How to Raise Money

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| Want to start a startup? Get funded by
Y Combinator. |

September 2013

Most startups that raise money do it more than once. A typical
trajectory might be (1) to get started with a few tens of thousands
from something like Y Combinator or individual angels, then
(2) raise a few hundred thousand to a few million to build the company,
and then (3) once the company is clearly succeeding, raise one or
more later rounds to accelerate growth.

Reality can be messier. Some companies raise money twice in phase
2. Others skip phase 1 and go straight to phase 2. And at Y Combinator
we get an increasing number of companies that have already
raised amounts in the hundreds of thousands. 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 opaque — 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 YC we're always warning founders about this danger, and investors
are probably more circumspect with YC 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 pinched between two kinds of
fear: fear of investing in startups that fizzle, 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 means 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 burn 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 should take
money from investors only if they require no convincing, and are
willing 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" means 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.
[4]
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
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. 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.
[6]

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.

[...]

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