HOW TO RAISE MONEY
The 5 minute summary of Paul Graham’s historic 10,000+ word essay “How to Raise Money"
Today’s Summary: Paul Graham’s 10,000+ word essay “How to Raise Money,” can be found here.
Why you should listen to Paul Graham: Paul Graham is a co-founder of Y Combinator, a startup accelerator in Mountain View, California. He is also a programmer, venture capitalist, and essayist. Y Combinator basically wrote the book on startup accelerators and is arguably the best accelerator in the world.
This essay is a must-read if you’re fundraising. It is, however, rather long, coming in over 10,000 words.
Here’s the nugget version. 1. Understand the landscape and what drives investors to invest
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.
Fundraising is opaque, but it doesn’t have to be. Investing is a business. And like all businesses, it can be learned. Do not go in blind. Learn and leverage investors’ two main drivers: (1) fear of losing money, and (2) fomo (fear of missing out).
Don’t let investors mislead you. Again, they’re running a business. If they can get more favorable terms (to your disadvantage) they will.
Investors will wait as long as they can to invest. The more time that passes, the more they de-risk the potential investment (that’s you), but they also risk losing the opportunity to invest.
2. 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.
[T]here 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.
Fundraising isn’t the end all be all. The goal should not be to raise capital, necessarily, unless you need to.
“Rapid growth is what makes a company a startup.” And raising external capital helps them scale faster.
Don’t attempt to raise capital if you’re not ready, you should:
Have something worth investing in.
Understand why it’s worth investing in.
Be able to clearly and concisely articulate that to investors.
3. Be in fundraising mode or not.
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.
Time is precious, but even more so when you’re a startup founder. When you decide to raise capital you have to commit 100%. Likewise, when you’re not raising capital, don’t be distracted by potential opportunities to raise capital. With that said, “You can take money from investors when you're not in fundraising mode. You just can't expend any attention on it.”
4. Get introductions to investors.
Before you can talk to investors, you have to be introduced to them.
If you’re in an accelerator, you can meet investors at demo day. If you’re not, or you want to supplement, the best introductions in number order are:
“From a well-known investor who has just invested in you.”
“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.”
Websites like Angellist, which should be treated as “auxiliary sources of money.”
5. 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.
Anything other than a signed term-sheet from an investor is a “no.”
“Investors prefer to wait if they can,” giving them the option to invest after gathering more information. This could be a huge time drain (read: resources drain) on you and the company. Don’t fall for this. “If you believe an investor has committed, get them to confirm it [in writing].”
6. Do breadth-first search weighted by expected value.
Talk to all potential investors in parallel, but give higher priority to the more promising ones.
Talk to investors at the same time (not serially), giving higher priority to the more promising ones.
The formula for assigning investment probabilities:
Expected value = how likely an investor is to say yes multiplied by how good it would be if they didExample: “If some investor isn't returning your emails, or wants to have lots of meetings but isn't progressing toward making you an offer, you automatically focus less on them.”
7. Know where you stand.
Never leave a meeting with an investor without asking what happens next.
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 are on it, and how fast you're moving forward.
Look at an investors actions rather than their words.
Investors invest all the time - it’s what they do. As such, they have processes in place that they follow. Don’t be pushy, but don’t be afraid to ask what the next steps are and keep them accountable staying on track.
If you get vague answers, assume the worst. If they’re interested, they’ll make it known.
8. 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.
The first commitment (like your first customer) is often the hardest.
Further, the first “substantial commitment” is often half the fund-raising battle. Substantial necessitates it’s from a well known VC firm or angel investor.
9. Close committed money.
It's not a deal till the money's in the bank.
When someone commits, move fast and close the deal. There are tons of reasons why a deal could fall through. Don’t count your chickens before they hatch.
“After they say yes, know what the timetable is for getting the money, and then babysit that process till it happens.”
10. Avoid investors who don’t “lead”
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.
Pay attention to lead investors, and give them extra points in your calculations. These are the investors that won’t sit around and wait until others invest. Investors who wait are “worthless initially.”
Translate, “I don’t lead” into a “no, except yes if you turn out ot be a hot deal.”
There are usually no lead investors before the series A rounds.
11. Have multiple plans.
The right strategy, in fundraising, is to have multiple plans depending on how much you can raise.
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 of investment they like to make, and also to judge your ambition, reasonableness, and how far you are along with fundraising.'
The amount of money raised will get you to certain milestones. Not all milestones, however, need to be reached on that particular raise. So you can have multiple plans depending on how much you need to hit certain milestones. For example, “if we raise a few hundred thousand we can hire one or two smart friends, and if we raise a couple million, we can hire a whole engineering team, etc.”
Be cognizant of the investor’s average check size that you’re speaking with (i.e., if you’re raising a pre-seed round don’t look at investors who normally write $10 million checks).
A good rule of thumb is to multiply the number of people you want to hire times $15k times 18 months.
Your biggest expense will be employees. 15k is the upper limit (don’t actually spend that much). This number is flexible and additional costs (like manufacturing) should be accounted for.
12. Underestimate how much you want.
You should on the whole err on the side of underestimating the amount you hope to raise.
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.
Cut your ideal raise in half, and tell investors that’s what you’re raising. Underestimating what you’re trying to raise “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.”
You’re not actually limited to raising that amount. “When you reach your initial target and you still have investor interest, you can just decide to raise more.”
13. Be profitable when you can.
We urge startups during YC to keep expenses low and to try to make it to ramen profitability before Demo Day. Though it sounds slightly paradoxical, if you want to raise money, the best thing you can do is get yourself to the point where you don't need to.
There are two types of companies that raise money
Companies that need it to survive.
Companies that don’t need it to survive, but could use it to grow (i.e, scale).
If you don’t need money it’s much easier to raise 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.’”
Think of fundraising like dating: “No one wants you if you seem desperate. And the best way not to seem desperate is not to be desperate.”
14. Don’t optimize for valuation
Fundraising is not the test that matters. The real test is revenue. Fundraising is just a means to that end. Being proud of how well you did at fundraising is like being proud of your college grades.
Valuation is not that important. Revenue matters, not raising money. “Not only is fundraising not the test that matters, valuation is not even the thing to optimize about fundraising.” Don’t think of raising money as the end all be all, it’s not. Instead, for a company that is about to die money is what you need “so you can get back to focusing on the real test, the success of your company.”
Be careful to avoid raising the first from an over-eager investor at a price you won't be able to sustain.
It will be easier to raise money at a lower valuation.
Investors care about price.
Your initial valuation (or cap) is set by the first investor who commits. By default, that cap becomes your asking price. You can, however, increase this cap later on.
For early eager investors, you can raise money using an uncapped convertible note with a most favorable nations clause (MFN) which allows you to kick the proverbial valuation can a bit further, as the cap will be determined by the next investors who give you money.
15. Yes/no before valuation.
Some investors want to know what your valuation is before they even talk to you about investing. If your valuation has already been set by a prior investment at a specific valuation or cap, you can tell them that number. But if it isn't set because you haven't closed anyone yet, and they try to push you to name a price, resist doing so.
If this is the first investor, it could be the “tipping point of fundraising,” and you should focus on closing the deal not discussing price.
Trick to initially avoid discussing price: “Tell them that valuation is not the most important thing to you and that you haven't thought much about it, that you are looking for investors you want to partner with and who want to partner with you, and that you should talk first about whether they want to invest at all. Then if they decide they do want to invest, you can figure out a price. But first things first.”
We usually tell founders to give the first investor who commits as low a price as they need to. This is a safe technique so long as you combine it with the next one.
16. Beware "valuation sensitive" investors.
Occasionally you'll encounter investors who describe themselves as "valuation sensitive." What this means in practice is that they are compulsive negotiators who will suck up a lot of your time trying to push your price down. You should therefore never approach such investors first.
Don’t waste time early on with compulsive negotiators. Save them for the end.
If you find yourself in a dance with one, slow down your interactions with them.
Some investors will try to invest at a lower valuation even when your price has been set. Only speak with them if you were going to lower it anyway.
Lowballing you is a dick move that should be met with the corresponding countermove.
Treat lowball offers as backup offers, and delay responding to them.
17. Accept offers greedily.
Don't try to look into the future because (a) the future is unpredictable, and indeed in this business you're often being deliberately misled about it and (b) your first priority in fundraising should be to get it finished and get back to work anyway.
Another way of saying this is, one in the hand is better than two in the bush. “If someone makes you an acceptable offer, take it. If you have multiple incompatible offers, take the best. Don't reject an acceptable offer in the hope of getting a better one in the future.”
You can leverage better offers made later, against offers made earlier. “When you get an acceptable offer that would be incompatible with others (e.g. an offer to invest most of the money you need), you can tell the other investors you're talking to that you have an offer good enough to accept, and give them a few days to make their own.”
Some investors use “exploding offers” - offers that are only valid for a few days. The best investors don’t use these, but lower-tier investors sometimes do.
If you’re given less than 3 working days to make a decision, it’s a sign you’re dealing with a sketchy investor. 3 working days is acceptable, any less is not.
It's a bad trade to exchange a definite offer from an acceptable investor for a potential offer from a better one.
18. Don’t sell more than 25% in phase 2
Our rule of thumb is not to sell more than 25% in phase 2, on top of whatever you sold in phase 1, which should be less than 15%.
Again, phase 2 fundraising refers to the types of startups funded on demo day, whereas phase 1 refers to your applications, for example, to accelerators.
The goal is to avoid messing up the series A by giving away too much early on. Don’t give away more than 40% (max) before the series A.
“If you're raising money on uncapped notes, you'll have to guess what the eventual equity round valuation might be. Guess conservatively.”
19. Have one person handle fundraising
If you have multiple founders, pick one to handle fundraising so the other(s) can keep working on the company.
The founder who handles fundraising should make a conscious effort to insulate the other founder(s) from the details of the process.
The founder who handles fundraising should be the CEO. You’re effectively a single founder when it comes to fundraising.
Don’t intro the entire co-founding team to an investor unless it’s the final step before a decision.
If your numbers grow significantly between two investor meetings, investors will be hot to close, and if your numbers are flat or down they'll start to get cold feet.
Although growth will slow, try to continue growing.
Fundraising is a segment of time, not a point, and what happens to the company during that time affects the outcome.
20. You'll need an executive summary and (maybe) a deck.
Traditionally phase 2 fundraising consists of presenting a slide deck in person to investors.
Although some companies don’t have to, you’ll probably have to create a slide deck to present to investors.
You’ll also want an executive summary.
You’ll also need an executive summary, which should “be no more than a page long and describe in the most matter of fact language what you plan to do, why it's a good idea, and what progress you've made so far. The point of the summary is to remind the investor (who may have met many startups that day) what you talked about.”
If an investor asks you to send them your deck and/or executive summary before they decide to meet it’s a sign they’re not really interested.
21. Stop fundraising when it stops working.
Stop fundraising when you start to get a lot of air in the straw. Don't keep sucking on the straw if you're just getting air. It's not going to get better.
When you’re fundraising options run out they’ll run out in the same way a straw does when you get to the end of the liquid and start ot get a lot of air.
That’s not to say to quit too early - but be realistic.
22. Don't get addicted to fundraising.
Fundraising is not what will make your company successful. Listening to users complain about bugs in your software is what will make you successful.
Many founders mistake a successful raise for a successful company. “Startups can be destroyed by this,” because it detracts from what actually matters, namely, building a business.
23. Don’t raise too much.
If you raise an excessive amount of money, it will be at a high valuation, and the danger of raising money at too high a valuation is that you won't be able to increase it sufficiently the next time you raise money.
Raising too much capital too fast can lead to a down round, which negatively affects the perspective of your company. “A company's valuation is expected to rise each time it raises money. If not it's a sign of a company in trouble, which makes you unattractive to investors. “
Raising too much too fast can lead to premature scaling. “The more you raise, the more you spend, and spending a lot of money can be disastrous for an early stage startup.”
If you do raise a ton of money, don’t spend it.
24. Be Nice.
It's a mistake to behave arrogantly to investors.
Following the above steps may leave a bad taste in some investors’ mouths so you’ll have to “cushion the blow” to ensure you don’t seem arrogant. A good way is to leverage the “inexperience card” and “blame” Graham: “sorry, we think you're great, but PG said startups shouldn't ___, and since we're new to fundraising, we feel like we have to play it safe.”
The startup world is a small world, so if you’re doing well don’t let it go to your head.
Be nice when investors reject you…
There are a plethora of reasons you may be rejected, and just because you’re rejected now doesn’t mean there won’t be an opportunity in the future. “In fact investors who reject you are some of your warmest leads for future fundraising.”
25. The bar will be higher next time.
When your company is only a couple months old, all it has to be is a promising experiment that's worth funding to see how it turns out. The next time you raise money, the experiment has to have worked. You have to be on a trajectory that leads to going public.
There are two main ways to fail between your seed and series A round:
They can’t find profitability, with some “being “just too slow to become profitable.”
Premature scaling, “which almost always means hiring too many people.”
VCs will push you to spend too much, “don’t listen to them.”
26. Don’t make things complicated.
I realize it may seem odd to sum up this huge treatise by saying that my overall advice is not to make fundraising too complicated, but if you go back and look at this list you'll see it's basically a simple recipe with a lot of implications and edge cases. Avoid investors till you decide to raise money, and then when you do, talk to them all in parallel, prioritized by expected value, and accept offers greedily. That's fundraising in one sentence. Don't introduce complicated optimizations, and don't let investors introduce complications either.
Fundraising is not what will make you successful. It's just a means to an end. Your primary goal should be to get it over with and get back to what will make you successful — making things and talking to users — and the path I've described will for most startups be the surest way to that destination.