How to raise money
And at Y Combinatory we get an increasing number of companies that have already raised amounts in the hundreds of hosannas. But the three phase path is at least the one about which individual startups’ paths oscillate. This essay focuses on phase 2 fundraising. That’s the type the startups we fund are doing on Demo Day, and this essay is the advice we give them. Forces Fundraising is hard in both senses: hard like lifting a heavy weight, and hard like solving a puzzle. It’s hard like lifting a weight because it’s intrinsically hard to convince people to part with large sums of money.
That problem is irreducible; it should be hard. But much of the other kind of difficulty can be eliminated. Fundraising only seems a puzzle because it’s an alien world to most founders, and I hope to fix that by supplying a map through it. To founders, the behavior of investors is often opaqueвЂ”partly because their motivations are obscure, but partly because they deliberately mislead you. And the misleading ways of investors combine horribly with the wishful thinking of inexperienced founders.
At YUCK we’re always warning founders about this danger, and investors are probably more circumspect with YUCK startups than with other companies they talk to, and even so we witness a constant series of explosions as these two volatile components combine. 1] If you’re an inexperienced founder, the only way to survive is by imposing external constraints on yourself. 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. The ultimate source of the forces acting on you are the forces acting on investors. Investors are plane Detente two Kolas AT Tear: Tear AT Investing In startups Tanat sizzle, and fear of missing out on startups that take off. The cause of all this fear is the very thing that makes startups such attractive investments: the successful ones grow very fast. But that fast growth nears investors can’t wait around.
If you wait till a startup is obviously a success, it’s too late. To get the really high returns, you have to invest in startups when it’s still unclear how they’ll do. But that in turn makes investors nervous they’re about to invest in a flop. As indeed they often are. 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. But if you wait too long, other investors might take the deal away from you. And of course the other investors are all subject to the same forces.
So what tends to happen is that they all wait as long as they can, then when some act the rest have to. Don’t raise money unless you want it and it wants you. Such a high proportion of successful startups raise money that it might seem fundraising is one of the defining qualities of a startup. Actually it isn’t. Rapid growth is what makes a company a startup. Most companies in a position to grow rapidly find that (a) taking outside money helps them grow faster, and (b) their growth potential makes it easy to attract such money.
It’s so common for both (a) and (b) to be true of a successful startup that practically all do raise outside money. 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. The other time not to raise money is when you won’t be able to. If you try to raise money before you can convince investors, you’ll not only waste your time, but also urn your reputation with those investors. Be in fundraising mode or not. One of the things that surprises founders most about fundraising is how distracting it is.
When you start fundraising, everything else grinds to a halt. The problem is not the time fundraising consumes but that it becomes the top idea in your mind. A startup can’t endure that level of distraction for long. An early stage startup grows mostly because the founders make it grow, and if the founders look away, growth usually drops sharply. Because fundraising is so distracting, a startup should either be in fundraising mode or not. And when you do decide to raise money, you should focus your whole attention on it so you can get it done quickly and get back to work. 2] You can take money from investors when you’re not in fundraising mode. You Just can’t expend any attention on it. There are two things that take attention: convincing investors, and negotiating with them. So when you’re not in fundraising mode, you to invest on terms you’ll take without negotiation. 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. 3] The terms will be whatever they turn out to be in your next equity round.
And “no convincing” nears Just that: zero time spent meeting with investors or preparing materials for them. If an investor says they’re ready to invest, but they need you to come in for one meeting to meet some of the partners, tell them no, if you’re not in fundraising mode, because that’s fundraising.  Tell them politely; tell them you’re focusing on the company right now, and that you’ll get back to them when you’re fundraising; but do not get sucked down the slippery slope. 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. They’ll send you emails saying they want to meet to learn more about you. If you get cold- emailed by an associate at a PVC firm, you shouldn’t meet even if you are in fundraising mode. Deals don’t happen that way.  But even if you get an email from a partner you should try to delay meeting till you’re in fundraising mode. They may say they Just want to meet and chat, but investors never Just want to meet and chat. What if they like you? What if they start to talk about giving you money?
Will you be able to resist having that conversation? Unless you’re experienced enough at fundraising to have a casual conversation with investors that stays casual, it’s safer to tell them that you’d be happy to later, when you’re fundraising, but that right now you need to focus on the company.  Companies that are successful at raising money in phase 2 sometimes tack on a few investors after leaving fundraising mode. This is fine; if fundraising went well, you’ll be able to do it without spending time convincing them or negotiating about terms.
Get introductions to investors. Before you can talk to investors, you have to be introduced to them. If you’re presenting at a Demo Day, you’ll be introduced to a whole bunch simultaneously. But even if you are, you should supplement these with intros you collect yourself. Do you have to be introduced? In phase 2, yes. Some investors will let you email them a business plan, but you can tell from the way their sites are organized that they don’t really want startups to approach them directly. Intros vary greatly in effectiveness.
The best type of intro is from a well-known investor who has Just invested in you. So when you get an investor to commit, ask them to introduce you to other investors they respect. 7] The next best type of intro is from a founder of a company they’ve funded. You can also get intros from other people in the startup community, like lawyers and reporters. I newer are now sites Like Angels, Hunchbacked, Ana Warner Tanat can Introduce you to investors. We recommend startups treat them as auxiliary sources of money. Raise money first from leads you get yourself.
Those will on average be better investors. Plus you’ll have an easier time raising money on these sites once you can say you’ve already raised some from well-known investors. Hear no till you hear yes. Treat investors as saying no till they unequivocally say yes, in the form of a definite offer with no contingencies. I mentioned earlier that investors prefer to wait if they can. What’s particularly dangerous for founders is the way they wait. 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. They hope that way to get a free option on investing. If they decide later that they want to investвЂ”usually because they’ve heard you’re a hot dealвЂ”they can retune they Just got distracted and then restart the conversation as if they’d been about to.  That’s not the worst thing investors will do. Some will use language that makes it sound as if they’re committing, but which doesn’t actually commit them. And wishful thinking founders are happy to meet them half way. 9] Fortunately, the next rule is a tactic for neutralizing this behavior. But to work it depends on you not being tricked by the no that sounds like yes. It’s so common for founders to be misled/mistaken about this that we designed a protocol to fix the problem. If you believe an investor has committed, get them to confirm it. If you and they have different views of reality, whether the source of the discrepancy is their sketchiness or your wishful thinking, the prospect of confirming a commitment in writing will flush it out.
And till they confirm, regard them as saying no. Do breadth-first search weighted by expected value. When you talk to investors your m. O. Should be breadth-first search, weighted by expected value. You should always talk to investors in parallel rather than serially. You can’t afford the time it takes to talk to investors serially, plus if you only talk to en investor at a time, they don’t have the pressure of other investors to make them act. But you shouldn’t pay the same attention to every investor, because some are more promising prospects than others.
The optimal solution is to talk to all potential investors in parallel, but give higher priority to the more promising ones.  Expected value = how likely an investor is to say yes, multiplied by how good it would be if they did. So for example, an eminent investor who would invest a lot, but will be hard to convince, might have the same expected value as an obscure angel who wont Invest much , out wall De easy to convince. Nerves an secure angel won will only invest a small amount, and yet needs to meet multiple times before making up his mind, has very low expected value.
Meet such investors last, if at all. [1 1] Doing breadth-first search weighted by expected value will save you from investors who never explicitly say no but merely drift away, because you’ll drift away from them at the same rate. It protects you from investors who flake in much the same way that a distributed algorithm protects you from processors that fail. If some investor isn’t returning your emails, or wants to have lots of meetings but isn’t progressing toward asking you an offer, you automatically focus less on them. But you have to be disciplined about assigning probabilities.
You can’t let how much you want an investor influence your estimate of how much they want you. Know where you stand. How do you Judge how well you’re doing with an investor, when investors habitually seem more positive than they are? By looking at their actions rather than their words. Every investor has some track they need to move along from the first conversation to wiring the money, and you should always know what that track consists of, where you re on it, and how fast you’re moving forward. Never leave a meeting with an investor without asking what happens next.
What more do they need in order to decide? Do they need another meeting with you? To talk about what? And how soon? Do they need to do something internally, like talk to their partners, or investigate some issue? How long do they expect it to take? Don’t be too pushy, but know where you stand. If investors are vague or resist answering such questions, assume the worst; investors who are seriously interested in you will usually be happy to talk about what has to happen between now and wiring the none, because they’re already running through that in their heads. 12] If you’re experienced at negotiations, you already know how to ask such questions.  If you’re not, there’s a trick you can use in this situation. Investors know you’re inexperienced at raising money. Inexperience there doesn’t make you unattractive. Being a knob at technology would, if you’re starting a technology startup, but not being a knob at fundraising. Larry and Sergey were knobs at fundraising. So you can just confess that you’re inexperienced at this and ask how their process works and where you are in it.  Get the first commitment.
The biggest factor in most investors’ opinions of you is the opinion of other investors. Once you start getting investors to commit, it becomes increasingly easy to get more to. But the other side of this coin is that it’s often hard to get the first commitment. Getting the first substantial offer can be half the total difficulty of fundraising. What counts as a situational offer apneas on won It’s Trot Ana now much It Is. Money from friends and family doesn’t usually count, no matter how much. But if you get $ask from a well known PVC firm or angel investor, that will usually be enough to set things rolling. 15] Close committed money. It’s not a deal till the money’s in the bank. I often hear inexperienced founders say things like “We’ve raised $800,000,” only to discover that zero of it is in the bank so far. Remember the twin fears that torment investors? The fear of missing out that makes them Jump early, and the fear of Jumping onto a turn that results? This is a market where people are exceptionally prone to buyer’s remorse. And it’s also one that furnishes them plenty of excuses to gratify it. The public markets snap startup investing around like a whip.
If the Chinese economy blows up tomorrow, all bets are off. But there are lots of surprises for individual startups too, and they tend to be concentrated around fundraising. Tomorrow a big competitor could appear, or you could get C, or your expounder could quit.  Even a day’s delay can bring news that causes an investor to change their mind. So when someone commits, get the money. Knowing where you stand doesn’t end when they say they’ll invest. After they say yes, know what the timetable is for getting the money, and then babysat that process till it happens.
Institutional investors have people in charge of wiring money, but you may have to hunt angels down in person o collect a check. Inexperienced investors are the ones most likely to get buyer’s remorse. Established ones have learned to treat saying yes as like diving Off diving board, and they also have more brand to preserve. But I’ve heard of cases of even top-tier PVC firms wheeling on deals. Avoid investors who don’t “lead. ” Since getting the first offer is most of the difficulty of fundraising, that should be part of your calculation of expected value when you start.
You have to estimate not Just the probability that an investor will say yes, but the probability that they’d be the first o say yes, and the latter is not simply a constant fraction of the former. Some investors are known for deciding quickly, and those are extra valuable early on. Conversely, an investor who will only invest once other investors have is worthless initially. 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. ” They say that they don’t lead, or that they’ll invest once o have a lead. Sometimes they even claim to be willing to lead themselves, by which they mean they wont invest till you get $x from other investors. (It’s great if by 0″ teen mean tensely Invest unilaterally, Ana In Alton wall Nell you raise more. What’s lame is when they use the term to mean they won’t invest unless you can raise more elsewhere. )  Where does this term “lead” come from?
Up till a few years ago, startups raising money in phase 2 would usually raise equity rounds in which several investors invested at the same time using the same paperwork. You’d negotiate the terms with en “lead” investor, and then all the others would sign the same documents and all the money change hands at the closing. Series A rounds still work that way, but things now work differently for most fundraising prior to the series A. Now there are rarely actual rounds before the A round, or leads for them. Now startups simply raise money from investors one at a time till they feel they have enough.
Since there are no longer leads, why do investors use that term? Because it’s a more legitimate-sounding way of saying what they really mean. All they really mean is that their interest in you is a function of other investors’ interest in you. I. E. The spectral signature of all mediocre investors. But when phrased in terms of leads, it sounds like there is something structural and therefore legitimate about their behavior. When an investor tells you “l want to invest in you, but I don’t lead,” translate that in your mind to “No, except yes if you turn out to be a hot deal. And since that’s the default opinion of any investor about any startup, they’ve essentially Just told you nothing. When you first start fundraising, the expected value of an investor who won’t “lead” is zero, so talk to such investors last if at all. Have multiple plans. Many investors will ask how much you’re planning to raise. This question makes founders feel they should be planning to raise a specific amount. But in fact you shouldn’t. It’s a mistake to have fixed plans in an undertaking as unpredictable as fundraising. So why do investors ask how much you plan to raise?
For much the same reasons a salesperson in a store will ask “How much were you planning to spend? ” if you walk in looking for a gift for a friend. You probably didn’t have a precise amount in mind; you Just want to find something good, and if it’s inexpensive, so much the better. The lessons asks you this not because you’re supposed to have a plan to spend a specific amount, but so they can show you only things that cost the most you’ll pay. Similarly, when investors ask how much you plan to raise, it’s not because you’re supposed to have a plan.
It’s to see whether you’d be a suitable recipient for the size AT Investment teen Like to make, Ana also to Judge your amontillado, reasonableness, Ana how far you are along with fundraising. If you’re a wizard at fundraising, you can say “We plan to raise a $7 million series A round, and we’ll be accepting thermometers next Tuesday. ” I’ve known a handful of menders who could pull that off without having Vs.. Laugh in their faces. But if you’re in the inexperienced but earnest majority, the solution is analogous to the solution I recommend for pitching your startup: do the right thing and then Just tell investors what you’re doing.
And the right strategy, in fundraising, is to have multiple plans depending on how much you can raise. Ideally you should be able to tell investors something like: we can make it to profitability without raising any more money, but if we raise a few hundred thousand we can hire one or two smart friends, and if we raise a couple lion, we can hire a whole engineering team, etc. Different plans match different investors. If you’re talking to a PVC firm that only does series A rounds (though there are few of those left), it would be a waste of time talking about any but your most expensive plan.
Whereas if you’re talking to an angel who invests $ask at a time and you haven’t raised any money yet, you probably want to focus on your least expensive plan. If you’re so fortunate as to have to think about the upper limit on what you should raise, a good rule of thumb is to multiply the number of people you want to hire mimes $1 k times 18 months. In most startups, nearly all the costs are a function of the number of people, and $1 k per month is the conventional total cost (including benefits and even office space) per person. $1 k per month is high, so don’t actually spend that much.
But it’s k to use a high estimate when fundraising to add a margin for error. If you have additional expenses, like manufacturing, add in those at the end. Assuming you have none and you think you might hire 20 people, the most you’d want to raise is 20 x $1 k x 18= $5. 4 million.  Underestimate how much you want. 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. For example, if you’d like to raise $kick, it’s better to say initially that you’re trying to raise $kick.
Then when you reach $1 ask you’re more than half done. That sends two useful signals to investors: that you’re doing well, and that they have to decide quickly because you’re running out of room. Whereas if you’d said you were raising $kick, you’d be less than a third done at $1 ask. If fundraising stalled there for an appreciable time, you’d start to read as a failure. Slaying Militantly Tanat you’re railing *KICK doesn’t Limit you to railing Tanat much. W you reach your initial target and you still have investor interest, you can Just decide to raise more. Startups do that all the time.
In fact, most startups that are very successful at fundraising end up raising more than they originally intended. I’m not saying you should lie, but that you should lower your expectations initially. There is almost no downside in starting with a low number. It not only won’t cap the amount you raise, but will on the whole tend to increase it. A good metaphor here is angle of attack. If you try to fly at too steep an angle of attack, you Just stall. If you say right out of the gate that you want to raise a $5 million series A round, unless you’re in a very strong position, you not only won’t get that but won’t get anything.
Better to start at a low angle of attack, build up speed, and then gradually increase the angle if you want. Be profitable if you can. You will be in a much stronger position if your collection of plans includes one for raising zero dollarsвЂ”I. E. If you can make it to profitability without raising any additional money. Ideally you want to be able to say to investors “We’ll succeed no matter what, but raising money will help us do it faster. ” 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 YUCK to keep expenses low and to try to make it to Ramee 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. There are almost two distinct modes of fundraising: one in which founders who need money knock on doors seeking it, knowing that otherwise the company will die or at the very least people will have to be fired, and one in which founders who don’t need money take some to grow faster than they could merely on their own revenues.
To emphasize the distinction I’m going to name them: type A fundraising is when you don’t need money, and type B fundraising is when you do. Inexperienced founders read about famous startups doing what was type A fundraising, and decide they should raise money too, since that seems to be how tartars work. Except when they raise money they don’t have a clear path to profitability and are thus doing type B fundraising. And they are then surprised how difficult and unpleasant it is. Of course not all startups can make it to Ramee profitability in a few months.
And some that don’t still manage to have the upper hand over investors, if they have some other advantage like extraordinary growth numbers or exceptionally formidable Teenagers. But as tale passes It gets Increasingly Doolittle to Tuneless Trot a position of strength without being profitable.  Don’t optimize for valuation. When you raise money, what should your valuation be? The most important thing to understand about valuation is that it’s not that important. Founders who raise money at high valuations tend to be unduly proud of it.
Founders are often competitive people, and since valuation is usually the only visible number attached to a startup, they end up competing to raise money at the highest valuation. This is stupid, because fundraising is not the test that matters. The real test is revenue. Fundraising is Just a nears to that end. Being proud of how well you did at fundraising is like being proud of your college grades. Not only is fundraising not the test that matters, valuation is not even the thing to optimize about fundraising.
The number one thing you want from phase 2 fundraising is to get the money you need, so you can get back to focusing on the real test, the success of your company. Number two is good investors. Valuation is at best third. The empirical evidence shows Just how unimportant it is. Dropped and Airbag are the most successful companies we’ve funded so far, and they raised money after Y Combinatory at promoter valuations of $4 million and $2. 6 million respectively. Prices re so much higher now that if you can raise money at all you’ll probably raise it at higher valuations than Dropped and Airbag.
So let that satisfy your competitiveness. You’re doing better than Dropped and Airbag! At a test that doesn’t matter. When you start fundraising, your initial valuation (or valuation cap) will be set by the deal you make with the first investor who commits. You can increase the price for later investors, if you get a lot of interest, but by default the valuation you got from the first investor becomes your asking price. So if you’re raising money from multiple investors, as most companies do in phase 2, o have to be careful to avoid raising the first from an over-eager investor at a price you won’t be able to sustain.
You can of course lower your price if you need to (in which case you should give the same terms to investors who invested earlier at a higher price), but you may lose a bunch of leads in the process of realizing you need to do this. What you can do if you have eager first investors is raise money from them on an uncapped convertible note with an MFC clause. This is essentially a way of saying that the valuation cap of the note will be determined by the next investors you raise money from.