Startup School Y Combinator: How to attract investment? [part 3]

Stanford course CS183B: How to start a startup . Started in 2012 under the leadership of Peter Thiel. In the fall of 2014, a new series of lectures by leading entrepreneurs and Y Combinator experts took place:







Ron Conway: I am often asked what is the reason for the success of the Airbnb? The reason is that each of the three founders of the company is as good as the other two, and this is a rarity. In the case of Google, one of the founders is better than the other (after all, he is the CEO). Why is this so important?

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When you start your business, you need to find a co-founder who will be as good as you, or better.

If you find it, your chances of success will grow extraordinarily. That is why Airbnb so quickly became so successful. The only exception is Mark Zuckerberg from Facebook. Undoubtedly, he has an amazing team, but this company is very different from all the others, as it rests on one person. So when creating your company, you need to find amazing co-founders.



How to attract investment? [ part 1 , part 2 ]



Sam Altman: Now questions from the audience.



Question: According to the generally accepted point of view, the purpose of attracting funding is its necessity. But the more opinions I hear, the more often there are other views on attracting investment. It is often said that the founders consider this rather an incentive to achieve a better result. In the worst case, it is “hire-absorption” [eng. acqui-hiring - takeover of a company with the aim of acquiring talented employees] in order to avoid total failure. How true is this point of view?



Ron Conway: If you find good investors with good connections and experience in the field of your company, they will give you something more valuable than just money. You should look only for such investors.



Mark Andressen: Of course, this point of view is correct, but in a sense, it does not matter, because it is impossible to plan all possible failures. In the end, this is not the scenario that you are counting on. Although this can happen, it usually does not play a big role in decision making. This may affect the choice of the investor when searching for the object of financing, but should not be so important when attracting investment, in general.



Question from the audience: In capital-intensive industries, the same rapid growth is not always observed as in the IT industry. What do founders need to know in such companies, and how can they cope with demotivation, because not everyone is involved in software or viral projects?



Mark Andressen: I would add here a few words to the remarks on the onion theory of risk and the correlation of risks with money. The more capital you have in a business, the more scrupulously you must take in determining future results and risks, as well as exactly what your business needs for prosperity. In this case, you need to plan everything very clearly, because the risk of failure is too high.



You need to determine exactly what you can achieve in round A, and what result in this round will be considered successful. If you attract too much investment in round A, you will have a lot of trouble in the future, as if you receive funding in the next rounds, the growing share of investors in the company will become too large. Therefore, you need to be as accurate as possible at each round and attract as close as possible to the required amount of funding. In addition, you need to be as accurate and sincere as possible when talking with investors about the risks and the results achieved.



By the way, this is very important. If you come to our company with a product like Twitter or Pinterest, which is gaining great popularity, demonstrates success and has great potential, then everything is simple. We do not hesitate to invest.



But if you come up with an interesting idea, in which you need to invest $ 300 million over the next five years, perhaps divided into five rounds - she has potentially good prospects, but this is not Twitter. We still invest in such ideas, but the high professionalism of the team plays a much larger role.

One of the ways to demonstrate your high professional skills is a quality financing plan. Returning to Steve Martin: be so good that it is impossible to ignore you. The financing plan must be clear and precise.

Ron Conway: In capital-intensive industries, there are several ways to borrow money besides venture capital.

Mark Andressen: You can get a venture capital loan, and after that - use leasing, but then again you will need high professional skills. If you want to get a loan, you need to clearly show how you run the company, otherwise you can easily go bankrupt on loans and destroy a company. This is a very time-consuming process that requires a slightly higher level of management than the following Snapchat.



Question: On what grounds can you determine that you should not cooperate with an investor?



Ron Conway: If he is the exact opposite of what I said about a good investor. If an investor does not have experience in the field of your company’s activity, there are no connections that will help you make acquaintances for further business development and for attracting investments in round A, then this person should not be taken money. Especially if investors want to enter the business only to earn. Such people are very easy to recognize.







Mark Andressen: If your company is successful, at least, if we are willing to invest our money in it to create a large franchise, then we are talking about a path of 10, 15 or 20 years. Please note that 10, 15, or 20 years is longer than the average length of marriage in the United States. The choice of the main investors who will take part in the management of the company is as important as the choice of a life partner. With these people, you will have to live, work together, rely on them and work under high levels of stress and anxiety for a long time.



This is an important point to which I constantly pay attention: some believe in it, some do not. If everything goes as it should, then it does not matter who your investors are. But almost never nothing goes right. Even in large and successful companies, even in Facebook, various kinds of problems arise again and again. Countless tense meetings, discussions and evening meetings are held when the future of the company is at stake, and everyone should work as a team, adhere to the same goals, move in the same direction, agree on things, dignify themselves and have a certain amount of stamina. to withstand the oncoming storm.



You can find a big difference between new founders and experienced founders: the latter are much more serious about this after they have gone through it once. Therefore, it is extremely important who is your partner. This is very similar to marriage and takes a lot of time and effort to figure out with whom you will have to cooperate. This is much more important than choosing between an extra $ 5 million market value and a check for $ 2 million.



Ron Conway: At SV Angel, we treat it like this: if you invest in an entrepreneur, invest until the very end. If we made the right decision, then we will invest in every company founded by those people. Having become an entrepreneur once, he will remain forever. We actually compare it with marriage too.



Parker Conrad: At the very first meeting, I often wonder if I respect this person and if he can teach me something. Sometimes at a meeting with venture capital investors it seems to you that they are slowly thinking, do not understand anything. And sometimes you come to them, and they reveal to you the whole essence of your business. So, when you leave, it seems to you that, although they did not give you an investment, this hour was so useful that now you have a clearer picture of what and how you need to do. There is a clear idea of ​​what the next couple of years will look like. If you want this person to take part in the company’s activities, even if he doesn’t have a checkbook with him, this is a good sign. If you do not want - bad.



Audience question: What limits the number of companies in which you invest: time, money or lack of good companies?



Ron Conway: At SV Angel, we are satisfied with the volume of one company per week. A team of 13 people will no longer work.



Mark Andressen: Ron, if you had twice as much time, would you invest twice as often?



Ron Conway: I would not advise doing this. I would rather just support existing companies. In addition, SV Angel has a conflict resolution policy. But when it still comes to conflict, this is usually due to the fact that the company has changed the structure. As a rule, we do not invest in companies between which there is an open contradiction. And if we invest, then we inform about the conflict to both companies. At a certain stage, it must be remembered that, in any case, we do not know the company's product development strategy.

We may not have secret information, but our conflict resolution policy speaks of such an important word as “trust”. In other words, we are waiting for a bad start, if we do not trust each other.

At SV Angel, the relationship between us and entrepreneurs is based on trust. If a person does not trust us, then he should not cooperate with us.



Mark Andressen: Back to the main issue of restrictions. We often discuss it in our company. The main limitation for a leading company specializing in venture capital investment is the notion of opportunity costs. It means that while you are doing something, you are missing out on the opportunity to do something else. This is not the magnitude of the costs when we invest 5 million dollars in a company, it collapses and we lose money. We are not worried because of losses, because theoretically our winners will compensate them to us.



What worries us is the fact that every investment we provide “pulls” two types of consequences for our company. The first type of consequence relates to a potential conflict of interest. The essence of our financing policy at the growth stage is that we do not invest in competing companies. We invest in only one company from this group. That is, if we invest in MySpace, and a year later, Facebook is successful, then we are in flight. In another way will not work.



Every time we invest in a company, we lose the opportunity to invest in other companies from the same group. And this is a rather difficult topic for discussion within the company. You know only firms that already exist; but you have no idea about companies that are not yet founded. God forbid you to invest your money in one of the first companies that will not become a leader, and lose the opportunity to invest by the time this leader appears.



The second option is the opportunity cost of time and resources of the main partners. Returning to the idea of ​​improving efficiency: we have a typical company consisting of eight main partners. When fully loaded, each of the partners may consist in 10-12 boards of directors of companies under our control.

You can imagine a ticket on which you can punch a limited number of holes: after each attachment a hole is punched. When all holes are punched, the investment opportunity disappears. By and large, this is exactly how the venture business works.

We can assume that every hole that is not pierced on a ticket belonging to our main partners at any given moment is an additional resource that a company can use if it does not finance a given company. But after each investment you have to punch a certain number of holes in turn. Thus, the ability of the company to make new deals is reduced. Each new investment blocks access not only to a number of competing firms, but also to other transactions that we physically do not have time to complete.



Thus, we return to what has already been said. If a given company is very good, it seems obvious that it will receive venture financing; so why don't we provide it? In fact, if we had unlimited opportunities, we would have done so, but considering that we are limited to a group of competing firms, and we do not have an extra seat on the board of directors even with a better perspective - because of this we have to stay in to the side.







Question: How could you be persuaded to invest money in a company that cannot show you your product? What are your judgments based on?



Ron Conway: Usually the founder and his team can convince us. That is, first of all, we invest in people, and not in the idea of ​​a product. The idea of ​​a product often changes a lot. Therefore, we first invest in the team. If the team consists of former users, its score will be, accordingly, lower, until the founders achieve a resounding success.



Mark Andressen: In our case, if at the time of investment the founders have nothing but a business plan, then we usually cooperate with the founder, with whom we have worked before, or with a fairly well-known founder. By default, it is assumed that we are always talking about web or mobile b2c services. But there are other types of companies, for example, for the development of corporate software, application software, SaaS.



In most cases, such companies do not have MVP, they need to complete the product in order to start selling it. In addition, they most often create a product during the period of Round A. There is not much benefit from MVP, since the customer is not going to buy MVP, customers need a finished product, which they will start using first. Therefore, companies need to attract 5-10 million dollars to create their first product. But almost always we are dealing with founders who are already familiar to us.



Voice from the audience: What is the ideal company management structure?



Parker Conrad: Fortunately, we have only me in the team, another co-founder and our partner from Andreessen Horowitz. Because of this, a little more trust arises and the fear disappears that a new CEO may come and dismiss you without any reason. But in most cases, if you trust your colleagues, there will be no problem with the structure. The case almost never comes to a vote, and when it comes, it means that by this time the structure has already been seriously broken. Most of the rights of venture investors are fixed outside the management structure.



For example, protective reservations are written in the financial round: you can’t get into debt, you can’t sell a company - a lot of things that, one way or another, you can’t do without prior agreement with your colleagues.



It is not as difficult as it seems. As a founder, I realized that if everything goes as it should in the company, then you will have endless possibilities in relation to your investors, regardless of the management structure and the rules in this round. If you say you want to do something, then we have to do it. Whether it is a bad investor or a good one, he will give his consent. Investors want to be with you at the same time, and if everything goes bad, it will no longer matter what protection mechanisms you have implemented in the system.



Mark Andressen: When the company is in a desperate situation, no matter what the conditions were for the next round: they are all being revised. I have been working in the management structure for 20 years, and I have never participated in a vote that would decide something. I participated in many discussions and debates, but never in the voting. Ultimately, the decision always becomes clear and is almost always taken unanimously. Therefore, the decision is almost always hidden in the process of reaching a general agreement, not in detail.



[ Translation of the 10th startup school lecture ]