YC Guide to Seed Fundraising Every

Founder Needs to Read

Source: Geoff Ralston via YCombinator

💰WHY RAISE MONEY?

Without startup funding the vast majority of startups will die. The amount of
money needed to take a startup to profitability is usually well beyond the
ability of founders and their friends and family to finance. A startup here
means a company that is built to grow fast 12. High-growth companies
almost always need to burn capital to sustain their growth before achieving
profitability. A few startup companies do successfully bootstrap (self-fund)
themselves, but they are the exception. Of course, there are lots of great
companies that aren’t startups. Managing capital needs for such
companies is not covered herein.

Cash not only allows startups to live and grow, a but war chest is also
almost always a competitive advantage in all ways that matter: hiring key
staff, public relations, marketing, and sales. Thus, most startups will almost
certainly want to raise money. The good news is that there are lots of
investors hoping to give the right startup money. The bad news is,
“Fundraising is brutal” 1. The process of raising that money is often long,
arduous, complex, and ego-deflating. Nevertheless, it is a path almost all
companies and founders must walk, but when is the time right to raise?

💰WHEN TO RAISE MONEY

Investors write checks when the idea they hear is compelling when they are
persuaded that the team of founders can realize its vision and that the
opportunity described is real and sufficiently large. When founders are
ready to tell this story, they can raise money. And usually when you can
raise money, you should.
For some founders, it is enough to have a story and a reputation. However,
for most, it will require an idea, a product, and some amount of customer
adoption, a.k.a. traction. Luckily, the software development ecosystem
today is such that a sophisticated web or mobile product can be built and
delivered in a remarkably short period at a very low cost. Even hardware
can be rapidly prototyped and tested.

But investors also need persuading. Usually, a product they can see, use,
or touch will not be enough. They will want to know that there is product
market fit and that the product is experiencing actual growth.

Therefore, founders should raise money when they have figured out what
the market opportunity is and who the customer is, and when they have
delivered a product that matches their needs and is being adopted at an
interestingly rapid rate. How rapid is interesting? This depends, but a rate of
10% per week for several weeks is impressive. And to raise money
founders need to impress. For founders who can convince investors without
these things, congratulations. For everyone else, work on your product and
talk to your users.

💰HOW MUCH TO RAISE?

Ideally, you should raise as much money as you need to reach profitability
so that you’ll never have to raise money again. If you succeed in this, not
only will you find it easier to raise money in the future, you’ll be able to
survive without new funding if the funding environment gets tight. That said,
certain kinds of startups will need a follow-on round, such as those building
hardware. Their goal should be to raise as much money as needed to get to
their next “fundable” milestone, which will usually be 12 to 18 months later.

In choosing how much to raise you are trading off several variables,
including how much progress that amount of money will purchase,
credibility with investors, and dilution. If you can manage to give up as little
as 10% of your company in your seed round, that is wonderful, but most
rounds will require up to 20% dilution and you should try to avoid more than
25%. In any event, the amount you are asking for must be tied to a
believable plan. That plan will buy you the credibility necessary to persuade

investors that their money will have a chance to grow. It is usually a good
idea to create multiple plans assuming different amounts raised and to
carefully articulate your belief that the company will be successful whether
you raise the full or some lesser amount. The difference will be how fast
you can grow.

One way to look at the optimal amount to raise in your first round is to
decide how many months of operation you want to fund. A rule of thumb is
that an engineer (the most common early employee for Silicon Valley
startups) costs all-in about $15k per month. So, if you would like to be
funded for 18 months of operations with an average of five engineers, then
you will need about 15k x 5 x 18 = $1.35mm. What if you are planning to
hire for other positions as well? Don’t worry about it! This is just an estimate
and will be accurate enough for whatever mix you hire. And here you have
a great answer to the question: “How much are you raising?” Simply answer
that you are raising for N months (usually 12-18) and will thus need $X,
where X will usually be between $500k and $1.5 million. As noted above,
you should give multiple versions of N and a range for X, giving different
possible growth scenarios based on how much you successfully raise.

There is enormous variation in the amount of money raised by companies.

Here we are concerned with early raises, which usually range from a few
hundred thousands of dollars up to two million dollars. Most first rounds
seem to cluster around six hundred thousand dollars, but largely thanks to
increased interest from investors in seed, these rounds have been
increasing in size over the last several years.

💰FINANCING OPTIONS
Startup founders must understand the basic concepts behind venture
financing. It would be nice if this was all very simple and could be explained
in a single paragraph. Unfortunately, as with most legal matters, that’s not
possible. Here is a very high-level summary, but it is worth your time to read
more about the details and pros and cons of various types of financing and,
importantly, the key terms of such deals that you need to be aware of, from
preferences to option pools.

Venture financing usually takes place in “rounds,” which have traditionally

had names and a specific order. First comes a seed round, then a Series A,
then a Series B, then a Series C, and so on to acquisition or IPO. None of
these rounds are required and, for example, sometimes companies will
start with a Series A financing (almost always an “equity round” as defined
below). Recall that we are focusing here exclusively on seed, that very first
venture round.

Most seed rounds, at least in Silicon Valley, are now structured as either
convertible debt or simple agreements for future equity (safes) 17. Some
early rounds are still done with equity, but in Silicon Valley, they are now the
exception.

💰CONVERTIBLE DEBT
Convertible debt is a loan an investor makes to a company using an
instrument called a convertible note. That loan will have a principal amount
(the amount of the investment), an interest rate (usually a minimum rate of
2% or so), and a maturity date (when the principal and interest must be
repaid). This note intends that it converts to equity (thus, “convertible”)
when the company does equity financing. These notes will also usually
have a “Cap” or “Target Valuation” and/or a discount. A Cap is the
maximum effective valuation that the owner of the note will pay, regardless
of the valuation of the round in which the note converts. The effect of the
cap is that convertible note investors usually pay a lower price per share
compared to other investors in the equity round. Similarly, a discount
defines a lower effective valuation via a percentage off the round valuation.
Investors see these as their seed “premium” and both of these terms are
negotiable. Convertible debt may be called at maturity, at which time it must
be repaid with earned interest, although investors are often willing to extend
the maturity dates on notes.
💰SAFE
Convertible debt has been almost completely replaced by the safe at YC
and Imagine K12. A safe acts like convertible debt without the interest rate,

maturity, and repayment requirement. The negotiable terms of a safe will

almost always be simply the amount, the cap, and the discount, if any.
There is a bit more complexity to any convertible security, and much of that
is driven by what happens when a conversion occurs. I strongly encourage
you to read the safe primer 18, which is available on YC’s site. The primer
has several examples of what happens when a safe converts, which go a
long way toward explaining how both convertible debt and safes work in
practice.

💰EQUITY
An equity round means setting a valuation for your company (generally, the
cap on the safes or notes is considered as a company’s notional valuation,
although notes and safes can also be uncapped) and thus a per-share
price, and then issuing and selling new shares of the company to investors.
This is always more complicated, expensive, and time-consuming than a
safe or convertible note, and explains its popularity for early rounds. It is
also why you will always want to hire a lawyer when planning to issue
equity.

To understand what happens when new equity is issued, a simple example

helps. Say you raise $1,000,000 on a $5,000,000 pre-money valuation. If
you also have 10,000,000 shares outstanding then you are selling the
shares at:

$5,000,000 / 10,000,000 = 50 cents per share

and you will thus sell...

2,000,000 shares
resulting in a new share total of...

10,000,000 + 2,000,000 = 12,000,000 shares

and a post-money valuation of...
$0.50 * 12,000,000 = $6,000,000
and dilution of...

2,000,000 / 12,000,000 = 16.7%

Not 20%!

There are several important components of an equity round with which you
must become familiar when your company does a priced round, including
equity incentive plans (option pools), liquidation preferences, anti-dilution
rights, protective provisions, and more. These components are all
negotiable, but it is usually the case that if you have agreed upon a
valuation with your investors (next section), then you are not too far apart,
and there is a deal to be done. I won’t say more about equity rounds, since
they are so uncommon for seed rounds.

One final note: whatever form of financing you do, it is always best to use
well-known financing documents like YC's safe. These documents are well
understood by the investor community and have been drafted to be fair, yet
founder friendly.

💰VALUATION: WHAT IS MY COMPANY WORTH?

You are two hackers with an idea, a few months of hacking’s worth of
software, and several thousand users. What is your company worth? It
should be obvious that no formula will give you an answer. There can only
be the most notional sort of justification for any value at all. So, how do you
set a value when talking to a potential investor? Why do some companies
seem to be worth $20mm and some $4mm? Because investors were
convinced that was what they were (or will be shortly) worth. It is that
simple. Therefore, it is best to let the market set your price and to find an
investor to set the price or cap. The more investor interest your company
generates, the higher your value will trend.

Still, it can be difficult in some circumstances to find an investor to tell you

what you are worth. In this case, you can choose a valuation, usually by
looking at comparable companies that have valuations. Please remember
that the important thing in choosing your valuation is not to over-optimize.
The objective is to find a valuation with which you are comfortable, that will
allow you to raise the amount you need to achieve your goals with
acceptable dilution, and that investors will find reasonable and attractive
enough to write you a check. Seed valuations tend to range from
$2mm-$10mm, but keep in mind that the goal is not to achieve the best
valuation, nor does a high valuation increase your likelihood of success.

💰 INVESTORS: ANGELS & VENTURE

CAPITALISTS
The difference between an angel and a VC is that angels are amateurs and
VCs are pros. VCs invest other people’s money and angels invest their own
on their terms. Although some angels are quite rigorous and act very much
like the pros, for the most part, they are much more like hobbyists. Their
decision-making process is usually much faster--they can make the call all
on their own--and there is almost always a much larger component of
emotion that goes into that decision.

VCs will usually require more time, and more meetings, and will have
multiple partners involved in the final decision. And remember, VCs see
LOTS of deals and invest in very few, so you will have to stand out from the
crowd.

The ecosystem for seed (early) financing is far more complex now than it
was even five years ago. There are many new VC firms, sometimes called
“super-angels,” or “micro-VCs”, which explicitly target brand-new, very
early-stage companies. Several traditional VCs will invest in seed rounds.
And there are a large number of independent angels who will invest
anywhere from $25k to $100k or more in individual companies. New
fundraising options have also arisen. For example, AngelList Syndicates
lets angels pool their resources and follow a single lead angel.
FundersClub invests selectively like a traditional VC but lets angels become
LPs in their VC funds to expand the connections available to its founders.
How does one meet and encourage the interest of investors? If you are
about to present at a demo day, you are going to meet lots of investors.
There are few such opportunities to meet a concentrated and motivated

group of seed investors. Besides a demo day, by far the best way to meet a
venture capitalist or an angel is via a warm introduction. Angels will also
often introduce interesting companies to their networks. Otherwise, find
someone in your network to make an introduction to an angel or VC. If you
have no other options, research VCs and angels and send as many as you
can a brief, but compelling summary of your business and opportunity.

💰CROWDFUNDING
There are a growing number of new vehicles to raise money, such as
AngelList, Kickstarter, and Wefunder. These crowdfunding sites can be
used to launch a product, run a pre-sales campaign, or find venture
funding. In exceptional cases, founders have used these sites as their
dominant fundraising source, or as clear evidence of demand. They usually
are used to fill in rounds that are largely complete or, at times, to reanimate
a round that is having difficulty getting off the ground. The ecosystem
around investing is changing rapidly, but when and how to use these new
sources of funds will usually be determined by your success raising through
more traditional means.

💰MEETING INVESTORS
If you are meeting investors at an investor day, remember that your goal is
not to close--it is to get to the next meeting. Investors will seldom choose to
commit the first day they hear your pitch, regardless of how brilliant it is. So
book lots of meetings. Keep in mind that the hardest part is to get the first
money in the company. In other words, meet as many investors as possible
but focus on those most likely to close. Always optimize for getting money
soonest (in other words, be greedy) 2.

There are a few simple rules to follow when preparing to meet with
investors. First, make sure you know your audience--research what they
like to invest in and try to figure out why. Second, simplify your pitch to the
essential--why this is a great product (demos are almost a requirement
nowadays), why you are precisely the right team to build it, and why

together you should all dream about creating the next gigantic company.
Next, make sure you listen carefully to what the investor has to say. If you
can get the investor to talk more than you, your probability of a deal
skyrockets. In the same vein, do what you can to connect with the investor.
This is one of the main reasons to do research. An investment in a
company is a long-term commitment and most investors see lots of deals.
Unless they like you and feel connected to your outcome, they will most
certainly not write a check.

Who you are and how well you tell your story are most important when
trying to convince investors to write that check. Investors are looking for
compelling founders who have a believable dream and as much evidence
as possible documenting the reality of that dream. Find a style that works
for you, and then work as hard as necessary to get the pitch perfect.
Pitching is difficult and often unnatural for founders, especially technical
founders who are more comfortable in front of a screen than in a crowd. But
anyone will improve with practice, and there is no substitute for an
extraordinary amount of practice. Incidentally, this is true whether you are
preparing for a demo day or an investor meeting.

During your meeting, try to strike a balance between confidence and

humility. Never cross over into arrogance, avoid defensiveness, but also
don’t be a pushover. Be open to intelligent counterpoints, but stand up for
what you believe and whether or not you persuade the investor just then,
you’ll have made a good impression and will probably get another shot.

Lastly, make sure you don’t leave an investor meeting without an attempted
close or at the very minimum absolute clarity on the next steps. Do not just
walk out leaving things ambiguous.

💰NEGOTIATING AND CLOSING THE DEAL

A seed investment can usually be closed rapidly. As noted above, it is an
advantage to use standard documents with consistent terms, such as YC’s
safe. Negotiation, and often there is none at all, can then proceed on one or
two variables, such as the valuation/cap and possibly a discount.

Deals have momentum and there is no recipe for building momentum

behind your deal other than by telling a great story, persistence, and
legwork. You may have to meet with dozens of investors before you get that
close. But to get started you just need to convince 5 one of them. Once the
first money is in, each subsequent close will get faster and easier 6.

Once an investor says that they are in, you are almost done. This is where
you should rapidly close using a handshake protocol 19. If you fail at
negotiating from this point on, it is probably your fault.

💰NEGOTIATIONS
When you enter into a negotiation with a VC or an angel, remember that
they are usually more experienced at it than you are, so it is almost always
better not to try to negotiate in real time. Take requests away with you, and
get help from YC or Imagine K12 partners, advisors, or legal counsel. But
also remember that although certain requested terms can be egregious, the
majority of things credible VCs and angels will ask for tend to be
reasonable. Do not hesitate to ask them to explain precisely what they are
asking for and why. If the negotiation is around valuation (or cap) there are,
naturally, plenty of considerations, e.g. other deals you have already closed.
However, it is important to remember that the valuation you choose at this
early round will seldom matter to the success or failure of the company. Get
the best deal you can get--but get the deal! Finally, once you get to yes,
don’t wait around. Get the investor’s signature and cash as soon as
possible. One reason safes are popular is that the closing mechanics are
as simple as signing a document and then transferring funds. Once an
investor has decided to invest, it should take no longer than a few minutes
to exchange signed documents online (for example via Clerky or Ironclad)
and execute a wire or send a check.
💰DOCUMENTS YOU NEED
Do not spend too much time developing diligence documents for a seed
round. If an investor is asking for too much due diligence or financials, they

are almost certainly someone to avoid. You will probably want an executive
summary and a slide deck you can walk investors through and, potentially,
leave behind so VCs can show to other partners.

The executive summary should be one or two pages (one is better) and
should include vision, product, team (location, contact info), traction, market
size, and minimum financials (revenue, if any, and fundraising prior and
current).

Generally, make sure the slide deck is a coherent leave-behind. Graphics,

charts, and screenshots are more powerful than lots of words. Consider it a
framework around which you will hang a more detailed version of your
story. There is no fixed format or order, but the following parts are usually
present. Create the pitch that matches you, how you present, and how you
want to represent your company. Also note that like the executive summary,
there are lots of similar templates online if you don’t like this one.

1. Your company / Logo / Tag Line

2. Your Vision - Your most expansive take on why your new company
exists.

3. The Problem - What are you solving for the customer--where is their
pain?

4. The Customer - Who are they and perhaps how will you reach them?

5. The Solution - What you have created and why now is the right time.

6. The (huge) Market you are addressing - Total Available Market (TAM)
>$1B if possible. Include the most persuasive evidence you have that this is
real.

7. Market Landscape - including competition, macro trends, etc. Is there

any insight you have that others do not?
8. Current Traction - list key stats/plans for scaling and future customer
acquisition.

9. Business model - how users translate to revenue. Actuals, plans,

hopes.

10. Team - who you are, where you come from, and why you have what it
takes to succeed. Pics and bios are okay. Specify roles.

11. Summary - 3-5 key takeaways (market size, key product insight,
traction)

12. Fundraising - Include what you have already raised and what you are
planning to raise now. Any financial projections may go here as well. You
can optionally include a summary product roadmap (6 quarters max)
indicating what an investment buys.

💰Fundraising Rules to Follow

● Get fundraising over as soon as possible, and get back to building
your product and company, but also…
● Don’t stop raising money too soon. If fundraising is difficult, keep
fighting and stay alive.
● When raising, be “greedy”: breadth-first search weighted by expected
value 2. This means talking to as many people as you can, prioritizing
the ones that are likely to close.
● Once someone says yes, don’t delay. Get docs signed and the money
in the bank as soon as possible.
● Always hustle for leads. If you are the hottest deal of the hour, that’s
great, but everyone else needs to work like crazy to get angels and
other venture investors interested.
● Never screw anyone over. Hold yourself and others on your team to
the highest ethical standards. The Valley is a very small place, and a
bad reputation is difficult to repair. Play it straight and you will never
regret it. You’ll feel better about it, too.
 ● Investors have a lot of different ways to say no. The hardest thing for
an entrepreneur is understanding when they are being turned down
and being okay with it. PG likes to say, “If the soda is empty, stop
making that awful sucking sound with the straw.” But remember that

they might be a “yes” another time, so part on the best possible

terms.
● Develop a style that fits you and your company.
● Stay organized. Co-founders should split tasks where possible. If
necessary, use software like Asana to keep track of deals.
● Have a thick skin but strike the right balance between confidence and
humility. And never be arrogant.

💰 What Not to Do While Communicating with

Investors
DON'T:

● Be dishonest in any way

● Be arrogant or unfriendly
● Be overly aggressive
● Seem indecisive - although it is okay to say you don’t know yet.
● Talk so much they cannot get a word in edgewise
● Be slow to follow up or close a deal
● Break an agreement, verbal or written
● Create detailed financials
● Use ridiculous/silly market size numbers without clear justification
● Claim you know something that you don’t or be afraid to say you don’t
know
● Spend time on the obvious
● Get caught up in unimportant minutiae - don’t let the meeting get
away from you
● Ask for an NDA
 ● Try to play investors off each other when you are not a fundraising
ninja
● Try to negotiate in real-time
● Over-optimize your valuation or worry too much about dilution
● Take a “No” personally

💰A Brief Glossary of Key Terms

The term you are looking for is not here? Disagree with the definition? Go
to Investopedia for a more authoritative source.

● Angel Investor - A (usually) wealthy private investor in startup

companies.
● Cap / Target Valuation - The maximum effective valuation for an
investor in a convertible note.
● Convertible Note - This is a debt instrument that will convert into
stock; usually preferred stock but sometimes common stock.
● Common Stock - Capital stock typically issued to founders and
employees, having the fewest, or no, rights, privileges, and
preferences.
● Dilution - The percentage of an ownership share is decreased via
the issuance of new shares.
● Discount - A percentage discount from the pre-money valuation to
give safe or note holders an effectively lower price.
● Equity Round - A financing round in which the investor purchases
equity (stock) in the company.
● Fully Diluted Shares - The total number of issued and outstanding
shares of capital stock in the company, including outstanding
warrants, option grants and other convertible securities.
● IPO - Initial Public Offering - the first sale of stock by a private
company to the public.
● Lead Investor - Usually the first and largest investor in a round who
brings others into the round.
● Liquidation Preference - A legal provision in a company’s charter
that allows stockholders with preferred stock to get their money out of
 a company before the holders of common stock in the event of an
exit.
● Maturity Date - The date at which a promissory note becomes due
(or at which it will automatically convert to stock in the case of a
convertible note)
● Equity Incentive Plan / Option Pool - The shares allocated and set
aside for grants to employees and consultants.

● Preferred Stock - Capital stock issued in a company that has specific

rights, privileges, and preferences compared to the common stock.
Convertible into common stock, either automatically (e.g., in an IPO)
or at the option of the preferred stockholder (e.g., an acquisition).
● Pre-money Valuation - The value of a company before when
investor money is added.
● Pro-rata rights (aka pre-emptive rights) - Contractual rights that
allow the holder to maintain their percentage ownership in
subsequent financing rounds.
● Protective Provisions - Provisions in a company’s charter that give
exclusive voting rights to holders of preferred stock. For example, the
approval of these stockholders, voting separately from other
stockholders, may be required for an acquisition.
● Safe - Simple Agreement for Future Equity - Y Combinator’s
replacement for convertible debt.
● TAM - Total Available Market. In pitches, this is the estimated total
revenue available for the product(s) you are selling.
● Venture Capitalist - A professional investor in companies, investing
limited partners’ funds.