. So rule number zero is: these rules exist for a reason. You wouldn't need a rule to keep you going in one direction if there weren't powerful forces pushing you in another."
> What this seems to be saying (to young people) is "it's ok to ignore what other older more experienced people say (or what established practices are) and try to disrupt in those situations because the guidelines and experience they have is bogus but I am telling you that my rules are right so just trust me".
In particular, I took the "this" in "What this seems to be saying" to mean preceding paragraph you quoted from pg's essay and the quote following it to be a restatement of an argument pg was making in this essay or elsewhere. Since pg's essay didn't talk about the "disruption meme", include the words "disruption" or "meme", or have anything to do with advice outside a fundraising context, I had assumed you were referencing previous essays.
So, either the "this" in "What this seems to be saying" is referencing something else or you're responding to a position nobody in this conversation, including pg, has taken. Wanting to be charitable, I assumed you misread the essay or over-generalized its argument.
Do investors read these essays? You've had some strong words for some of the types, e.g. "contemptible subspecies of investor". Would any of them email you and say, hey man, f u?
I would imagine not. Not only is PG very influential at many of the companies these investors would want to invest in, but most of these investors are also going to be hesitant to out themselves as being a "contemptible subspecies of investor".
Everyone in the community reads these essays. I would hazard that pg's goal in them is to coach both startups AND investors in how to behave toward each other. In this case, such bold language is him saying, "don't be this guy".
"But the foundation of convincing investors is to seem formidable, and since this isn't a word most people use in conversation much, I should explain what it means. A formidable person is one who seems like they'll get what they want, regardless of whatever obstacles are in the way. Formidable is close to confident, except that someone could be confident and mistaken. Formidable is roughly justifiably confident."
For years I've been toying with making a start-up board game. This essay could easily serve as the basis for that.
Slight disagree with the line:
"For example, if a reputable investor is willing to invest on a convertible note, using standard paperwork, that is either uncapped or capped at a good valuation, you can take that without having to think."
A good valuation means you're going to have to think anyway and if you don't need it you don't need it so then you're just going to have an obligation + temptation to use the funds. There is no such thing as 'free money' and a convertible note is simply deferring a part of the process and you'll need to take care of it sooner or later by going for funding (or paying back the loan). So if you are not sure if you are going to do a follow up round just yet I'd advise against getting a convertible loan, you now have a good chunk of the hassle of having an investor without having properly gone through the process required. Of course you could simply bank the money and pay back the loan if you are still of the same opinion later on but this rarely happens. It's the start-up equivalent of easy credit card debt, and if the valuation turns out to be low you could end up regretting taking the money (for instance, you could lose control like this). Better to negotiate it when you're strong or if you feel very secure about your future valuation.
Having seen a lot of this from the other side of the table quite a few of the passages strike me as extremely negative about investors, I'm sure Paul has a ton more experience than I do so this carries a lot of weight with me but I don't recognize the behaviours he sketches with the investors that I normally work for. Maybe they are the exception (I'm sure they'd like to think that :) ), but I can't imagine it is this black.
Investors look at the process of investing mostly as risk elimination, and as a second best as risk reduction by enumerating the risks. If an investors bails at the last moment (for instance after you've already agreed on terms) that would either reflect very bad on the investor, or more commonly on the party invested in. It's not as clear-cut imo as it is sketched here that all start-ups are angelic and innocent and investors are all sharks to a man and employing dirty tactics to get you to sign on the dotted line.
Again, it's clear on which side my bread is buttered but I simply wouldn't work for investors deploying such tactics, but have yet to see this sort of behaviour in any VC of some stature. Otoh I've seen plenty of trickery by companies about to be invested in (and lots of good companies too).
Just to add a common misunderstanding - a convertible note is debt and raising capital is equity. Debt means you owe something (in this cause equity at a later time), and equity means you own something. I know this is probably "Fundraising 101" but often its the basics that people get wrong.
The article gives valuable insights into raising capital and the art of negotiation in this domain.
Overall, negotiation and funding could almost be expressed as a rule table. Certain heuristics and rules. Rather than flip flopping strategies on how to negotiate and deal with investors, I think it may be good to have a set of rules/heuristics to follow and see if it leads to your goal. If it fails, alter it and see the result. Anyhow, thats what I intend to do for my company, GridCrowd.
For negotiation PG mentions that its may be ok to just admit your a noob or not knowledgeable on certain aspects of funding. I respectfully wonder if there is another stratedgy from what I've learnt in negotiations in the non-funding world?:
Negotiate from a perceived position of strength.
You don't have to say your a noob, miss the detail and expose it if it becomes necessary. This way you may be able to attain more action on behalf of the investor moving through their process. The noob strategy allows them to indicate a process that could be tailored to their advantage. I don't know investors, so its hard for me to understand their objectives and how they behave. I'll re-read PGs advise again, he does have great credibility and wiseness so maybe I need more study on this strategy.
"When everyone wants you, it's hard not to let it go to your head. Especially if till recently no one wanted you. But restrain yourself."
Reminds me of a great quote from a family member. When my cousin's son started playing football, my cousin told him "the first time you get into the endzone, act like you've been there before".
I have a question. Since I'm nowhere near the valley and the start-up community in my community might as well be non-existent, I was wondering how I might go about meeting and getting introductions to investors. Not being well connected with a very poor local community makes it hard for me to know where to start.
Since I'm nowhere near the valley and the start-up community in my community might as well be non-existent, I was wondering how I might go about meeting and getting introductions to investors.
In that case, it's probably good to think of ways to move to the valley.
It sounds like the only investors in your area are probably individuals who happen to be wealthy, i.e. potential angel investors. But outside of the valley, angels tend to be family or people you're already acquainted with. And even if you can get them to invest in you, they're going to be less experienced than valley angels, meaning they may be dangerous to you. E.g. they'll probably rely heavily on their lawyer to structure the deal, and since you're not in the valley, that lawyer probably isn't a startup specialist, so you'll need to be extra careful they're structuring the deal properly (and structuring your company properly, if they're incorporating you).
Investment can be had in places other than the valley, of course. But the reason you want to be in the valley is because (a) that's where the top investors are, and (b) there are a lot of them. Raising investment anywhere else therefore increases the risk of having bad terms forced on you by clueless angels or predatory VCs.
Choosing to seek investment in the valley is like choosing the high ground in a battle: it's naturally suited to protect you from dying. And since avoiding death is every startup's most important goal, the valley is therefore the most important place to be.
> But outside of the valley, angels tend to be family or people you're already acquainted with.
Find out who the LPs are of any private equity fund, there are your angels (by the 10's if not the 100's), and none of them will be family or people you are already acquainted with. Additional upside for those locations where this matters: and all of them will already be vetted as qualified investors.
If you're a programmer, the best route to investors is probably through other programmers you know. If you know any who are founders or early employees at a startup, they can introduce you to their investors. They can also introduce you to other founders, who can introduce you to their investors.
Get 1,000 users in a month and you don't need any introductions. You can cold email them and they will jump you. Maybe not jump you, but that should give you an idea.
Don't waste any idea on fundraising until you have product fit, market fit and first initial traction. Trying to fund raise before that is the sign of an amateur and if you actually get an investor interested before product fit, you will get a very shitty deal and the whole process will kill you.
An interesting point here is arrogance towards investors. The art of "arrogance" is to be arrogant in what you are saying while being very kind and nice in the way you say it.
It's very hard as a first time founder to mimic the arrogance that is natural for experienced founders. If you can do it, it's great, if you can't, it will burn your bridges and blacklist you.^^
If you can pull it off though, you're the master. It's the pinnacle of hustling, having nothing to offer but being as confident as the next Mark Zuckerberg.
So you'd need to be as confident as Mark Zuckerberg when he had $1M users when you only have 1000 users. However, that also only works if you intrinsically think of yourself as a very high-value individual and if you have worked for several on you to think that way. Otherwise, investors will quickly spot your fake.
There's a lot of great advice in this post, and much of it rings true. Specifically, the following tidbits are true ~100% of the time in my limited experience:
- "Investors will try to lure you into fundraising when you're not. It's great for them if they can, because they can thereby get a shot at you before everyone else."
- "What investors would like to do, if they could, is wait. When a startup is only a few months old, every week that passes gives you significantly more information about them."
- "Though you can focus on different plans when talking to different types of investors, you should on the whole err on the side of underestimating the amount you hope to raise."
- "You will be in a much stronger position if your collection of plans includes one for raising zero dollars—i.e. if you can make it to profitability without raising any additional money."
- "If you have multiple founders, pick one to handle fundraising so the other(s) can keep working on the company."
- "It's a mistake to behave arrogantly to investors." (I also think it's a mistake for investors to behave arrogantly to founders)
That said, I wanted to comment on a few of the other points in this (awesome) essay:
"To founders, the behavior of investors is often opaque—partly because their motivations are obscure, but partly because they deliberately mislead you."
That's a strong statement. First, not all investors mislead -- many are honest people. Second, startups are also often guilty of misdirection, which doesn't mean you shouldn't call out shitty investors, but I do think you should call out both sides instead of making one side sound like the bad guy.
"Do you have to be introduced? In phase 2, yes."
I think this is true 95% of the time, but it's not 100% true. My partners and I get pitch decks emailed to us by random people. Most of the time the pitch decks are subpar, but I think that's because not being able to get a real intro is a sign that your team/idea/traction/something else is subpar. However, this is just a signal, and there is no rule - written or unwritten - that says "if we don't know the sender then the deck goes in the trash." If you email us something that falls within our thesis and looks promising, we'd love to talk to you.
"Never leave a meeting with an investor without asking what happens next. What more do they need in order to decide?"
This is great advice. Most founders we talk to already ask "what's next" at the end of a meeting, but not all of them do.
"And while most investors are influenced by how interested other investors are in you, there are some who have an explicit policy of only investing after other investors have. You can recognize this contemptible subspecies of investor because they often talk about "leads.""
I guess I'm one of the members of that contemptible subspecies. My partners and I are in the middle of raising a fund, but we were investing with our own money for the better part of this year. Our checks were too small to lead, but there were lots of startups that didn't have terms. If you're raising 1m on a 5m pre, then we don't need a lead to invest. If you're raising 1m-2m on a ??? pre, then we would prefer to wait to find out what ??? is. We're not super valuation sensitive, so 7m vs 8m is fine, but there's a big difference between a 6m pre and an 10m pre. What makes this more difficult is that founders will not reveal terms for obvious reasons. They can't say, "we're going to be raising at a 6m-9m pre" because that immediately shows that they would be willing to go to 6m. They may as well not mention 9m. So instead, they say something like, "we'll know terms once we get a lead." Okay, fine.. then we'll wait for the lead. =)
"Sometimes an investor will ask you to send them your deck and/or executive summary before they decide whether to meet with you. I wouldn't do that. It's a sign they're not really interested."
I'm surprised by this advice. As an investor, it saves everyone a ton of time when I can look at a deck before a meeting. I will sit down for 15-45 minutes before a meeting, go through deck, do some internet research, and think of questions I want to ask. This saves time because I can find out answers to the basic questions that I would ask in the deck, and then we can focus on more interesting questions and concerns during the meeting.
"Sometimes an investor will ask you to send them your deck and/or executive summary before they decide whether to meet with you. I wouldn't do that. It's a sign they're not really interested."
I can look at a deck before a meeting. I will sit down for 15-45 minutes before a meeting, ... more interesting questions and concerns during the meeting.
It sounds like you want a deck before a meeting, which isn't contradicted by PG. PG says don't give a deck before not having a meeting. In more straightforward logic don't give decks to window shoppers. If they can't spare time to meet with you then they aren't interested, don't bother giving them a deck. Nothing in that quote suggests withholding a deck after they decide to meet with you but before the meeting.
"And now that I've written this, everyone else can blame me if they want. That plus the inexperience card should work in most situations: sorry, we think you're great, but PG said startups shouldn't ___, and since we're new to fundraising, we feel like we have to play it safe."
>> These lines will echo in the glass conference rooms of the valley for years to come...
A question on a side digression: "falls within our thesis" - I often hear/read the term "thesis" being used by investors, and I am curious what exactly is meant by it. Is a thesis a tome of 100+ pages? Is a thesis two sentences, something like "we think that local/mobile/social will be hot this year"?
An investment thesis is basically a hypothesis about what sort of companies will do well as investments. Some investors don't have a specific thesis, and will invest in any company that looks good to them. Others have a specific take on the startup ecosystem. For example an investor might believe that infrastructure companies are a great bet going forward, or they might think that the sharing economy is the right bet, or, as in case of my fund, they might think that companies building valuable and proprietary datasets (and tools for working with those datasets) present the best opportunities. If an investor has a thesis, they will invest exclusively or mostly in companies that fall within that thesis.
It means, not much. More akin to the ivestor has thought about it before. In this case, 'thesis. As in 'Hypothesis', but abbreviated. Not like a shorter version of a dissertation. The investment is "hypothesis testing", by creating a data set, to see if it should be rejeceted. etc
"Sometimes an investor will ask you to send them your deck and/or executive summary before they decide whether to meet with you. I wouldn't do that. It's a sign they're not really interested."
I am both surprised and relieved by this advice. I see some investors over optimize on deck creation and presentation skills. Personally, I have not seen any correlation between how fancy the deck is and subsequent success
Seems to me like the bottom two are not really disagreements. For the second to last, if they gave you terms, you'd invest, right?
For the last, you presumably aren't deciding whether to meet with them based on the deck; it's just nice to be able to review it so your mind is prepared.
You're right on both counts. On the first point, I was trying to say that there are legitimate reasons to wait for a lead, and waiting for one is not always a matter of vacillating or stalling.
What about how a phase 1 startup could find investors in the first place? PG talks a lot about how it goes by introductions. What's the solution to the chicken/egg problem?
"How not to have to raise money" should have been more useful to startups. Unfortunately, many have been conditioned into thinking that success can't be achieved without fundraising.
Thank you, pg. I would amend the summary by including an encouraging word to the founders:
"Avoid investors till you decide to raise money, and then when you do, talk to them all in parallel, prioritized by expected value, and accept offers greedily; build rejection into your plans by having a range of realistic, acceptable fundraising targets. Get back to work quickly."
Great article PG. I'd like to see more case studies on a successful fundraise at the individual level. How much foreplY do you need before you ask them to bed? How many initial meetings will here likely be? How long does this take?
this is perhaps the most honest and accurate description of what you will likely find in raising money - couple with fantastic advice. in fact, it accurately reflects my first experience and rookie mistakes raising money in a secondary market: wasting time by being led on by investors who don't lead; eventually closing a first investor, which started a rush; etc. if you're raising money for the first time, please read this multiple times...for your sanity's sake.
> But there may be cases where a startup either
wouldn't want to grow faster, or outside money
wouldn't help them to, and if you're one of them,
don't raise money.
Having the essay earlier would have saved me a lot
of time and effort. For my startup, I tried for a
long time to raise money, and as in the essay it was
a huge distraction from the real work. Eventually,
at absurdly high cost in time and effort, I
concluded the more common half of what is in the
essay.
Since I wanted to try hard to crack the nut of fund
raising, I kept at the effort until I got some
decent understanding.
Also I had to conclude that VCs and I do projects
and project planning and evaluation in very
different ways. Since it was quite a while ago that
I was 20 years old, and I've done a lot of projects
and seen a lot of business, I prefer my approaches
to project planning and evaluation. Also, for my
project, my technical background, in applied
mathematics, is far above that of all but maybe 10
VCs in the country. There is likely not a single VC
in the country who could understand the crucial core
of my project, some original applied math I derived,
and only a few VCs who could even direct a competent
review of that crucial core. So, I just can't be
impressed by what VCs think of the crucial core of
my project. When I was fund raising, I wondered how
the VCs would evaluate my work; the answer is, they
wouldn't! So, they don't have a clue about what
they are missing.
So, net, VCs will evaluate my project based on
traction which should mean that, for me, a solo
founder with meager burn rate, by the time a VC
wants to write a check, as in the quote above from
the essay, I will no longer be willing to accept
one.
After the fund raising effort, I settled on the line
in the essay I quoted above: For me, and as often
in the essay, the VCs are just too much trouble to
work with to be worthwhile. Yes, the VCs are
trouble in fund raising, but also the VCs will bring
Board overhead, more time/money with lawyers and
accountants, and, then, in case of the success they
want, an IPO with all the Wall Street and SEC
nonsense. Handling all that would be a full time
job for me, the CEO of my company; that's not the
kind of work I want to do; and my hands would be
taken from actually building and running my company.
I see another point: In the US, businesses are
started and succeed coast to coast in big cities
down to crossroads by solo founders by the millions
each year. Such a business might be a pizza shop,
auto repair shop, landscaping service, big
truck/little truck business, etc.
My startup, with me as solo founder, is in
information technology (IT) which should be a huge
advantage: E.g., my first server farm will cost
less than the truck and lawn mower of the guys who
cut grass in my neighborhood, and the Internet
connection I need will cost less than $100 a month.
Moreover if I half fill the Internet connection,
then from simple arithmetic my revenue and earnings
in one year will be quite comparable with funds from
a Series A.
So I just view my startup as a one person pizza
shop but with some big advantages from IT; e.g., a
pizza shop owner needs to be in the shop for each
dollar made, and my server farm can be making money
while I sleep.
For PG's definition of a startup in terms of very
rapid growth, so rapid that VC funds become
important, that's not important to me. I need a
nice business; I don't have to shoot for another
Google and wouldn't want to manage anything that big
anyway.
A recent remark of Mark Andreessen is that there are
only about 15 startups a year that deserve a Series
A. So, the essay is talking about only about 15
startups a year and, thus, I am not disappointed the
essay is not talking about my startup.
The VCs and I will have to disagree on how to plan,
evaluate, start, and build a company. If I am
successful, then likely that disagreement will have
been a big part of my success.
The VCs remind me of the Mother Goose story The
Little Red Hen when she could get help only when
she had fragrant, hot loaves of bread coming out of
the oven and customers lining up to buy and no
longer needed any help.
For me, one really serious turnoff of VCs is that,
since they have really no chance of understanding
the crucial core of my business or how I do
projects, no way would I want to report to a Board
with VCs. Vinod Khosla has some recent remarks on
how helpful Board VCs are!
Another big turnoff of VCs is that, as reported on
Fred Wilson's blog, on average over the past 10
years, the VC ROI has been poor. Net, VCs do not
have a lot of credibility in business.
Another big turnoff is that too many VCs were not
STEM majors and have written little to no code.
Another big turnoff is that my startup, as is
recommended for startups, is doing work that is new;
well, there is some education for how to work
effectively with things that are new, a Ph.D.
degree; I have an appropriate one from a famous
research university, and nearly no VCs do. I will
have a tough time viewing a VC as a helpful
colleague in the crucial core of my business.
I can relate to most of what you're describing but wanted to point out that your business (any business) is a lot more than "core" of your business. If you're content with the rate of growth, you are already profitable or don't need additional funding etc. than you may not need the VCs. PG's essay repeatedly states not to raise money. But if you do want to make strategic investments, accelerate growth, etc. you will need to do many things that are outside the "core" of your business. In that case you may try to find VCs that have experience doing that, or at least can open doors for you so that you can find the right people to help you get there, etc.
>
I can relate to most of what you're describing but wanted to point out that your business (any business) is a lot more than "core" of your business.
Yes, but I've been a B-school prof, and last month got
a lesson in business: A house in my neighborhood
in NY USA had
the shrubbery too tall, and a crew was hired to come in
with a chain saw and cut back the shrubbery. They had
a nice new truck. My guess is that they were recently
from Mexico and that the lead guy was there running all
his business. And he was doing fine without an MBA
or VC!
Basically, for millions of businesses in the US, the
non-core functions get handled plenty well enough by
just the founders without help from an MBA or VC.
I did mention Khosla's recent remark on
how much VCs help founders run their businesses.
Your point about "strategic investments" may be correct:
Sure, a standard PE idea is a roll-up. However,
I'm not sure that really VC capital is the best
for such investments, but in some cases maybe it is.
For "growth", I don't see the crucial need for VC
given that the VCs want to see a lot in traction,
at Series A and certainly for a growth round
after a Series A. It seems to me that
a founder should just let the
revenue from the assumed traction fund the growth.
Lots of businesses, pizza shops to auto body shops,
do, and an IT business should have an advantage.
Besides, some of PGs growth timing looks fishy
to me, especially get a VC round, hire people,
and show big results in 18 months. Maybe can
do that work and get the additional revenue
in the 18 months, but I'd have a tough time
believing that could get a good team built
-- advertize, interview, select,
move, house bought, kids in school,
spouse in a job, introduced in the office,
familiar with the office procedures and
tools,
train, build team -- in 18 months.
Seems to me that the growth bottleneck is
team building, not funding.
Just to provide a counter example to balance your assessment of VCs: Our lead investor has a Ph.D. in EE from Stanford. Our secondary investor has an engineering degree from MIT and is a serial entrepreneur. They have been very helpful in terms of advice and support.
I made two points, that likely the VCs
could not evaluate my project and likely
only a few VCs could direct an evaluation.
For the first of these two, a
EE Ph.D. very likely would not understand
the crucial, core applied math of my startup
due to not taking the right prerequisite
courses in graduate school. If they studied
from Luenberger at Stanford, then maybe they
would have some of the prerequisites!
For the second,
directing a competent review of my work, a
EE Ph.D.
would likely be able to do that, especially
once I gave them a list of reviewers, and I
did indicate that a few VCs could so direct
a review.
There is a huge problem with VC: Necessarily
they are looking for exceptional cases. So,
what the average deal looks like provides poor
guidance on what a really desirable deal would
look like. And since the VCs are also looking
for things that are new, what the best deals
of the past 10 years looked like also provides
little guidance.
There are ways to know that something really is
exceptional and powerful early on, and the US
DoD has provided a long list of examples for
the past 70 years or so. E.g., the first GPS
was done by the US Navy for the SSBNs, and the
crucial, core work started on the back of an
envelop at the JHU/APL. The planning document
was enough to remove risk, and the rest is
history. Early in my career, I wrote software
in the group that did the software for the
continually updated orbit determination
calculations for that Navy system and heard
the stories about how the system was invented
and pushed forward. It really is possible to
evaluate projects on paper and confirm that
they are powerful and exceptional; results
on paper are how nearly all of research works,
and the work really can be evaluated and seen to
be powerful if it is; but nearly no VCs can
evaluate projects on paper, and maybe their
LPs wouldn't let them fund on that basis
anyway.
So, the VCs are looking for exceptional
projects, and there are ways to create,
present, and evaluate such projects, but
VCs don't do or pay attention to
those things. This situation is so
incredible that it took me a while to
believe it. No wonder their ROI is low.
