A Fundraising Survival Guide

[A Fundraising Survival Guide]

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

August 2008

Raising money is the second hardest part of starting a startup.
The hardest part is making something people want: most startups
that die, die because they didn't do that. But the second biggest
cause of death is probably the difficulty of raising money.
Fundraising is brutal.

One reason it's so brutal is simply the brutality of markets. People
who've spent most of their lives in schools or big companies may
not have been exposed to that. Professors and bosses usually feel
some sense of responsibility toward you; if you make a valiant
effort and fail, they'll cut you a break. Markets are less forgiving.
Customers don't care how hard you worked, only whether you solved
their problems.

Investors evaluate startups the way customers evaluate products,
not the way bosses evaluate employees. If you're making a valiant
effort and failing, maybe they'll invest in your next startup, but
not this one.

But raising money from investors is harder than selling to
customers, because there are so few of them. There's
nothing like an efficient market. You're unlikely to have more
than 10 who are interested; it's difficult to talk to more. So the
randomness of any one investor's behavior can really affect you.

Problem number 3: investors are very random. All investors, including
us, are by ordinary standards incompetent. We constantly have to
make decisions about things we don't understand, and more often
than not we're wrong.

And yet a lot is at stake. The amounts invested by different types
of investors vary from five thousand dollars to fifty million, but
the amount usually seems large for whatever type of investor it is.
Investment decisions are big decisions.

That combination—making big decisions about things they don't
understand—tends to make investors very skittish. VCs are notorious
for leading founders on. Some of the more unscrupulous do it
deliberately. But even the most well-intentioned investors can
behave in a way that would seem crazy in everyday life. One day
they're full of enthusiasm and seem ready to write you a check on
the spot; the next they won't return your phone calls. They're not
playing games with you. They just can't make up their minds.
[1]

If that weren't bad enough, these wildly fluctuating nodes are all
linked together. Startup investors all know one another, and (though
they hate to admit it) the biggest factor in their opinion of you
is the opinion of other investors.
[2]
Talk about a recipe for
an unstable system. You get the opposite of the damping that the
fear/greed balance usually produces in markets. No one is interested
in a startup that's a "bargain" because everyone else hates it.

So the inefficient market you get because there are so few players
is exacerbated by the fact that they act less than independently.
The result is a system like some kind of primitive, multi-celled
sea creature, where you irritate one extremity and the whole thing
contracts violently.

Y Combinator is working to fix this. We're trying to increase the
number of investors just as we're increasing the number of startups.
We hope that as the number of both increases we'll get something
more like an efficient market. As t approaches infinity, Demo Day
approaches an auction.

Unfortunately, t is still very far from infinity. What does a
startup do now, in the imperfect world we currently inhabit? The
most important thing is not to let fundraising get you down. Startups
live or die on morale. If you let the difficulty of raising money
destroy your morale, it will become a self-fulfilling prophecy.

Bootstrapping (= Consulting)

Some would-be founders may by now be thinking, why deal with investors
at all? If raising money is so painful, why do it?

One answer to that is obvious: because you need money to live on.
It's a fine idea in principle to finance your startup with its own
revenues, but you can't create instant customers. Whatever you
make, you have to sell a certain amount to break even. It will
take time to grow your sales to that point, and it's hard to predict,
till you try, how long it will take.

We could not have bootstrapped Viaweb, for example. We charged
quite a lot for our software—about $140 per user per month—but
it was at least a year before our revenues would have covered even
our paltry costs. We didn't have enough saved to live on for a
year.

If you factor out the "bootstrapped" companies that were actually
funded by their founders through savings or a day job, the remainder
either (a) got really lucky, which is hard to do on demand, or (b)
began life as consulting companies and gradually transformed
themselves into product companies.

Consulting is the only option you can count on. But consulting is
far from free money. It's not as painful as raising money from
investors, perhaps, but the pain is spread over a longer period.
Years, probably. And for many types of startup, that delay could
be fatal. If you're working on something so unusual that no one
else is likely to think of it, you can take your time. Joshua
Schachter gradually built Delicious on the side while working on
Wall Street. He got away with it because no one else realized it
was a good idea. But if you were building something as obviously
necessary as online store software at about the same time as Viaweb,
and you were working on it on the side while spending most of your
time on client work, you were not in a good position.

Bootstrapping sounds great in principle, but this apparently verdant
territory is one from which few startups emerge alive. The mere
fact that bootstrapped startups tend to be famous on that account
should set off alarm bells. If it worked so well, it would be the
norm.
[3]

Bootstrapping may get easier, because starting a company is getting
cheaper. But I don't think we'll ever reach the point where most
startups can do without outside funding. Technology tends to
get dramatically cheaper, but living expenses don't.

The upshot is, you can choose your pain: either the short, sharp
pain of raising money, or the chronic ache of consulting. For a
given total amount of pain, raising money is the better choice,
because new technology is usually more valuable now than later.

But although for most startups raising money will be the lesser
evil, it's still a pretty big evil—so big that it can easily kill
you. Not merely in the obvious sense that if you fail to raise
money you might have to shut the company down, but because the
process of raising money itself can kill you.

To survive it you need a set of techniques mostly
orthogonal to the ones used in convincing investors, just as mountain
climbers need to know survival techniques that are mostly orthogonal
to those used in physically getting up and down mountains.

1. Have low expectations.

The reason raising money destroys so many startups' morale is not
simply that it's hard, but that it's so much harder than they
expected. What kills you is the disappointment. And the lower
your expectations, the harder it is to be disappointed.

Startup founders tend to be optimistic. This can work well in
technology, at least some of the time, but it's the wrong way to
approach raising money. Better to assume investors will always let
you down. Acquirers too, while we're at it. At YC one of our
secondary mantras is "Deals fall through." No matter what deal
you have going on, assume it will fall through. The predictive
power of this simple rule is amazing.

[...]

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