I originally wrote this essay for The Information, where it was published on Feb 16.

Here's a fun little paradox in fundraising: Founders and the media love to talk about how quickly funding rounds happen these days—think about the big, rapid-fire raises from OpenSea, DataBricks and others—but when you watch a fundraising process from start to finish, it’s never as fast as it seems. Even the tidiest-looking processes, ones that seem to kick off on day X and sign term sheets on day Y, aren’t what they appear to be.

The best-run rounds are always running, just at different levels of intensity. This breaks some brains because founders want to believe you’re either fundraising or you’re not. In reality, great founders are always fundraising. It’s just that sometimes they call it “fundraising” and sometimes they call it “building relationships.”

This is an important point for founders to internalize because the illusion of fast, aka hot rounds hurts companies. Specifically, founders come to expect that they can emerge from a hole, say “We’re raising” and be done in a few days.[1] The early-stage market hasn’t taken quite the same beating as later-stage or public markets, but still, now is no time to be stupid. The truth is that nearly every fast round I've ever seen (and I’ve seen many) actually started months earlier with careful relationship- and narrative-building or extensive work by an investor—or in many cases both.

Let’s look at this from the investor’s perspective. Every venture capitalist has some quality bar a company needs to clear to trigger an investment. That usually consists of two key components: the overall market or opportunity, and the founder and company in the context of that opportunity. While different investors may consider these in different orders or with different weights, they all form views on each.

Developing a feel for a particular market requires research. That might involve commissioning a consulting firm[2] to perform due diligence on a particular region and its regulatory structure, or it may mean simply talking to potential users and building a view on what solutions may or may not work. This can take weeks or months, most of it before an investor ever talks to the founder of a prospective investment. Some investors run this process quickly, some run it slowly, and to be sure, some don’t run it at all.[3]

But just because a venture capitalist has all the information necessary to make a quick investment decision doesn’t mean they will—there’s still the company to consider. Here again, we run into different speeds and philosophies. When I worked at Y Combinator, we made most of our decisions in 10 minutes. Other investors need hours with founders, often distributed over months or years. Once a venture capitalist has these pieces, the question becomes whether the price of the deal makes sense.

When you understand this framework, the pace at which many follow-on rounds seem to occur doesn’t look quite so fast. These (mostly) aren’t discrete fundraising decisions. They’re continuations of situations where an investor did all or most of the work to get to a “yes” at a given round but lost, then reevaluated the price, made another decision to say “yes” and convinced the founder to take more money.

Founders can use this understanding to their advantage by realizing that they do not have to be passive bystanders in the investor knowledge-gathering process. Think about it this way: An investor evaluating a market needs information. That investor needs to talk to people. Founders are people who happen to know quite a lot about their markets and also generally like talking about them, and investors are usually happy to listen![4] As they listen, they can’t help but be influenced by a convincing story and growing metrics.

That said, founders have to be smart about what information they share and when they do it.

Those who spend too much time with investors and who share too much information too often inevitably hurt their companies. It can be hard for founders to see the balance here, so as someone who’s seen many rounds happen,[5] I’d offer these rules of thumb:

1. Meet with investors who can actually make the decision to lead a round. This is not necessarily someone with the title of partner.
2. Meet with those investors once per quarter—maybe once a month in extreme cases.
3. Share high-level metrics, but not enough to let someone form a full picture.
4. Prepare concrete asks that can’t be executed during the conversation, such as: “Here are three portfolio companies that would be good customers. Can you introduce me to the heads of analytics at each?”
5. Track follow-ups.

Maybe someone wants to make the semantic argument that this isn’t fundraising. There’s no deck, there’s no ask, there’s no official invite to a fundraising kickoff party.[6] But it is a meeting between someone who wants to provide funding in exchange for equity and someone who is willing to sell equity for money. If that isn’t fundraising, I don’t know what is. When founders run this part of the process effectively, they’re able to target their later, formal fundraising efforts solely at investors they know are interested.

From there, things should move along at a nice clip, in no small part because the founder is now effectively running an auction. I’ve written extensively about this in the past, so I won’t rehash all of it here, but the main point is that competition forces investors to move quickly. This is in part because good investors generally know when other good investors are interested, but it’s also about the way founders act when they have options versus when they don’t. This is hard to fake, and it works.

I’ve seen founders attempt to force a quick process by setting arbitrarily short timelines, by refusing to produce reasonable data or answer questions, by generally being jerks—all things they believe are effective based on what they’ve read, not based on the work they’ve put in. Startup orthodoxy confirms what these founders want to believe: that they can keep their heads down pretty much forever and get chased by money whenever they need it. Maybe that was true at one time. But markets change, and founders who adapt reap the benefits.

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Thank you to Jillian Goodman for your help writing this.

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[1] We’re focused here on priced rounds: Series A, Series B and up. Seed rounds are different.

[2] This is a strategy for rapidly building knowledge on many opportunities that I first saw happening at Tiger Global Management and that other funds have adopted.

[3] There are plenty of investors who operate on gut, but this happens less and less as you move through Series A to B and up.

[4] Venture capitalists like to have meetings. This is a major part of their jobs. Go have a meeting! They’ll listen for longer than your parents and you will get free coffee out of it.

[5] When asked this question, I generally come back to Potter Stewart’s famous quote from a distinctly different context: “I know it when I see it."

[6] Not a thing. At least not yet.

A year ago, I left YC and felt a bit lost about what to do next.[1] A lot of people were pretty sure they knew what I should do. But...I didn't and most of their suggestions didn’t excite me.

As I thought through my possible paths, I realized that I didn't have a useful framework for making a decision. My gut wasn't helpful since too many things seemed interesting. I started asking friends for advice, and Henrik Werdelin gave me the structure I needed to figure out what I should try next.

As I worked through his advice and its implications, something odd happened - a whole lot of my friends started hitting the same confusing decision point through which I’d just gone. Maybe we're all going through natural career evolutions, maybe these are early onset midlife crises, and maybe a few years of inescapable existential dread about a never ending pandemic is just screwing up all our preconceived notions about how our lives should/need to work.

Whatever the case, I keep having the same conversation, so writing it out seems useful.[2]

The 1st, and most important thing to keep in mind is that no career decision is perfect, no decision without risk. Oh, and no one actually cares what you do. This is especially hard for high achievers to internalize, harder still for people who have succeeded publicly. Maybe this is hardest of all for people who feel as if nothing they've done has matched their self perception and internal expectations.

The next thing to do is to start making lists. In particular, three lists:

The 1st list is an amalgam of all the qualities you want in your next role and what you get from having that role. This is expansive by design. For instance:

• Work with people who are actually funny

• Easy commute

• Do not work weekends

• Earn at least x

• Coworkers are the same in person as on social media

• Build on personal expertise

• Creates interesting future options

• Other stuff

It is ok to have items on here that are intensely personal and maybe unexpected. Perhaps you want less risk or ambition than you've shown in the past. Maybe you know that you’ll never be happy with a boss. Write it all out.

List two is all the jobs that you think sound interesting. Try to go way beyond your existing set of experiences to things you always thought were interesting but never seriously explored. You're going to throw most of this out, but that's ok. You could write:

• Get a PhD is American History

• Run for office

• Join a government agency

• Start a software company

• Be a baker

• Hedge fund - work at or start

• Start a nonprofit

Obviously this list will be informed by what you know and what you want. Some of it will be impractical. That's ok.

The final list is made up of people you know and with whom you'd actually work. Sometimes this list is long and sometimes it is short. There's no right answer here.

Once you have these lists, you start cross referencing them to see what mix of qualities, roles and people seem like the best trade.

There's no science here. You could decide that salary is the most important criteria of all and use that as the single lens. Usually, the balance is more nuanced. What helped me most was forcing myself to list all the options, interests, and criteria. I'd never done that and it required me to think more deeply about what I did and did not want.

This process took me some time, and I ended up choosing a set of what I enjoyed in a way that capitalized some unfair advantages I'd built in my career. I had come to an answer, but I was still too scared to try it. At that point, another friend, Omri Dahan, gave me the final piece I needed. He pointed out that I was still trying to optimize for long term perfection, and suggested that I should, instead, take a risk for six months. I hadn’t internalized the idea that very few career decisions are permanent. I thought I was choosing the job I’d have for the rest of my life, but I wasn’t. I was choosing the next thing to learn about and try. I was fortunate to be able to run that experiment. Eight months later, it's become clear to me that I made the right choice from the perspective of how much I've been able to learn and build. Perhaps more important to me, the problem set keeps getting more complex and interesting. Still, though, I know this is just another experiment that I’ll run it until it no longer makes sense.

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[1] I'll note that "what to do" and "job" here aren't necessarily the right terms. I'm using them as stand ins for the the thing you do that isn't family/personal life. Some people will go through this exercise and decide that there's nothing for them outside of personal/family life. I'm happy for them, but my wiring needs to have a balance of family and work.

[2] By writing from personal experience, I know that this process won't work for everyone and every situation. But if you find it useful, great!

Here’s a painful contradiction at the heart of spending time on startups: all the good stuff you can create is in the future, but all the patterns you look at to learn what to do are in the past. This makes your brain do funny things. On the one hand, you see how huge things can get, on the other hand, it’s easy to think “well, crap, all the huge things already happened and I wasn’t a part of them.” So you start a new thing, and it is tiny compared to the huge thing. That can start a recursive loop of pessimism. My bet is that this kills a lot of interesting new things before they can ever get going.[1]

And ok it gets worse. Maybe you had a chance to join/invest in that small thing that’s now huge.[2] You look at your non-existent alternate reality success and that hurts. Maybe you had many of these opportunities. [3] So now you feel stupid on top of discouraged!

I know I’ve fallen prey to this mindset. It’s the source of most of my worst decisions as an investor. I’ve spent a lot of time wrestling with feelings of anger and stupidity about things I didn’t invest in which other people did.[4] It’s a rough place to be, but I’ve increasingly come to rely on a different way of thinking about opportunity and success that’s been hugely helpful.

For lack of a better and more unique term, I’ve been thinking of this mindset as “pots of gold.” You could also maybe call it unbridled optimism, but it isn’t quite. The core of it, silly as this may sound, is to think about three things:

1. The origin story of the big things around you

2. Remember that the future is bigger than the past

3. Have confidence that either you or the smart people you know can build something significantly bigger than seems reasonable[5]

If you can hold this in your head and actually believe it, you get set free from all kinds of things. All of a sudden, the stuff you missed isn’t bad, it’s validation to take more risk in the future. Even better, each miss gives you something to learn, input to iterate your model of the world. This frame of the world says that there’s always more opportunity in the future than the past, so trying to build new things has a higher expected value than you probably realize.

This is hard to do. Thinking about the world this way means that you have to objectively understand why you were wrong in the past. Most of us don’t want to do that because it is painful. It also requires a significant amount of imagination, which is tiring for most people older than ten. You’ll also need a near endless reserve of patience since compounding growth takes a long time to manifest a significant outcome.[6]

But even though - or especially because - this is hard, it is much more fun than feeling sad about what you didn’t do. Go do something other than staring at what other people did and brag about on the internet. Take a risk, learn about something new, invest in it, start something. Find another pot of gold.

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[1] For sure a corollary to the Innovator’s Dilemma, but happening inside the brains of founders.

[2] I wrote about this dynamic here: https://blog.aaronkharris.com/why-build-toys.

[3] A number of coins and tokens and NFTs means this applies to just about everyone.

[4] To be sure, I also got this right a few times, which is also kinda maybe the point here.

[5] I recently joked to a friend that I have total confidence in my friends and optimism for the things they do, and absolutely no confidence in myself and the things I want to build. He said he had the same mindset, which made us realize we should probably have some more confidence in ourselves.

[6] Zoom in on the early parts of even the most aggressive "hockey stick" and the growth and scale will look positively boring.

Thanks to Zach Sims, Adora Cheung, and Harj Taggar for the conversations that helped me figure out how to express this idea.

For a long time, I was a strong believer in investor pro ratas. As a founder, I understood the trade and was comfortable with it. As a partner at YC, I thought it made enough sense that I helped design an entire programmatic pro rata system that covered every investment YC made. I reasoned that the usual mechanic of a pro rata let an investor continue to buy ownership as a reward for an early bet and continued help, and that founders could always use extra money.

I was wrong. Pro rata is actually a bad term for founders dressed up as a “business model” or “support” feature. I learned this the hard way, through many uncomfortable conversations with founders where I insisted on getting pro rata in tight rounds where the founder wanted to bring in new investors or limit dilution. I learned this through rough conversations with founders who expected a pro rata investment during a difficult fundraise and didn’t get it. I saw the warping influence of pro ratas in the way that founders communicated with investors around fundraising and needs.

This took a long time for me to see because, well, I had conflicted incentives. I spent most of the last ten years as an investor, and investors want pro ratas in term sheets because it is, essentially, an option on a future financing. In and of itself, this is ok. The problem is that the option is:

1. Free

2. One sided

3. Unrelated to value

4. Ignored constantly

The option is free because an investor does not have to pay more to get a pro rata right - it is generally called “standard” and left at that.[1] It is one sided because I’ve never seen a situation where an investor was forced to do a pro rata against her will, whereas I have seen, and have been a part of essentially forcing founders to take pro ratas that they did not want.[2] Pro ratas are unrelated to value because they do not correspond to the amount of work/value/help that an investor actually provides over time beyond an initial financing. There are investors who are incredibly helpful to founders that earn the trust of founders who are then invited to invest more - or not. There are investors who do a bit here and there and then march up to the table and demand their ownership when a financing rolls around. There are investors who request pro rata, and then, at financing, ask for what they can get. There are founders who say to particularly helpful investors: “Hey - your team is amazing. Do you want to buy ownership in this round?” On top of all this, the term is ignored so often in so many ways that it seems a bit like a strange legal joke.

Maybe the most ridiculous piece of the whole thing is I have yet to meet an investor who has said “We looked at your cap table, we see you have promised pro ratas. Of course we will honor each of those perfectly and adjust our terms to account for your early investors.” This simply doesn’t happen. Each new investor does their darndest to get as much ownership as possible, previous contractual terms be damned.[3][4]

I spent a long time trying to build continued value for founders in order to make the pro rata more of an even exchange. But in the past, I never actually made that trade clear and two sided. The way this should work is as follows:

1. Investor wins deal to invest money at time A for ownership B.

2. Investor and founder hit it off. Investor works butt off to help company as requested by founder.

3. Company raises a new round. Investor is helpful in this.

4. Founder asks investor - or investor asks founder - to buy more ownership.

5. Negotiate, decide, move on.[5]

Or, maybe this better:

1. Investor wants to invest, makes offer. Investor wants pro rata.

2. Founder says “cool, I like you, if you want pro rata, you’re going to have to sweeten the offer by x.”

3. Investor agrees to change in price/dilution some other trade and gets pro rata

4. Pro rata is now a mutually agreed, purchased, more weighty term

5. Sure, founder could still try to reduce pro rata later since any contract can, technically be broken. However, this would be a valid place for an investor to go to war.[6]

This would align founders and investors in a far better way than a contract. Contracts aren’t worth spit.[7] Relationships are what counts. Working with people who value good work matters. Pro ratas ignore those nuances and are out of step with how startups and venture capital work. There's a way for pro rata to become a good term, but the term will have to evolve to get there.

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[1] Crazy! This is valuable term! Investors should have to pay more to get it.

[2] There’s a lot of ways to make this argument. The arguments aren’t morally wrong, they’re in fact the right argument in situations where a founder has signed a contract to do something. But here’s the thing - the contract shouldn’t exist in the first place.

[3] Allowances here are sometimes made for “good friends.” Incidentally, “good friend” is my favorite term in venture. It almost never means actual friend. Real friends rarely talk about how close they are to third party business associates.

[4] When founders do say “hey, we have pro ratas we want to honor,” the response is generally “ok, for sure, go ahead, but the post stays the same.” This is another way of saying “Dear Founder - you take the dilution!” One could argue that this is a fair response, that the founder made the commitment and has to honor it, but it would be nice to see some give and take in the conversation.

[5] This is certainly complicated. This model would imply that there are gradations of help provided by investors to founders, and that a founder who declines more ownership would receive less help over time. Of course, this is true. Some founders in a portfolio do, in fact, get more help than others. I also get that this also applies a fiercely mercantile lens to any interaction between investor and founder. But I’ll also argue that that is, in fact, a primarily mercantile/capitalist relationship. The relationship does sometime morph into an actual friendship at which point there are wildly different and more complicated rules because emotions.

[6] Or court, since that’s how business usually works.

[7] While I do think that contracts have value, I’ve seen enough lawsuits and renegotiations to know that the contract isn’t what keeps people from doing what they promise to do.

Twenty years later, I can’t remember what I saw and what I think I saw. I remember listening to the news with my mom, Judah, and Mimi as the anchors casually mentioned that a small plane seemed to have hit a tower. We were on I-95 - or maybe the Garden State - headed south to visit Penn ahead of applications.

I looked out the window and could see some smoke. A tree broke my sightline. And then a flash of fire and a jet of smoke. Bigger than a small plane but what did I know? Also, the small plane had already hit, right?

There was still nothing on the news. Then maybe it was another small plane but something seemed wrong. And then the reports started that a big plane had hit? Or maybe two? And then we were on campus. Mostly, there was some confusion, but the day was on a crumbling routine. We checked in at the tour area. We didn’t have smartphones. There was no information. We started the tour, and soon we started to sense that hell had broken out 80 stories above lower Manhattan.

Walking into Hillel, the TV was on. The tower fell. The towers fell. My mother started to cry. My father had been there the day the van blew up. He’d left already. I was 7 then and didn’t know what it had meant.

No one knew what was going on, but the tour was over. We wandered for a short time and then got back in the car.

I-95 was empty. Not empty, just us and humvees, olive and tan trucks. It seemed that every armory in every county in all of New Jersey was empty and on the highway. Jets were overhead. Calls started going out and in to see who wouldn’t be coming home from work. Then we saw lower Manhattan. Or maybe we saw just a plume of smoke. We prayed, but didn’t cry. It was too shocking.

My sister lived, then, not close but maybe too close? She’d heard a jet accelerate overhead, she ran outside and saw another. My brother walked to his apartment. A friend’s father missed a meeting because a broken shoelace led to a missed bus led to a missed train meant he came home that night. A friend’s brother didn’t. 

The tower of smoke was bigger than those of glass and steel. Much bigger. The flags tried to blow it away but couldn’t. It cleared itself over time.

I first wrote this essay a few years ago. A founder mentioned it to me over the weekend, and so I decided to re-publish it here. One thing that's bothered me in the time since I wrote it is the way in which toys, which are meant to be harmless and fun can become companies capable of wreaking havoc on the world. I mention Facebook below, which was quite fun when it first showed up on campus. I don't personally find Facebook fun now, and think it has caused a lot of damage in the world. Thinking through the way in which you build things, even toys, to create positive forces in the universe is hard, and maybe more important for that challenge.

Some of the biggest technology companies look like toys in the beginning.[1] From a classical business building perspective, this shouldn't happen. Toys are for fun. Businesses, especially huge ones, are for making money. Toys are small and of limited use. Large companies contain multitudes and perform a huge array of functions.

This trend does not fit with history either. Standard Oil, US Steel, and Boeing were all iconically huge companies that were built as businesses. None of them went through a phase where they looked like toys. Startups can be different, though, because of the expectations of them and the seriousness with which people approach them.

Expectations

If you give people a tool and tell them it will perfectly solve an important problem, any imperfection in the tool is going to make them angry. If you give someone a toy and say “Look what I made! Isn't it fun? It kinda does this thing.” then you've set yourself up for a positive reaction. It's much easier to beat low expectations than high ones, so you've materially increased your chances at having a happy user.

And “happiness” is an important way to think about early users. People spend more time with something that makes them happy, especially when they don't expect it. Happy users are easy to get feedback from, because they know that you can make the product better and make them happier. They're also likely to tell friends about the cool new product that they're using, which means you start to get users without having to dip into the dark arts of marketing.

When you look at something you build from the perspective of how happy it might make someone vs. how angry it could make them, it also becomes easier to experiment and put things into the wild. This isn’t just about low stakes, it’s about how seriously you take what you’re doing and how seriously other people take it, at least at first.

Seriousness

Business is about making money and working with customers. These are very serious and scary things. Toys are for playing and trying new things. This isn’t serious at all.

Maybe that seems bad if your goal is to make your toy into a startup, and your startup into a big company. That implies you have to be serious right from the start. But if you are serious right from the start, a number of things start to go wrong.

The first thing that goes wrong is you become unwilling to experiment with ideas that aren’t clearly aligned with making a big company. This means that people building serious things focus rapidly on revenue. They become risk averse and innovation averse. Companies built on new technologies have to capitalize on non-obvious ideas, ones that wouldn’t pass muster in large corporations. Otherwise, the large existing companies would do these things themselves.

Facebook is a great example of this. Early on, all users could do was look up people they’d met at parties on campus at Harvard from other dorms and poke them. This seems silly because it was. Very few people saw it as more than a toy, which is why they were willing to give it time. It was something to play with when not working. I don’t think we would have been willing to play with something that felt like a serious business, which would have meant that Facebook wouldn’t have gotten it’s early happy and engaged users.

The second thing that goes wrong when you take your toy too seriously is that you signal to the bigger and better funded companies already in the marketplace that you are onto something important and profitable. This is bad, because those companies will start paying attention to your toy too early and copy/buy/kill it. Airbnb looked like a doofy hipster thing to hotels for a very long time. And then, when it was too late, they realized that it wasn’t a toy at all. By that time, Airbnb had enough customers, revenue, and funding to survive the attacks of the incumbents.

The third thing that goes wrong when you take your toy too seriously is that you immediately start optimizing on the things that you believe serious businesses should - profit and margins. While these things are important in the long run, focusing on them too early injects an impossible set of things for an early startup to do.

Startups only have so much time and ability to focus. At the earliest stages, that focus needs to be on making things that users love and want to play with. A startup’s early and heavily engaged users are its only real base of strength and chance for growth. Focusing on anything else puts them at an immediate disadvantage to better funded, organized, and wide reaching companies.

When toys become companies

Not all big companies start out as toys, just as not all toys eventually become big companies.

This is just as often a question of motivation and goal for the creator as it is a question of whether or not the toy was good or bad. Most people who make things don't want those things to become companies, which is great - it would be unfortunate if every interesting thing made for the world had a commercial purpose behind it.

The founders who do turn toys into companies are generally the ones who relentlessly push what they've made to users and obsessively improve the toy in response to feedback. They then have to master a whole set of skills that are orthogonal to making things - hiring, managing, business building, fundraising, etc.

This is an atypical path, which is why it's so exciting when it happens. When we meet founders who we think are going to combine the toys they've built with the ability to build something lasting, we generally fund them whether or not we're sure the toy is actually a business.

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[1] Two examples: Facebook was a way for people to waste time while Apple helped hackers build home computers before there was any business case for it.

Too often, founders approach fundraising as if they are supplicants to the investors. They understand that fundraising features many asymmetries, but the founders mostly see the asymmetries that are tilted towards the investors. Here’s the thing - in today’s market, the asymmetries largely favor the prepared founder.

This is a rough catalogue of the major asymmetries:[1]

• Experience - The more fundraises someone sees, the more skilled they are in getting what they want.

• Capital - This is what the investor has that the founder wants.

• Ownership - This is what the founder has that the investor wants.

• Speed - This is the pace at which the investment process moves.

• Information - Data on how the business is faring. Particulars about the progress of the fundraise.

• Price - How much the business is worth.

• Emotion - A key element in any negotiation.

Near as I can tell, there is only one item on this list that is squarely in an individual investor’s column:

Experience

Simply put, it is an investor’s job to invest. This means she does it frequently, knows the language, the paths, the places to negotiate and relent. She has a better sense of where the market is and what tactics work on founders. The best investors use their experience at an intellectual level - to evaluate a deal and rapidly make a decision - and at an emotional level - to influence what deal a founder takes and when.

Even founders who have raised multiple rounds have not done as many as a good investor, or as that investor combined with her partners.[2]

Every other item on the list can be tilted to the founder’s advantage. This is what the best and most prepared founders do.

Capital/Ownership

It is true that the point of fundraising is to get capital. Investors have that capital, and founders do not. However, this does not actually mean that the investor has the advantage because the founder has something that the investor wants even more: ownership. This may seem purely psychological, but it is important.

Investors have more access to capital from LPs than they do to equity in great startups. This seems strange to most founders, because they have not internalized how abundant capital is in today’s market.

Founders who see this dynamic for what it is have a psychological advantage when pitching - they know that they are in control, which in turn creates confidence. An investor who believes that the equity she is trying to purchase will be worth 100x what it is today will move mountains of money to get that equity.

Speed

Most founders that are new to fundraising allow investors to control their fundraising timelines. They believe the investors who say “we need to meet once a month for six months to evaluate you” or “we only have investment committee meetings on Monday mornings between 9-11am PST.” Neither of these statements are true. In fact, there is no such thing as a required timeline or minimum time spent for an investor to issue a term sheet.

Founders can largely control the pace of their own fundraises by preparing the market of investors ahead of time. This means building the right relationships over the months preceding an active fundraise and executing a tight and coordinated process when the time to raise arrives. This also means that founders should plan fundraising activities around the natural rhythms of their businesses, the calendar, and their runways.

This is even true in the case of a “pre-empted” round - a round in which the investor offers a term sheet before the founder is “ready.” Some founders believe that they need to take a pre-emptive offer, but no one will force them to do so. The most prepared founders are, however, always ready for a term sheet because they have sets of relationships which they can use to check the market at any time. These founders also know whether or not a pre-emptive offer makes sense given the path of the business.

Information

There are three types of information that influence the path of any fundraise:

• Information about the company

• Information about the process of the fundraise

• Information about the market in which the fundraise occurs

I’ve written about how founders can use information to their advantage in a fundraise ( https://www.ycombinator.com/library/3N-process-and-leverage-in-fundraising), so will just summarize the major points.

Founders should assume that all information they share about their company with an investor will be public and that it will always be used to evaluate an investment in the company. With this knowledge, founders can choose who sees what information and when, creating a dynamic where investors are always pressing for more. This is a clear advantage for the founder because it allows him to control the pace of the process and manage the excitement of the investor.

Information about the process works similarly. The only person that actually knows what’s happening in a fundraise is the founder, provided the founder is paying attention. Founders should release information about meeting cadences, offers, term sheets, etc. when they choose to, and not simply when asked.[3]

The final type of information, market data, generally favors the investor. This is relevant because it informs what terms are good/bad. However, founders can significantly decrease this imbalance by talking to other good founders or to advisers who see many rounds at any given time. Price is a subset of this information set.

Emotion

There are many emotions involved in fundraising. Investors are able to approach a raise with emotional detachment since, for them, the raise is just one in a series of business transactions.[4] Founders generally experience far more emotional range and depth during a raise since their companies are extensions of themselves. While, to some extent, business is business...it isn’t.

Rather than try to balance this one, it is useful to recognize that there are emotional games played on both sides. Founders should be aware that investors work hard to get founders to “fall in love” or to believe that there are (morally) right and wrong decisions on picking a capital provider. This isn’t actually true. Investors who lose deals may be upset, but they move on. Founders who negotiate hard aren’t hurting the feelings of investors - and the same should be true in the other direction.[5]

Some of the emotions investors leverage to win deals:

• Guilt: “Look how long we’ve known each other! Look how much I’ve done for you! Isn’t that worth something?

• Fear: “If you don’t pick us, we will fund your competitor and grind you into dust.”

• Greed: “Don’t you want to be rich? I’ll make you rich.”

• Inferiority: “You’d have to be stupid not to work with us. This is an intelligence test. Don’t fail the intelligence test.”

There are more, but this is a reasonable catalogue of the ones I see most often.

The key thing to understand about asymmetries in fundraising is that they most disadvantage founders who are unprepared. I’ve always thought that Sequoia’s focus on the “prepared mind” was a useful model for approaching a consequential decision.

To the investor, a prepared mind means having the right frameworks and knowledge to evaluate an opportunity and most effectively and quickly move to take advantage of it. To the founder, a prepared mind follows the same model, but the opportunity set is different. Founders don’t need to be prepared to evaluate their business, they need to be prepared to run a fundraising process with knowledge of their strengths and weaknesses, of leverage points and norms, of asymmetries and of ways to utilize or mitigate them. There’s never going to be a perfectly even interaction between two people. That’s only a problem if you were expecting it to be.

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[1] For the purposes of this essay, I’m not going to address asymmetries of power resulting from the personal attributes of either founders or investors. These are critically important dimensions of fundraising, but are so nuanced that I only feel comfortable addressing them directly with founders vs. in this fixed essay form.

[2] This is, admittedly, not true for a brand new investor at a brand new firm putting money into a seasoned founder, but I’m going to ignore that for the sake of argument.

[3] The way in which a founder releases information - who, when, how much - is a topic for an entire tactical essay.

[4] This isn’t to say that all investors actually do approach fundraises with emotional detachment, just that they should be able to do so more easily than founders.

[5] Adora Cheung’s advice here is that founders should find their peak toughness while negotiating with investors. This is a perfect framing - tough doesn’t mean being a jerk or unfair or amoral, it means knowing and pressing your advantages.

Thanks to Adora Cheung and Janelle Tam for helping me write this.

The way we talk about fundraising is wrong. Specifically, I don’t think that founders sell equity when they raise money. It’s the other way around - founders use their equity to buy capital from investors.[1]

Investors know this, which is why they spend so much time and money on marketing.  That marketing makes it clear that money isn’t enough to win deals, at least not the competitive ones. Investors make a big fuss about their ability to advise companies, their ability to help companies hire, and their ability to help companies raise future funding rounds. These capabilities can all be real, but, if a founder is valuing any of these items as worth more than 0, then each is worth some amount of equity.

Think about it this way: if all the founder needed was cash, then the smart thing to do would be to optimize for the least dilution to get the money needed. If the founder needs cash + advice, then the founder should figure how much dilution he needs for the cash, and how much dilution for the advice. The founder would keep doing this until he’d assembled all the required capital and services to grow the company.

For instance, the founder could say “In this next round, I need to buy capital, a brand, a board member, and help with the next round. I’m willing to spend 14% of my equity on the capital, 2% on the brand 2% for the board member and 1% on help with the next round. That means I’ll sell 20% of my company in this financing.” Founders are doing this implicitly when they pick a given investor over another because of “brand,” but it should be explicit.

This calculation will change for different founders at different stages. An experienced founder may not need help from a board member or care about the investor’s brand. This founder may decide she only needs capital, which is worth 12% of her company. That’s all she should sell in the round.

A less experienced founder that knows her next round is likely to be difficult may put a premium on the brand of the investor and the investor’s ability to help pull a round together. If each of these is worth 3%, and the market price of the cash is 15%, then the dilution on the round is 21%.

Once you reframe the fundraising transaction this way, the current model breaks down. The natural next question is to ask why any of these elements should be combined inside of a given investor in the first place. Founders should unbundle these items. This would have been extremely difficult in the past, but the market has evolved. There are now specialists at each of the things that the founder may need from outside parties. These specialists do not necessarily work as VCs. Founders should be able to pick and choose the best of each of these specialists at the best price, rather than averaging them out just to buy some dollars from an investor.

This is the fourth in a set of essays drawn from watching the interactions between investors and founders during several hundred Series A and B in the last few years (The first three are https://blog.aaronkharris.com/abundant-capital, https://blog.aaronkharris.com/distributed-capital and https://blog.aaronkharris.com/conflicted-capital). If you are wondering how this dynamic impacts your company, please reach out at a@aaronkharris.com.

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[1] All transactions are bidirectional, but founders use their abundant resource - equity - to buy scarce resources - mainly cash.

I’ve spent a long time wrestling with how to advise founders about investors and the conflicts of interest generated by opposing incentives.[1] These considerations are especially important when a founder thinks about fundraising. The founder needs to figure out how to treat internals, how to balance the incentives of those internals with new investors, how to assess the various conflicts that might arise and the likelihood of those conflicts. This is exhausting and seemingly unavoidable.

Part of the analysis here is to figure out what to do with investor attestations to being the most “founder friendly,” as if this term is a talisman. Investors hold up their hiring prowess, willingness to grant extraordinary voting powers, secondary offers, etc to show how they are friendlier than everyone else. Unfortunately, no amount of upfront promises can make up for the fact that investors are definitionally conflicted with founders any time the financial interest of the LP diverges from the founder.

This conflict doesn’t make investors bad or immoral. In fact, the vast majority of the investors I’ve met, even those that have fired founders, are good people. It’s deeper than that, even. Investors mostly want to do the right thing for founders. There are emotional and business reasons for this impulse, but ultimately the fiduciary responsibility has to win. Founders need to understand that venture investing is a business where friendship is an input or an outcome, and not the other way around.

Rather than trying to tease apart every instance at which investors and founders might find their incentives misaligned, I think it would be helpful to focus on one particular divergence since it seems to surprise founders every time. This scenario plays out every time a company raises a round that an internal investor could lead. This means that the company has a multistage investor on the cap table which has the capital and mandate to lead the round in progress.

This type of conflict used to be rare, but it seems to be popping up in every round I see. Ever larger numbers of VC funds are now multi-stage, which means they generate internal conflicts at any round they want to lead. Many angels now have sidelines in running SPVs,[2] which makes them multi-stage investors with the same type of conflict as the VC. Finally, given how closely rounds now follow one another for hot companies, the time in which an investor can think about something other than her position for the next round has shrunk. Every interaction a founder has with an investor is colored by this dynamic.

To name the incentives for the founder at fundraise:

• Least distracting process

• Best possible terms

• Best possible partner for building a large company

• Balanced cap table

• Not piss off the internals[3]

To name the incentives for the investor at fundraise:

• If the belief is that the company is a future $100B behemoth

• Lead the round and build ownership

• At lowest price possible to win

• If the belief is that the company is good not great

• Lead the round if the price is right

• Maintain ownership

• If the belief is that the company is not good

• Help the round get done by someone else to preserve brand

• Maintain most ownership in case the company surprises to the upside

Many founders approach internals at the very start of a new fundraise, which allows the internal investor to choose first. This gives the investor significant leverage in any resulting negotiation. The investor’s decision also sends a signal to the rest of the market about the company’s prospects, which could sour a fundraise.[4] In this scenario, the founder needs to treat the investor like Schroedinger’s cat - keep the investor in the dark about the fundraise until such time as the founder wants information to leak.

This is a tricky dynamic since the internal investor often has information rights, probably wants to be helpful, but does want an early look at the deal. However, the best thing for the company would be a clean and competitive process. The “founder friendly” move here would actually be for the conflicted internal to proactively recuse himself from the fundraising conversations until explicitly invited in by the founder. This is unlikely to happen.

Instead, a founder needs to take control of the fundraising process even before talking to internal investors.[5] I generally advise founders to do something along the following lines:

1. In the months leading up to a fundraise, create touch points with likely future leads, i.e. coffee meetings. At the very least, this gives the founder a group of investors that can be activated when necessary. In the best case, this can lead to pre-emptive offers.

2. When the founder determines that the company is ready to raise, the founder needs to prepare a deck, practice a pitch, and decide which funds and partners are top choices.

3. Once the founder has that set together, start scheduling initial meetings with external investors. 

4. Once those meetings are on the calendar, approach the internals and say “Ok, we’ve got strong interest for an A, and are going to run a process, we’d love for you to take the lead here. Can we set up a formal meeting?”

1. If the investor declines the meeting and says “we’re not interested in investing at this time,” then the founder and investor need to figure out a narrative for the rest of the world about why the investor is passing. This is unlikely to happen without first having a meeting.

2. If the investor is interested, she’ll often ask to meet in order to “practice the pitch.” The founder should decline a practice meeting and push for a formal partnership meeting, citing the process and desire to not waste the investor’s time with a “practice” pitch.[6]

5. Run the process.

To be sure, there are significant nuances in running a process under these circumstances. Founders would do well to have an unconflicted third party with significant experience here to ask for advice on the evolving dynamics. Barring that, remember that an awful lot of awkwardness can be smoothed over by simply being polite.

This is the third in a set of essays drawn from watching the interactions between investors and founders during several hundred Series A and B in the last few years (The first two are https://blog.aaronkharris.com/abundant-capital and https://blog.aaronkharris.com/distributed-capital). If you are wondering how this dynamic impacts your company, please reach out at a@aaronkharris.com.

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[1] https://blog.aaronkharris.com/investors-and-their-incentives

[2] Special Purpose Vehicle - basically an insta-fund that has a single position.

[3] There are quite a few ways to piss off the internals. The founder could take an outside offer at the same or lower price than the insider’s offer. The founder could refuse to grant super pro rata. The founder may need to renegotiate pro rata. All of these present potential problems and are even more stressful if the internal is also a board member.

[4] https://www.ycombinator.com/library/3N-process-and-leverage-in-fundraising.

[5] This principle holds at every round, but becomes more complicated once a company has a formal board. Founders should not actively hide information from the board, but do need to hold board members at arms length when appropriate. The nuance in how this is done is tricky and varies depending on the situation.

[6]There are quite a few tactical paths at this point that can only be solved with sufficient context.

In theory, the hard part about finding capital for unproven founders with unproven technologies in unproven markets should be that no one wants the risk. There was a time when that was true, but it isn’t anymore.[1] For a founder, the issue is different: venture capital is abundant, but it’s not very evenly distributed.[2]

There are groups of founders to whom this uneven distribution is an advantage. These founders are well connected or pedigreed and can use their access to capital as an advantage in building their startups. That’s good for them, and they should use every advantage they have.

But the world of startups would be better overall if capital could more easily find great startups. That should be a given, but in looking at the various bottlenecks in the system, it is clear that, at least some of the time, some of the parties involved are actively impeding access and distribution. Other bottlenecks are the result of the fact that venture markets are immature.

Manufactured impedance

Professional investors are in something of a bind when balancing accessibility and exclusivity. On the one hand, the best investors generally believe that returns are driven by significant outliers. These outliers are unlikely to come from an expected source or pattern match precisely on previous outliers. This means that investors would be best served by having the largest possible funnel and the least biased filtering mechanisms. In other words, investors should treat any and all inbound investment opportunities as potentially incredible and equal weight their attention to them.

However, this presents a set of problems. Investors who tout their willingness to look at everything equally and actually do so will lose their auras of exclusivity. This aura is important in convincing founders to contact the investor and later when investors try to win deals - when given the opportunity, most people choose exclusive clubs over inclusive clubs.

Then there’s the practical problem: capital may be abundant, but good people and their time are scarce. Let’s say, for instance, an investor decides to follow the “evaluate all inbound” model. This investor actively markets that she’ll meet every company that emails her. The strategy works and the emails pour in.

That investor will then need the time to meet hundreds of companies each week. Software can help route and filter, an application process can eliminate some number of in person meetings, but the investor will need partners and staff to deal with volume.[3] New partners and staff cost money, which means raising more funds. Larger teams and larger funds start to impact exclusivity, as does the greater numbers of investments dictated by adding people and looking at more companies.[4] Investors who want to pursue the abundance path will get caught in a recursive loop that seems dangerous to their model.

Structural impedance

The other set of barriers to capital distribution exist because venture markets are relatively new and immature. There are many markets without local venture capital investors. Foreign investors may be interested, but face challenges in understanding the nuances of those markets and those founders.[5] This impedes the flow of capital to companies that should get it.

Because venture markets are relatively new, they are also unnecessarily opaque. Information within these markets is rightly viewed as incredibly valuable, and so it is rationed by those who have it. This makes it hard for new entrants with money to figure out where to put that money. Instead, LPs are required to route it through the professional venture investors that have access to information about what companies are raising and which are not. The analogy here would be an equities market which forced university endowments to call hedge fund managers to discover what stocks exist.

There are a number of other structural bottlenecks to evening out the distribution of capital. What is so interesting about these and the manufactured bottlenecks is that they could all be solved by either a new common set of behaviors, or an intermediary that made it significantly easier for startups to access the sources of capital already looking for them.[6]

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[1] See https://blog.aaronkharris.com/abundant-capital

[2] Apologies to William Gibson for bastardizing one of my two favorite quotes about the future and technology. The other is from Arthur C. Clarke: "Any sufficiently advanced technology is indistinguishable from magic."

[3] Operating under the assumption that the investor can successfully generate inbound interest.

[4] Partners at venture funds are primarily evaluated on the quality of their investments. This means they have to actually make investments, especially early in their careers.

[5] When Rappi first launched, US investors failed to understand the radical differences in their economics relative to US counterparts. These differences were driven by dramatically lower employment costs and urban densities that were only apparent if you’d studied Latin America enough.

[6] To some extent, YC’s Demo Day does this for seed stage companies. However this function has not yet been replicated at later stages.

The venture capital industry was built on the premise that both capital and high quality companies are scarce. For most of the history of the industry, this has been true. I remember sitting at demo day in 2011 and marveling at the fact that the combined capital of all the VCs in the room was less than that controlled by the hedge fund at which I had worked. But the model is wrong. Venture capital is abundant, and that fact should fundamentally change how founders fundraise.

This scarcity model has shaped the structure of startups and VCs - most of what an early stage startup does is designed to convince a VC to invest. Companies treat VCs as a limited resource that is both hard to access and hard to convince. Investors do their best to perpetuate this idea because it allows them to retain control of the pitch and fund dynamic.[1]

Something interesting happens, though, whenever a company has a signifier of quality - a YC demo day slot, a high quality angel, pedigreed founders, or, even better, strong growth. In these cases, there are investor feeding frenzies, leading to oversubscribed rounds, ever climbing prices, and investors willing to accept ownership targets they - until recently - would have termed unacceptable.

To be sure, there have always been bidding wars in private equity (of which venture is a subset), but these bidding wars are so frequent now as to be approaching the norm. If capital was actually scarce, this wouldn’t happen, there wouldn’t be enough money to create so many bidding wars.[2]

Bidding wars aren’t the only evidence of capital abundance. The VCs are changing their businesses because of this abundance, whether or not they admit the reason. The evidence is in the new funds that seem to launch on a daily basis, the multi-billion dollar growth funds that have become increasingly common, and the ownership targets at various rounds that continue to drop.

At the same time that capital has become more abundant, founders have become smarter about fundraising. There are now a huge number of blogs, classes, essays, guides, and advisers ready to help founders navigate the previously opaque world of fundraising. As a result, founders can approach each funding event with a clear plan of how to run a process. Running an orderly process further increases the chances that a company will see competitive bids.

As a thought experiment, assume that the abundance model is here to stay. It is also safe to assume that founders will not suddenly forget their newfound knowledge about process. I think this should encourage founders to think about changing fundraising in a few major ways:

1. Founders should approach every fundraising as an auction. This is what each process already is, but the auction is inefficient. There’s lots of language and pseudo-moral arguments about why this is bad, but most of those fall apart if capital is abundant.

2. Founders should expand their funnels beyond the traditional VCs. These VCs hold a marketing and branding advantage, much of which is built around the signal to later rounds. If, however, each round is an auction, this benefit evaporates. YC’s demo day proved this funnel expansion works at seed, and there’s no logical reason it should fail at later rounds.

3. Once a founder has the information produced by this process, she can decide whether to minimize dilution, maximize price, or optimize around the partner. The answer will change based on the situation, but having access to the choice is important.

Founders are hesitant to run this model because they fear that running an auction will create a negative quality signal. Investors encourage this belief because it allows them to keep deal flow proprietary. This is flawed logic. The quality of a company can’t be determined by the investors to whom that company talks when raising money. The quality of a company is determined by whether or not the company is good, and good companies should take advantage of abundant capital markets.[3]

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[1] Perhaps more importantly to the investors’ business model is that this dynamic creates a reason for the existence of VCs. If founders and LPs both internalized how non-scarce capital actually is, they could find one another directly, bypassing VCs.

[2] It’s important to remember that, even though capital is abundant, it remains unevenly distributed. There are companies that struggle to raise money - some of these may be bad investments, but many are good. This is a problem of access rather than capacity, which is a whole different issue.

[3] When a company IPOs, it opens ownership up to anyone who can afford a share. Imagine, for a second, an investor arguing that this is a sign of low quality.

I sent this email to the whole team at YC yesterday:

When I joined YC 7.5 years ago, there weren’t many people around. PG and Jessica were still running things. We had offices in Mountain View, Palo Alto, and on Kearny street, but they were nearly always empty. The only meeting on any calendar was the lunch on Thursdays where we’d talk about companies over takeout or at a table in a crowded restaurant.

The ways in which we’ve changed since then have been amazing to see. YC has grown in every way imaginable. The scope of what YC funds is larger. The team is bigger and more capable. The number of companies is pushing towards some ever receding upper bound. There’s more software, a larger community, and more programming designed to help YC founders build better futures.

I feel a deep sense of pride and honor at the part that I’ve played in that change and growth. I recall the first conversation I had with Aaron King about the Series A for Snapdocs. The questions he and I worked through were the kernel of the Series A program. I am amazed to see the directions in which Janelle is now building YCA. I’m grateful for the part I played in our conversations about growing beyond seed investing - conversations which eventually took shape as YCC. And, of course, there are fifteen batches worth of applications, interviews, dinners, office hours, and demo days rattling around in my head.

I’ve been thinking, recently, about the founders with whom I’ve had a chance to work. I’ve lost count of the number of incredible people I’ve gotten to know over these last years. Thinking back, it’s easy to see how the sheer weight of numbers can drive a person to be jaded about the problems that founders face. But the other night, as I spoke with a founder about a tough situation, I was reminded about how important it is to that individual that she gets the best possible advice. This is a lesson I learned time and again, and is something I hope I’ll never forget.

And then there’s the funny stuff. There were stolen air conditioners, barefoot pitches, robots that did not make sandwiches, update emails pulled from the I Ching, bandages, inhaled jet fuel, and literal blood on the interview floors. These are the things that I’ll remember long after everything else.

The truth is, I only meant to stick around YC for two years. Somehow, that two became two more, and then some more. As meaningfully as I’ve enjoyed my work here, it’s time for me to move onto something different and new and outside the bounds of what YC does. That’s a strange, exhilarating moment, and an important one for me and for my family. The pandemic provided the practical and existential nudge I needed to see the depth of this need.

To my fellow partners - thank you for your tireless work for our founders and for YC. Thank you for everything you’ve taught me, for all the strange conversations we’ve had, and for all the demo day presentations we’ve crafted.

To PG and Jessica and Trevor and RTM - thank you for giving me this opportunity and for making YC the kind of place I could love enough to stay long after I meant to leave.

To Janelle - thank you for building YCA with me and for being the best person I could imagine to take it into the future.

To everyone else - YC’s mission in the world is abstract. It could mean so many things, but it wouldn’t be anything without your work. Whether you are managing founder expectations about housing in the Bay Area, helping someone understand the mysteries of cap tables, talking someone down off the ledge of yelling at a reporter, or making sure that there will one day be an office to come back to, you are what makes YC a viable, vital force in the world.

I’ve never liked goodbye.

aaron

Over the last few years, I’ve noticed that good companies are increasingly over-diluting themselves in their seed and A rounds. Counterintuitively, dilution seems to rise along with price. One would expect the opposite correlation. Strong founders who command high prices should be using that higher price to sell less of their companies in exchange for money to grow. As I’ve tried to understand what’s going on, I’ve tried several arguments.

Somewhere in the last week, I’ve come to understand an error I’ve been making when talking to founders about how much money to raise. I realized that the conversation about raising always anchors back to the idea of adding “months of runway.” That always seemed appropriate to me because it was a measure of the amount of time a company had to stay alive. Staying alive seemed good since it increased the time a company had to find product market fit and to grow.

But I now realize that this is the wrong framing because simply staying alive is an inadequate goal for a company.  Founders start companies to find product market fit and grow. Venture capital is designed to speed growth, not to extend runway.

As a result, in recent conversations, I’ve started to ask founders: “How much could you get done in the next 12 months with the amount of capital you are planning to raise? If you’re a good company, you’re either going to raise your Series A - or Series B - in the next 12 months or have significant revenue such that you won’t need more capital.[1] If you’re doing badly, why would you want to keep working on this for 24 or 36 months? That’s a waste of your time.”

Founders who raise too much capital are acting out of fear rather than acting out of confidence. This fear made sense ten years ago when seed financing was relatively scarce. This is when much of the fundraising advice I read as a founder was written. However, the world has changed and so should the advice

Financing is more accessible to good founders than it has ever been.[2] Confident, competent founders should take the risk of running out of money vs. the certainty of over-dilution.

Good founders respond to this framework as it shifts the argument from one in which “winning” is about adding months of runway to the bank to one in which “winning” is fast and high quality execution - as evidenced by hitting milestones. It’s also easy to draw a straight line from this framing to the best companies. When a company raises a Series A nine months after launch - or Demo Day - with 80% of its seed funds in the bank, it’s apparent that those founders sold too much.[3]

A founder’s decision on how much money to raise in any given round is more art than science. It is a fraught decision since it necessarily forces founders to make predictions about the future. There is no perfect answer, and over-optimizing around any single factor is a mistake. However, it seems clear that shifting the goal of fundraising from adding runway to progress would limit both the amount of money companies believe they need and the dilution that founders take in the process of building successful startups.

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[1] And if this is true, investors will chase you anyway.

[2] Even during COVID. I did not expect this to be true, however, this market is one of the most active I've ever seen.

[3] Seeing this dynamic on a regular basis while running YC's Series A program is what led me to realize my mistake. Without fail, the founders raising the most competitive rounds have the most capital left, and thereby the most unnecessary dilution.

Thank you to Daniel Gackle and Michael Seibel for your thoughts and edits.

Small children are great at asking questions. Their questions are simple, direct, and utterly without ego. If you spend time with 2-5 year olds, you’ll find yourself answering a near infinite series of progressively more challenging questions. This is one of the main paths by which children learn about the world.

ex. Child question: “Why is the sky blue?”

Adults are generally bad at asking questions. Adult questions come with long preambles, caveats, and agendas. Adult questions don’t seem to be designed to learn about the world, they seem to be designed to avoid looking dumb.

ex. Adult question: “I know the sky isn’t actually blue, and that if I look up, I know there’s nothing between me and outer space except air and maybe some clouds. Beyond that, there’s outer space. Outer space is effectively black because there isn’t light. Yet the sky often, though not always, appears to be various shades of blue. What triggers that blue? Is it something about how light interacts with air? Or gravity? Magnetic fields?”

The contrast between child questions and adult questions is striking, but it isn’t a function of age, it’s a function of conditioning. At some point, children get social signals that asking questions makes them appear stupid. This can come from a frustrated parent, annoyed teacher, or mocking friend.

Kids internalize this feedback and start to ask fewer questions as they grow up. The scope of things about which adults ask questions get narrower and narrower, shying away from things that are new or hard to understand. At the same time, adult questions get longer and longer. Most of this length isn’t important for the question, it is meant to prevent the audience from thinking the questioner is stupid.

These questions aren’t terribly useful to either the questioner or the questionee. If you’re not sure what this type of question looks like, watch a congressional hearing. The questions are meant to prove points, not produce knowledge.

Adult questions reinforce their own badness. When an adult spends most of a question proving his own intelligence, the question doesn’t produce new knowledge. This reinforces the perception that questions aren’t worth practicing. Without that practice, the questions continue to get worse.

I’ve been thinking about questions because I noticed that I’ve become increasingly self conscious about not knowing things, and cover for that by asking adult questions. Some of this is a function of the fact that I’m older and some of it is a function of the fact that my job involves giving a significant amount of advice. I noticed, as well, that conversations in which I ask simpler questions are more enjoyable and more interesting. These conversations lead to new ideas and better plans.

I’m particularly conscious of this dynamic in conversations with founders. Many founders believe that adult questions are the best questions because of their interactions with investors. On the one hand, investors tell founders that asking questions is a good thing. On the other hand, founders are judged for asking questions that are “too basic.” Founders who do things without asking questions first are generally rewarded for being “fast” whereas those that ask some questions first are derided as being “slow.”

However, successful startups are not defined by the questions that a founder asks. They are defined by what a founder does with the information at hand, and how quickly. Founders who acquire new information quickly and act are more successful. Founders who dither or get caught in infinite loops of ignorant execution generally fail.

Founders and investors would have better conversations if each side dropped the pretense of needing to “look” smart and asked child questions. This isn’t a complex task, but it does require focus.

The way I’m working on this is to stop myself each time I’m about to ask a question and figure out what I actually want to know, and then see if I can just ask that specific question in no more than a single simple sentence. If the question does not produce a satisfying answer, I’ll try to understand if it is because I worded the question poorly, or did not provide enough context. If I need more context, I’ll add one or two sentences of context, and ask the question again.

This strategy does not always work: I don’t always catch myself in time, I sometimes ask poorly worded questions, sometimes the question requires more context than is practical. However, I’ve found that the act of thinking about the question I want to ask and examining it in this child/adult dichotomy has helped me ask better questions, have better conversations, and learn more things. That’s enough of a reason to continue doing it.

Experts are generally right until they're wrong. Unfortunately, it's very easy to get fooled into thinking that experts are always right. This is because they are...experts. They are authoritative and knowledgeable. This is especially true when it comes to trying new things in existing fields. We are biased into believing that knowing a lot about something confers an ability to predict the future.

The problem with expertise is that it doesn't necessarily come paired with an openness to new ideas. Expertise can be used to shut down new ideas and avenues of exploration just as easily as it can aid in invention. I've been guilty of this when hearing about new ideas. In fact, it often feels easier to shut things down than to use what I know to figure out how to make something new actually work.[1] Perversely, being negative may make someone seem like more of an expert than they are, creating a negative feedback cycle.

When you don't know much about a subject, you're free of the constraints of what has been tried. That means people who are inexpert will often have wilder ideas. Sometimes, that's called naive or stupid. However, when those ideas happen to work, then it's called genius or groundbreaking.

That doesn't mean that every problem can be solved by creative ignoramuses. There seems to be a level of expertise which, when paired with the right environment, is conducive to productive creativity. I wish I had a way to know those levels for different areas.

Without a clear set of rules to use in evaluating expertise, I instead try to evaluate founders based on what I can learn from talking to them. This is especially true in areas that I understand fairly well. While there are certain things I might expect a founder to understand about what they're doing, I'm much more interested in how they think and test assumptions. This is part of how I try to figure out if I'm investing in potential (good) or track record (not so good).

One of the tricks in doing this is to see whether or not the tests that founders run cause them to ask increasingly interesting questions. Coming up with questions is a good sign of creativity, while answering them well builds the expertise necessary to actually get something done.

Technology increases the likelihood that a seemingly naive approach to a problem will work because it reduces the iterative cycle of trying that approach. Given enough time and resources, you could try every single solution[2]. In the real world, though, we have to pick solutions to work on. This is where the good founders are separated from the bad ones. The good ones get better and more open as time goes on, while the bad ones get more closed down and start rejecting ideas out of hand.

The same is true for investors. The best ones use new knowledge to open up new ideas, while the worst use it to close out entire categories of ideas.[3] That's short sighted because the world constantly changes, which makes new things possible. Founding and an investing in those new possibilities is what creates the companies that change the world. That creates new areas in which to be expert, starting the cycle all over again.

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[1] https://archive.org/stream/ERIC_ED211573#page/n0/mode/2up

[2] And enough monkeys at enough typewriters will eventually produce Hamlet.

[3] This is different than investors who understand the limits of their expertise and focus on specific sectors. An investor can be sector focused and open to lots of new ideas within that sector, just as an investor can say they'll invest in anything only to shoot down every idea.

Thanks to Craig Cannon for feedback.

Originally posted on the YC blog, here: https://blog.ycombinator.com/why-vcs-sometimes-push-companies-to-burn-too-fast/

In Investors and their incentives, I tried to give a broad breakdown of the incentives that drive the major types of startup investors. I want to dig deeper into a behavior that VCs sometimes exhibit which seems strange from the point of view of founders. Despite praising frugality, VCs sometimes push companies to spend more money, faster. Sometimes this leads to faster growth. More often it leads to empty bank accounts. I've seen a number of companies get killed by this dynamic, and it took me a long time to understand why it happens.

I recently had a conversation with a founder who'd just finished a number of unsatisfying conversations with investors. The founder's company was growing well, had crossed $1mm ARR, but still couldn't raise money. According to conventional wisdom, that should have been enough to open some checkbooks. Unfortunately, that's not how fundraising works.

• $1mm ARR
• 10% weekly growth
• Repeat founders who were previously funded
• 2 Fortune 500 pilots, 5 in pipeline
• Engagement rates that are higher than Facebook

Fundraising is a frustrating process that resists well-meaning attempts to make it into a predictable science. That's actually quite fitting, though, since while much about startups can be measured, that measurement never guarantees success. Success comes from using the unique advantages you have and combining them into a coherent, self-reinforcing story and product.
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[1] https://www.wikiwand.com/en/Parametric_insurance
[2] http://tomtunguz.com/mrr-growth/

Thanks to Craig Cannon, Dalton Caldwell, Sam Altman, and Andy Weissman for your edits.

It is incredibly important to understand the incentives of investors when you are raising money. This used to be fairly easy - you raised money from Venture Capitalists who wanted to see a big return on their investment. The best of these investors were incredibly focused on doing the one thing they did well: investing in technology companies.

Investing in emerging markets such as India, Kenya, and Nigeria isn’t quite what I naively thought it would be. Before I started, I thought that finding a good company in an emerging market would just mean copying models that worked in developed markets. All I’d have to do is figure out how the business would need to be tweaked for a lower price point, identify the best founders working on the problem in the new market, and invest in them. Any structural difference in the new market would just serve as a barrier to other companies from moving in. In the last few years, though, I’ve learned that while this is one way to invest, it’s unlikely to identify the largest companies that have yet to be built. I now think that the better way to invest in startups in the developing world is to ask “How would you solve a problem if you started fresh with today’s technology?”

This probably seems like an obvious question, and one that founders and investors should be asking themselves with any opportunity. But, one of the more surprising things that I've learned is the degree to which the sequence of technological adoption changes the opportunity set available to startups and how we think about them. This isn't something you can actually see when looking at a single market, it's similar to comparative literature where each pair of markets that you examine in tandem illustrate the differences and gaps.

Credit cards and payments are a good way to illustrate this dynamic. We'll use the US as the base case. The US has an extensive and well established financial system, from trustworthy savings banks to a wide array of credit options to standardized and reasonably secure systems for transferring money. When M-PESA, Kenya's mobile money transfer system launched in 2007, Kenya did not have many of these pieces of infrastructure. What they did have was an unmet need to quickly and safely transfer money over long distances. They also had Safaricom, the largest cellular operator in the country. Not only did Safaricom provide the phones and coverage needed to make transfers possible, their network reached more of the population than the branches of any bank. On top of that, the banks lacked the lobbying power to kill off an upstart that was actually being run by a powerful company.[1]

Contrast this situation with the one faced by companies like Venmo on launching in the US. The foundation of the market is different here, with huge amounts of regulation governing money transfer alongside a fairly sophisticated (if not perfect) system to send money. Mobile money is just a convenience in the US and also faces barriers to widespread adoption from entrenched technologies, user behaviors, and regulations. In contrast, mobile money is a solution to a deep and unmet need in Kenya with a relatively green field from competition, regulation, and behavioral norms.

M-PESA wasn’t a startup that investors had access to, but let’s pretend it was. If those investors had focused on how a payments company would ever make significant revenue given the small size of the average transfer, they would have missed the opportunity to invest in a system that was handling 25% of Kenya’s GNP in 2013!

Something similar is currently playing out in India. Imagine if the first credit cards had been created today, with ubiquitous smartphones, rather than in the late 40s. Instead of serial numbers printed on paper[2], you’d probably have an app tied to your phone and some uniquely verifiable identity token. It would be easier and more efficient to create a vertically integrated system that combined the features of multiple players within the payments stack. This is the situation in India, where there are around 20 million credit cards and 220 million smartphones. Credit and debit cards aren’t a big thing there, which is why payment is so often handled in cash. In fact, they have a Cash on Delivery (COD) rate of close to 80% for goods purchased online[3]. That means that there are opportunities to build startups in India that look like credit card processors in the developed world, but there’s an even bigger opportunity to invent a new way for people to pay, and to own all the pieces.

It probably makes sense to always try to identify the optimal solution to a problem no matter where you are investing. However, finding ideal solutions is harder to do in developed markets because there are layers and layers of infrastructure, technology, and regulation that have gradually built up around most big problems. No matter what approach you take to a problem, those factors will influence how you think about it.[4]

It seems to me that the best investors are those that can most clearly articulate this thought process and hold onto it while accommodating the particulars of a given market. This is the underlying logic for investors who talk about the importance of identifying new platforms, or of catching the next wave. The companies that fit these criteria rewrite the rules of how their markets work by building entirely new foundations of infrastructure and user expectations. By doing so, they unlock the types of huge opportunities that you'd otherwise only expect in a developing world market with a clean slate.

While some great founders may think this way, many of the best simply have a vision of the world as it should exist that’s only possible with what they are making. Rather than trying to work around barriers, these founders either ignore them or are naive about their existence. Either way, they end up building things that others would have deemed too hard or pointless because of all the things other people had done. I think that's why so many great companies start as projects without much attention to commercial relevance.[5] When you start thinking about all the million different things that an existing market imposes on a new idea, it can be enough to stop you in your tracks. That's not to say that great founders ignore the market. What they actually do is react rapidly to what their companies encounter on first contact and move quickly to adjust and get better.

Developing markets are a kind of mirror of the future, or maybe of the present if things had happened differently. As such, they're hugely instructive in understanding the types of companies that can be built, and of the founders who can build them. I think it’s clear that there will be huge startups built in the developing world. More importantly, though, thinking about how and where those startups will occur forces us to think about solving problems from first principles. Starting with a clean slate lets founders and investors think about how to change the world as quickly as possible, rather than incrementing their way forward.

While thinking about wiggles (Ignoring the Wiggles ), I looked at when the biggest tech cos in the world started relative to NASDAQ. At first, I thought I'd find no correlation between how well the index was doing and when successful companies were founded.

Startups that do well often follow a set of common principles. These principles influence how they develop products, build teams, raise money, and get customers. The most successful startups, though, are exceptional and often seem to go against these principles in various ways. For founders looking to learn from the experiences and paths of other startups, this can cause confusion and lead to bad decisions.

I think this happens because of how hard it is for outside observers to understand the full context of why given decisions are made in other organizations. It is also nearly impossible to separate causation and correlation, even with perfect understanding of the rationale behind a decision. I've spoken with many founders who point to outcomes at other companies as justification for decisions that they are making with their own companies. These founders rarely give enough weight to to factors like timing, luck, and the impact of particularly skilled employees or founders in producing those outcomes.

That creates a paradox. One of the best ways to learn how to succeed is to follow good examples set by others. At the same time, following those examples can often lead to very bad decisions that harm companies. Figuring out which examples to follow, and how to follow them seems hard.

There is, however, a clear framework for figuring out what to do. First, don't do anything just because you see someone else doing it. For instance, there are many successful jerks, but that doesn't mean you should be a jerk. Some companies succeed while spending huge amounts of money, but you should probably spend as little money as possible to achieve your goals.

Second, when you see a successful company doing things that appear to break from sound principles, look at those examples through the lens of your own company and circumstance. If you take the set of things that exceptional companies do, and overlay it on the set of things that make sense for your business and team, you'll end up with the set of things you can learn from exceptional companies and mimic. You can do this even without perfect knowledge of causation, because simply knowing that something is possible is often enough, given the right people, to achieve it.

You can also look at your existing practices and plans to discover whether or not you have to change them. First is to look at the decisions you are making at your company and ask whether or not you've derived them from the logic of your own business, or if you're doing them only because you saw a successful company do something similar. If it's the latter, you then have to figure out if those decisions make sense in the context of your business without the benefit of outside examples. This is especially hard to do because you can't use your own exceptionalism as a reason for doing something. People and companies aren't exceptional because they say they are. They are exceptional because evidence shows them to be so.

What's really happening when you run this exercise is that you're deriving decisions for your company from first principles. Things other companies do may provide some ideas, but the best decisions come from focusing on what will help your company succeed on its own terms.

As your company grows, you may realize that many of the things you do don't line up with the principles you initially thought would govern your company. That's a good thing, because it means that you've figured out the pieces of your business that are exceptional. While you can't copy exceptionalism, proof that it is possible is everywhere. You can use examples of that proof to help make decisions, but ultimately, you'll have to create it yourself. And if you can create it, you have a good shot at building a great startup.

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Thanks, Geoff Ralston, for your help writing this.

A few months ago, I wrote about things that look like work, but aren't. As I paid more attention to founders doing these things, I started thinking about why they were happening. I realized that the behaviors were largely a function of bad goal setting.

When founders choose bad goals, they create bad metrics around them and try to hit those metrics. This means that those founders are optimizing for things that look like progress, but aren't. This is dangerous for startups because founders that aim for bad goals warp everything they do towards measures of progress that don't help the business grow and succeed.

If you find yourself thinking that these things are progress, you need to examine what you're aiming for.

Things that look like progress but aren't:

• Conversations with large enterprises - This is a big one for companies that rely on enterprise sales. Usually, these "conversations" are non-binding, low level, and scattered. They rarely lead anywhere. There is a type of conversation that is actually progress, but it is generally paired with a clear sales plan, a list of stakeholders, and clear asks met along the way.
• Press mentions - This feels so good, which is why it is tricky. External validation is awesome! But it isn't as awesome as engaged users or paying customers. If you're looking to get press as a means of building SEO, then press mentions can constitute progress. That only makes sense if SEO is part of your strategy and you're measuring things properly. Russ D'Souza talked abut how they do this so well at Seatgeek: http://chairnerd.seatgeek.com/how-seatgeek-measures-pr-coverage/.
• Winning awards - This is another one of those pieces of external validation. Certainly helpful when proving to your mother that you're not wasting your time, but not material to the success of your company. Awards may recognize either the progress you've made, or how good you are at PR. Focus on making progress.
• Getting retweeted by someone famous - This is similar to press mentions, but even worse. When a founder is trying to do this, they're usually working on their personal brand at the expense of their startup. That's definitely the wrong thing to do.
• Meeting someone famous - Famous people are really interested in startups these days. It feels good/cool to say you met someone famous. Don't underestimate the value of having great experiences, but don't mistake it for a sign of success.
• "Getting into" elite conferences, like Davos - This is some strange combination of awards and meeting famous people.
• Eyeballs - Had to include this because it's part of what drove valuations in the tech bubble. Turned out this wasn't progress. There's a corollary today: uniques. That can be a good measure of progress if you're a media site generating revenue off of impressions, but in almost all other cases, it's a vanity metric.
• Cumulative registrations - The cousin of eyeballs. People who register for your company but don't use it aren't actually helpful. In fact, this is probably a bad sign because it means that people don't actually want to use your service. (Suggested by Geoff Ralston)
• Hiring - When you hire for the sake of a world class team, that isn't progress. If you're hiring because you can't handle the load on your service or product, then it probably is a good sign and it is progress. (Suggested by Paul Buchheit)
• Fundraising - So many founders confuse raising money with success. That's how the press views it, but it's one of the worst things that founders can tell themselves. Fundraising is just a tool to accomplish your real goals, not a goal in and of itself.
• Getting into an accelerator, even YC - This is a corollary of fundraising and awards. At YC, we'll do our best to help you figure out what your goals are (if you don't already know), and work with you to achieve them, but it's what happens after you get in that counts, not getting in. YC is neither necessary nor sufficient for success.

Starting a company is, in large part, an act of ego. When that business is a startup, the ego component is even larger. This is a good thing.

Ego is what gives the founder the confidence to create something new. Ego powers the belief that the new thing the founder creates will be good enough to change the way that tens, thousands, even millions of people live their lives. Maybe we don’t always call this ego -- maybe we call it vision, or confidence, or passion -- but the idea is the same.

But as important as ego is to the founding of a company, it is also corrosive to the creation of a good culture. Unbridled ego becomes arrogance. It doesn’t allow for other people to achieve and contribute. Founders who do not keep their egos in check are unwilling to acknowledge the help given to them by others, and have a hard time building and retaining great teams.

To start a company founders need ego, but to build a great company, founders need to be modest. Modesty is what allows founders to see all the things that contribute to their success, especially the things over which they have no control. With modesty, founders can see the important role of luck in their success. They can recognize, acknowledge, and reward the part played by cofounders, employees, and customers. They’re resilient when things go wrong because they can see beyond themselves.

The interplay between ego and modesty is obvious when you hear founders talk about their companies. As a company grows, the best founders increasingly talk about “We” and not just “I.” Every discussion about the achievements of the company is a chance to highlight the contributions of other people and of the organization overall.

This isn’t to say that the best founders disappear into the background of their own companies. The “I” still plays a strong part. It remains the founder’s job to consistently set the vision and the example for every employee. When that goes away, a company risks moving into stasis or decline.

Perhaps the most important place to use “I” over the life of a company is when things go wrong. When figuring out what happened, and who bears responsibility for fixing a problem, “We” is insufficient and even dangerous. In that case, modesty doesn’t drive the use of “We,” arrogance does. Arrogance won’t allow a founder to admit that he was wrong, so he slides to “We” to cover for it, to blame the organization. But diffuse blame means that no one figures out what actually happened and how to fix it. Do that often enough, and the badness grows until it kills the company.

It’s tough to balance “I” and “We” and it gets harder as a company grows and becomes more successful. As a company does better, the easiest stories for the press to write are those about the genius of the founders. At the same time, as more and more things happen at a company that the founders don’t directly touch, founders may start to feel disconnected from the thing that they created. This is a hard thing to face, and some founders respond to it by claiming sole credit for successes that are the work of many people. From the other side, as the company grows, some founders fade into the background and stop providing the singular vision and leadership that the company needs to succeed.

There doesn’t seem to be an easy answer as to how to strike the right balance, nor is there a single paradigm for what works best. What does seem clear, though, is that founders need to keep these questions in mind, and, if they find themselves only using “I” or only using “We,” to think long and hard about what they might be missing.

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Thank you, Colleen Taylor, for your edits.

I've noticed a common bias that shows up in some founders: they believe that their competitors are stupid or uncreative. They'll look at other businesses and identify inefficiencies or bad systems, and decide that those conditions exist because of dumb decisions on the part of founders or employees. 

This is a bad belief to hold. In truth, competitors in the market are usually founded and run by intelligent people making smart and logical decisions. That doesn't mean that all the decisions they make are necessarily the right ones, but they're rarely a function of outright stupidity.

Where companies do things that diverge from what seems smart from the outside, it's a much better idea to ask why those companies are doing things from the presumption of intelligence and logic rather than the presumption of stupidity. If you don't ask these questions, you might find yourself making the same decisions, or ending up in the same place with your own set of rationalizations. I see this all the time.

In fact, we made this mistake when we started Tutorspree. We looked at all the local agencies and the way that they acquired customers and charged for packages of lessons. We assumed they asked for so much money up front because they were greedy and not smart enough to figure out a better system. It turned out that packages of lessons were a logical outgrowth of high upfront acquisition costs and the long term dynamic of tutor/student relationships. A large enough subset of customers appreciated the breaks on pricing and commitment created by booking multiple lessons up front that it made sense to model the business that way. It took longer than it should have to realize this because of our bias.

If, instead, you presume intelligence and analyze the reasons a business looks the way it does, you will often see the challenges you might face ahead of time and, as a result, design a solution that is actually better, as opposed to simply looking new. It is a lot harder to think this way because it means that you can't just dismiss the things other people do and assume you'll be better. You actually have to prove that you know how to be better. That can be really scary because, much of the time, you might not be able to figure out how to be better. Everything you think of might lead you to the same place you see your competitors.

That, though, is no reason to stop working on your company. I think it's actually a reason to keep going, and to keep gathering information and generating new ideas. This is part of what's so cool about starting a company, you get to make up new rules as you go along, and you can toss out old ones as you go along. Two founders looking at the same problem can easily come up with multiple solutions. Each solution might look similar from far away, but the small differences add up. Importantly, if you know that other smart people started in a similar place and ended up with the wrong answer, you'll think a lot more critically about each of your decisions and never get lazy about challenging your own assumptions.

Of course, just because you presume intelligence doesn't mean that every decision made was smart. People and organizations make bad decisions for all kinds of reasons. The thing is, you don't learn much by understanding that a call was bad, you learn by understanding the inputs and the organization that enabled the bad decisions.

Even with this framework, there's no guarantee that you'll end up in the right place, no matter how much you analyze those whose decisions have left you with an opportunity. At the end of the day, there's only so much you can learn from looking at competitors. Truly great businesses aren't built as counterpoints to existing companies. They become great because they meet a deep need that isn't being satisfied. That usually requires the kinds of creative and cognitive leaps that no amount of market analysis could possibly give you.

When infrastructure is built, it usually starts out as a large scale project that can only be accomplished by government. It can be built in undeveloped areas for a fairly large amount of money, or in developed areas with massive amounts of cash and even more political capital. That's hard to do in democracies, though seems to work well in places like China.

This dynamic means that we'd expect infrastructure to fail over time as the inertia arrayed against repairs and new construction grows. That seems to be what's happening in the US.

When infrastructure decays and fails, though, it creates a lot of opportunities. Citizens who were meant to be served by the infrastructure become unhappy and are when that unhappiness is great enough, they will spend their own dollars on alternatives. This is a more direct process  than funding infrastructure through tax dollars, though it can produce different types of outcomes.

In the United States today, these opportunities are being exploited by a range of startups and companies who are essentially building private infrastructure, mainly for the relatively wealthy.

Food

Instacart is building new infrastructure to deliver food to homes. In most early use cases, this looks like pure convenience, however, over the long run it could impact and start to eliminate food deserts. By making food available in more places, Instacart has the power to change where people want to live. That process will reshape how cities grow and, eventually, are built. I'll also say that in a place like NY, where supermarkets are small, crowded, and overpriced, it seems clear that the current system only exists because there's no better alternative. Instacart is that alternative.

Transportation

This process is also starting to play out on our roads. Most of our highway system was created by a single gigantic bill, the Federal Aid Highway Act of 1956. It would be hard to imagine today’s Federal government getting its act together or finding enough money to repair roads on a national scale. Harder still would be believing that a place like the Bay Area would figure out a way to install effective and efficient public transportation to ease the stress on our roads and highways which are nearly always gridlocked. Technology is starting to provide ways to bypass those problems by improving throughput on existing systems without changing the physical plant.[1]

Self driving cars are the most extreme example of this trend. If we do actually arrive in a world where self driving cars are ubiquitous and built on the same standard such that they can communicate with one another at long range, congestion gridlock should largely vanish as the cars plan miles ahead and subtly change speeds to clear up slow downs before they start. Even before that future, though, apps like Waze help drivers plan better routes and alleviate some stress on the most crowded points in the system.

Energy

I think the trend is also impacting power generation and consumption in the US. Companies such as  Solar City will install your own power plant on your roof which means you're no longer subject to brownouts or price increases at peak times. In most of the US, this is more of a ‘nice to have’ and cost saving measure, but in the third world, solar power could provide a viable and efficient alternative to the construction of large power plants and electric delivery systems. These systems would be a fraction of the price of the old way of doing things and be significantly more reliable thanks to their distributed architecture.[2]

Private can’t mean wealthy

There is, however, an underlying tension in the rise of this new infrastructure in that the first segments of the population to get it are generally the wealthier ones who can afford to use it. Two tiered systems may be fine when they exist in non-essential parts of our lives. However, when there are two tiers, determined by wealth, for services as basic as energy, we're in a dangerous place.

That's part of why infrastructure exists the way it does. No single piece of the population would spend enough money to build services and systems useful for everyone. I think that's always going to be true for certain projects, such as bridges. But, as technology drops the cost of delivering the types of services we traditionally associate with infrastructure, I think we'll see the market extend its reach farther and farther. There's a huge amount of money to be made by ensuring universal coverage, but it won't be easy to unlock all of it.

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[1] At best, though, this is a partial solution. Throughput is well and good, but if the roads actually start to collapse, we'll need other solutions.

[2] Even though this seems like a good idea, there are still quite a few hurdles, not the least of which would be figuring out the right financing structure to make the installations profitable for the companies doing them. This is harder than it might seem for developing countries without sufficiently developed/ubiquitous banking systems.

I think that the way that employees are getting compensated at startups is starting to break. The old model of relatively low salary and "high" equity only works when there's a healthy public market for that equity in the not too distant future. If IPOs are getting significantly delayed and are potentially at risk of not happening at all,[1] we need to change how compensation is structured.

Options only make sense as compensation when you can draw a clear line from the point at which you get the options to the point at which those options are equivalent to cash. This happens when two conditions are met: 1) the stock price is enough above the strike price on the options to make exercising worthwhile to the employee and 2) there is someone willing to quickly buy the stock. This tends to happen with access to liquid markets, which traditionally means public ones. That's the only place where an employee can sell whenever she wants and can know the price she'll get with a high degree of certainty. It's also the only place where an employee can really hedge out some or all of the risk of her options.[2] That hedging is important if the value of the options rise significantly and lead to an employee having 99% of her net worth in a single illiquid asset.

When shares can only be sold in private transactions on secondary markets, and, increasingly can only be sold with the consent of the company, the options are actually worth less. This is true for three reasons.

The first reason is that control is an important factor in asset pricing. Think about this in a situation where an employee would like to sell stock to fund the purchase of a home. In a public company, that employee could exercise the options, sell the stock quickly and use the cash to buy that home. If that employee instead wants to sell stock in a private company, and the company does not let the employee do so, the employee cannot get the cash to buy the house. Because that employee cannot do what they want with the equity, that employee should discount the value of the options they hold.

The second reason that options are worth less in the absence of robust public markets is that the terms of sale of stock in the future are unclear. An employee being granted options has no idea under what conditions he will be allowed to sell stock in the future. The future sale might be subject to board approval, there might be a heavily restricted set of buyers, the employee could be told that no sales are allowed whatsoever for a variety of reasons. Each of these possibilities adds uncertainty which makes the options harder to value and worth less.

Founders need to account for this change in the value of options when giving them, and employees need to account for the change when evaluating their offers and negotiating. This is, however, hard to do in the absence of information. Without a liquid public market to value stock, it's hard to say what the options are worth. The best guess an employee has in this scenario is to go by the most recent valuation given to the company during a fundraise. The further from that fundraise an employee is, the less relevant the price. Furthermore, without the ability to compare how different employers control and handle the sale of private stock, it's nearly impossible for an employee to know what is standard.

The third reason for why individual options are probably worth less now than they used to be is that both employer and employee need to account for the fact that the time until IPO or liquidity is longer than it used to be. This is a big issue. To get the true value of offered comp, employees need to add their offered salary to the present value of the options offered. When calculating that, the further out the payout, the less it is worth today.[3]

This is an especially important calculation when trying to hire employees away from larger companies who are already public or can offer larger cash packages to employees. Those offers also tend to include options or stock grants which have known price and sale terms. Because of their easy to understand high dollar value, these offers are hard to compete with. Options in early stage startups are much harder to value even without all these new factors. Given uncertainty around the final value of those options, the time until they can be exercised and sold is hugely important. As you move further out on the curve, not only does the discount factor become a larger lever, uncertainty over the final value gets more extreme. You can be pretty sure that a company currently worth $10mm won't be worth $1b in 3 months, so you have a reasonable band of expectation. Once that value calculation moves to years out, nearly anything is possible and needs to be factored into the calculation.

I'm not the only one thinking about this, and, indeed, there are instruments available that let employees take immediate advantage of long term options. Some banks or private investors will provide loans collateralized by options. This can be good, but debt is very different than having cash. Taking advantage of this kind of strategy could also lead to potentially tricky situations where, if the option value as determined by secondary transactions falls (which could happen quickly and dramatically given the lack of liquidity in the system), the creditor could claim the assets before the term is up. Even if the price then recovers, the employee is out of luck and money.

Founders need to deal with these issues, and given how fierce the competition for good employees is, I think someone will do so soon. One response would be to increase overall options packages to account for the fact that they are now less valuable.

Another path would be to create an internal liquidity pool capable of buying shares from employees at predetermined trigger points. Maybe this could be funded by existing investors, or maybe by other employees or existing shareholders. Because the sale points are predetermined and don't provide an open market, the value of options would still be discounted, but not as much as a scenario with no guaranteed access to liquidity.

It may make sense for some companies to start creating revenue share programs as standard practice - especially for companies that never plan to going public (of which there appears to be a rising number). This could be a powerful means of retention, though would only work with companies throwing off enough cash.

I think that something even more basic needs to happen first: companies need to standardize their secondary sale and options repurchase practices. We're living in the wild west right now - each company and each employee is doing things on their own. An employee that wants to sell shares on the secondary market generally starts asking friends if they know anyone who wants to buy those options. Generally, they'll find a broker who offers to matchmake and who then gets a cut of the overall sale in exchange for their work. The price that gets set isn't shared from one deal to another, and the rules around whether or not the company can block the sale aren't standardized. This isn't fair to employees, and will lead to confusion and bad outcomes.

Maybe what we need is two things. The first is a founder pledge that they will do everything in their power to let common holders sell into secondary markets above a certain valuation, say, $500mm. The second is that founders of highly valued private companies need to participate in a robust, standardized, secondary market to allow for the clearance of those shares.

My guess, though, is that there will be a number of different solutions with the market choosing the best one as evidenced by the quality of talent hired and retained by the company using them. Founders should be watching for that and be willing to adopt best practices as soon as they arise.

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[1] There have been a lot of articles and blog posts about this recently, but Andreessen Horowitz's recent "US Tech Funding - What's Going On" is the best analysis I've seen. They note that the average time to IPO is now 11 years vs. 4 in 99, and that the overall number of tech IPOs is plummeting as privately funded companies raise huge late stage private rounds instead.

[2] You can do this a number of different ways and hedge out either your exposure to the company itself or do the overall market. Hedging out this risk probably deserves an entire post as it can get complicated. And, while nearly impossible to do it perfectly, is important to significantly reduce risk.

[3] We'd do this as a lump sum calculation for simplicity. You can play with that calculation here: http://www.calculatorsoup.com/calculators/financial/present-value-investment-calculator.php

There are a lot of party rounds happening right now in early stage investing. Definitions vary, but calling a round with greater than 10 investors a party seems about right. My thought is that party rounds tend to leave companies without an investor who cares enough or has pockets deep enough to bridge the company when necessary. Some rounds do actually have a strong lead, along with a syndicate of smaller, useful investors. Those generally have different dynamics.

What I've been trying to figure out is whether or not party rounds are increasing in frequency or not. Anecdotally, it feels like they are. Has something changed in the valley that party rounds should become preferred? The JOBS Act made it easier for large numbers of small investors to back companies in a way that was not previously legal. Platforms like Angel List reduce the friction required to find investors by creating a central, easily accessibly clearing house for companies looking for money and investors looking to give it to them. Or maybe the growing size and frequency of Demo Day type events (YC's included) have created an environment where party rounds are the new normal.

I took a look at Crunchbase, expecting to see that the overall number of party rounds has been rising uncontrollably. Interestingly, that's not what I found.

What's actually happening is that there are more startups getting funded, and the number of party rounds going to those companies is rising roughly in tandem. What's really surprising is that party rounds as a % of overall rounds actually fell from a peak of 3.7% in 2010 to 2.2% in 2012, though it's now back up to 3.42%.

So it seems that we're not seeing a new normal when it comes to early stage investing. We're actually seeing an overall stable pattern ticking up in the last year after a drop. The real story here is the one about the overall number of startups getting funded as the economy has come out of the Financial Crisis. That number is clearly rising, though 2014 tailed off a bit[1]. More startups mean more innovation, and that's great.

The structure and composition of a single round of funding isn't the most important factor in a startup's success or failure. It's just another piece of the story, and one that doesn't seem to be changing much.[2]

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[1] Not sure why the number would have dropped in 2014. Might be a function of the data available to Crunchbase when this run of the db was pulled on April 3, 2015.

[2] I am still curious about whether or not party rounds are a positive or negative influence, but don't yet have an answer.

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