When I was going through YCombinator in the summer of 2011, I felt like I was the only person in the entire class who knew nothing about taking investment. I remember distinctly when Jessica Livingston announced the $150K we would be getting from SV Angel and Start Fund. When she told us the terms, the room erupted in shouting and applause. I sat there Googling nervously, trying to understand what had just been said and wondering if I really belonged in YC at all.
Being surrounded by such a select group of founders, each in varying stages of building their companies, you pick up the knowledge you need very quickly. This is the most valuable part of the 3-month YCombinator session. One piece of knowledge you learn very early on is that investors tend to have a herd mentality. What I would later realize through observation was that founders tend to as well.
I remember getting the strangest looks from my peers when I suggested that I might decline the Start Fund money. I had spent time socially with the SV Angel team and knew them well, but I had never even heard of Start Fund. Taking money from someone I did not know seemed crazy to me, but I was becoming increasingly self-conscious that something might be wrong with me for thinking this way. After going through the paperwork with my lawyer and spending quality time talking with Felix from Start Fund, I ultimately felt confident in taking Start Fund’s investment.
When Demo Day came around, focus rapidly shifted from product development into fundraising. As a single founder at the time, or “pre-cofounder” as I liked to refer to myself, I knew that I would not be able to raise money on anywhere close to the same terms as my multi-foundered peers. In fact, I did not even bother trying. After my last Demo Day pitch, I skipped mingling with investors, biked to Whisman Park in Mountain View, and proceeded to sleep in a field for two hours. I figured it was time better spent given the madness of the previous three months.
My classmates were returning with stories of deal terms on convertible notes with caps of 8M, 10M, 12M, and beyond. I was happy for them, but I just could not pin down what the real long term benefits of optimizing for term sheets was. Like before, I presumed this was simply evidence of my lack of experience. When I openly questioned whether these high caps were a good thing, I started receiving weird looks again. I meant it only as a question in the pursuit of deeper understanding, not a criticism of any kind.
It was not until I began chatting with my friends Christina and Dwipal, early YouTubers turned angel investors, that I discovered an opportunity that no one else seemed to see. Christina and Dwipal both told me that they had not invested in a single YCombinator company out of my class, despite liking a good number of them. They had been completely priced out! Here were two of the smartest entrepreneurs I know, with deep industry experience, an extensive network that spans the globe, and some of the biggest wins in Internet history under their belts, and they could not get a YC company to do a deal with them on reasonable terms. I realized that there must be other angel investors in the same situation as they were, people who could bring incredible value to a startup.
Once I had found a cofounder and it became time to fundraise, I decided to structure our raise on the hypothesis that the market was overvaluing YCombinator companies and undervaluing quality angel investors. To test this hypothesis, we would raise a small amount, $500K, on a cap at about half the market rate for YCombinator companies at the time. If it proved to be a bad bet, there would still be enough of the company left to do a second seed round on market terms, averaging out the dilution. I set to work finding the most valuable set of angel investors I could and then offered them our terms.
The results were amazing. We had verbal commitments for half of the round within 3 days and the rest of the round was closed out over a 45 minute conversation at a coffeeshop in Lower Manhattan during my layover from a trip to Europe. While I had expected to be spending weeks or months trying to fundraise, the whole process was basically over before I knew it and I was back in my seat coding.
Our investor list ended up being better than we could have ever hoped for. We have experts in infrastructure, engineering, product, user experience, mobile, content policy, business, and entrepreneurship. All of our non-institutional angels were either the creators of or very early employees at well known Internet companies such as Etherpad, Rentjuice, Vimeo, and YouTube. The breadth and depth of experience of our investors is incredible. They are readily accessible and eager to help. We are so unbelievably fortunate.
What we have learned from this experience is that giving good terms to good investors will create overwhelming compounding value for your company. Think about it. With too high of a cap or valuation, what incentive does an investor have to go to work on your behalf in the short term when the real return on their investment requires several orders of magnitude of growth, which has a very low likelihood of happening ever? This presumes you can get them to even take the deal to begin with. The good investors will not even bite.
If you give the right investors the right deal, they will instantly become part of your team. Our investors have secured deals for us that have allowed us to run much of our infrastructure for free or far cheaper than what is available on the open market. They have gotten us in the door places that other companies would only dream of. Because of an investor’s work on our behalf, we stole the business from a competitor right before they were about to sign a major deal. Our investors have introduced us to the best lawyers, accountants, sales people, etc. I can go on and on.
We have been experiencing explosive growth over the last few months. Crediting it to our feats of engineering would simply not tell the real story. Our investors have played a substantial role in helping us grow and develop in a way I would never have expected. Even now, as we move into our next stage of our company, I could not be more excited to work with them in positioning the company for the future.
While this may seem like a love letter to our investors, that is simply not my intention. What I hope to impart is how optimizing for smart money has benefited us and could benefit you. Smart money is more expensive, but the value that it can bring your company is exponential. My enthusiasm comes from unexpectedly being in a position where I can see how tremendously powerful and valuable having everyone’s incentives aligned can be.