The founder of YC tells you how to raise funds in more than 10,000 words

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Paul Graham (famous programmer, venture capitalist, blogger, founder of YC) is here to teach you about financing again. Click here to view the original English text. The following is a translation of the article from Drunk Startup (WeChat ID: drunkstartup), which was jointly completed by Huahua Zhong, Zhang Wenping, and Chen Baoxin, and authorized to be published by 36Kr. Readers, please cherish their translation work of more than 16,000 words, enjoy~

Translator’s Note:

It's Paul Graham again.

Since we delayed writing this article for so long, by the time we finished proofreading it, the capital market seemed to have gone from midsummer to late autumn. But it seems more appropriate to talk about “how to raise funds”.

I don't plan to write a long introduction before a good article, especially when this article has 16,000 words after translation, and there are 27 annotations... In fact, I know that this kind of article has poor dissemination, tiring reading experience, and difficult translation... It is the most thankless type of article. But our standard has always been only one - recommending articles that are still valid when you read them ten years later, no matter what cycle the economy is in, how the market changes, or how entrepreneurship evolves.

For example, this one.

－－－－－The following is the main text－－－－－

Most startups raise money multiple times. A typical trajectory might be: (1) get a few tens of thousands of dollars from Y Combinator or individual angel investors, then (2) raise hundreds of thousands to millions of dollars to build the company, and then (3) once it’s clear the company is becoming successful, raise one or more rounds of investment to accelerate growth.

The real world may be more chaotic. Some companies raise funds twice in the second stage, while others skip the first stage and go directly to the second stage. In Y Combinator, we find that more and more companies have already been funded before. But the typical trajectory mentioned in the first paragraph basically conforms to the development path of a startup.

This article focuses on the second stage of fundraising. This is what YC companies do on Demo Day, and this article is my advice to them.

Wrestling

Fundraising is hard in two ways: like lifting a heavy object, and like solving a puzzle. The former is because convincing people to give you a lot of money is hard. This problem can't be solved - it's supposed to be hard. But some difficulties can be solved. Fundraising is like solving a puzzle because it's new territory for most founders, so I want to draw you a map.

Investors’ behavior is often ambiguous to founders, in part because their motives are unclear, but also because they often deliberately mislead you. Investor misdirection is often combined with wishful thinking on the part of inexperienced founders. At YC we’ve long warned founders about this danger, so investors may be more cautious around founders who come from YC. Nonetheless we’ve witnessed the chain reaction that can occur when these two volatile ingredients combine. [1]

If you are an inexperienced entrepreneur, the only way to survive is to impose external constraints on yourself. Don't trust your instincts. Here is a set of rules for behavior. At some point, you will be tempted to ignore them. Therefore, the most important rule is: these rules exist for a reason. If there is no powerful force forcing you to go in one direction, you don't need a rule to keep you going in the opposite direction.

The forces that act on you also act on investors. Investors are often caught in two kinds of worries: the fear of investment failure and the fear of missing out on successful startups. But this is also the charm of the venture capital industry. It is the worst to wait and see. If they wait until the startup team is about to succeed before thinking of investing, it will be too late. In order to get a high return rate, they must make their own judgments and decisions in the early stage, which makes them nervous and afraid of investment failure, and in fact they often fail.

What investors like to do if they can is to wait and see. When a startup is just a few months old, the development of each week is very fast. However, if you wait too long, other investors may take your business away. Of course, other investors are under the same pressure. So what often happens is that when someone seems to be making a move, everyone else has to make a move.

Don’t rush to raise money unless you need it and it’s right for you

The high financing success rate of startups seems to make the outside world think that financing is one of the prominent characteristics of startups. But this is not the case. The characteristic of startups is rapid development (Note: we have translated an article called Startup = Growth, you can reply "Growth" to view it). Most companies grow rapidly mainly because: (a) they get external investment that allows them to grow faster; (b) their rapid growth also makes it easier for them to obtain investment. Especially for those startups that successfully raise funds, it is normal to do (a) and (b) at the same time. But there are many startups that do not want to develop and expand too quickly, or external funds cannot help them develop well. If you are one of them, then don't rush to raise funds.

Another bad time to raise money is when you don’t have the ability to do so. If you rush to raise money before you can convince investors, you not only waste time, but also damage your reputation in the investor circle.

Either go full-on funding mode or don’t even think about it

One of the most surprising things about fundraising for entrepreneurs is how distracting it is. When you start fundraising, everything else falls by the wayside. The problem isn't the time it takes to raise money, but that it becomes your top priority. Entrepreneurs can't afford that level of distraction for long, because early-stage startups are driven primarily by the founders, and if the founders' minds are elsewhere, growth usually drops off dramatically.

Because fundraising is such a distraction, startups should either focus on raising money or not think about it at all. When you decide to raise money, you need to focus on getting it done quickly and getting back to what you were doing.[2]

It’s possible to get money from investors without going into fundraising mode. Just don’t spend your energy on it. There are two things that occupy your attention: convincing investors and negotiating with them. So, if you’re not in fundraising mode, but you don’t need to negotiate with an investor and they willingly accept the terms you’re offering, then you can take the money. For example, if a reputable investor is willing to invest in convertible debt, with standard terms, and at a good valuation (with or without a cap), then it’s a no-brainer to take the money. [3] “No negotiation” means: don’t spend even a minute meeting with the investor or preparing materials. If an investor says they’re ready to invest when you’re not in fundraising mode, but they need you to attend a meeting with the partners, say no. Because that’s fundraising. [4] Tell them politely that you’re focusing on the company and will get back to them when you’re ready to raise money.

Investors will try to trick you into raising money. This is great for them because it allows them to get ahead of other investors. They will email you and say they want to meet you to get to know you better. If you get this email, you shouldn’t go for the meeting even if you’re in fundraising mode, because that’s not how fundraising works. [5] But even if you get an email from a partner, you should delay the meeting until 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 say they want to give you money? Can you resist the temptation to have this conversation? Unless you’re already experienced and can have casual conversations with investors, tell them that you’d be happy to meet with them when you need to raise money, but right now you need to focus on your company. [6]

Companies that successfully raise money in the second round are sometimes able to retain several investors. This is good: if the financing goes well, you won't have to spend time convincing them or negotiating terms in the future.

Ask others to introduce you to investors

Before meeting investors, it’s best to be introduced by someone else. If it’s a Demo Day, you will be introduced to a lot of people at the same time. But even so, you still need to find more introductions.

Is it necessary? In the second stage of financing, yes. Some investors say you send them a business plan, but if you look at their website, you can tell that they don't want startups to contact them directly.

Different referrals have different effects. A good way to get a referral is to have a well-known investor who has just invested in you introduce you to others. So, when you find an investor, you can ask him or her to introduce you to others. [7] You can also find other founders, lawyers, or journalists in the startup community.

There are some websites like AngelList, FundersClub and WeFunder that can introduce you to investors. We recommend that startups consider them as a supplementary source of funds. Fundraising mainly depends on your own resources. Besides, once you successfully get funding from some investors, it will be much easier to rely on these websites for financing later.

Before I heard Yes, everything I heard was No

If the investor does not make a clear offer and say yes without any additional conditions, they will interpret whatever he says as no.

I mentioned earlier that investors will try to wait and see. What’s particularly dangerous to founders is the way they wait and see. Basically, they’ll lead you by the nose. Sometimes it looks like they’re about to invest in you, but then they say no. If they’re going to say no at all, many won’t even say no. They’ll just stop responding to your emails, hoping to have the option of either investing or not investing. If they decide to invest in you later, it’s usually because they’ve heard that you’re popular, and then they’ll pretend that they had a lot on their plate and start contacting you again as if nothing happened. [8]

This isn’t even the worst thing an investor can do. Some investors will make you think they’re committed to investing, but they’re not. Wishful thinking entrepreneurs will make up the rest. [9]

Fortunately, the next rule will introduce tactics to deal with this behavior. But whether it is effective depends on whether you are fooled by those Nos that sound like Yes. It is common for founders to be misled. I have designed a more secure mechanism: if you think that investors are promising you something, let them confirm it on paper. No matter what disagreements you have with them, whether the contradictions come from their superficiality or your wishful thinking, the paper agreement can make these hidden dangers go to hell. Before this happens, treat everything they say as No.

Breadth-First Search vs. Expected Value

When you start looking for investors, it’s best to do a breadth-first search and sort by expected value. You should approach different investors at the same time, rather than approaching them one by one because you don’t have the energy. And if you only approach one investor at a time, they won’t feel the pressure of competition from their peers. But you can’t spend the same amount of time and energy on every investor, because there are always some that can bring you better prospects. The most effective solution is to approach multiple investors at the same time and spend your time on those that are more promising for cooperation. [10]

Expected Value = How likely is it that an investor will invest in you x how much they will invest. So if you have a very well-known investor who can make a big investment but is hard to convince, then you should have a similar expected value to a less well-known angel investor who can’t invest as much but is easy to convince. However, if you have an unknown investor who can’t invest a lot but needs to meet with you several times before making a decision, then his expected value is very low. If you have the choice, schedule meetings with these investors last.[11]

Breadth-first search by expected value will eliminate investors who never explicitly say no but drift away, because you drift away from them at the same rate. If some investors don't respond to your emails, or meet with you many times but don't move forward with the investment process, you can automatically block them. But you should try to be objective when evaluating them, and don't let your likes and dislikes of them affect your judgment of their expected value.

Clarify your own situation

When investors are habitually enthusiastic, how do you tell where you are? The answer is by watching their actions, not their words. Every investor has a routine from the first conversation to the final transfer of money. You should understand what that routine is, and where you are and how fast you are moving forward.

Never leave a meeting with an investor without asking what’s next. What do you need to do to get them to make a decision? Do they need to meet with you again? What will it be about? How soon? Do they need to do anything internally, such as talk to partners or research something? How long do they expect the process to take? Don’t sound too pushy, but be clear about where you are. If an investor is vague or refuses to answer questions like this, prepare for the worst; if they’re interested, they’ll usually be happy to talk about what’s needed between now and the final payment because they’ve already thought about it. [12]

If you are experienced in this type of negotiation, you should already know how to ask this question. [13] If you are not very experienced, there is a trick you can use in this situation. Because investors usually know that you are inexperienced in fundraising. If you are starting an Internet startup, your status as a technical rookie will not be welcomed, but being a fundraising rookie will not affect investors' perception of you. Larry and Sergey (note: the founders of Google) were also fundraising rookies. So it is best to tell the investor directly that you have no experience in fundraising and ask questions without hesitation. [14]

Get the first term sheet

In fact, most investors' views on you also represent other investors' views on you. Once investors start to promise to invest in you, you will feel as if the other investors you are in contact with are also ready to negotiate contracts with you. But the other side of the coin is that it is often difficult to get the first commitment.

So getting a real, solid offer is half the battle. The real offer refers to who the financing comes from and how much it is. Funds from friends and family should not be counted, no matter how big the amount is. But if you get money from a well-known VC firm or angel investor, you can almost start your business. [15]

Get the promised money as soon as possible

The deal is not done until the money is in the account. I often hear new founders say, “We’ve raised $800,000,” only to find that the bank account is still zero. Remember the twin fears that torment investors? The fear of missing out on a good investment by exiting too early, and the fear of losing the investment. This market is prone to buyer’s remorse, and the market provides them with all kinds of reasons to rationalize their behavior. The influence of the secondary market on the early investment market is also subtle. If the Chinese economy has a bubble tomorrow, no one will be immune. The market is also full of surprises for a single startup, and there are even more surprises when raising funds. A big competitor may appear tomorrow, or you may be ordered to close tomorrow, or even tomorrow your co-founder may suddenly quit. [16]

Sometimes a one-day delay may cause investors to change their minds. So when someone promises to invest, get the money as soon as possible. After they say yes, you must find out the timeline for getting the funds until you get the money. Institutional investors have someone in charge of the transfer of money. For individual angel investors, you must chase them closely.

Inexperienced investors are most likely to go back on their word, while more famous institutions place more emphasis on saying yes, and they also need to take care of their own brands. But I have also heard that even top VC firms can go back on their word.

Avoid getting entangled with investors who don’t “lead the round”

Since the first offer in a round is the hardest, factor that into your “expected value” when determining it from the beginning. Assess not only the likelihood that they will say yes, but also the likelihood that they will be the first to say yes. The latter is not simply a subset of the former. Some investors are known for making quick decisions, and these people are extra valuable early on.

Conversely, an investor who only invests in a follow-on round is of little value in the early stages. While most investors are swayed by how interested other investors are in you, some make it a point to only invest in investors who have already invested. You can identify these types of investors because they often talk about "leading a round." Sometimes, they claim to be willing to lead a round, but in fact they won't invest until you get money from other investors. [17]

Where does the term “lead” come from? A few years ago, startups would typically raise Phase 2 funding from more than one investor, but they would all invest at the same time and the documentation process would be exactly the same. You would only need to negotiate with one of the so-called “lead” investors, and the other investors would all sign contracts with you on the same terms, and their funds would all be deposited into your account at the end.

The A round of financing still works in the above way, but the situation before the A round has changed. In fact, before the A round, there is no so-called "round" where several people invest at the same time. Now startups raise funds from investors one at a time until they have enough.

Since there is no longer a lead round, why do investors still use this term? Because they use this more legitimate way to express their true intentions. What they really mean is that their interest in you represents the interest of other investors in you. When they use the term lead round, their actions sound more organized and more legitimate.

When an investor tells you “I want to invest in you, but I won’t lead the round,” what that translates to in your mind is, “I refuse, unless you suddenly become very popular.” Since this is true for everyone, they basically say nothing.

When you first start raising money, the expected value of not being a "lead" investor is zero. If possible, consider such investors last.

Make multiple plans

Many investors will ask you how much money you plan to raise. This makes founders feel like they should come up with a specific amount. But in fact, you shouldn’t do this. It’s a mistake to set a firm plan in the unpredictable fundraising process.

So why do investors ask this? It's like a salesperson in a gift shop will ask you "What's your budget?" You don't really have a specific amount in mind, you just want to find something nice, and if it's cheap, that's even better. The salesperson asks you about your budget not because you have a specific plan for how much you want to spend, but because they can sell you the highest price within your budget.

Similarly, when investors ask you how much money you plan to raise, it's not because you really need an accurate plan. Investors want to know whether you will be a suitable investment target for their investment size and to judge your ambition for financing, the rationality of your judgment on the company, and the sustainability of the investment.

If you’re good at fundraising, you can say, “We’re looking to raise $7 million in our Series A, and we’ll be accepting term sheets next Tuesday.” I know a few founders who can say that without getting laughed at by investors. But if you’re not, do what I suggested before: do the right thing and tell investors what you’re in for.

The right strategy when raising money is to have multiple plans, depending on how much money you can raise. Ideally, you should be able to tell investors: we can be profitable without any more money, but if we raise a few hundred thousand, we can hire one or two awesome friends, and if we raise a few million, we can build a whole engineering team.

Different plans satisfy different investors. If you are talking to a VC firm that has only done Series A financing (although there are only a few such firms), you should sell your most expensive plan, otherwise it is a waste of time. If you are talking to an angel who invests $20,000 at a time and you haven't raised any money yet, you can focus on the cheapest plan.

If you are lucky enough to need to consider a funding cap, a good rule of thumb is to multiply the number of people you want to hire by $15k per month in salary by 18 months. In most startups, almost all of your expenses are spent on people, which is proportional to the number of employees, and $15k per month per person is the agreed-upon total cost (including benefits and even office space). $15k per month is a bit high, and in reality you don't spend that much. But you can use a high valuation when you raise money to make up for the error. If you have additional expenses, such as manufacturing, you can add them at the end. Assuming you don't have, and will probably hire 20 people, the most you can want to raise is 20 x $15k x 18 = $5.4 million. [18]

Lower your expectations on the amount

Although you can prepare different fundraising plans for different investors, overall you should keep your expectations low.

For example, if you want to raise $500,000, you'd better say you want to raise $250,000. Then when you raise $150,000, you're more than halfway there. This gives investors two useful signals: you're doing well, and they need to make a decision quickly because you have limited space. But if you said you wanted to raise $500,000, and you raise $150,000, you're less than a third of the way there. If fundraising stagnates for a while, you've basically failed.

But if you only want to raise $250,000 initially, it doesn’t matter if you underestimated. Once you reach your initial funding goal and investors are still interested, you can decide to raise more, which startups often do. In fact, most startups that successfully raise money end up with more money than they originally wanted.

I'm not saying you should lie, but you should lower your initial expectations, there's no harm in that. It won't be a ceiling on how much you raise, but it will tend to increase your final round overall.

A more appropriate metaphor here is the angle of attack - the angle between the wing of the airplane and the wind flow when taking off. If you try to take off at a larger angle of attack, you won't be able to fly at all. That is to say, if you say you want to raise $5 million in Series A, unless the situation is very favorable to you, you will not only not get the financing, but you may get nothing. It is best to start with a low angle of attack, and then slowly increase the angle if necessary after speeding up.

Try to make a profit if possible

If you don't plan to raise money for your future development, you will be in a more proactive position, which means that you can be self-profitable without the need for external funding. Ideally, you can tell investors: "We will succeed anyway, but raising money will speed us up."

There are lots of analogies about fundraising and dating, but this is one of the best. If you're hysterical, no one will want you. And the best way to not look hysterical is to not be hysterical. This is one of the reasons at YC we push startups to keep costs low and try to pay for their own meals by demo day. As paradoxical as it sounds, if you want to raise money, you better be able to survive without it.

There are two distinct types of funding: one where the founder needs the money, so they seek it out, knowing that if they don’t get it they’ll probably go bankrupt or at least have to lay off some employees, and one where the founder doesn’t need the money, but getting it will allow the company to grow and expand faster. To emphasize the difference, I’ve named them as follows: Type A funding is when you don’t need the money, and Type B funding is when you can’t survive without it.

Inexperienced founders know famous startups raise Type A rounds, so they decide to raise money because that’s what startups seem to do, except when they raise money, they don’t have a clear path to profitability, so they’re raising Type B rounds. Then they’re surprised at how hard and unpleasant it is.

Of course, not all startups can earn enough money to support themselves in a few months. Some unprofitable startups can still gain the upper hand over investors if they have advantages, such as excellent growth numbers or exceptional founders. As time goes by, it becomes harder to get financing from a strong position if you are not profitable.

Don’t optimize for valuation

What should your valuation look like when you raise money? The most important thing about valuation is that it doesn’t matter.

6. Founders with high valuations are prone to being overly arrogant when raising money. Founders are generally very capable, and valuation is often the only visible number for a startup, so they often compete to raise money at the highest valuation. This is stupid, because fundraising is not the test, the real test is revenue. Funding is just a means to an end. Being proud of how much money you raised is like being proud of your college grades.

Not only is fundraising not an important test, valuations don’t need to be optimized for fundraising. Through the second round of fundraising, you should make money first, and then go back to focusing on the real test, which is the success of your company. Good investors come second, and valuations come third.

Past experience has proven how unimportant valuations are. Dropbox and Airbnb, our most successful companies, raised money after Y Combinator at pre-money valuations of $4M and $2.6M respectively. Prices are much higher now, and if you can raise money, you may need to raise at a higher valuation than Dropbox and Airbnb. Let this satisfy your competitive streak. You are better than Dropbox and Airbnb at a game that doesn’t even matter!

When you start raising money, your initial valuation (or valuation cap) is set by the first investor who funds you. For subsequent investors, if there is a lot of interest in you, you can raise the price, but the valuation given by the first investor will become the default asking price.

So if you are raising money from multiple investors, as most companies do in their second round, you need to be careful not to raise an amount from an overly aggressive investor that you can’t sustain. You can lower your price if you need to (in which case you should offer the same terms to the people who invested at the higher price before). But you may lose some control in the process of realizing you need to do so.

If you have an aggressive first investor, what you can do is sign an unrestricted modifiable note with a MFN when you raise money. This means that the valuation cap can be set by the next investor.

Lower valuations make it easier to raise money. It shouldn't be, but it is. Phase II prices can vary by 10x, and successful companies have a return on investment of at least 100x. Investors should choose startups based solely on whether they believe the company will succeed, not on price. But even though it's a mistake for investors to care about price, many still do. If an investor likes a startup, but won't invest at a valuation of $X, it may be easier to raise money at a valuation of 2/X.

Yes and No before valuation

Some investors will want to know what your company’s valuation is before they even start talking to you. If your valuation has been capped or capped by a previous investment, you can tell them what it is. But if you haven’t done a deal with anyone yet and the valuation isn’t set, and they want you to give them a number, turn them down. If this is your first investor, this may be the trigger point for raising money. This means that closing this round is the most important thing, and you need to steer the conversation to the financing itself rather than shifting to a price discussion.

Fortunately, there is a solution. This isn't just a negotiating trick -- this is the approach you (both parties) should take. Tell them that valuation isn't the most important thing to you, that you're not looking for valuation, that you're looking for investors who can partner with you and see you as a partner, and that you should first talk to them about whether they want to invest. If they decide to invest, you can offer a price. But make sure you do it upfront.

Since valuation is not that important, but financing is, we usually tell founders to give the first investor who wants to invest the lowest price possible. This is a safe way to tie this up with the next investor.

Beware of “valuation-sensitive” investors

You will meet investors who say they are "valuation sensitive". In reality, they are compulsive negotiators who take up a lot of your time to negotiate down the price. You should not approach these people in the first place. You should not chase a high valuation, but you certainly don't want to unnecessarily lower your valuation because the first investor to invest is this type of investor. Some of these investors are valuable, but you should approach them at the end of the financing. You can say "this price is what anyone else would offer, you can take it or leave it", and don't mind if they leave it. This way, you not only get the market price, but also save a lot of time.

Ideally, you know which investors are notoriously “valuation-sensitive” so you can hold off on trading with them until the end, but there may be investors you’re not familiar with early on. If you just read the “expected value” section, you know what we should do in this case: slow down the frequency of our interactions with them.

Even if your price is set, there are still many investors who want to invest in you at a price lower than your valuation. If you find that your valuation is too high and you may not be able to complete the required financing, lowering the price is also a backup plan. So if you happen to want to do this, you can contact these investors. However, since investment meetings are usually scheduled a few days in advance, you may not be able to predict whether you will need to lower the price, so in practice, it is best to consider these investors last.

If you're shocked by a lowball offer, treat it as a fallback and hold off on responding. If someone's offer is genuine, you have a responsibility to respond within a reasonable time. But a lowball offer is annoying, and you should respond accordingly.

Greedily accept bids

I’m a little afraid to use the word “greed” when writing about investing because it can be misleading. But “greed” is more about not focusing too much on the future. Greed will drive you to grab the best options in the present, which is exactly what startups should do when raising funds in the second phase and beyond. Don’t focus too much on the future because (a) the future is unpredictable and you can often be deliberately misled in this industry, and (b) your first priority in raising funds is to raise funds and get back to work.

If someone makes you an acceptable offer, accept it. If you have a lot of different offers, take the best one. Don't reject an acceptable offer in the hope that you'll get a better one later.

These simple rules can cover a lot of different situations. If you're raising money from a lot of investors, take them when they agree to invest. If you feel like you've raised enough money, your mental threshold will be higher.

Some investors will reduce the time others think by giving you an "explosion" bid, which means that the bid is only valid for a few days. The best investors are rarely explosive. For example, Fred Wilson never gives an explosive bid because they are confident that you will choose them. But lower-level investors will give a short-term bid because they feel that the other party has other choices and will not choose themselves. A three-working day expiration is acceptable. If you talk to many investors at the same time, it won't take that much time at all. But if the deadline is shorter than three days, it may mean you are dealing with hasty investors. You usually catch them bluffing, and you need to catch them.

It seems that your goal should be to find better investors than accepting bids greedily. This is certainly true. But in the second phase, "finding the best investors" and "coming greedily" do not conflict—because good investors don't take longer than others to make a decision. The only situation in which these two strategies conflict is that you need to give up an acceptable bid to see if you can get a better one. If you negotiate with multiple investors at the same time and reject explosive bids with too short deadlines, this won't happen. But if it happens, "geting the best investors" is generally a good idea. The best investors are also the most picky because they can choose any startup. They will almost reject everyone who negotiates with them, which means that usually a good deal for an acceptable affirmative bid in exchange for a better bid may not be a good deal.

(The situation is different in the first phase. You cannot apply for multiple incubators at the same time, because some incubators specially arrange a schedule to prevent similar things from happening. In stage 1, "greedy acceptance of investment" and "get the best investors" are indeed in conflict, so if you want to apply for multiple incubators at the same time, you should ensure that the one you want most enjoys the best decision.

(In Stage 2) Do not sell more than 25%

If you do well, you may end up raising a round A. I say maybe, because in round A, things change very quickly. Startups may avoid these. Only one company we have invested in has found a way to successfully pass the A round.

That means you should avoid doing things that would mess up the A round in previous financing. For example, if you sell 40% of the company, it will be difficult to raise the A round because venture capitalists are worried that the remaining equity will not be enough to motivate the founders.

What we recommend is not to sell more than 25% of your equity in the second stage, no matter how much you sold in the first round, but less than 15% in the first round. If you raise funds with uncapped notes, you should conservatively estimate how much of your final equity circle is.

Find someone to deal with financing

If there are multiple founders, find one to handle the financing so that others can continue to work in the company. Since the danger of financing is not the time it will occupy, but the fact that it will become your primary concern, the founder responsible for financing should work hard to keep other founders from participating in the details of the financing.

(If founders don’t trust each other, there may be friction. But if founders don’t trust each other, you also need to consider some more critical issues than financing.)

The founder in charge of financing should be the CEO, and it should be the strongest among the founders. Even if the CEO is an engineer and the other founder is a salesperson? Yes. If you happen to be this type of entrepreneurial team, you should regard yourself as an independent founder when raising funds.

It is OK to lead all founders to meet an investor who has invested a large amount or must go through this step before making the final decision, but you must wait until the time you have to meet. It is very similar to introducing your co-founder to an investor and introducing your boyfriend/girlfriend to your parents - you have to wait until things are really serious before doing it.

Even if one or more founders pay attention to the company itself when raising funds, the company's development will still slow down. But you should still try to develop as quickly as possible, because financing is not a time point, but a time period. What the company experiences during this period will affect the overall performance. If your operating numbers change during two investor meetings, investors will be eager to invest, and if your operating numbers remain flat or decline, you may be rejected.

Prepare an executive summary and (or perhaps) a financing document (deck)

Traditionally, the second phase of financing involves doing presentation to investors in person. Sequoia has written something related (on their official website) and you should accept their opinions.

I say "traditionally" because I'm ambivalent about presentation because it seems a bit outdated (hopefully it's true). Many of the successful startups we invest in are not presentation in the second phase. They just chat with investors and explain what they plan to do. For successful startups, financing usually goes fast because they can also use not having enough time to showcase them as an excuse.

You may also need an executive summary that is no more than a page of paper to describe your plan in the simplest language, why this is a good idea, and what progress you are currently making. This report is to remind investors (who may have met many startups that day) what you are talking about.

Suppose you give someone else a copy of your document, and it may be circulated by the person you least want to tell. But don't refuse to give your investor documents for this reason. You need to pay for this as a business-related cost. In fact, this effort is not high. Although the founders are outraged by their plans to leak to their competitors, I don't think any startup's performance has been affected.

Sometimes investors will ask to receive your documents before deciding whether to meet you. I won't do that. This is a sign that they are not really interested. (Note: This doesn't seem to apply in our country...)

Stop financing when there is little hope

When will you stop financing? Ideally, you have raised enough money. But what if you can't raise that much? When will you give up?

It is difficult to give general advice on this, because some startups insist on financing without hope, and end up miraculously successful. But I usually tell founders that most of the straws are sucked up by air. When you drink a drink, you can feel when you finish drinking it because the air is getting more. The same may be true for financing. Don’t suck it again when you suck it. Things won’t turn around.

Don't be addicted to financing

Financing is a laborious task for most entrepreneurs, but some people find it more interesting than entrepreneurship itself. Early startups generally have a monotonous job, but financing is different. When things go well, the financing process becomes very pleasant. Instead of sitting in your messy apartment and listening to the bugs of the product complained by users, you talk to investors about millions of dollars in a restaurant with beautiful environment. [26]

For those who are good at financing, obsessed with financing can become more dangerous, and doing what you are good at is always pleasant. If you are one of them, be careful, financing cannot make the company successful, and listening to customers complain about bugs can be done. The biggest danger of being addicted to financing is not that you will spend too much time or get too much money on it, but that you will start to think that you are a successful person and don’t care much about the troubles that can really bring you success. Your startup may also be ruined.

So when I see younger founders raising funds very successfully, I usually lower my expectations of this startup in my mind, and the media may report that they will become the next Google, but I subconsciously feel that "they will die miserably."

Don't raise too much money

Although there are only a few startups that need to worry about this, it is indeed possible to get too much money. The danger of over-financing is not easy to detect. One of them is that it brings very high expectations. If you get too much money, the company will have a high valuation and you may not be able to get enough money the next time you raise it.

The valuation of a startup will generally rise with each financing. Otherwise, it will become a signal that the company is in trouble and you are not that attractive to investors. If your valuation after financing in Phase 2 is $30 million, then your valuation before financing should be at least $50 million next time. And you have to perform very, very well to raise $50 million.

It is actually very unfavorable to set the threshold for the next round of financing performance by your current competitiveness, because there is no close connection between the two.

But the funds themselves may be more dangerous than the valuation problem. The more you take, the more you use it, and uncontrolled spending is a disaster for startups. Too much spending can make profits more difficult, or worse, it will make the company less flexible because a large part of it is spent on labor costs, and the more people it is harder to change the direction of the company. So if you raise a large sum of money, don't rush to spend it (I know this advice is almost impossible to practice, and it can almost burn a hole in your pocket. But I think I have an obligation to at least try to persuade you.)

Be nice

Founders sometimes get out of investors because they appear arrogant when they raise funds. Sometimes it’s because they are really arrogant, and sometimes it’s just because rookies clumsyly try to imitate experienced strong founders they’ve seen.

It is actually wrong to be arrogant and rude to investors. Although there are specific investors who like a certain arrogance in specific circumstances, investors actually have a big difference in this regard, just as the whip can make some people surrender to their feet but will make others resist angrily. The safest way is to not act arrogant at any time.

Here I want to give you a way to be strong, but if you want to use it, you have to have some diplomatic means. For example, if you want to refuse a meeting with an investor because you are not in the financing state, or you want to reduce contact with an investor who follows too slowly, or you don’t want to accept an accidental financing offer, what you want to do next is definitely not something that investors like. So you have to learn to speak and use gentle words to buffer this kind of shock. At YC we tell the founders that you can blame us. Now that I have written this, anyone who sees this article can put the blame on me. Add to the card of inexperience, you can say this: Sorry, we think you are great, but PG says startups should not do whatever they should do. Since we are newcomers to start businesses, we think it’s better to have insurance.

Arrogance is the most undesirable when you have a good financing prospect. When everyone is optimistic about you and wants to invest in you, it is unlikely that you will be able to lower your head and act humble. Especially since no one has invested in you some time ago. But you still have to restrain yourself. The startup circle is a very small circle, and everyone will have ups and downs. There are stories here that verify the saying "God will first make it proud if God destroys it." [27]

When investors reject you, you should also be good. Good investors will not stick to their first impression of you. If they reject you in the second round but you perform well afterward, they will still invest in the third round. In fact, investors who reject you are likely to be the warm guide of your future investment path. Any investor who spends a lot of time making decisions is about to agree. Usually several of the other party's investment team have already favored financing, but they need a little more evidence to convince others who are skeptical. So it is wise to not only treat people who have rejected you politely, but also (unless they are really bad) to treat this as the beginning of a new relationship.

The next time the standard will be higher

Suppose that the financing in Phase 2 is the last round of financing you can do. Then you must try to make a profit with this amount of funds.

In the past few years, the investment industry strategy has evolved from selecting a small group of outstanding people to invest and fully support it in the next few years to casting a net investment in early start-ups and survival of the fittest in the next stage. This may be the best strategy for investors: it is too troublesome to choose early investors by yourself, so let the market make a choice. Entrepreneurs are often surprised to find that the third round of financing will be so much difficult.

When your company is only a few months old, its meaning is to make a promising test product, which is worth investing to see how it will turn out. The next time you raise money, this experiment is best already successful. You need to be on the road to listing. Although there is a lot of evidence to prove that the experiment is successful, it is usually profitable. The third round of investment generally requires Class A financing.

Usually startups disappear in two forms after two rounds and before three rounds. Some companies simply because they are profitable too slowly. They get enough money to support two years so that they don’t feel the urgency of making a profit. So they don’t work hard to make a profit for a whole year. But by then, not making a profit has become a habit. When they finally try to do it, they find that they can’t do it anymore.

Another form is to make spending too fast, which usually means hiring too many people. Usually you shouldn’t run out and hire 8 people after completing the second round of financing. Usually you want to wait until your business grows to a point where (usually operating income) can support these people. Many investors will encourage you to hire people boldly. They always make you spend too much money, part of the reason, maybe because they mistakenly believe that spending money can solve everything, and part of it is because they want to sell your company at a good price in the next round. Don’t listen to them.

Don't make financing too complicated

I realized it was a bit strange to end this super long post with "Don't make financing too complicated". But if you look back on this post, you can see that it is actually composed of points one by one. After you decide to raise funds, you should contact investors, and you should contact several investors at the same time, and sort them according to the valuations they gave, and get as many financing offers as possible. This is my financing experience.

Financing won’t help you succeed. It’s just a means to achieve your goal. Your first priority is to get it done as soon as possible and get back to what you should do. Creating products, communicating with users, etc. is the way to success.

Be good, take care of yourselves, and don't leave the path .

－－－－－－－－－－－－－－－－－－

Note:

1. The worst chemical reaction occurs between unpromising startups and mediocre investors. Good investors will not personally guide the startups forward. Their reputation is too precious. Promising startups can get enough money from good investors, so they will not talk to ordinary investors. Only those who perform averagely have to find mediocre investors. When such investors mess up things, the consequences will be more serious than usual, because these seemingly unpromising startups often need money urgently.

(Not all projects that seem unpromising are done badly, and some of them become poor ugly ducklings just because they are contrary to the popular entrepreneurial model.)

2. A YC entrepreneur told me, "I think we're doing a good job in financing overall, but I can screw up on the same thing twice - because I'm trying to manage and raise companies at the same time."

3. Here you need to pay attention to a hidden danger that I will write about later: avoid getting too high valuations from an urgent investor, so that you will have an unattainable goal next time you invest.

4. No matter what they say, if they really need another interview then it means they are not ready to invest. They are still thinking, which means you need to convince them. This is financing.

5. Investment managers in venture capital firms often send marketing emails to investors. Naive founders will think, "Wow! A VC is interested in us!" But managers are not investors, and they have no right to decide. Although they may introduce their favorite startups to partners in the company, partners are usually biased against projects like this. If you want to approach a specific company, find someone they respect as a middleman.

If you have been introduced to an investment company, it is OK to talk to the investment manager. Or it is OK to meet you on the demo day and decide to be reviewed by the investment manager. This is not a promising path, nor is it high priority, but at least it will not be as worthless as marketing emails.

Because the reputation of "investment manager" is not very good, few companies will give them the title of "partner", and things become a bit complicated. If you are an entrepreneurial project person at YC, you can ask who we are, or you can investigate online. Generally, real investors will have official titles. If someone speaks on a newspaper or a blog on the company's official website or is a member of the board of directors, he is likely to be a real partner.

There are titles such as "Investment Manager" and "Partners", which are so different that they cannot be summarized.

6. Avoid talking to potential acquirers casually for similar reasons. This can lead to a more serious distraction than financing. Don’t meet with a potential acquirer unless you want to sell your company right now.

7. Joshua Reeves recommends that each investor introduce you to two other investors. Don’t let investors who have rejected you make recommendations, as this will only have the opposite effect in many cases.

8. This is not always as deliberate as it sounds. Many procrastination and poor communication between founders and investors are caused by habits in the venture capital circle. These habits are usually formed because they are more in the interests of investors.

9. A founder of YC who read the draft of this article wrote: "This is the most important section, and I think it deserves to be written more clearly. 'Investors always want more benefits than they deserve. Even if the investor is interested in you, he may not invest. The strategy for this is to make the worst plan: the investor is just pretending to be interested until they give you a certain commitment.'"

10. Although you should arrange your meetings with investors as closely as possible, Jeff Byun mentioned a reason not to do this: if you arrange your meetings with investors too tightly, you will not have time to improve your plan.

Some founders will deliberately meet with a group of bad investors first to improve the problems in the plan.

11. There is no efficient market in this regard. Some useless investors have a high share of the market.

12. Coincidentally, this paragraph happens to be about Sales 101. If you want to see its practical application, talk to a car dealer.

13. I know that a very good diplomatic founder can end a meeting with investors as naturally as saying, "Can you hand over salt?". But if you are not a good person (or you are not sure), don't do that. Nothing is less convincing than a nerdy founder with a sleek tone.

Investors have a good impression of nerd founders. So if you are a nerd, be a nerd and don't self-defeat to imitate a slick salesperson.

14. Ian Hogarth proposed a way to see if investors are sincere: see how much resources they are willing to spend on you after the first meeting. A serious investor will start helping you even before actually investing.

15. In theory, you may need to consider the so-called "crisis signs" principle. What if a well-known venture capital institution invests a seed round but does not want to invest again next time it raises funds? Other investors will assume that the venture capital institution knows you very well, after all, they are very famous, and if they stop investing in the next round, it must mean you are bad. I said the "theoretical" reason is that the current crisis signs in practice are not enough to become a problem. And in the only few cases where it becomes a problem, those startups are really doing badly and gradually disappearing.

If you are so extravagant that you can choose a seed investor, you can rule out venture capital companies for safety reasons. But this is not the most critical.

16. Sometimes competitors threaten you with litigation when you first start financing because they know you need to disclose this fact to investors, so your financing becomes difficult. If this happens, you will be more frightened than investors. Experienced investors know this trick and know that litigation rarely happens. If you encounter such threats, it is best to tell investors everything frankly. Blinking will make them more alert.

17. Another related trick is to claim that they will only invest with other investors, and the reason for this is to prevent you from investing inadequately. This is basically nonsense, they just can’t accurately assess your minimum capital needs.

18. You won't hire all these 20 people at once, and you may still benefit in 18 months. But these are acceptable or within the error range.

19. Class A financing is much better, and once it is available, it may be worth doing something different. A YC founder told me that if he could start a business again, he would “get rid of the idea of ​​how important the early stages of building a reputation has to have on the founder.”

20. I don't know if this will happen, because there are many possibilities, or they don't think they have the ability to predict the outcome of a startup (at least this behavior is not irrational). Inference in other examples is similar.

21. If you have a startup project in YC and meet an investor who insists on your own valuation, any YC partner can help you estimate a market price.

22. If the investor is sincere, you should also respond friendly. When an investor sends an invitation without time limit, you should reply to him in a timely manner out of morality.

23. When you are raising small A-type investments, tell your investors. You should update some information to investors in time at the meeting table, which is also a good way to urge them to invest. They won’t like you raising money from others, and may pressure you to stop. But they have no reason to make you promise when you have not made a promise. If they want you to stop raising money, they will give you a series of A-type financing agreements and a term to stop financing.

If potential Series A investors have a good reputation and they obviously quickly follow up with your investment process, you can be gentler, especially if there are third-party institutions like YC who are involved in ensuring no misunderstandings. Be cautious, though.

24. Weebly made a profit from a seed round investment of 650,000. They did try a Series A round in the fall of 2008 (unquestionably partly because it was fall of 2008), but the terms they received were too harsh, so they finally decided to give up the Series A.

25. Another benefit of having only one founder in charge of investment talks is that you never have to negotiate with the other party in a real way, which is something that inexperienced entrepreneurs should avoid. A YC founder told me: "Investors are very professional negotiators, especially when they are on a certain issue. If only one founder is in the room, before making a decision, he can say, "I need to discuss it with my partner." I used to do this.

26. If the financing has been so pleasant that it can be addictive, you are lucky. More often you need to focus on the other extreme: being rejected by investors so much that morale is sluggish. Just like the (very successful) YC founder wrote after reading this draft:

"It's hard to mentally face the loss of being rejected repeatedly in financing. If you don't have a good mindset, you're likely to lose. Users may love your product, but these investors who are considered wise don't understand you at all. For me, although rejection still hurts me, I've accepted that investors can't think about it in many ways. And you have to follow some frustrating rules (many of which are listed) to achieve the final victory."

27. The original sentence in King James's Bible is: "Pride goeth before destruction, and an haughty spirit before a fall."