by Sam Altman2/23/2016
We’ve modified our fundraising strategy advice to YC founders. In the interest of everyone having the same information, here is the email I sent to the current batch this morning.
As Y Combinator’s prominence has grown in recent years, we’ve seen a flood of new investors who are very focused on investing in YC companies in the current batch. Some of these investors are very aggressive and offer attractive terms with no diligence. There are obvious good things about this, but there are really bad ones too. We’re now about a month away from Demo Day, which is when the investor outreach usually starts in earnest (as we’ve said before, we recommend politely deferring these requests to meet until closer to Demo Day).
So we’re modifying our advice about how to raise money at the end of YC.
Before we get to that, here’s a very important point: some good companies will struggle to raise money. Fashionable companies, good or bad, have a much easier time raising money than unfashionable companies. This is a bug in the market that some of the best investors learn to exploit, but it still doesn’t help you much if you need to raise and can’t. Try not to get demoralized if you don’t get the response from investors you were hoping for–be relentlessly resourceful and figure out a way to make it work with what you have.
Also, the environment seems to be changing. It will very likely be somewhat harder to raise money now than it’s been in past years, but it’s too early to say for sure (so far we haven’t seen nearly as much of an effect on early-stage fundraising as the level of press coverage would seem to indicate).
Ok, on to our advice.
1) You should care more about good investors than good valuations. Use the YC investor database, talk to us, talk to alumni, and talk to the founders of the companies that investor has funded (especially in cases when the companies haven’t worked out). However, you should insist on clean terms (in practice, offering messy terms is a sign of being a bad investor).
2) You should aim to sell only about 20% of the company in your seed round (though 25% is ok if you’re raising a ‘large’–say more than $2.5 million–seed round).
3) You should raise enough money to get to your next significant milestone.
4) You should try to get the process over with reasonably quickly so you can get back to work. The founders that fall in love with fundraising rarely go on to be the most successful.
So here’s what I would do if I were a YC founder in the current climate.
I’d close the first, say, $200k from the first reasonably good investors that offer it on reasonable terms–say a $5 million pre-money valuation or higher. This removes some uncertainty and pressure, gives you capital to execute with while raising the rest of your round, puts you in a stronger position, etc. It’s worth a discount for all of this.
Beyond that, I’d then collect interest from investors. Get to know them and let them get to know you. This doesn’t have to take a long time; a few weeks and 3 meetings per investor for a seed round is enough, and in some cases both sides will feel ready to make a decision after one meeting. But don’t feel the need to take offers in the order they come in; you have a limited amount of space in the round, investors are on your cap table for a very long time, and you want to pick the best people you can get. Every batch, some of the best companies regret selling a lot of stock early on and then getting interest from great investors later.
Then, after a set number of weeks you decide to spend fundraising, make the allocation decisions at the same time. It’s cleanest to offer everyone the same terms that invests at the same time–everyone claims they add extra value and needs advisor shares, but no one else thinks anyone should get them. If you deviate from this, you should be transparent and let everyone in the round know about advisor shares or different terms. (If you fill up your initial raise and then have more interest but are sensitive to the dilution, it’s fine to ask new investors if they want to raise more at a higher price. They can always say no.)
Use the Handshake Deal Protocol when you’re ready to make allocation decisions. (Though it’s worth noting we only recommend the HDP for seed rounds. If you’re raising a Series A, i.e. millions of dollars from one investor, use the tried and true term sheet to indicate an agreement.)
Other reminders for fundraising:
– The best investors know that the most important thing to figure out at this stage is how much your users love you. Great engagement and word of mouth growth are magic for fundraising.
– Growth is obviously still really helpful.
– It’s important to articulate why the company will eventually be in a strategically valuable position (i.e. a monopoly).
– It’s important to articulate your mission.
– Don’t be arrogant–this is a tactic that somehow does manage to work for fundraising some of the time for some founders, but most of the time it doesn’t.
As always, reach out to us along the way with questions.
Sam Altman is the CEO of OpenAI. He was the president of YC from 2014-2019. He studied computer science at Stanford, and while there, worked in the AI lab.