Fundraising and YC
Fundraising is hard.
When my former colleagues and I left RBC to start IEX, we did not fully appreciate how difficult it would be to raise the capital we needed to build the business. Brad organized a meeting on January 19, 2012 where he gathered senior executives from ten of the largest institutional investment firms in the world. He pitched them on the idea of forming a consortium to back IEX, and the meeting went incredibly well. Brad sold the entire room on the vision, and it seemed like we would be off to the races. Unfortunately, however, the consortium fell apart over the following few months.
It wasn’t that these prospective investors lost faith in Brad or the idea — it was just that their companies weren’t in the business of funding startups. The conversations wound up getting kicked up the chain, getting bogged down by legal and compliance reviews, and eventually losing momentum. The one investor that stayed true that entire time was Capital Group, and without them, IEX never would have gotten off the ground. For 7 agonizing months, Brad and Ronan traveled around the country pitching the idea of IEX to new prospective investors. They spoke with dozens of VC firms, PE firms, and wealthy individuals, on top of the literally hundreds of asset managers with whom they had pre-existing relationships (mutual fund companies, hedge funds, family offices, etc.). Finally in August 2012, they met with David Einhorn at Greenlight, who decided to back us too, and from there Brad (with ample help from Capital Group and Greenlight) was able to bring the rest of the round together.
With Proof, we decided we do a few things differently on the fundraising front. We would obviously love to have a group of backers like the one that eventually invested in IEX, but we didn’t want the primary path to funding to have such a low probability of success, especially given that our team has a substantially smaller buy-side network than Brad had at the onset of IEX.
Fundraising at Proof
We primarily considered two paths for funding this venture: either 1) bootstrapping (i.e. self-funding) and tapping our friends and family or 2) pursuing venture capital funding. Each of these options appeared to offer relative advantages and disadvantages.
Bootstrapping / friends & family
Pros
- Fast and easy to solicit the investments
- Relatively insensitive on terms and price
- Have our friends and family involved in our (hopeful) success
Cons
- Unclear how much capital would be available
- Less strategic help
Venture Capital
Pros
- Strategic help operating the business, finding customers, and pursuing any future fundraising
- “Frothy” environment, almost unlimited capital out there
Cons
- We had almost no prior experience dealing with VCs, so we didn’t really know what to expect, but it would likely be a much more intensive process
We decided to pursue both paths. We would start with a modest friends and family round to give our loved ones the chance to “come along for the ride,” and then we would try to follow it with some institutional funding. To help us learn more about VCs and the Silicon Valley tech ecosystem, we participated in a startup incubator called Y Combinator. We had heard great things about YC from friends who had gone through the program, but mixed things from most other folks in Silicon Valley. YC has an insane track record of churning out successful companies (Airbnb, Dropbox, Stripe, DoorDash, Instacart, etc.), but they do take a 7% cut of your company which is a hefty price tag. Ultimately, we decided to do it as we really had little idea what we were doing on the fundraising side, so it seemed like a worthwhile educational experience, and the downside was limited.
The moment after Prerak and Beau joined the team, which happened to coincide with the beginning of YC, we kicked off our friends and family fundraise. We didn’t want to test the fundraising waters prior to them joining to make sure they could buy into their equity while it was still worth almost nothing on paper. The friends and family round went extremely smoothly and in retrospect probably made us a little overconfident for when we would do our institutional fundraise.
Our YC experience
Allison, Prerak, Beau, and I spent 3 months, from June through August, living and working out of a house in San Mateo to participate in YC. To be honest, just spending this quality time together was probably the best part about the summer, although I doubt we would have ever thought to do it without this excuse.
The program itself was fine — not bad but not amazing. There were weekly dinners where a YC partner would give a short presentation (generally a rehash of one of Paul Graham’s essays), followed by a talk by a successful former participant. YC currently has over 200 startups per batch, compared to a dozen or two in the early days. We got the impression that these weekly dinners used to be an intimate, extremely special experience, but now it’s more like attending a talk at a conference. The content is great, but it can be accessed just as easily by reading Paul Graham and other YC folks’ blogs.
Additionally, there were biweekly “group office hours” sessions where we, along with the 7 other fintech companies in the batch, would gather with the four YC partners who were our main points of contact throughout the summer. These sessions were nice in that we had the opportunity to get to know our batchmates, but the guidance in the sessions was still not super applicable to us. It was often very tactical advice about how to quickly achieve growth. The vast majority of participants in YC are tech companies who have either already launched or can get a beta product out the door during the program, but since we’re in such a heavily regulated industry, we couldn’t just spin up a half-baked trading platform. At the recommendation of our group partners, we did build our Find My Fills tool as well as solicit letters of intent from potential customers, which do seem to have been worthwhile exercises.
The final piece of regular YC programming is individual office hours where a company schedules a one-on-one session with a partner. These were the most useful part to us as and where we got specific guidance on how best to focus our time.
YC culminates in an investor pitch day called Demo Day (which was actually spread over two days), and the last two weeks of YC were geared toward Demo Day preparation. At this event, each startup presents for two minutes in front of a couple thousand potential investors, some in person and others who watch online. This is where the program really shined. They have it down to a science how to drum up an incredible amount of investor interest, and they excel at coaching their startups on how to present themselves effectively. During these two weeks, we received a substantial amount of guidance on how to pitch Proof as well as how to approach fundraising.
Since all the startups are well coached, the presentations kind of seem the same. They strongly advise against breaking from the formula — for example, they tell you not to incorporate humor into your pitch unless you’re 100% sure your joke will land (“VCs are not a good audience”). Ultimately, all presentations are basically as follows:
- “We are doing X”
- “Our total addressable market is Y billion dollars”
- “Check out our incredible month-over-month growth”
- “We are the unique team that’s perfectly suited to tackling this problem”
Alas, our pitch followed this formula as well (except for number 3 since we haven’t launched yet). We do actually think our market (US equity trading) is compelling, and we do think our team is quite special, but no question our presentation blended in with the group.
In retrospect, it seems like one of the main goals of the program is to make sure your company fits this formula well on Demo Day. There is a major emphasis on choosing a growth metric early and devoting 100% of your energy toward pumping that metric any way you can. It’s definitely not bad advice since it works, but it is a little bit silly. YC also strongly discourages companies from speaking to VCs prior to demo day, which certainly makes sense if you’re trying to make that growth curve as impressive as possible prior to engaging.
Throughout the program, it always seemed taboo to say your reason for participating in YC was to get their help with fundraising — you’re there to build a great company, not to raise money. This is the area in which they were the most helpful to us, though. We got a ton of (often conflicting) advice from friends, mentors, peers, etc. on how to approach fundraising, but out of everyone, the advice we got from our YC partners was the most helpful, and seemed to be the most genuinely aligned with our best interests.
Post Demo Day
For about a month long stretch starting just before Demo Day, my calendar was filled morning to night with investor meetings. It was fun and stressful and exhausting. We got rejected a ton, and there were a lot of ups and downs. It was substantially harder than we expected, but we’re ultimately happy with where we ended up, and we’re extremely grateful to the folks who decided to back us. I do wish we’d gotten a little more coaching from YC on how best to handle this process, especially when we were in the midst of it. They had group sessions on fundraising, as well as several written pieces for us to review, and they did help us come up with a personalized game plan beforehand. Almost everything they told us turned out to be apt, but I think we would have benefited from even more hand-holding. Our YC partners were somewhat available for advice during this period, but they seemed to be spread pretty thin what with having to support 50 other companies trying to raise money at the exact same time.
Demo Day itself and the few days afterwards were by far the craziest. YC provides an app for investors to “like” companies, which initiates an email chain, and we also received a lot of direct outreach from VCs as well. The dynamic is pretty weird — the investors need to vie for the startups’ attention, which definitely feels backwards. YC also provides its startups with an investor database where you can look up a specific investor and see what kind of experience companies from past batches had in dealing with them. All in all, YC does a fantastic job of putting the startup in the driver’s seat and giving them a good chance to succeed.
Our approach
We went into fundraising with a few strong preferences:
1. We wanted all investors to get the same terms.
YC somewhat encourages its companies to have a “rolling” valuation during fundraising, where early investors lock in one set of terms but later investors have to pay up, especially if there is a lot of demand. This seemed pretty unfair to us, so we took the approach of collecting indications from potential investors up until a week after Demo Day, and then setting the terms for everyone then. During this time, YC pushed us to just get the money in the bank, and they were right in that our approach opened the door for a handful of folks to back out of their soft commitments. I do wonder in retrospect if there might have been a better approach where we could have locked folks in while also staying true on this point.
As an aside, it’s only fair to mention that we did raise our friends and family round on substantially better terms than the post-YC round, and they were only a couple of months apart, so in that sense we did sort of have a rolling valuation. The pricing for the F&F round was arbitrary — we just picked a number that seemed reasonable at the time, and we didn’t change the terms even when it was significantly oversubscribed (we just cut everyone back). Also we tried to be extremely forthcoming about the different terms in the post-YC round, and we made sure all new investors understood the delta prior to making a decision.
2. We didn’t want to take more dilution than necessary
This is kind of obvious, but we did make a point of projecting how much capital it would take to get us one year of runway post-launch, and then raising exactly this amount and not more.
3. We wanted to get to know our investors
Another common YC practice seems to be making “handshake deals” on the floor of Demo Day right after your presentation, with the idea being that you meet someone and they join your round on the spot. This seemed wholly unappealing to us, and we made an effort to have multiple conversations and perform due diligence on each investor (and vice versa), prior to including them in our round.
Having a lead VC investor
There seem to be two common approaches for seed rounds: either one VC takes down the majority of the round and sets the pricing terms for everyone, or the company chooses the terms and raises on a larger number of smaller checks. YC did not express a strong recommendation either way on this front, but many other Silicon Valley folks told us we’d be better off with a strong lead investor who would have real skin in the game and pour resources into helping us succeed.
We spent the early part of our fundraising process, about two weeks, almost exclusively speaking with potential lead investors. During this time, YC gently advised us against creating too much formal structure — for example, they recommended against adding anyone to our board if possible. Ultimately while we did meet some wonderful folks through this process, our attempt to find a lead investor was a failure. The worst part was that whereas there was an overwhelming amount of interest during and immediately after Demo Day, even just a week later it felt like we’d squandered a significant amount of our momentum. It wasn’t horrible though — we just locked down the terms based on the non-lead interest we had at that time, and we broadened our search a bit. It wound up taking about a month to get fully subscribed, and another month to wrap up the remaining conversations and hammer out final allocations. During the first of these two months, I was still in full-on fundraising mode where it was taking up the majority of my time, but by the second month things were mostly back to normal and I could go back to focusing on the core business.
The composition of the round
Angels vs. VCs
Prior to making the decision to set the terms ourselves, almost all of my conversations were with institutional VC firms, but afterwards it was a healthy mix of both VCs and angel investors. The majority of these meetings were a direct result of our participation in YC, although we also looped in a handful of folks from our preexisting network. The most surprising statistic from this process was how much better our hit rate was with angel investors. Part of this can be explained by the fact that most of the angel investors we spoke to were direct referrals from other investors who had already committed.
It certainly would have saved me a lot of time had we spent less time talking to VCs and focused more on angel investors, although I am glad I got the chance to meet so many smart and thoughtful people. Plus, we did receive some benefits from firms who rejected us including introductions to potential customers and invitations to present at the Primary Summit and participate in the Unusual Academy, both of which were wonderful.
The numbers
Since this wouldn’t be a proper Proof blog post if we didn’t share a bit of data, below are breakdowns of the round itself by investor and how I spent my time during the fundraising process. 130 pitch meetings in a little over a month. Whew!
Most common reasons for rejection
One nice thing about VCs is they almost always give you feedback on why they turned you down. YC cautions startups to “believe the no, not the why” — in other words, don’t put too much stock in the reason the VC gave for turning you down as they often sugarcoat the bad news. But nevertheless, here were the most common reasons we were given from the folks who said no:
- They have a minimum ownership % which was greater than what we had left in the round (or more than the entire size of the round!); or on a related note, our valuation was too high for a pre-product company.
- US equity trading is too crowded and competitive — VCs seem to prefer companies who have a decent shot at becoming a monopoly
- We’re outside their domain of expertise
- They prefer to wait until after we launch and see what kind of traction we get
Who knows if these reasons were true — maybe they just didn’t like us. But I will say many of the rejection emails we received were thoughtful and kind which definitely softened the blow.
Final thoughts
Fundraising was no doubt a slog, and it’s a great relief to finally be done. Looking back, it was a lot of fun to meet so many smart people in such a condensed period of time, but it was all-consuming, especially in the heart of it.
It seems fairly common for tech startups to spend a substantial amount of energy either actively fundraising or focused on hitting the right metrics to enable them to go back to the well to raise their next round (i.e. the “VC treadmill”). Our hope is that this capital we’ve raised is enough to get us through launch and to the point of profitability, especially if we stay disciplined and efficient. If that happens, we may never need to raise another cent.
All in all, fundraising in Silicon Valley was a good learning experience, maybe even a check off the bucket list, but it’s good to finally be back to the real work: building Proof!
