I wanted to follow up one of my previous posts about How to Get into Y Combinator — in which I talk about the four kinds of risks investors look at when deciding to invest in your company — with a much more practical post about how to raise money from investors.
I’ll caveat here that in my own experience with One Month, we were fairly fortunately to have been accepted into Y Combinator, and so the process of fundraising was significantly easier than it would have been otherwise. That being said, I truly believe that’s because the partners at Y Combinator, including Paul Graham, have distilled some important truths about fundraising that they were able to pass along.
The first lesson is that the first investment is the hardest.
When you start fundraising, if you’re lucky you’re going to get a lot of “soft” commitments. These sound something like, “I really like the company and I’d like to invest, let me know when the round’s about to close.” In some cases, they may even say that they’re in, but they’re just putting up a little resistance to actually giving you the money.
You need to recognize that it’s not an investment until you actually have their money.
And it’s also in their interests as investors to wait as long as possible to actually invest. If they believe they can commit now, and put the money in later, they will always do that. Why? Because sometimes more information will come up and investors will back out. It happens all the time.
As an entrepreneur you need to apply a strong pressure here.
One of the advantages to using a convertible note or Y Combinator’s SAFE financing document as your fundraising tool in the seed stage is that you can collect money immediately as it comes in instead of all at once at the end. This is called a “rolling close.” It alleviates some of the risk of having to get buy-in from a bunch of people simultaneously and then having one person or problem fuck it all up.
The strategy that I learned at Y Combinator was that as soon as I got a soft commit from an investor, I wrote up a convertible note (using Clerky) for the highest amount they mentioned they might invest and sent it to the investor with the following email:
Our round is getting pretty tight, be we should have room.
I’ve sent over the standard YC convertible note docs using Clerky for a $100k investment at a $6M cap. Take a look and let me know if you have any questions and either [lawyer’s name] (legal counsel) or I can get back to you. Otherwise, just sign and we can guarantee your spot in the round.
So you really have to do whatever you can to close the first investment in a round. The first $25k or $50k or $100k. In terms of focusing your energy, don’t spend a ton of time on small investments like $5k or $10k (we actually didn’t accept any investment under $20k in our first round).
The momentum builds after you get your first investor, because it’s likely that investor will introduce you to other investors, and so on. Like a chain reaction. Sometimes that doesn’t happen but in a large enough round it will.
The second lesson I learned was don’t create a pitch deck or a business plan.
You’ll hear, “do you have a deck?” from investors all the time. The stock response that the YC partners told us to give was (roughly):
We’ve been too busy running the company to prepare a pitch deck. I’m happy to meet in person to tell you more about the company.
In the early stages, if an investor asks for a pitch deck, he or she doesn’t know what she’s talking about. It just turns out it’s not really necessary. And it saves you a ton of time doing something that isn’t important.
Instead of a pitch deck, prepare whatever short document you think the investor will need to see in order to invest (a simple Google doc will do), but only send it to the investor after your first meeting.
The later in stages you get, the more documents you’ll need to prepare, but in the seed stages you may not need to do any.
The third lesson is that with a “rolling close” you can change the amount you say you’re raising.
This can be helpful for applying pressure to investors that are on the fence.
At first we told investors we were only looking to raise about $250,000, and we had already gotten $150,000, so if they wanted to guarantee a spot in our round they would have to do it immediately.
This helps counter that investor feeling of, “I can still wait it out and get into the round right before it closes. I have time.”
The major caveat here is that it’s important to know how much the person or fund you’re talking to needs to be able to invest. This is a major mistake we made. We said we were raising the same number ($250,000) for angel investors and funds initially, but that essentially ruled out the funds.
Many funds have to be able to invest large amounts of money (anywhere from $500–750k to $3–5 million) for it to even be worth considering you as an investment. If you say you’re only raising $500k and you already have $250k, that essentially rules you out as an investment.
Find out what terms the fund typically invests in, the size of the fund, and how far through the fund they are. Almost all VCs are willing to tell you that information almost immediately.
But you don’t really need a lead in a seed round. It can be helpful for filling up the round faster, convincing others to get on board, and later for strategic stuff like introductions and advice, but it’s not really necessary. You can raise the entire round in checks like $50k or $100k if you need to.
And as time goes on, you up the amount you’re raising. You can even theoretically up the valuation cap on the note as you get more interest.
Take easy money.
If someone wants to invest, and you like the terms, take it. But be discerning. Talk to some of the companies they’ve already invested in, especially the ones that didn’t succeed, to see how the investor relationship worked (you may have to reach out to these companies yourself).
The last thing you want is an investor that’s going to cause trouble or be difficult to work with. (For example, we had one investor who asked for his money back after three months and didn’t want to sign a standard convertible note extension even after all our other investors had.)
At the end of the day, investors often aren’t as helpful as you’d like them to be. Their helpfulness comes in waves. If you reach out, they may offer a hand, but most of the time the intros they’ll make come right after they invest, and trails off as the excitement wears off. That’s okay. Money is money. And you wouldn’t want them too involved anyway.
Finally, don’t talk to associates.
It’s a waste of time. Insist on communicating with partners and getting partners involved early on. If you’re talking to an associate at a fund you like, ask which partner would really be interested in a company like yours and then ask if they can put you in touch with that partner.
Because some firms know this, Associates often go by the name of “Investor,” or “Venture Partner” instead.