Startup Investor School Day 1 Live Stream
Y Combinator2018-03-05
Startup Investor School#Y Combinator#Sam Altman#Geoff Ralson#Kirsty Nathoo#Carolynn Levy#YC#Investing#Live Stream#Live#Stream
18K views|6 years ago
💫 Short Summary
The video covers a course on startup investing by Y Combinator, emphasizing the role of investors in the startup ecosystem, the power law in investments, and the importance of identifying high-potential opportunities. It discusses the characteristics of successful founders, the impact of market size and trends on investments, and the use of Simple Agreement for Future Equity (SAFE) contracts. The video also addresses scenarios like mergers, failures, and dissolution processes, highlighting the need for patience and strategic decision-making in startup investing. It emphasizes the value of maintaining integrity, reputation, and supporting founders for successful investments.
✨ Highlights
📊 Transcript
✦
Structure of the course
01:58Lectures are followed by QA sessions with designated time for questions.
Questions can be asked via Twitter using a specific hashtag.
Class includes accredited and non-accredited investors.
YC extends invites to demo days, offering both virtual and in-person experiences.
✦
Overview of Venture Investing and Silicon Valley's Role.
06:01A $70,000 seed investment in 1957 led to $35 million, driving wealth creation and innovation.
The course educates investors on startup fundamentals, mechanics, decision-making, and future trends.
Experienced investors will share insights to guide better investment decisions.
The goal is to create a repository of information for continuous improvement and feedback.
✦
The benefits of investing in startups
10:43Startup founders exhibit unlimited energy, new ideas, and a willingness to take risks.
Investing in startups allows for shaping the future and leveraging time for significant returns.
Investing can be addictive, similar to slot machines, but can also lead to high rewards with successful investments.
✦
Importance of understanding the power law in investing.
13:03Best investments yield significantly higher returns than all others combined.
Challenge conventional investing wisdom and prioritize strategic decision-making.
Avoid herd mentality and missed opportunities by focusing on high-potential opportunities.
Maximize returns through careful investment choices rather than following trends or popular opinions.
✦
Angel investing focuses on seeking potential homerun investments rather than worrying about failure rates.
14:45The goal is to find companies that could become massive successes, with the key being to think about the magnitude of success rather than the likelihood of failure.
Successful companies often sound like bad ideas but have the potential to be giant.
YC has funded around 1,600 companies, with the top five representing two-thirds of the value created.
Generation-defining companies are often started by individuals outside of traditional networks.
✦
Importance of Reputation and Relationships in Startup Investing
17:52Founders have more leverage in choosing investors due to high demand for good startups.
Reputation is key to success as an investor, with founders valuing relationships over maximum returns.
Fighting over failing companies can damage an investor's long-term reputation.
Being open to random emails and introductions can lead to valuable connections and opportunities.
✦
Importance of reputation for founders in attracting investors.
20:11Founders rely on reference checks from other founders for decision-making.
Being responsive, available, and clear about reasoning helps in securing good deals.
Instances where overpaying for investments led to successful outcomes.
Some of the best investments were initially perceived as expensive.
✦
Importance of identifying founders with the potential to create billion-dollar companies.
23:16Emphasize on attracting talented individuals to startups through proactive support and recruitment.
Criteria for investment include any business model or sector with potential for significant growth.
Starting a hard company, like nuclear fusion, may be easier due to increased interest and support.
Success in building groundbreaking companies lies in selecting founders with the drive and vision.
✦
Key Traits of Successful Founders.
26:49Founders must possess traits such as obsession, focus, formality, love, intelligence, creativity, and strong communication skills.
Communication skills are crucial for founders to pitch ideas, hire, raise funds, and set company direction.
Execution speed is highly correlated with success, requiring founders to relentlessly execute and quickly adapt to new ideas.
Rapid progress and continuous experimentation with new ideas are key predictors of success for founders.
✦
Importance of Founder's Rate of Improvement in Startup Success
29:30Founder's rate of improvement is crucial for startup success, not just business growth.
Recognizing founders with potential to become strong leaders, such as Brian Chesky, is valuable.
Long-term commitment and a sense of mission are essential for startup success.
Y Combinator emphasizes mission-driven founders for success in their portfolio.
✦
Importance of prioritizing small markets with rapid growth over large markets in startup success.
33:15Replicating success of companies like Facebook and Uber can be risky and challenging.
Independent thinking is crucial for identifying high-growth markets and making successful investments.
✦
Differentiating between real and fake trends is essential in the market.
35:28Real trends are characterized by a dedicated user base that is highly engaged and advocates for the product.
The success of the iPhone exemplifies a real trend with its passionate user base.
Virtual reality headsets have not achieved the same level of adoption, indicated by low usage frequency.
Early identification of real trends is crucial for making successful investments and business decisions.
✦
The importance of investing in VR technology and identifying good ideas that may initially appear as bad ideas.
37:51Emphasizes the need to focus on products rather than growth hacking and marketing strategies in Silicon Valley.
Encourages skepticism towards ideas that are overly promoted by founders.
Stresses the significance of finding innovations with real pricing power and competitive advantages.
✦
Key highlights of startup investing.
41:21Focus on companies that become more powerful, gain pricing power, attract more users, and are harder to compete with as they grow.
Emphasizes exponential growth potential and modeling growth and decay rates instead of trusting intuition on growth projections.
Success of internet and mobile startups often attributed to organic word-of-mouth referrals.
Importance of scalable growth strategies in startup investing.
✦
Importance of Investor Support for Founders.
45:45Investors should assist founders with hiring, strategic advice, and tactical advice.
Founders seek help with finding good people, interviewing, and closing deals.
Support with future fundraising and strategic guidance is valuable.
Being accessible for quick phone calls, especially during emergencies, can greatly impact founders' success and satisfaction.
✦
Importance of integrity in founders and assessing their ethical values.
47:25Venture firms conduct studies on pro rata rights, recommending it for companies in up rounds led by a top VC.
Pro rata rights enable future investments in subsequent rounds.
Data shows benefits of exercising pro rata in the current world environment.
Making decisions based on founders' actions and ethical choices is crucial for investment success.
✦
Impact of security tokens and ICOs on financing
49:52Emphasize the importance of securities laws and caution against incompetence and scams in the industry.
Reflection on past examples like Reddit and Dropbox.
Mention challenges of accurately assessing market size in rapidly evolving industries.
✦
Key highlights on consumer behavior and startup founders.
53:26Consumer behavior is shifting towards new markets like Uber, indicating potential for market growth.
Startups with at least one technical founder and multiple co-founders are preferred.
Founders should be self-aware, open to feedback, and driven to improve.
Investing in startups requires patience and long-term commitment, as success can take a decade or more to achieve.
✦
Importance of patience and passion in investing.
56:37Emphasis on listening to experienced investors for valuable insights.
Short break before session on investing fundamentals and mechanics led by Carolyn Levy and Christina.
Carolyn Levy credited with inventing the SAFE, Kirsty serves as CFO of YC.
Speakers highly knowledgeable, with experience dealing with thousands of companies in startup investments.
✦
Investing using Y Combinator's safe.
01:10:58The safe is for early-stage startups without a priced round or preferred stock, offering a fair way for investors to support them.
Having a clear strategy and direction is crucial when choosing investments.
The safe is ideal for startups lacking a lead investor or defined terms, providing a flexible and straightforward funding option.
✦
Overview of the Safe, a simple agreement for future equity used by startups to raise funds quickly and efficiently.
01:14:08The Safe is a convertible security that is not considered debt, does not accrue interest, and does not require repayment.
The document is concise, only five pages long, with key negotiation points being the investment amount and valuation cap.
The Safe does not include voting, information, or liquidation rights typical in preferred stock, as it converts to preferred stock in the future inheriting negotiated rights.
Pro rata rights are included in the Safe for investors.
✦
Types of SAFE Contracts
01:16:26The capped SAFE contract involves negotiating a target valuation cap with the company.
The uncapped SAFE contract converts at the same price as the Series A round.
The MFN SAFE contract allows for adjustments based on subsequent investor terms.
The segment also explains the mathematical calculations involved in SAFE conversions and how to understand ownership percentages based on valuation caps.
✦
Valuation cap in a SAFE determines how it converts into shares, not the current valuation of the company.
01:19:45It rewards early investors for taking on more risk.
Conversion of a SAFE into shares occurs during equity financing rounds like Series Seed or Series A.
Terms negotiated in a term sheet impact the number of shares a SAFE converts into, not how it converts.
When a priced round closes, an options pool is created or increased, SAFEs convert into shares, and new money comes in from lead investors.
✦
Explanation of calculating share prices for investors in a round of funding.
01:22:13Number of shares an investor receives is determined by dividing the investment amount by the price per share.
Price per share is calculated by dividing the company's evaluation by the shares issued.
Covers the concept of capitalization, safe holder valuation, and conversion prices for safe investors.
Detailed example provided to illustrate calculations and steps involved in the funding process.
✦
Overview of capitalization of shares and options pools in a company.
01:26:18Cap tables show ownership distribution among founders, employees, and investors.
Safe investors receive more shares early on despite investing less money.
Safe investors face uncertainty about ownership percentage until the priced round.
A rule of thumb is provided for estimating ownership based on investment amount and company valuation.
✦
Discussion on scenarios of mergers, acquisitions, or company failure post safe agreement.
01:30:31In mergers or acquisitions, investors may convert their safes into common stock based on target valuation, leading to potential returns exceeding initial investment.
An 'aqua hire' involves acquiring companies taking talent without converting safes.
Tools like Angel Calc and spreadsheets can help investors model different conversion scenarios and plan for future ownership outcomes.
✦
Challenges faced by companies that fail despite raising money from angel investors.
01:33:10Creditors, including vendors and employees, must be repaid before stockholders receive anything in the dissolution process.
In many cases of dissolution, there is not enough money to pay back investors, indicating a complete failure.
Some companies become self-sustaining and profitable but lack interest in raising more funds or being acquired.
The Safe document does not cater to these scenarios, as it is tailored for high-growth companies, not lifestyle businesses.
✦
The process of signing and converting safes involves a handshake protocol through emails.
01:35:40This protocol ensures agreement between founders and investors and helps avoid misunderstandings before proceeding.
Reputation is crucial, as backing out of a handshake deal is seen as bad practice.
YC founders commonly use Clerke, an online platform for sending and signing safes with standard YC safe templates.
The platform allows for specific investment details to be added, includes wire details, and founders may use other platforms like HelloSign for signing documents.
✦
Key Highlights on Investor Due Diligence and Process
01:39:18Investors are advised to thoroughly review all details in documents, such as legal names and signature blocks, before signing.
It is important to promptly wire money after signing to confirm the agreement.
Founders appreciate investors who are quick to act and do not prolong the investment process.
When safes convert, additional documents negotiated by lead investors and legal teams will need to be signed.
Reviewing conversion calculations and cap tables is crucial due to common mistakes.
Founders may set sudden closing dates, requiring investors to be prepared to act promptly.
✦
Importance of being satisfied with investment documents before signing.
01:44:16Focus on potential upside rather than negotiating downside protection.
Be a helpful angel investor without being overbearing.
Tolerate failure and pivots in startups.
SAFEs are complex, key takeaways include using them for investment, understanding rights as a holder, and practicing patience in the startup process.
✦
Importance of long-term commitment and strategic investment decisions in staying with a company through its ups and downs.
01:44:45Cap and Series A valuations are crucial in determining investment outcomes and potential rewards.
Early investors have significant upside potential in their investments.
Discussion includes pro-rata rights, dilution concerns, and how investment type (safe, convertible note, equity) affects returns.
Emphasis on maximizing gains through long-term commitment and strategic investment decisions.
✦
Importance of Dilution and Valuation Caps in Fundraising.
01:50:25Founders should prioritize treating investors fairly and honoring their pro rata rights.
It is essential to push back against lead investors who do not respect the terms of the safe and enforce contractual rights.
Lawyers can assist in ensuring compliance with agreements and protecting the interests of founders.
Founders must be proactive in understanding and advocating for their rights throughout the fundraising process.
✦
Investment decisions as an LLC or individual depend on circumstances, with direct investment recommended for personal funds and pooled investments benefiting from an LLC structure.
01:52:15Changes in seed round dynamics over time explain the absence of pro rata in conversion rounds.
Angel investors often negotiate side letters to secure pro rata rights for additional share purchases.
The speaker emphasizes the flexibility of investment strategies and the suitability of the SAFE document for various investment approaches.
The SAFE document is highlighted for its simplicity compared to traditional documents like the PPM for priced rounds.
✦
Use of safes in investments varies by country and situation, with some companies in India unable to use them.
01:57:26Lead investors are becoming more strategic in safe conversions to minimize dilution.
Pro-rata rights in conversion rounds are becoming a trend.
Founders often struggle to understand safe terms and implications, requiring education on dilution and pre-money conversions.
The safe document itself does not specify pre-money or round conversions, focusing on defining capitalization and conversion price.
✦
Importance of Legal Structures for Startups
02:01:31Investing in Delaware C-corporations is recommended for startups, with additional research needed for foreign companies.
Preference for C-corporations over LLCs for high-growth companies is emphasized.
Negotiating terms such as target valuation or discount rate with companies is discussed.
The need for clarity and negotiation in securing the best possible terms for both parties involved in the investment is highlighted.
✦
Understanding safe and convertible complexities in startup investing is crucial.
02:04:22The speaker developed angel calc to model safe conversions.
Transparency with founders and protecting investor rights is essential.
Investors should address conflicts with founders directly to avoid jeopardizing deals.
Power dynamics typically favor founders, so investors should be cautious yet fair in their dealings.
✦
Importance of being safe rather than in debt and supporting the founder as an investor.
02:06:50Discussion on founder meetings, investing experiences, and a conversation with the CEO of Y Combinator.
Event concludes with a thank you message and a reminder about the next day's schedule.
01:51and the the way the course is organized
01:55is there's a lecture and then there's a
01:56QA afterwards so please hold your
01:58questions until the Q&A session at the
02:02end unless the an instructor explicitly
02:04says they want questions during their
02:06talk I will also take questions from the
02:13streaming audience too to ask a question
02:17please use the Twitter hash tag pound
02:21ycs is and will take as many of those
02:24questions as we can time willing so
02:31there's a mixture here of watching a
02:34class of accredited and non-accredited
02:35investors for the accredited investors
02:41as most of you know we are going to be
02:43an extent going to be extending an
02:45invite to YC winter 2018 demo days which
02:50are March 19th and 20th it's a virtual
02:52invite you can watch it online but also
02:54as a cool little kicker we're going to
02:57invite randomly ten of you to come in
03:00person to YC demo day which is which is
03:03kind of a pretty special occasion and
03:05and I hope I hope whoever comes enjoys
03:08it a lot so this is our first time
03:15teaching this class hopefully not the
03:18last we do ask you guys to give us
03:21feedback for what worked what didn't
03:23work what was too obvious or too subtle
03:25what was missing at the end of the class
03:27will be a survey I'll say this again at
03:29the end but please do give us feedback
03:31you can also give us feedback real-time
03:34as you like you can email me at Jeff GE
03:36o FF at Y Combinator comm anytime you
03:38like honest opinions are great I want to
03:43start off also by pointing out I won't
03:46be up here very much it's mostly a bunch
03:48of instructors from inside and outside
03:50YC they're all volunteers and they're
03:52very busy people and they've been
03:53gracious enough to donate their
03:56incredible experience and time to us and
03:58I'm I'm very grateful for everyone who
04:00said who agreed to do this
04:05before we get started I wanted to spend
04:07a couple of minutes saying why talking
04:10about why we're doing this
04:13how many of you have made angel
04:15investments before could you raise your
04:16hands so you don't need any of this crap
04:19you guys have already done this okay so
04:21there's a lot of experience and we know
04:23there's a lot of experience but we're
04:27doing this for mainly two reasons one is
04:30that angel and seed investors are a
04:33critical part of this startup ecosystem
04:35it's the first money in usually it's
04:37what allows companies to actually take
04:39flight and and become real big
04:42interesting scalable companies it's also
04:46a little self-serving we think that more
04:48great angel investors great seed
04:50investors are great for YC companies and
04:53we hope you will invest in YC companies
04:55the we also think it's good for you for
04:58people people who have all of you who
05:00have invested you know it's an amazing
05:01way to get a window into the to the
05:04future to be part of this future that
05:06that founders are really creating to get
05:09a window into what's going to happen so
05:11so it's all good what are we hoping the
05:15outcomes will be venture investing has
05:19been around for hundreds of years but
05:24really the kind of venture investing
05:26that that we think of in Silicon Valley
05:27for the last 50 years this guy named
05:29George doriel made made a he was a VC he
05:33was an early VC this firm called AR DC
05:36and he made what we'd consider a seed
05:38investment of $70,000 in 1957 until this
05:42new tiny computer company called Digital
05:45Equipment Corporation sometimes called
05:48digital often called DAC and that
05:50$70,000 turned into 35 million dollars
05:54which a lot of people found pretty
05:56interesting that led to what
05:59kick-started an incredible flowering of
06:01innovation and and a lot of wealth
06:03creation that that has never seen the
06:07like in the world and we hope that some
06:12of y'all had that same experience
06:13hopefully investing in YC companies it's
06:16still possible
06:17and there's lots of examples and if
06:19we're lucky some of the folks who are
06:21gonna talk to you we'll give you some of
06:23those examples
06:26so we also hope that you all go to be
06:29better smarter investors after this
06:32course I'm sure that's why some of you
06:35are here some of you are here to get
06:37some of those insights and I'm sure also
06:39that you will tell us if if we achieve
06:41that goal and lastly we want to create a
06:45permanent repository of this information
06:48so anyone can make use of it in future
06:54years so we hope to make the repository
06:57better and better and in fact if there's
06:59anything that you all you can you can
07:00look at this online that investors that
07:02startup school.org
07:03and if there's anything you think we
07:05should add just mail it to start-up
07:07school at Y Combinator calm and well
07:12we'll look at it and if we like it we'll
07:13add it ok very briefly now we have four
07:22days about ten hours so we can only
07:26cover so much this is going to be about
07:28the fundamentals of startup investing
07:31there will be a few deeper dives but not
07:33that many we want to hit the major
07:35points kind of like a an investing 101 I
07:41guess we will start off with fundamental
07:44questions of why how and which companies
07:47and that's today and then we'll talk
07:50about the mechanics of startup investing
07:54clearly many of you know these mechanics
07:56but I think we'll cover it perhaps in
07:59ways you haven't seen before then we're
08:03going to walk through some of the dance
08:04that you have to do to make your
08:07decisions and to to talk with
08:08entrepreneurs and founders and and
08:12figure out which are the companies that
08:13are going to be part of of your
08:15investing future we're going to hear
08:18from a bunch of extraordinarily
08:20experienced and talented at least by the
08:24results investors during the course and
08:28and then we're going to complete with a
08:31a little bit of context and and a little
08:35bit of a look towards the the future of
08:37startup investing startup investing has
08:39changed radically over the last decade
08:42and I think most of ex-us expect a lot
08:45more changes in the next decade as well
08:48and in the end we'll finish up with a
08:52conversation about the role that you all
08:55can and may want to play as you think
09:00about your role as an investor and what
09:02that means
09:03I hope you all make it to the end I
09:06think it's going to be really useful and
09:08I think we have a pretty great lineup of
09:10instructors that'll be very relevant and
09:14useful to everyone so with that I'm
09:17going to turn it over to our first
09:19speaker Sam Altman the president of Y
09:23Combinator who actually had the original
09:25idea for this course so I'm pretty
09:27grateful for that and he's also the man
09:30who has said you want to sound crazy but
09:34you want to actually be right Sam
09:45thank you Jeff and thank you all for
09:49coming this is it's cool to see so many
09:51people in the room so I want to talk
09:54about why how and and what to do to
09:58invest in startups I'm only gonna talk a
10:00little bit about why especially given
10:02how many of you already invest in
10:04startups but I did do something to get
10:06ready for this class which was I asked
10:09some of the best investors I know why
10:11they invest in startups and I contract
10:14Oh Steven I think it's automatically
10:16advancing no problem so and then I
10:22compared that with reasons I've heard
10:23from other people who I don't think are
10:25as good and I think it is worth thinking
10:27about why the people who have sort of
10:30done the best in the field what their
10:31motivations are to invest perfect this
10:36was one I heard from a few people these
10:38exact three words from a few different
10:39people and this resonates with me the
10:42thing that I like the most about
10:43investing in startups is that it's
10:44energizing I feel like I am constantly
10:47on working with people that are not
10:49burned out on the world at all they have
10:50unlimited energy they have new ideas and
10:53they have the sort of the beauty of
10:55inexperience and they don't know they're
10:57your people that are doing things for
10:59the first time are willing to do things
11:00that anyone who has got a few more
11:03battle scars won't try and that is
11:05incredibly energizing to be around help
11:09shaping the future was something that
11:10the very best investors said again and
11:12again and as part of that the leverage
11:16on time the ability to work on multiple
11:18things came up again and again and again
11:22most of the time you lose one extra
11:24money but occasionally you do get to
11:26make a hundred or a thousand decks and
11:28that for the same reason slot machines
11:31are so satisfying is incredibly
11:33addictive it's also satisfying because
11:37every once in a while a founder of a
11:39great company who is you know no super
11:41famous will tell you hey that thing you
11:43did for me eight or ten years ago was
11:46this make or break difference to my
11:47entire career and that's that's deeply
11:50gratifying you get to be around some of
11:54the most talented people in the world
11:56there is this sense of just
11:58endless optimism around the future that
12:01is really important to my own personal
12:02happiness to be around and I haven't
12:04found that in too many other places in
12:06the world besides startup founders it's
12:10incredibly humbling I write on the back
12:13of every stock certificate on a post-it
12:15note my confidence interval and what I
12:16thought was gonna happen with the
12:17company and you get used to being wrong
12:20a lot and that framework that mental
12:24adjustment that you know you're usually
12:26gonna be wrong that has been helpful to
12:28me and everything else I've done in life
12:29you do learn a lot though and if you if
12:33you treat this as something that you're
12:35gonna try to get better at and sort of
12:37deliberately practice ah you can learn a
12:41lot and you can get better at this
12:42really quickly all right so now I want
12:46to move into the two main sections the
12:48how and the what the number one mistake
12:53that I used to make when I started
12:55investing was actually not a
12:57misunderstanding of the power law the
12:58number one mistake was that I cared too
13:00much about what other investors thought
13:01and the sooner you can free yourself of
13:03this the better the I think this is a
13:06very common mistake that people make
13:08when they start investing you get very
13:10swayed by what previously successful
13:13investors think the first question that
13:15most people ask why see startups is who
13:17else is invested in year round people
13:19totally outsource I would say 80% of
13:23investors outsource 80% of their
13:25decision-making to what other people
13:27think about an investment opportunity
13:28the problem is everyone does that
13:31and so there's this weird schooling
13:33effect where a company gets hot for no
13:35discernible reason or it fits a trend or
13:37whatever and then everybody wants to
13:39invest in one company and it's just
13:41because a few people decided they liked
13:43it so the number one mistake I made was
13:46to be too swayed by what other investors
13:48thought good and bad about a company
13:49after I corrected for that the second
13:54biggest mistake I made was not investing
13:55the power and not understanding the
13:56power law the power law means that your
14:00single best investment will be worth
14:03more to you in return than all of the
14:05rest of your investments put together
14:06your second best will be better than 3
14:09through infinity put together
14:11and this is like a deeply true thing
14:13that most investors find and this is so
14:16counterintuitive that it means almost
14:18everyone invests the wrong way so the
14:20question that you should be thinking
14:22about the question that most people
14:24think about when they start angel
14:25investing is can I hit a bunch of
14:27singles and in most other kinds of
14:30investing that's the right way to do it
14:31you know if you're going to invest in
14:32stocks or bonds or whatever that's how
14:34you do it you're just compounding
14:35singles for a long time but angel
14:39investing is a business of homeruns and
14:40you want to look for things that can be
14:43potential homeruns and we're going to
14:45talk about that again and again through
14:46this but this is I think the most
14:48important thing to learn and the thing
14:51that most investors get wrong so it's
14:54all about it's all about the magnitude
14:59if your biggest success it is not about
15:01the failure rate most investors talk
15:04about their failure rate still you know
15:05when we have people that are trying to
15:07build angel firms come talk the question
15:10the first question they ask is what is
15:12your failure rate what's an acceptable
15:13failure rate totally the wrong question
15:15totally the wrong way to think about
15:17angel investing you can have 95% of your
15:20investments fail if one of them returns
15:22a billion dollars and you'll be totally
15:23happy and so this is what you want to
15:27think about the first question that I
15:28try to ask myself when I meet a start-up
15:31is not why is it going to fail it's not
15:33what could go wrong the first question
15:35is how big could this be if it works can
15:38I imagine this founder this idea this
15:40market supporting a you know massive
15:44massive company and then I think about
15:47all the things that could go wrong but I
15:48found that if I thought about what could
15:50go wrong first I filtered out the
15:51companies that could be giant the
15:53companies that could be giant are at
15:54this intersection of sounds like a bad
15:57idea is a good idea and because that's a
16:00very narrow intersection and because
16:02they sound like a bad idea the best
16:04investments are the ones that are
16:05easiest to talk yourself out of if you
16:07start off thinking about why they could
16:08go wrong so then there's a question
16:12about how do you find these companies
16:14how do you find the companies that can
16:15be the handful of companies that get
16:18started every decade that are
16:20responsible for almost all of the
16:22returns just to put some numbers on the
16:25power
16:26YC has funded I think around 1,600
16:29companies maybe 1700 our top five
16:33companies represent about two-thirds of
16:36the value that we've created and our top
16:38one company represents about one third
16:39so this is like a nearly one-third so
16:43this is like this very extreme very
16:44counterintuitive thing all right how do
16:46you find these companies another thing
16:50that I think is surprising is many of
16:52these companies that are sort of a
16:54generation-defining companies are
16:56started by people who are out of network
16:59who are not well-known who are not sort
17:01of the people that you know can start a
17:05company and get a bunch of press right
17:06away and so you have to find these and
17:09that the best way to do that is from
17:11other founders this is part of what we
17:14try to do at YC is we try to get our
17:16founders to like us so much that they
17:18refer all of their friends to us because
17:21they say these you know YC creates so
17:23much more value than it takes you've got
17:25to go work with them and we this idea of
17:29like word-of-mouth
17:30as the way to find companies to invest
17:33in has been great if you're just
17:34starting out I think what I have seen
17:36the most successful angel investors do
17:39is just start helping founders for free
17:41realizing they may not get to invest in
17:43those companies but that they'll get the
17:45referrals down the road and so much of
17:47this is about people connecting you to
17:49other people that you don't know we
17:52talked about this at YC this value of an
17:53open network a lot of angel investors
17:56like to brag about how difficult it is
17:58to get a meeting with them how you have
17:59to have a connection otherwise they'll
18:00never take you seriously and it's got to
18:03be from like you know someone they
18:05worked with a bunch and you've got to be
18:06well-known and experienced and we just
18:09make it really clear anyone in the world
18:11can go to our website click apply
18:13we try to respond to emails to people
18:14that email us we take people seriously
18:17that have no personal brand no
18:19reputation no network we ask people that
18:23are in our network to connect us to the
18:25most promising people they know that we
18:27don't already know but this idea that
18:29were available and we're open I think
18:33this was in the two or three most
18:35important secrets of YC this was
18:37something that we did that was
18:39different other people hadn't done it
18:40before in fact people bragged about the
18:42opposite and we went totally other
18:44direction and I strongly recommend this
18:46be be open to that random email that
18:49comes in be open to the introduction of
18:51someone that on paper doesn't seem like
18:54you know that there's someone you want
18:56to meet nine times out of ten you waste
18:57your time that other time makes it
19:00totally worth it so one big shift that's
19:05happened in the last ten years
19:07I'd say or maybe 15 even is there now
19:09way more people that want to invest in
19:12good startups than there are good
19:14startups and so it founders have really
19:18become in the driver's seat founders
19:20founders of good companies have a lot of
19:22choice when it comes to investors and
19:24founders talk a lot now the network has
19:26gotten big enough that the asymmetry
19:28that used to exist where investors had a
19:30lot of leverage is gone and I don't
19:32think it will come back anytime soon
19:35your reputation matters a lot it is way
19:38more important to your future success as
19:40an investor that founders like you and
19:43say that investor did the right thing by
19:44me than it is that you squeeze out you
19:47know a few drops of juice from a failing
19:49company the number of investors that I
19:51have seen do incredible long-term damage
19:53to their reputation by fighting over the
19:56carcass of a company that was never
19:57because of the power law going to matter
19:59to them anyway but try to get out you
20:01know ten thousand dollars or whatever
20:02from a dying company if you're playing
20:05the long game that's not worth it
20:06reputation especially reputation when a
20:09company is going badly is super super
20:11important and I think that is the secret
20:16at this point in sort of 2018 Silicon
20:19Valley to doing deals the thing that we
20:22tell founders to do and the thing that
20:24founders do anyway when they're trying
20:26to choose between a number of investors
20:28that all want to invest in their company
20:29is they they do reference checks on you
20:31just like you do on them and more and
20:35more the thing that I have seen founders
20:37use is the criteria to make the decision
20:40about which investors to work with is
20:44what the other founders that investor is
20:45fun to have to say and so I think this
20:48will this will continue to be important
20:49there are other things you can do I
20:51think
20:52helping before you close the deal is
20:54good deciding quickly being clear about
20:57your reasoning being responsive being
21:00available all the things you want from a
21:01founder those all help to but but this
21:05reputation of being good to work with
21:07that goes a long way and people remember
21:09that for a long time
21:12the other question I get all the time is
21:14how do I get a good bargain like how do
21:16I get a better term than they're better
21:18terms than everybody else we recently
21:21had a company they had let's say you
21:24know ten investors and that we're gonna
21:25join their seed round every one of the
21:28ten had asked for advisor shares every
21:30one of the ten had said well unlike all
21:32those other investors
21:33I really do work super hard you know I'm
21:35the only investor in a round that
21:36usually gets advisor shares so you need
21:39to give them to participate and
21:40everybody asked for this all ten same
21:42thing I'm the only one I need advisor
21:44shares and I think you know a lot of
21:48people are just looking for a good deal
21:49because valuations feel high they have
21:51felt hi to me for eight seven years now
21:53I went back and looked at my destined us
21:59mminton vestments I've made have either
22:02been a ridiculous deal because no one
22:04else wanted to invest or a deal that
22:06felt incredibly expensive the more I was
22:10willing to sort of overpay in my mind to
22:13invest in a company often the better it
22:15did and especially when I felt like I
22:17was getting screwed if it was like a
22:19huge opera months after some other round
22:21it was painful I did it anyway I think
22:24because the companies that work
22:26sometimes work so fast and you're
22:28anchored to like what a fair deal is you
22:31got to watch out for this but my
22:33experience investing in startups is my
22:37best investments with one or two
22:38exceptions have been the deals that felt
22:40the most expensive to me and the one or
22:42two exceptions were companies where I
22:45understood something that no one else
22:46did and thus there was no competition
22:48whatsoever
22:49other than that the company is where I
22:51like tried to value invest have not been
22:55as good I think
22:56value investing is not a winning
22:58strategy when it comes to being an angel
23:01investor most of the time
23:04all right I will try to go kind of fast
23:07to this to leave time for questions so
23:10there's a big question of what to invest
23:12in and here's the framework I use I will
23:16consider anything that I believe could
23:18be a ten billion dollar company and that
23:21is such a tight criteria I have no other
23:24rules so I am willing to look at any
23:26stage I'm willing to look at any sector
23:29I am willing to look at any business
23:30model there are other investors who have
23:33this like oh I only do this one thing at
23:35this one stage and maybe they make that
23:38work I have never figured out how to do
23:40that the good the great companies the
23:43companies that are in that number one
23:44spot on the power-law are so rare that I
23:48suggest you only select four things that
23:50can be there and other than that be
23:52really open-minded speaking of the
23:57really big companies I think I don't
24:00know if this was always true I suspect
24:01it may have been but I think today it is
24:04easier to start a hard company than an
24:06easy company and this sounds super
24:08counterintuitive but if you're gonna
24:10build a really big company you got to
24:12convince people to come work with you to
24:14pay attention to you to write press
24:15articles about you to care about you to
24:17advise you and if you are starting the
24:19twenty two thousand the photo-sharing
24:21application it's really hard if you are
24:24starting a nuclear fusion company a lot
24:26of people want to help with that and I
24:29think especially for the companies that
24:31end up breaking out this is really
24:34important you know this thing that is so
24:36interesting people proactively want to
24:38help you for free want to come be part
24:39of your team whatever this is something
24:42to look for so like is this a company
24:45that I believe will be able to recruit
24:47hundreds of really talented people who
24:49could otherwise start their own
24:50companies is a super important filter
24:52that I don't think people think about
24:54enough one thing that we've learned at
24:57YC is to mostly pick the founders it is
25:01difficult to hear an idea at the very
25:05early stage and say yeah this idea has
25:07what it takes to be a ten billion dollar
25:09company you can say an idea doesn't have
25:11it which we'll talk about but it's
25:13difficult to say this is for sure the
25:14big idea however
25:18I think you can with practice identify
25:20founders and I'm going to talk about how
25:22that have it have a chance at creating
25:24one of these companies Paul boo hi one
25:27of our partners made a list of the four
25:28traits that he thought founders that go
25:31on to create giant companies have and
25:32they are obsession focused formality and
25:35love um he said this sort of in passing
25:38in a meeting like two or three years ago
25:39I've thought about it a lot since
25:42there's there's other obvious things
25:44that everyone screens for but pay
25:48attention to these speaking of the
25:51obvious things that everyone screens for
25:54intelligence is really important you can
25:56give a founder an idea and they can
26:01start a company the problem is they need
26:04to come up with new ideas for a company
26:06basically like every week you have to
26:08come up with crazy new ideas big changes
26:10all the time we we tried an experiment
26:12once at YC we funded twenty teams of
26:16strong founders that didn't have ideas
26:17but were otherwise really good and what
26:20we learned they all failed and what we
26:21learned is that the good founders are
26:24the people that have ideas all the time
26:26so there's an intelligence components to
26:28this there's a creativity component to
26:30this there is an ability to think
26:32independent thoughts component to this
26:34but whatever you want to call this this
26:36idea of this particular kind of
26:38intelligence that leads to seeing
26:40problems in different ways and thinking
26:42of ideas that don't yet exist but should
26:44you've got to have that in a founder
26:49communication skills I think are one of
26:51the most important founder
26:56qualifications that people don't think
26:58about enough so so much of your job as a
27:01founder is about communication you are
27:04every time you hire someone every time
27:07you go raise money every time you try to
27:09sell the product every time you try and
27:11set a direction for the company you do
27:13it like a huge amount of a founders job
27:15is being an evangelist for the company
27:18and if you don't have really strong
27:22communication skills or if you don't
27:23develop them quickly
27:24you're at a big disadvantage think about
27:27their there are obviously famous
27:29exceptions to this but if you think
27:30about it on the whole
27:31the founders of the really super
27:33successful companies tend to be great
27:35communicators execution speed there's a
27:40lot of ways to measure this but and we
27:44talk about this a lot the need to sort
27:45of relentlessly execute as a founder
27:49this is incredibly correlated with
27:51success so one way we test this during
27:54YC is between office hours which we have
27:56every week or 10 days how much progress
27:59do the founders make how quickly do they
28:01take a new idea and try it and say hey I
28:04came back and I tried that this didn't
28:07work but this other thing did in the
28:08process I had these three new ideas I
28:09tried those just this relentless cadence
28:13of execution is incredibly predictive of
28:16success and it we had a joke once where
28:21the there were all these founders who
28:23are incredible on paper they never
28:26actually quickly they always have great
28:28reasons for why they didn't but they
28:31still never go and be successful and
28:32then there are these people who just
28:34like get an amazing amount of stuff done
28:36they their iteration speed the speed
28:40with which they can have a hypothesis
28:42tested and implement it is unbelievable
28:45that's really correlated with with huge
28:46success the rate of improvement of the
28:52founder so if you look at a founder who
28:57comes to meet you for a seed round and
29:00compare that founder to Brian Chesky you
29:02will be disappointed 100% of the time
29:05that is the wrong comparison you will
29:06never write a check however just like
29:11startups you look at the growth rate you
29:15should look at the growth rate of the
29:16founder as well so one thing that we can
29:19often tell over the 10 weeks of YC is
29:21how fast a founder is improving this is
29:23different than how fast the business is
29:25improving and you know like humans
29:30always underestimate exponential growth
29:32we're not we're not well evolved for
29:34that and so if you notice a founder who
29:36is improving incredibly quickly over the
29:38couple of months you get to know that
29:40founder pay a lot of attention again you
29:44won't you
29:45won't get Brian Chesky in a first
29:47meeting but you can find people who are
29:48on a trajectory to develop into a Brian
29:51Chesky and that is super valuable this
29:54is one of those things where I have seen
29:57it you know maybe like 10 times in my
29:59career so far where I just knew that
30:01this founder was going to like develop
30:04into an incredible leader and it's
30:06basically been every time I felt it it's
30:07been right I really do trust this like
30:10this rate of improvement metric I think
30:14one thing you have to be increasingly
30:16aware of are the wrong motivations so
30:20starting a startup is a very long-term
30:23commitment you know if it's gonna work
30:25it takes more than a decade it's really
30:28hard there are a lot of days where you
30:29just want to give up and there are a lot
30:31of people now who start a startup
30:32because they think it is a way to get
30:34rich quickly and unfortunately it's just
30:38not so as startups have become the new
30:41default career trajectory for ambitious
30:44people there are a lot of people who are
30:46doing a start-up as a resume item or as
30:48a way to get rich quickly this does not
30:50work the amount of pain that you have to
30:53suffer for a start-up you realize at
30:55some point you know what I can do pretty
30:57well in any series of other jobs with
31:00much less risk and much less negative
31:02effect on my life so you really do want
31:06to stay focused on the mission driven
31:07founders again if we look at our own
31:10success and failures in our portfolio of
31:13YC every time we thought a company was
31:19going to go really well and didn't the
31:22company the founder did not have this
31:24deep sense of mission so it's something
31:25we really look for as a primary
31:27motivation and then another way I used
31:32to get tricked a lot is there were
31:34founders that I didn't think we're that
31:36good but they hate to stumble on a nice
31:37business or you know they had this
31:40metric that was growing pretty well or
31:41all of my other investor friends were
31:45investing and so I got scared and did it
31:46anyway but but I think this focus on
31:51truly exceptional founders like people
31:53that I'm like wow I want to go work for
31:54him or her is really important I've I've
31:58I have never once made a lot of money
32:01backing a founder that I thought was
32:02only okay but a business that was
32:04otherwise good I talked a little about
32:09this but we have a word of YC called
32:10scenesters this is different than people
32:12who just want to make a lot of money
32:13there are increasing number of people
32:15who just like want to be around startups
32:19and go to startup parties and talk about
32:21being a founder treat that as a red flag
32:24obviously low integrity people um that
32:27doesn't work out either okay um this is
32:31maybe the third biggest misunderstand
32:34you know I had and I think for many
32:35people it's their number one biggest
32:37misunderstanding people always say that
32:41what matters is not a startups current
32:43revenue but its growth rate and that's
32:45true however in the same sentence
32:47investors will say but the only thing I
32:49care about is the size of the market
32:50today and this is obviously ridiculous
32:53on its face right like if you think
32:55about the biggest companies today ten
32:58years ago many of those markets did not
33:00exist if you think about the size of the
33:02social networking market when Facebook
33:04started if you think about the size of
33:06ride-sharing apps when uber started
33:10that's a really bad metric and
33:12unfortunately it has become Dogma among
33:13investors that you know size of the
33:15market is the most important thing even
33:17really good investors say this I think
33:21they either I think they actually mean
33:23what they care about is the size of the
33:25market in ten years but they don't say
33:27it that way
33:27and what you should care about of course
33:29is the size of the market in ten years
33:31if the market is huge today first of all
33:35you probably have a lot of big
33:36competitors already going after it big
33:39companies from doing that second of all
33:40you don't get to surf this wave of this
33:42new technological change that pulls
33:44startups along and creates a ton of
33:47value in a short period of time but you
33:49should prefer a small market growing
33:51super quickly to a very large market
33:54today
33:54super counterintuitive if you chase the
33:57things that worked in the last set of
34:00companies which is what most investors
34:02do you know Facebook works they all want
34:04to fund more social networks
34:05uber works they want to fund more what
34:07ride-sharing apps that is much harder to
34:10do the second time it's far better
34:12but more difficult if you can identify
34:14the next rapidly growing market and
34:17invest there this is where this is where
34:22independent thought is really important
34:24if this is not something where you can
34:26just sort of follow what everybody else
34:28says by definition you've got to learn
34:30to form your own thoughts about about
34:33what the next really big market is going
34:34to be one way that I like to do this one
34:38way that I like to say you know is the
34:40market growing really quickly is to
34:43think about this question of whether
34:44something is a real trend or a fake
34:46trend and I'll talk about that in a
34:48second actually right now okay so it has
34:54almost become a joke to make fun of like
34:57angel investors moving like a school of
35:00fish after one you know declaring
35:02somebody's a hot trend and then two
35:04years later never talking about that
35:05again and saying well that just didn't
35:07work but so there's this question but
35:09sometimes they're right you know
35:11investors in Silicon Valley as a whole
35:13for example got mobile right as a thing
35:16in a big way but then they got most
35:18other things in the last ten years wrong
35:19and I think every time someone talks
35:21about a big trend my first reaction is
35:24skepticism and I suggest yours is as
35:26well okay but how do you differentiate
35:28between a real trend and a fake trend a
35:32real trend is one where although not
35:36that many people are participating yet
35:39the people who are use the platform a
35:42lot every day and tell their friends
35:45spontaneously how great it is so when
35:48the iPhone came out most of the mobile
35:51industry would make fun of it because
35:52Apple only sold a million or two million
35:54whatever it was in the first year but if
35:57you talk to anyone who had an iPhone
35:58they would say this is the greatest
36:00piece of like you know technology I've
36:02ever had people used it like many hours
36:05every day they it was absolutely
36:08life-changing so even though the number
36:10of people that had it were small you
36:11could identify that as a real trend
36:13because the people who had it were not
36:16only like daily active users but hourly
36:17active users and they were they were the
36:20best free advertising Apple could ever
36:22have hoped for because they told
36:24everyone like this is the future you've
36:25got
36:26if you contrast that to something like I
36:29got to pick on somebody I'll pick
36:31virtual reality if you contrast that to
36:33virtual reality everyone talks about it
36:35is the next trend it may be in the
36:37future but today if you talk to people
36:39who have VR headsets they don't use them
36:42every hour they don't use them every day
36:43most of them don't use them every week
36:45they sit on shelves that has clearly not
36:48become a a real trend platform yet it
36:51may in the future and the point at which
36:53you know people that you know are a lot
36:56of people you know small number of
36:57people you know even start putting their
36:59headset on for hours every day and
37:01telling all their friends they've got to
37:02buy one it's the greatest thing in the
37:03world that is the time to start
37:05investing heavily in VR
37:20so so this question you know are people
37:23actually using the platform I think is a
37:25really important one when you're trying
37:26to think about you know the next
37:27technology wave and you do want to try
37:29to figure this out you do want to try to
37:30figure this out the certainly not all
37:35but most of the biggest technology
37:36companies get created soon after one of
37:39these massive platform shifts Sequoia
37:42says this thing that I've always liked
37:43which is you cannot create a technology
37:45wave that is well beyond the capability
37:49of a small company to do but you can
37:51surf one if you can find the wave and I
37:53think that's really important and I
37:54think it's actually like if you use this
37:57framework pretty reasonable to evaluate
38:02ok so I mentioned this a little bit
38:05earlier what you are looking for are
38:07good ideas that look like bad ideas
38:11these are things that you can articulate
38:13there is a reason that this is going to
38:16be huge that most of the world is
38:17missing
38:19unfortunately what most people end up
38:21chasing are bad ideas that look like
38:22good ideas I would say this is where
38:25like 90% of all angel capital and the
38:28startup ecosystem goes so this is
38:33something that is worth trying to avoid
38:34and the one very common way that people
38:39make this mistake bad ideas that look
38:41like good ideas are chasing the thing
38:45that worked 2 years ago and so if you
38:48ever find yourself doing that be very
38:50skeptical if you find yourself tempted
38:53to invest in one company where there's
38:55hundreds of others working the same
38:57thing be very skeptical if you find
39:00yourself tempted to work on something
39:02that the founders work super hard to
39:06convince you is not going to be a
39:07long-term commodity be very skeptical
39:10the more people talk about like it is
39:13absolutely true that you want to
39:15something that has real pricing power
39:18that comes from a network effect a moat
39:20a varied entry whatever it is but the
39:25more founders tried it like when that's
39:27true it's so obvious that the more
39:28founders try to sell you on why they're
39:30super differentiated and why they have
39:32this long-term competitive
39:34the more skeptical you should be but I
39:36have found this framework just trying to
39:38think about is this a good idea that
39:40seems bad or is this a bad idea that
39:42seems good I found that has helped me
39:45make good decisions a bunch of times
39:48this is sort of ycs mantra but it's so
39:51important that I want to talk about it
39:53again the the best companies all have
39:57great products unfortunately the current
40:00fashion in Silicon Valley I think has
40:04gone a little bit too away from this and
40:05it's too much about growth hacking and
40:08sales and marketing machines and
40:09everything else and that does work for a
40:12while you know you can get away actually
40:15for a pretty long while by executing
40:17really well to grow a mediocre product
40:21but you don't usually create like a
40:24Facebook size company by doing that and
40:27I think asking it become the companies
40:31often won't have a great product by the
40:33time you're making an angel investment
40:35but if you don't believe they can't
40:37won't get there at some point it I don't
40:41think it'll be a huge company most of
40:43the time and and here is the very simple
40:46framework I use for this if I think
40:48about all of the most successful
40:51internet and mobile startups I heard
40:54about those because this is like true
40:57for enterprise and consumer apps I heard
41:00about those because they were so good
41:01that one of my friends spontaneously
41:04told me about it they were not being
41:06incentivized to that was not they didn't
41:08mark it to me didn't advertise to me it
41:09was just like someone I trusted said you
41:12got to try this new thing it's amazing
41:13and if the startup is not gonna get
41:17there I think they will not be at that
41:20number one spot
41:21on your on your power-law of returns so
41:23I think this is like a really important
41:24filter related to that and I mentioned
41:29this earlier a little bit human
41:31intuitions about exponential growth are
41:32terrible we clearly had no evolutionary
41:35need for this we can like visualize
41:37linear growth very well we can like you
41:39know visualize the trajectory of an
41:40arrow very well we very few people that
41:43I have met actually maybe none can sort
41:46of tell me what
41:47you know like let's say 25% monthly
41:50growth 1.25 to the 36th power is say
41:53where well it's coming to be in 36
41:54months it's really hard and it is how
41:58these companies get super valuable so I
42:02long ago learned to stop trying to trust
42:05my intuition on this now and I just
42:07model it out and I try to model the
42:09decay rate about how how much I think
42:11growth will slow down but I try to say
42:13okay you know given that this company is
42:15growing by word of mouth how big can it
42:18be in five years and yeah I've learned
42:21not to trust my intuition on that I
42:26mentioned this a little bit earlier but
42:29I wanted to mention this near the end of
42:31the presentation there are a whole bunch
42:33of words a whole bunch of different ways
42:35that people talk about this this is one
42:37of the most important concepts in
42:39start-up investing this is one of the
42:41things that differentiates investing in
42:44startups from investing in small
42:45businesses um you are looking for a
42:48company that gets more powerful as it
42:51gets bigger you are looking for a
42:53company that gets increasing pricing
42:54power as it gets bigger you were looking
42:56for a company that has an easier time
42:57getting more users as it gets bigger
42:59that gets harder to compete with as it
43:01gets bigger and you know this is often
43:05fairly obvious sometimes it's not
43:08sometimes you really have to think hard
43:10but you know like once you do you can
43:13come up with a story for it this is
43:16something that a lot of people get wrong
43:17because they get caught up in oh this is
43:19going this is so cool today this company
43:21has discovered this wonderful thing
43:23almost all of the value in a start-up is
43:27the you know revenue the earnings is
43:28going to generate in years 10 11 and 12
43:30from now and so if you can't answer this
43:34be pretty skeptical and then finally one
43:40other question that I like to think
43:41through before making an investment is
43:43what do I understand that other people
43:45don't there can be a lot of answers to
43:47this but this is this comes back to not
43:51basing your decision too much off the
43:53decision of other investors I like to
43:57understand in ax mum if I don't have an
43:59answer to this question
44:01I I don't feel like I have any
44:03competitive edge in there in that
44:05particular investment decision but and
44:09sometimes the answer this question is
44:10just like everyone's bullish on this
44:12company but I'm more bullish because I I
44:14understand a specific thing about this
44:16market and and everyone thinks it's good
44:19I think it's even better so I'll pay
44:20this very high valuation but this is a
44:23question that I have found helpful for
44:26me in in many scenarios all right
44:30unfortunately I took all the time but
44:31maybe I can do like five minutes of
44:32questions we definitely have time for
44:38some questions I just wanted to remind
44:40all the folks who are live-streaming
44:43that the hashtag for questions is is YC
44:47s is it's YC s is I think the beginning
44:51of the livestream might have missed that
44:53so please do send some questions and I
44:55you know we started a little late so
44:57perhaps running a little long and then
44:59we'll take a quick break
45:00Thanks all right yes what can a least
45:08age investors do to add a lot of value
45:09to founders almost all if you ask
45:12founders this which you know they're the
45:14customer here I think that makes sense
45:15almost always the number one thing they
45:17want help with is hiring so helping them
45:20find really good people help them
45:21interview you know back when I was sort
45:23of an active angel investor before YC I
45:25would tell founders like you can use me
45:27as much as you want for interviews like
45:29you I will I will help recruit I will
45:31help source people I well then I will
45:32help close I think people really like
45:34that help with future fundraising and
45:37then help with just sort of like
45:39everyone wants to like provide the big
45:41strategic advice and that is really
45:44valuable I think one of the things that
45:45I did well when I was an angel investor
45:48was I would just try to be available all
45:50the time for tactical advice so I would
45:52meet for like the big strategic what can
45:54this become advice and that's fun but I
45:56think a lot of it'll you comes just from
45:57being available at 11 o'clock on a
45:59Friday night when a founder needs a
46:01two-minute phone call for some emergency
46:02so super availability for tactical
46:05advice I think is good
46:12what flaws are acceptable in a founder
46:14and a you know series cedar series a
46:18stage um a lot I think like don't
46:21compromise on the things that don't get
46:24better like don't don't compromise on a
46:26boundary of integrity but if you think
46:29the founders improving fast I think I
46:32think a lot so I like I bucket this is
46:34traits that I believe can change and
46:36traits that I believe can't and if the
46:38founder is improving quickly and it's
46:39something that I think is changeable you
46:42know we've had many many very
46:45unsophisticated founders but that we're
46:47smart I wanted to learn and were you
46:49know doing this for the right reasons
46:51super mission oriented come through this
46:52door these doors and they have just
46:54progressed really fast so you know they
46:56were founders who I think had like no
47:00domain-specific knowledge about like one
47:03funny thing is when you are negotiated
47:07an investment a lot of the time a
47:09founder who's otherwise very good will
47:10have no idea because they've never done
47:12this before and it kind of spooks you
47:13you're like wow you don't know what like
47:14evaluation is and that's the kind of
47:16thing that's like that's a father that's
47:18okay
47:25how do you judge for integrity with a
47:28founder that comes out of network so in
47:31our experience we we've gotten this
47:33wrong a handful of times but we have
47:35prevented ourselves from this mistake
47:37hundreds of times because even in our 10
47:40minute interview if you give like a
47:41founder a chance to sort of tell you
47:43about the unethical things they do they
47:44will often do it
47:46and yet surprisingly often so I think
47:51the answer is you just listen to the
47:52decisions they've made so far in
47:54building the business and if you're like
47:55that's not a decision I think is okay
47:57you can expect more of them in the
47:58future but just listen in the first few
48:01meetings and you'll be surprised
48:02we definitely have been fooled by plenty
48:04of people but we also make our decisions
48:07in 10 minutes
48:15results-based observations about when to
48:18exercise parada and when not to
48:20several venture firms have done very
48:23sophisticated studies of this and they
48:25have all come to the following
48:26conclusion which is if the company is
48:30raising an up round led by a good VC say
48:33a top quartile VC you should always
48:36exercise pro rata and if you do that
48:39across their whole portfolio you'll be
48:42happy now this could change if the world
48:44really changes and but in the world
48:47today there's like very clear data on
48:48this what's pirata so often when you
48:52invest in a company you will get not
48:54always but often you will get something
48:56called a pro rata right which is your
48:58right in future rounds to invest enough
49:01dollars in the new round to maintain
49:02your ownership level sure
49:32all right do I think security tokens and
49:34icos will change financings probably but
49:42not in the way that most people think I
49:43think this idea that like everyone is
49:46going to just raise money from the crowd
49:48I like I think we'll find out that we
49:51have securities laws for a reason and
49:52that we want some level of that and that
49:56the level of you know I think like there
49:59are some incredibly important ICO is
50:01happening right now but they are dwarfed
50:03by the number of sort of things that are
50:05between just incompetence and scams
50:08however I do think that it's possible
50:11that we just find a much better
50:12mechanical way to track the investments
50:15we do right now so that's possible a bad
50:18idea that seemed sorry a good idea that
50:21seemed like a bad idea you know this is
50:26like one of our darlings but I just like
50:27it's a it's an example that sticks with
50:29me so much because they were in my own
50:31YC class in 2005 was reddit so when
50:35reddit started I remember very clearly
50:37like telling my friends about it because
50:40I was like oh there's this site and you
50:41know you can like find these links and
50:43and and I remember people looking at me
50:45like and they were good well-meaning
50:47people nice people that is the dumbest
50:50thing I've ever heard like there's all
50:53these things already on the Internet
50:55you know this one is just like pictures
50:56of cats or whatever it was at the time
50:59and the in it and there's no way you
51:03will ever make money on this business so
51:06that's like there's other more famous
51:08examples but that is the one that for me
51:10resonates very deeply because I was I
51:15heard so directly from people I trusted
51:17so much and I remember like when they
51:19would say it I would just be like oh
51:20yeah I guess it's not a very good idea
51:22like I had all this conviction that
51:24totally went away when people I trusted
51:26said said said something was bad there's
51:31another common version of
51:34this problem which is where there's an
51:36idea that seems good in the abstract but
51:39everyone assumes the big companies will
51:42crush you
51:42so Dropbox is an example of this where
51:45when when we funded them and when they
51:47were kind of getting going everyone was
51:48like oh it's a perfectly nice product
51:50but you know Google Microsoft whatever
51:53guaranteed to crush them soon all right
51:56other questions yes
52:12um you know when uber was getting going
52:17there were there would be all of these
52:18articles that would come out it felt
52:19like every year where someone would say
52:21uber is not worth X the entire taxi
52:23market is only worth you know 10% of X
52:26and so and this just this kept going um
52:29and that is really hard right because
52:31you don't you don't have a sense for
52:35exactly how big the market is because
52:37growing so quickly I think one thing you
52:39can do is look at like shifts in
52:41consumer behavior that are creating new
52:43markets so like if you thought of uber
52:47as a replacement for booking limo
52:49services that was one thing if you then
52:52started to realize that people had begun
52:54to use it as a replacement for taxis and
52:57then public transit and then car
52:58ownership you could project forward Wow
53:00this market is actually going to be
53:02quite big because all of this other
53:04consumer behavior is going to shift here
53:26um all right a solo non-technical
53:30founder I wouldn't say I never would
53:33I've done it before
53:34I think it can work I do like it when
53:36that founder learns enough to build an
53:40MVP where I've seen that go wrong the
53:43most often is then the ability to
53:46attract evaluate and retain technical
53:48talent and so we have a strong strong
53:53preference for founding teams that have
53:56at least one technical founder we also
53:58have a strong preference for teams that
54:01have at least two co-founders again none
54:03of these are absolutes because this is
54:05all about the power law we are always
54:07willing to consider exceptions so I
54:09would never answer a question like that
54:10and sad would never but I would try to
54:12be clear like here's what I've seen work
54:14more often what is the next question
54:16Oh a good amount of self-awareness um I
54:26think I think a good amount of like
54:29willingness to take a feedback and a
54:32drive and a desire to improve is really
54:34important but you know you you do also
54:39have to sort of believe that you can
54:41succeed in spite of all of your flaws
54:42and and so that that's almost more
54:46important to me than like someone who
54:48really spends a lot of time categorizing
54:50everything about it if they're willing
54:52to listen willing to improve I've
54:54usually found I can work with that
54:55founder one more question in the back
55:04how do you think about evaluating your
55:06time and resources to different founders
55:08a self-indulgent way to do this but one
55:12that works is only fund founders that
55:15you want to allocate a lot of time to
55:17because if you don't and if you're like
55:19if the founder is like difficult to work
55:21with or doesn't listen or you're just
55:24not excited about the business a that's
55:26probably a red flag for their qualities
55:28as a founder and be you then you won't
55:31spend time and you won't help them and
55:32you won't get this differentiated things
55:33so I like I won't fund a founder that I
55:40don't want to spend a lot of time
55:41helping and as that has always worked
55:43pretty well for me all right thank you
55:46all very much so just just a couple of
55:56quick notes Sam mentioned that you want
56:01to look for founders who understand that
56:05startup success can take as long as a
56:07decade or more I think it should be
56:09obvious that the same thing is true for
56:11for you all investing investing is not
56:14again investing startups I should say is
56:16not a get-rich-quick scheme it requires
56:21both patience and passion the the the
56:25interest that that that is hopefully
56:28reciprocated by the founder and the
56:30second thing I will point out as someone
56:33who has done a lot of angel investing
56:35and compares his results to sands that
56:37he's really really good at it
56:39so I hope you do listen quite carefully
56:43or have listened quite carefully to what
56:45he has to say
56:45we are going to take a short break so
56:49please try to be back here by 11:15 10
56:53minutes and then Christine Carolyn are
56:57going to talk about investing
56:58fundamentals and mechanics thank you
58:48No
59:13thank you and can we also just check the
59:15sides
59:25yeah I'm gonna turn up right now Hey
59:35oh you're doing a livestream yeah so
59:50you're our engine and then we're just
59:53gonna have to jostle for position on
59:54here okay
01:00:23[Music]
01:01:21cuz I I'll let him know
01:01:24hello hey hello everybody
01:01:36quick announcement in the spirit of
01:01:41having kinks apparently we have a couple
01:01:43of overflowing toilets the one in the
01:01:46back is not working the one here is
01:01:48working if there is too long a line you
01:01:51may go across the street it's a 335 if
01:01:55you go right to the left when you go in
01:01:57there are toilets please feel free
01:07:09hello
01:07:14hello hello hello everybody please come
01:07:19take your seats we're gonna get started
01:07:20right away please thank you hello
01:07:33[Music]
01:07:36yes and they're not too particular about
01:07:38what kind of do
01:08:12okay so first announcement is that
01:08:17apparently our toilets are closed here
01:08:18there's a there's a city problem but it
01:08:23stops here so you if you need to use the
01:08:26restroom please go across the street to
01:08:283:35 give it one sec for people to come
01:08:36in all right this next session is
01:08:40actually one of my very favorites
01:08:42because there's so much mystery in the
01:08:45fundamentals of how you actually do a
01:08:48startup investment what it really means
01:08:50and how it works and there are no two
01:08:52people who are greater experts in that
01:08:54on the planet than my colleagues carolyn
01:08:57levy and christina who who who who have
01:09:01dealt with these issues with I guess
01:09:05thousands of companies now it's
01:09:08certainly all sixteen or seventeen
01:09:10hundred YC we should what is the actual
01:09:13number probably no nobody knows it
01:09:16anyway
01:09:17hundreds of companies they know this
01:09:19stuff better than anyone
01:09:20Carolyn is the is the person who
01:09:25actually invented the safe
01:09:27she used to be attorney it it it will
01:09:29see any before coming here and Kirsty is
01:09:31the CFO of YC they too have have a
01:09:36couple of pithy quotes you can guess who
01:09:40said what because I don't know one said
01:09:43all investors who can help should do so
01:09:48asking for additional shares is just
01:09:51asking for a freebie I'm guessing that's
01:09:53Kirsty but I'm not sure
01:09:58having money is very valuable but
01:10:02someone who helps with strategy and
01:10:04direction is priceless so choose wisely
01:10:07so with that I will give you Carolyn
01:10:18this is working okay
01:10:21yeah I have no idea which quote is mine
01:10:23and which one is Kirsty's and we were
01:10:25going to introduce ourselves but since
01:10:26Jeff just did it we will move right
01:10:29along like Jeff said this is the
01:10:31mechanical part okay this presentation
01:10:36is about how to invest using Y
01:10:38Combinator's is my mic not on did people
01:10:42nine lights on just on low better better
01:10:51better better okay I think we're good
01:10:56okay
01:10:57so as I was saying this presentation is
01:10:58about how to invest using Y Combinator's
01:11:01safe which is the first thing I'm going
01:11:03to talk about and then Kirsty's gonna
01:11:05describe how the safe converts in an
01:11:08equity financing I'm gonna talk about
01:11:11how the safe converts in other events
01:11:14quick word about process and then we had
01:11:16some advice that Sam kind of covered but
01:11:19will Tucker will just reiterate it
01:11:20because it's important okay so a lot of
01:11:25you raised your hand when Jeff asked or
01:11:27Sam asked how many people have already
01:11:28angel invested so I'm wondering how many
01:11:31of you have already used the safe - oh
01:11:34that's a lot okay okay so um I'm gonna
01:11:38talk about the basics for some of you
01:11:39that's gonna be stuff you already know
01:11:41but for those of you who've never used
01:11:42it hopefully that will be helpful it
01:11:44will be helpful okay um we drafted the
01:11:51safe for very early stage startups so
01:11:54that means that the company maybe hasn't
01:11:56written or definitely hasn't raised a
01:11:57price round doesn't have any preferred
01:12:00stock outstanding you absolutely can use
01:12:04the safe for companies that are later
01:12:05stage that have already raised a priced
01:12:07round and issued preferred stock in fact
01:12:09some of you may have already done that
01:12:10but we intended it for very early-stage
01:12:14startups a time when you may not want to
01:12:17use the safe as if you are looking at a
01:12:19company that has already issued
01:12:22convertible promissory notes to earlier
01:12:24investors and if that's the case you're
01:12:27gonna want to go ahead and just use that
01:12:28same note not use the safe and that's
01:12:30because it's a lot less complicated for
01:12:32a company to have all of its investors
01:12:35on the same document and it's also more
01:12:37fair to have all the investors on the
01:12:39same footing so obviously if you find a
01:12:43company you want to invest in and they
01:12:44are actually doing a priced round you're
01:12:46going to invest in that price round and
01:12:48buy preferred stock but for the vast
01:12:50majority of early-stage startup they
01:12:53don't have a lead investor they don't
01:12:55have a person setting the terms setting
01:12:58the price of the round and most the time
01:13:00for very early-stage startups they don't
01:13:02even know what they're doing yet and
01:13:04that's where the safe comes in because
01:13:06for these very very early-stage
01:13:08companies they just want to raise a
01:13:10little bit of money from their friends
01:13:12and from family and from angels and with
01:13:15the safe they can do that very
01:13:17efficiently very quickly and very
01:13:20cheaply because neither the investors
01:13:22nor the company need to get legal
01:13:24counsel okay the safe is an acronym
01:13:30stands for a simple agreement for future
01:13:32equity as I said before it is a
01:13:35convertible security it converts into
01:13:39shares of the company's stock the
01:13:41premise is very simple you the investor
01:13:44give money to the startup right now and
01:13:46at some point in the future you're going
01:13:47to get your stock one of the most
01:13:50important things I say this a lot the
01:13:52safe is not alone
01:13:54it is not debt it does not accrue
01:13:57interest there is no right to be repaid
01:14:00at some point in the future at some
01:14:02maturity date so please don't call it a
01:14:04safe note that makes me really crabby
01:14:08okay what does it look like I brought
01:14:11one it's it's five pages long
01:14:15compare that to a set of financing
01:14:16documents which is about five documents
01:14:19and none of them are five pages long
01:14:20they're all much longer there are only
01:14:23two key terms I'm going to show you
01:14:24this is what the intro paragraph of the
01:14:26safe looks like you can see that there
01:14:29are two blank spaces there the first one
01:14:33is the amount of money that you're going
01:14:35to invest in the startup and the second
01:14:37one is the valuation cap Kirstie's going
01:14:41to get into detail about what the
01:14:42valuation cap is when she speaks next
01:14:45but those are the only two things that
01:14:47you negotiate with the company it is
01:14:48just that simple after the intro
01:14:53paragraph there is a whole section that
01:14:54describes the conversion events which we
01:14:56will get into in a minute there is a
01:14:59section of definitions because it's a
01:15:01legal document we always have to have
01:15:02definitions and then the rest of it is
01:15:04boilerplate and an example a boilerplate
01:15:06company makes reps and warranties to you
01:15:09about the status of the company you make
01:15:11some representations to the company
01:15:13about being an accredited investor and
01:15:15then there's a really skinny
01:15:17miscellaneous section at the end I want
01:15:21to point out what is not in the safe for
01:15:23those of you who own preferred stock
01:15:25have made an investment and company and
01:15:27gotten preferred stock you will know
01:15:28about voting rights and information
01:15:31rights and liquidation rights those are
01:15:33not in the safe because the safe is not
01:15:35yet stock when you're safe converts and
01:15:37you get preferred stock you will be
01:15:39piggybacking on all those same rights
01:15:41that the lead investor in the round has
01:15:43negotiated for the preferred stock so
01:15:45you won't find those things in the safe
01:15:47so um what you will find in the safe is
01:15:50pro rata and Sam conveniently defined
01:15:52that for some of you who don't know who
01:15:54didn't know what it was before it's the
01:15:55right to buy more stock in future round
01:15:57so that you maintain your percentage
01:16:00ownership of the company the safe has a
01:16:02section that says that you will get
01:16:04those pro-rata rights in the next round
01:16:06not the conversion round but the next
01:16:08round so if you're safe converts in a
01:16:10series a preferred stock financing that
01:16:13document will bake in the right for you
01:16:15to buy shares of this series B financing
01:16:18so that you can maintain your pro rata
01:16:20percentage
01:16:26okay so um what we are what I've been
01:16:31talking about is what we call the capped
01:16:33a f--- it's the one that has the target
01:16:35valuation Kirstie's gonna describe that
01:16:37in a lot more detail it's the most
01:16:38commonly used safe that we have but
01:16:42there are a couple of other versions of
01:16:44the safe that I'll go over briefly there
01:16:46is something called a discount safe
01:16:48instead of negotiating that valuation
01:16:51cap in the intro paragraph you and the
01:16:53company will negotiate a discount rate
01:16:55and the discount rate will then apply to
01:16:57the shares when you convert the safe
01:17:00typical discount rate ranges in between
01:17:03ten and twenty percent so for example if
01:17:07this series a round that your safe is
01:17:09converting in is the lead investor has
01:17:10priced it at $1 per share and you've
01:17:12negotiated a 20 percent discount your
01:17:14effective price is 80 cents share it's
01:17:16pretty simple
01:17:18there's also an uncapped safe which not
01:17:23as not not very common to use this has
01:17:26neither a target valuation nor a
01:17:28discount so really you're just
01:17:29converting your safe into the same price
01:17:31that the series a is paying there's no
01:17:33reward for being the early money that's
01:17:35why it's a pretty unusual safe to have
01:17:37but occasionally a company has such
01:17:39great demand that they can get away with
01:17:42serving up an uncapped safe so just be
01:17:44on the lookout for that
01:17:45and then a third version is what we
01:17:49called the MF n safe MF n stands for
01:17:52most favored nation it's a it's a
01:17:54concept we borrowed from contract law
01:17:56and there is no target valuation in this
01:17:59safe but there's this MF n paragraph
01:18:01that says that if a subsequent investor
01:18:04negotiates a target cap or rather target
01:18:08valuation or a discount you get to amend
01:18:10your safe to take the terms that that
01:18:12investor got so that so then your safe
01:18:14is no longer uncapped and now Chris
01:18:23all right so now we're going to talk
01:18:26about how the safe converts and we'll
01:18:28cover how the valuation cap works the
01:18:31maths behind the safe converting so this
01:18:33is going to turn into a maths class and
01:18:36also how to understand your ownership so
01:18:40first of all the valuation cap this is
01:18:42one of the things that as Carolyn
01:18:44mentioned is one of the things that you
01:18:46will negotiate with the founders and
01:18:49you'll also hear it referred to not only
01:18:51as a valuation cap but a target
01:18:53valuation or just simply a cap and the
01:18:57caps the highest valuation that your
01:18:59safe will convert at so if the priced
01:19:02round is lower than the valuation cap in
01:19:05the safe
01:19:06your safe will convert into shares at
01:19:08that priced round valuation and it's
01:19:11important to note that people get really
01:19:13confused with the cap they think it's a
01:19:15current valuation of the company that's
01:19:17really not what it is all it is is a way
01:19:20for you to be rewarded for coming in at
01:19:23the earlier stage when in theory you're
01:19:25investing at a riskier stage it's it's
01:19:28the way to for you to get your rewards
01:19:31and your bonus and so ideally what you
01:19:33really should be thinking is if I'm
01:19:35putting money in at this cap then what
01:19:37do I think the series a price how much
01:19:40higher do I think the next price rounds
01:19:42price is going to be and ideally you
01:19:45want that high because then your reward
01:19:47is better okay so your safe will convert
01:19:54into shares when the company completes
01:19:55and equity financing i priced round and
01:19:59different companies depending on the
01:20:02stage of the company that priced round
01:20:04might be called the series seed it might
01:20:06be a Series A or there might be some
01:20:08situations where they've already raised
01:20:10the series a and there's some safes
01:20:11bridging them to the series B so it's
01:20:14just whatever the next price round is
01:20:16and we'll try to refer to it just as a
01:20:19priced around here but sometimes it just
01:20:20slips in this it's a Series A but it can
01:20:22be any price trend and in that equity
01:20:27financing the company the founders will
01:20:30negotiate with a lead investor in that
01:20:33round and will create a term sheet
01:20:35that sets out the terms of that rant and
01:20:39those terms don't impact how your safe
01:20:42converts because that sets out in the
01:20:45safe itself but what it does impact is
01:20:48how many shares the safe converts into
01:20:50as we'll go over in a moment so when the
01:20:55priced round closes three things happen
01:20:58and in the documents they're all
01:21:00happening at the same time but in the
01:21:03calculations they actually go in order
01:21:05and you'll see why in a moment
01:21:06so first of all an options pool is
01:21:10created or increased if the company
01:21:12already has one and usually the closing
01:21:16option pool which is negotiated as part
01:21:18of the term sheets negotiations it
01:21:20usually is around 10% of the post round
01:21:26shares and that's kind of what makes
01:21:29this calculation a little bit
01:21:30complicated as we'll see in a moment
01:21:32next thing is that the safes convert
01:21:35into shares and although the safes
01:21:38themselves don't state this the term
01:21:41sheet will usually specify that the SIRT
01:21:44the safes convert in the pre-money and
01:21:47what that basically means is that this
01:21:50the shares that the safes have converted
01:21:52into are considered when the price per
01:21:56share for the lead investor is being
01:21:58calculated and again you'll see that in
01:22:00an example in a moment and then thirdly
01:22:03the new money comes in so the lead
01:22:06investor and anybody else who's
01:22:07investing in the round at that time will
01:22:09invest their money and buy their shares
01:22:13okay here comes the mass so it's a very
01:22:21high level for any investor the number
01:22:24of shares that an investor will receive
01:22:25is the investment amount divided by a
01:22:29price per share and the price per share
01:22:31is calculated by dividing evaluation by
01:22:35the shares issued by the company and the
01:22:38shares issued by the company is
01:22:40otherwise often or always referred to in
01:22:42the documents as the capitalization of
01:22:45the company and so for a safe holder the
01:22:48valuation is
01:22:50the cap and the capitalization is
01:22:52usually the issued shares plus the
01:22:54increased options pool for the new
01:22:57investor the valuation is the priced
01:23:00round valuation and the capitalization
01:23:02is the issued shares the increase in the
01:23:05options pool and the shares that the
01:23:07safes have converted into alright here's
01:23:12an example so on the left over here we
01:23:16have an example situations so we have
01:23:18founders who have nine million shares
01:23:21issued and there's three founders in
01:23:24this example and they're all sharing the
01:23:25shares equally and at demo day in March
01:23:28the company raises $800,000 on safes and
01:23:33they all have the same valuation cap
01:23:35they all have an eight million dollar
01:23:36cap then fast forward to November 2019
01:23:42and it can take that long maybe even
01:23:44longer before a priced round happens and
01:23:46they raise a priced round which is where
01:23:50they raise four million dollars at a 16
01:23:52million dollar pre-money valuation and
01:23:56the terms that are negotiated in the
01:23:59term sheet as well are that the options
01:24:01pool will be increased to ten percent of
01:24:03the post money and the safes convert in
01:24:06the pre money and I'm not going to get
01:24:09into the calculation of how the option
01:24:11to pool increase number works because it
01:24:14gets very circular as I'll show you in a
01:24:16moment but just trust me that it's going
01:24:19to increase to this very not round
01:24:22number of just over one point four
01:24:23million shares okay those are the
01:24:27details so the first thing that happens
01:24:30we've increased our options pool the
01:24:33next thing that happens is that our
01:24:34safes convert so the safe capitalization
01:24:38as defined in the safe is the issued
01:24:41shares plus the increase in the options
01:24:43pool so ten point four ten point four
01:24:46three million shares the safe conversion
01:24:50price is the valuation cap because the
01:24:53cap is less than the priced round
01:24:55divided by that capitalization to give a
01:24:58conversion price of seventy seven cents
01:25:01so the
01:25:03as the safe investor buys our the
01:25:07$800,000 investments divided by this
01:25:10conversion price to give us just over 1
01:25:14million shares everybody with me still
01:25:18ok good so then the next thing that
01:25:24happens is our new money calculation
01:25:27happens so this is the lead investor in
01:25:29the price round so this time the
01:25:32capitalisation doesn't include just the
01:25:34issued shares and the increase in the
01:25:36options pool it also includes the shares
01:25:39that the safes have converted into so
01:25:41this time we have a capitalization of 11
01:25:44point 4 million shares and then the
01:25:48price per share is calculated again
01:25:51using the price per share
01:25:53sorry their valuation from the term
01:25:55sheet the 16 million divided by the
01:25:58eleven point four seven million shares
01:26:00to give a price per share of 139 and so
01:26:05those that four million dollars from the
01:26:07new money investors will buy two point
01:26:11eight seven million shares
01:26:18okay so bringing this all together this
01:26:21is a very simple cap table it's much
01:26:24prettier than cap tables normally look
01:26:26so for those of you that are not
01:26:29familiar with cap tables how this works
01:26:31is it's just a way of explaining the
01:26:35ownership of the company and who owns
01:26:37what and in what proportions so here you
01:26:41can see that we have our three founders
01:26:43they own common shares their numbers
01:26:45haven't changed the number of shares
01:26:47that they have stays the same we have
01:26:50our increased options pool this is where
01:26:53the employees will be issued shares from
01:26:56in the future and then we have our safe
01:26:59investor who has their 1 million approx
01:27:03shares and you have the price ground
01:27:05investor who has the 2.8 million shares
01:27:08and these safe investor and priced
01:27:11investor has preferred shares founders
01:27:14and employees have
01:27:16common shares so what you can see from
01:27:21here is that even though the safe
01:27:24investor has put in eight hundred
01:27:27thousand dollars of the total four point
01:27:30eight million that the company raised
01:27:32proportionally between these two
01:27:34investors they actually have a much
01:27:36higher number of shares and that's
01:27:38that's the cap coming into play and
01:27:41that's how the safe investor gets the
01:27:43reward for their early investing so
01:27:46that's how that works it's also shows
01:27:50percentage ownership and you can see
01:27:52that my maths did work our options pool
01:27:55is 10% of the total post post money
01:28:00shares which is the total of these two
01:28:02numbers now safe investors have quite a
01:28:08hard time of it because at the time that
01:28:11you actually sign your safe you don't
01:28:15really know how much ownership you're
01:28:17going to wind up with after the priced
01:28:19round and the reason for that is that
01:28:22even though the safe says how the safes
01:28:24going to convert it doesn't specify how
01:28:27many shares it's going to convert into
01:28:29because that is dependent on the terms
01:28:32of the priced round and so in this
01:28:34example the safe investor has just over
01:28:37seven percent of the shares and the way
01:28:42you can think about it when you're
01:28:43signing you safe if you're thinking
01:28:45about ownership it's kind of a rule of
01:28:46thumb of $800,000 invested at an 8
01:28:51million cap gives an eight point eight
01:28:55million post-money valuation of the
01:28:57company
01:28:58so the safe investor would own
01:28:59approximately nine percent of that but
01:29:03that assumes that the safes convert
01:29:04immediately on signing and there's no
01:29:06money there's no new money and that's
01:29:08actually never happens so the reason why
01:29:13this 7 percent is not nine percent is
01:29:16why it's less is because the safes have
01:29:19been diluted by the new money coming in
01:29:22and just as an example to just explain a
01:29:28little bit more if the
01:29:30of the priced rounds had all been
01:29:32exactly the same except that the
01:29:35investor had only put in two million
01:29:37dollars instead of four million dollars
01:29:39then the ownership here would be just
01:29:42over eight percent so that just tells
01:29:45you exactly you know you you really
01:29:46can't tell how much you're going to get
01:29:49until the price trend because that's
01:29:57quite difficult it's important to do
01:29:59your own modeling and to think about how
01:30:01you you know what scenarios could happen
01:30:04to explain your ownership going forward
01:30:07and so there's a couple of things that
01:30:09we can that we have shared with you to
01:30:11help with that
01:30:12Jeff wherever he's gone has written some
01:30:15software called angel calc and that is
01:30:18modeling software that allows you to see
01:30:20various different scenarios and there's
01:30:23also going to be a spreadsheet that I'm
01:30:25going to put on to the resources page at
01:30:27the investor school website so that you
01:30:30can see you can play around with the
01:30:31calculations and you can see how safes
01:30:35might convert in the future okay
01:30:48okay so suppose you've invested in a
01:30:52company and before it raises a price to
01:30:56round something else happens and
01:30:58examples of what else could happen is
01:31:01that it could get acquired it could fail
01:31:03or nothing could happen so I'm going to
01:31:06talk about those okay I think it's
01:31:11easiest to understand what happens in
01:31:13the safe in a merger acquisition
01:31:14situation if you look at both extreme
01:31:17ends of the spectrum the first one
01:31:22extreme end would be you know a home run
01:31:24situation and buy home run effect I
01:31:26think Sam mentioned this as well this
01:31:28term this is where an acquiring company
01:31:30is coming in and paying a lot of money
01:31:32for the startup you invested in so what
01:31:36happens to the safe well you are going
01:31:38to convert it into shares of common
01:31:40stock your gonna do that by using the
01:31:43target valuation to determine the number
01:31:45of shares of common stock you get and
01:31:47then you are gonna participate in the
01:31:49proceeds of that merger along with the
01:31:51founders and the other common
01:31:53stockholders in that case you can expect
01:31:55a return that is well in excess of what
01:31:58you paid for your safe this is also what
01:32:01would happen in an IPO by the way so
01:32:02same same situation same result rather
01:32:06okay other end of the spectrum is the
01:32:08aqua hire and I don't know if this is a
01:32:10term that all of you in the room are
01:32:11familiar with but this is a situation
01:32:13where an acquiring company is coming in
01:32:16and just taking the talent out of the
01:32:18startup that you invested in so the you
01:32:20know founders and key employees they are
01:32:22not paying money for the intellectual
01:32:24property or any other assets and these
01:32:26are deals where there is usually very
01:32:28little money in that situation you are
01:32:31going to elect to have your safe paid
01:32:34off so the safe gives you the option and
01:32:41because you know most deals aren't at
01:32:44these two extremes of the spectrum
01:32:45they're somewhere in the middle what you
01:32:47need to do when you're confronted with
01:32:48this situation is actually do the math
01:32:51and figure out how you get the best
01:32:53result whether it's converting into
01:32:54shares of common stock and taking in
01:32:56merger proceeds or just getting paid
01:32:58back
01:33:02okay so sometimes a company raises money
01:33:07from you and other angel investors and
01:33:10just can't make it work
01:33:13hopefully they try really hard but
01:33:15sometimes it just doesn't happen and
01:33:16they fail and when failure happens
01:33:19companies need to go through an actual
01:33:21dissolution process and part of the
01:33:24process requires that creditors be
01:33:26repaid in in a dissolution situation
01:33:30they need to pay off their trade debt
01:33:31which is vendors and landlords and they
01:33:33obviously have to have to have to pay
01:33:35their salary any employees they have to
01:33:37have need to pay the salaries if there
01:33:40is any money left over the safe says
01:33:43that you are next in line so if there's
01:33:45money the safe holders and any other
01:33:47investors will get paid back often it's
01:33:49pennies on the dollar but they get
01:33:51something before stockholders get
01:33:54anything and honestly in a dissolution
01:33:55situation not only is there never any
01:33:57money for stockholders but there's
01:33:58rarely enough to pay back investors
01:34:00either this is usually just a total
01:34:02failure and you know you can expect this
01:34:04to happen some of the time what happens
01:34:09if nothing happens so this would be a
01:34:13situation where the company has raised
01:34:15angel and you know raised from angels
01:34:17and actually become self-sustaining you
01:34:21know profitable and they just putter
01:34:24along and suddenly they have no desire
01:34:26to raise a priced round and nobody's
01:34:28knocking at their door to acquire them
01:34:30so what happens well the safe doesn't
01:34:35address this and there's a reason why
01:34:36the safe doesn't address this situation
01:34:38number one when you try to draft for all
01:34:41these corner cases it stops being a
01:34:43simple document and becomes a very
01:34:45complicated document in a very long
01:34:47document and number two this just
01:34:50doesn't happen very often this is in
01:34:51high-growth world this is extremely rare
01:34:55but if you want to fund lifestyle
01:35:00companies you definitely do not want to
01:35:02use the safe because then you're going
01:35:04to have this problem all the time if you
01:35:06have accidentally funded a lifestyle
01:35:08company then I think our advice would be
01:35:12you go talk to the founders about it
01:35:14because hopefully you invested in really
01:35:16good people and they would want to do
01:35:18right by you and figure out how to make
01:35:20you whole that kind of goes back to
01:35:22Sam's point about being really careful
01:35:23about the founders you choose to put
01:35:25your money into Oh Curtis is going to
01:35:30talk about process okay so we've talked
01:35:37about what safes are and how they
01:35:38convert but now let's talk about the
01:35:40process for actually signing the safe
01:35:42and then also for converting it into the
01:35:45shares so the first thing in this
01:35:48process is the handshake protocol and
01:35:52the reason why we created this is to
01:35:55help to avoid misunderstandings founders
01:35:58are by nature very optimistic and we've
01:36:01seen many situations where the investors
01:36:05said something like yeah I'm interested
01:36:08meaning I'm interested in finding out
01:36:10more about the company and the founder
01:36:13hears this as I'm going to invest in
01:36:15your company q lots of misunderstandings
01:36:18and confusion so the handshake protocol
01:36:22is just simply a set of emails that sets
01:36:26out in writing the key terms and make
01:36:28sure that everybody is in agreement so
01:36:31the founder sends an email to the
01:36:33investor and says just confirming that
01:36:36you're in for X dollars at Y cap and
01:36:40then you reply to the email to confirm
01:36:42and at this point there's a handshake
01:36:45deal and it's considered bad practice at
01:36:48this point to back out and again
01:36:51reputation is everything in this world
01:36:53so you know you don't want to be doing
01:36:56things like backing out because it can
01:36:57harm your reputation and on the flip
01:36:59side the founders are under no
01:37:02obligation to take your money until that
01:37:05handshake deal is completed so
01:37:07especially in a hot deal where there's
01:37:09loads of people trying to get in you
01:37:11want to run through the handshake deal
01:37:12process so that you know that you're
01:37:14actually going to be able to get into
01:37:15the round and you can read more on this
01:37:20on our website as well there's a
01:37:23slightly more detailed blog post about
01:37:24it but those are there those are the
01:37:26points most YC founders will use Clerke
01:37:33to send and sign safes and this is an
01:37:36online platform that uses the standard
01:37:39YC safe in a template form and then the
01:37:42founders add the specific details for
01:37:44your investment into that template and
01:37:47you'll you'll receive a signature
01:37:49request through Clerke where you can
01:37:51review the details either in summary
01:37:53form or the full safe itself and you can
01:37:58assign the documents so you don't need
01:38:01to do it all in person
01:38:02the founders will also include wire
01:38:04details at that point so you have those
01:38:07handy as soon as you've signed sometimes
01:38:10the founders might use other platforms
01:38:12and especially non YC founders there's
01:38:15lots of options out there hello sign is
01:38:18another assigning platform similar to
01:38:21DocuSign or simply they might just
01:38:24download them from our website which is
01:38:26this link and send them to you in an
01:38:29email to sign and send that way all of
01:38:32those work is just preference so when
01:38:38you receive a signature request through
01:38:41Clerke or whatever other means you
01:38:43should check the details in there are
01:38:45what you previously agreed to in
01:38:48addition you should check that the name
01:38:50and signature block on the safe is
01:38:53correct particularly if you're investing
01:38:56through a trust or through a fund or
01:38:58you've created an LLC the founders won't
01:39:01always know the legal name if you
01:39:02haven't set that out specifically for
01:39:04them so you should make sure that those
01:39:06details are correct before you sign the
01:39:09safe don't sign the safe and then tell
01:39:12the founders it needs changing and you
01:39:15should be ready to wire the money as
01:39:18soon as you sign the safe the safe isn't
01:39:21valid until the money is wired and one
01:39:25of the things that when we ask founders
01:39:28what makes a good investor one of the
01:39:30things that comes up a lot is that the
01:39:32investors sign and wire the money
01:39:35quickly you know it's important to the
01:39:38founders that
01:39:39raise their money and get back to work
01:39:42and so fun so investors that delay the
01:39:45process or that say that they want to
01:39:47invest and then say to the founders oh
01:39:49but hang on because I just need to close
01:39:51my fund or I'm just this companies
01:39:53nearly exited and I'm just waiting for
01:39:55the transaction to happen so I can get
01:39:57some money really if those if that's the
01:40:00situation you should probably not be
01:40:02talking to invite two founders about
01:40:04investing in their company until you
01:40:06actually have that money available now
01:40:16when your safes convert in the price
01:40:18trend you'll be asked to sign more
01:40:20documents and these documents will be
01:40:22the same documents that the lead
01:40:24investor has signed and will have be
01:40:26negotiated by the lead investors and
01:40:27their legal team and the company's legal
01:40:29team and you'll you'll receive an email
01:40:32from either the founders or their
01:40:34lawyers asking you to sign some
01:40:37documents you may at this point need to
01:40:40ask them to send you the conversion
01:40:43calculations otherwise known as a pro
01:40:46forma cap table so that you can actually
01:40:49confirm how many shares your safes are
01:40:51converting into and see your post money
01:40:54ownership and you should definitely make
01:40:57sure to review that the the cap tables
01:41:00that we see and we've now seen thousands
01:41:03of cap tables it's surprising how many
01:41:06times the lawyers actually get the
01:41:07conversions wrong so I really strongly
01:41:09recommend that you do review those cap
01:41:12tables and you make sure that you are
01:41:13happy with the calculations for how your
01:41:15safes convert and now sadly you might
01:41:19not actually have much time to review
01:41:21these documents and to review the cap
01:41:23table you know the founders will be
01:41:26focusing on the lead investor they'll be
01:41:27negotiating with the lead investor and
01:41:29they'll have set a closing date and then
01:41:32they'll suddenly send you an e-mail out
01:41:34of the blue saying we need to close
01:41:36tomorrow here are the documents you have
01:41:38to sign and you know yes you want to be
01:41:41a good citizen and you don't want to
01:41:43hold up the closing but also you know
01:41:45this is this is your investment and you
01:41:48need to make sure that you're happy and
01:41:49that you've reviewed the documents and
01:41:51that you
01:41:52you know accept the terms in there so
01:41:55don't don't sign until you are happy
01:41:58with those documents all right okay so
01:42:07as I mentioned Sam kind of already said
01:42:12some of the stuff hmm
01:42:14but I'll just reiterate because these
01:42:16are really important points the first
01:42:19piece of advice and this is what we
01:42:21meant about think about the outs upside
01:42:23this is this is just Sam's power-law
01:42:25point if you believe in the power law
01:42:29and you invest that way you mean then
01:42:32what you're not gonna do is waste time
01:42:34negotiating downside protection because
01:42:37what you've realized is that eking out a
01:42:39one and a half x return on all these
01:42:42little investments is not worth it when
01:42:44you're have the mindset that you're
01:42:46funding the next Google and that's gonna
01:42:48be your you know 100x return the next
01:42:51point you wanted to make is be helpful
01:42:53and Sam also touched on this a lot be
01:42:57helpful when the founders ask sometimes
01:43:01angels write checks and they completely
01:43:03disappear and sometimes angels write
01:43:06really really small checks and then they
01:43:07pester the heck out of founders forever
01:43:09don't do that figure out be the kind of
01:43:12angel that just gives the right amount
01:43:14of help sometimes angels think that they
01:43:17need to ask to be on the board of
01:43:19directors in order to be officially
01:43:20helpful and you don't and please don't
01:43:22because it's actually not something the
01:43:25founders probably want sometimes I mean
01:43:27there's exceptions but usually they
01:43:28don't want early investors on their
01:43:31board of directors and lastly tolerate
01:43:34failure I think that all the other
01:43:37speakers in this course are going to
01:43:38talk about this a lot I think it's
01:43:42really easy to get buyer's remorse when
01:43:44a company really starts to struggle and
01:43:47I think that gets even worse when the
01:43:49founders decide to pivot but you should
01:43:52expect and prepare for pivots and
01:43:54remember the safe is not alone you can't
01:43:56go running in there and ask for your
01:43:58money back just because the founders
01:43:59start doing something different you need
01:44:01to tolerant you need to tolerate that
01:44:03and you need to be supportive and you
01:44:04need to give the founder as a chance
01:44:09okay so in conclusion we have covered
01:44:13quite a lot here and safes although on
01:44:16first glance look simple can get quite
01:44:18complex so if there's anything to take
01:44:22away from this these are the key points
01:44:24so use the safe to invest it's the
01:44:27fastest and easiest method understand
01:44:30your rights as a safe holder and at the
01:44:32point of conversion I cannot stress this
01:44:36enough but understand your ownership and
01:44:38understand where that comes from
01:44:39and finally be patient you know this is
01:44:43this is a long game you're going to be
01:44:45with the company through highs and lows
01:44:46and you know you need to you need to see
01:44:49it out so good luck to you all I hope
01:44:53you all make lots of great investments
01:44:56and I think we have some time for some
01:44:59questions you want us to take questions
01:45:35so the the the question is how do you
01:45:40make sure that you are fully rewarded is
01:45:42that what you were saying okay so so and
01:45:49the vulnerability of the cap to the
01:45:51subsequent money so you know the numbers
01:45:53we're talking about here are an eight
01:45:56million dollar cap and a sixteen million
01:45:57dollar series a pre-money valuation if
01:46:00you're invested in the next Google
01:46:04you're going to exit at thirty billion
01:46:08dollars or whatever the number is so
01:46:10whether your cap is eight million and
01:46:13the Series A is 16 million or whether
01:46:15your cap is 10 million and the Series A
01:46:17is 14 million there is still a huge
01:46:20amount of upside there so and that's and
01:46:23that's where you need to think that's
01:46:24you're still going to get that that
01:46:26upside because you still have that that
01:46:28ownership from having that early
01:46:30valuation investment and also you need
01:46:33to remember you do have pro-rata rights
01:46:34and member Sam made the point that you
01:46:36need to exercise those because yes you
01:46:38are gonna get really really really
01:46:40diluted because you're the early money
01:46:42but if you can't afford it and you can
01:46:44keep putting more money in then when you
01:46:46have that liquidity event you should
01:46:48recognize all that upside I think the
01:46:52question was directed towards the safe
01:46:54itself as potentially vulnerable and I
01:46:57don't see that I I think that that's a
01:47:00misunderstanding of the way convertibles
01:47:03convertible debt or a safe actually
01:47:06converted to shares of stock and and
01:47:09again as they said I will hearken back
01:47:11to Sam's idea that it won't matter in
01:47:15the end whether you invest in a safe a
01:47:17convertible note or equity if you invest
01:47:20it in air B&B
01:47:21at ten fifteen twenty or thirty million
01:47:24dollars you'll still have the sort of
01:47:26returns the Daurio saw with if you
01:47:29invest seventy million dollars you can
01:47:30do the math do the math of investing
01:47:32seventy thousand dollars in a in a
01:47:34company that becomes worth ten twenty or
01:47:36thirty billion dollars at a valuation of
01:47:38ten or twenty million and it will be
01:47:41stunning
01:47:45let's go from here
01:48:02so the question was who controls how
01:48:05much money the founders raised on safes
01:48:07and what do you do as an investor if you
01:48:11sign a safe with let's say an eight
01:48:13million dollar cap today and then the
01:48:15founder comes and racism signs another
01:48:17safe with another investor tomorrow at a
01:48:19five million dollar cap so the first
01:48:23part of the question the the founders
01:48:25decide how much they're going to raise
01:48:26on the safes and you know the advice
01:48:29that we give to the founders is to be
01:48:31very thoughtful about how much you
01:48:33actually raise on the safe because you
01:48:35are selling the company you know you're
01:48:37selling part of the company and so we we
01:48:39cancel them to be very careful about
01:48:40dilution and to really think about that
01:48:43so whilst the investor doesn't have a
01:48:46huge amount to say in that the founders
01:48:48are thinking about how to how to make
01:48:51that work for them the second part of
01:48:54the question is about the cap and it's
01:48:58pretty unlikely that you will sign a
01:49:01safe with a valuation cap of 8 million
01:49:03let's say and then the next day they'll
01:49:05sign a cap with 5 million usually you
01:49:09know like like Sam and Jeff have
01:49:11mentioned there is some elements of herd
01:49:12mentality going on in investing and so
01:49:15if if an 8 million cap works for other
01:49:18investors then you know the next
01:49:19investor is likely to take that as well
01:49:21maybe the situations where sometime
01:49:24further down the road they they might
01:49:26raise money with a slightly lower cap
01:49:28and it's really circumstance dependent
01:49:31at that point you know there's there's
01:49:34there's there's nothing written into the
01:49:36documents to protect you from that
01:49:37unless you have the MF n provision in
01:49:40there but you know again we we advise
01:49:44founders to treat people fairly and you
01:49:49know if things have changed or
01:49:50something's happened then then you know
01:49:52see what they can do to help their
01:49:54investors
01:50:11we see this happen all the time
01:50:13oh did everyone hear that question mm oh
01:50:17for the loaf right okay so what happens
01:50:20when the lead investor in this state
01:50:22let's say you have a safe and it's
01:50:23converting into a series a round and the
01:50:25lead investor is not respecting the
01:50:27rights and the safe for example the pro
01:50:29rata right you need to fight back on
01:50:32this we see this happen all the time we
01:50:34we advocate we tell our founders all the
01:50:36time you do not get to ignore the rights
01:50:39and the safe this is a contractual right
01:50:41you're breaching the contract if you do
01:50:43not give the safe holders their pro rata
01:50:45right this goes back to something her
01:50:47she said - it kind of sucks when they
01:50:49only give you 24 hours to read these
01:50:51documents because you should immediately
01:50:52be going through and making sure that
01:50:55they did give you these rights right and
01:50:57you should also be checking the cap
01:50:59table to make sure that they converted
01:51:01you're safe correctly but so the answer
01:51:03to the question in short is notice find
01:51:05it
01:51:05notice it tell them that's not okay push
01:51:08back on it make them honor their
01:51:09contract and oftentimes it's actually
01:51:11the lawyers who are who are trying to
01:51:13make this more streamlined and the
01:51:15founders either don't know it's
01:51:16happening or they haven't really
01:51:18registered and so if you go and say to
01:51:20the founders hey look you know I'm I
01:51:21should have pro-rata rights here then
01:51:23then they'll be they'll be pretty
01:51:24willing to make that change in the
01:51:27documents their reputation matters - by
01:51:29the way not just yours so if they screw
01:51:32you out screw you over and don't give
01:51:33you the right that you had that reflects
01:51:35poorly on them as well
01:51:53so the question was should we consider
01:51:55investing as an LLC or as an individual
01:51:57for tax considerations and various other
01:52:00things well so if you're immersed in an
01:52:03LLC they're pass-through entities anyway
01:52:05so that the taxes would still roll up
01:52:07into your personal tax returns and
01:52:10usually it just depends on circumstances
01:52:12you know if you're investing your own
01:52:13money it usually makes sense to just
01:52:15invest directly or if you have a trust
01:52:18to be able to do it through that if you
01:52:20start to be pooling money together
01:52:22either amongst a number of investors or
01:52:25using other people's money to invest
01:52:27then it makes more sense to create an
01:52:29LLC or some kind of fund structure
01:52:48okay so the question is why is there no
01:52:50pro rata in the conversion round and is
01:52:52there way to get it if you want it so
01:52:55the reason that we didn't put pro rata
01:52:58in the conversion round is because back
01:53:00at the time that we drafted the safe
01:53:01this goes back to about 2013 seed rounds
01:53:05looked a little different there was
01:53:07usually a shorter time in between the
01:53:09seed and the series a things have
01:53:14changed a lot in the last couple years
01:53:16and so we are actually thinking about
01:53:18well maybe we need to rejigger things
01:53:20maybe it should look different because
01:53:21the timing is now very different but in
01:53:26the interim what a lot of angel
01:53:27investors do is they do just like you
01:53:29said they sign a side letter and they
01:53:31say that they they give themselves you
01:53:34know they negotiate with the company for
01:53:35a side letter to give themselves a pro
01:53:38rata right to not only have their safe
01:53:40convert into Series A but then to
01:53:42purchase more shares on top of the
01:53:44conversion shares at the lead investor
01:53:46price so that does happen
01:55:09well you got it I mean if that works
01:55:11better for you then you should continue
01:55:13to use it because it's just kind of all
01:55:14about your investment strategy and sort
01:55:17of your approach to it I think in this
01:55:19class you're gonna hear a lot about the
01:55:21approach that Sam described and for
01:55:22those kinds of investments we think the
01:55:25safe works really well but obviously
01:55:26you're all going to have different
01:55:28strategies and you need to use whatever
01:55:29instrument works best with your strategy
01:55:57I'll do the first so the question was do
01:56:00you need a ppm a private placement
01:56:01memorandum to do a safe and the answer
01:56:03is emphatically no you don't even need a
01:56:05term sheet to do the safe you don't even
01:56:07need a ppm these days to do priced round
01:56:10nobody nobody really does those anymore
01:56:12safe is just one document that's all you
01:56:15need for priced round it's usually just
01:56:18a term sheet that's all you need so I
01:56:19don't I haven't seen a ppm in years
01:56:21that's the answer to that and then the
01:56:24second question was dis a frown the
01:56:26world and in general the answer is yes
01:56:29but there are some situations where they
01:56:32don't necessarily work I know that we've
01:56:33heard some companies in India aren't
01:56:38able to use safe so I think it depends
01:56:39on the who the investor is they have to
01:56:41be on a certain list and also I think in
01:56:45the UK they have sort of rejiggered the
01:56:48safe a little bit to make it so that it
01:56:50works more for the enterprise investment
01:56:53scheme relief that's available over
01:56:55there but it's you know if you are
01:56:57investing in other countries and you're
01:56:58investing in in companies in other
01:57:00countries then you should do your
01:57:02homework to make sure that it actually
01:57:03is a valid document in that country
01:57:26so the question is sometimes that this
01:57:29question has had safes that don't
01:57:33converse in the pre-money and how common
01:57:35is that well so first of all it's it's
01:57:38getting less and less common that the
01:57:40safes convert at the same time as the
01:57:42round series a lead investors are
01:57:45guessing more clever about this and
01:57:48realizing that if the safes converse in
01:57:49the pre-money then the the lead
01:57:54investors getting less dilutions and
01:57:55really all that's happening is if the
01:57:58safes do converse in the round
01:57:59they'll just massage the valuations to
01:58:01still get to the same place whether they
01:58:03want to be which is usually around 20%
01:58:04of the company post series a there was a
01:58:08second part to that question I will say
01:58:10that that exact point is exactly what
01:58:13this gentleman was saying about pro rata
01:58:15because that is more of a trend that
01:58:18we're seeing that sort of argues for
01:58:20going ahead and having the safes also
01:58:21have a pro-rata in the conversion round
01:58:23so these things are all tied together
01:58:25and again I'll just go back you said the
01:58:27the Primmer doesn't do the math that way
01:58:29again 2013 when it was you have to you
01:58:32know things looked a little different
01:58:33and they've evolved and and so we are
01:58:35definitely talking about evolving the
01:58:36safe in certain ways and just to
01:58:38reiterate the safe itself doesn't
01:58:40mention this it doesn't mention that it
01:58:42will be in the pre-money or it will be
01:58:44in the round all the safe says is how do
01:58:47you define the capitalisation to work
01:58:49out your conversion price for the safe
01:58:51itself
01:59:34yeah yeah so so the point there was that
01:59:37founders don't understand this either
01:59:38and that's absolutely right and you know
01:59:42again one of the things that I spend
01:59:44hours and hours with founders as they're
01:59:47raising money at demo day and beyond is
01:59:49is explaining to them how this works
01:59:52and how to think about dilution and how
01:59:54to understand what conversing in the
01:59:56pre-money means and all these different
01:59:58terms and you know at the end of the day
02:00:00it's it's one of those things that
02:00:02there's only so much we can do and if
02:00:05the founders don't want to understand it
02:00:07then you know there isn't a lot there
02:00:09that we can do for them there's so many
02:00:11resources though so maybe you know maybe
02:00:14everybody just needs to go to these
02:00:15resources if you do the math and you do
02:00:18the pro rata aren't starting off the pro
02:00:19rata the pro forma cap table and
02:00:21everyone agrees that what that looks
02:00:22like it is so much better it just you
02:00:25everyone just needs to take the time to
02:00:26model it out it eliminates so much
02:00:28confusion if you take the time to do
02:00:30that
02:00:49okay the question is is there case law
02:00:51around investor liability when you're
02:00:53investing as an individual rather than
02:00:54through a legal entity there is tons of
02:00:58case law regarding an stockholder non
02:01:02liability for for bad things that the
02:01:05corporation does if the stockholders
02:01:09aren't liable then certainly if you go
02:01:10even further out the circle and you just
02:01:12have people put money in for in exchange
02:01:14for a convertible security there's not
02:01:16it's not a problem so you're you're fine
02:01:19if I understand your question correctly
02:01:31okay so the question is what's the
02:01:32optimal legal structure for the startup
02:01:34so for YC we invest in mainly Delaware
02:01:39c-corporation in California or wherever
02:01:51else it might be obviously if you're
02:01:54investing in foreign companies then
02:01:56you'll need to do a little bit more
02:01:57homework because we don't necessarily
02:01:59know what the how all the structures
02:02:02work in all the different countries we
02:02:05have seen some investments where people
02:02:08have invested into LLC's but it's we
02:02:12don't really understand how that happens
02:02:14so I would recommend that you you stick
02:02:16with c-cups high-growth companies are
02:02:18not LLC's our our MFN standard and safe
02:02:29know they are in the safe
02:02:31the most favored nation that I discussed
02:02:33sort of in the middle of the
02:02:34presentation those are not standard
02:02:36those go along with the those are part
02:02:40of the safe that doesn't have a cap so
02:02:42what this what this person maybe ask me
02:02:44is can I get can I negotiate a target
02:02:47valuation or a discount rate with a
02:02:48company and also have an MF n so that if
02:02:51someone gets something better I can
02:02:53amend my safe after the fact and get
02:02:55that better term it's kind of like what
02:02:57your question was what happens if I do
02:02:59eight million and next day and another
02:03:01angel does five million can I get the
02:03:02benefit of that we don't have that
02:03:04flavor of safe because I kind of feel
02:03:06like you make a bargain you live with it
02:03:08right you get the bet you and the
02:03:10company negotiate the best bargain you
02:03:11can get the two of you and then that's
02:03:14what you live with so we don't we don't
02:03:17we don't have that flavor of safe up on
02:03:20our website you can you can drop an MF n
02:03:22into the safe if that's what you and the
02:03:24company agree is fair
02:03:25so it's possible you could just cut and
02:03:28paste that paragraph right into a capped
02:03:29or a discount safe if you want to I
02:03:31wouldn't I would counsel founders that
02:03:33that's probably not the right way to go
02:03:34but you could try it
02:03:39[Applause]
02:03:48just a couple of quick things and then
02:03:52we're done for today
02:03:54so safes are weird and convertibles are
02:03:59weird I had done over a hundred
02:04:01investments and I decided not all safes
02:04:04but mostly in convertibles and I decided
02:04:06I better figure out what happens when
02:04:10they convert and I realized I had very
02:04:12little ideas someone back there pointed
02:04:14out that that both investors and
02:04:17founders get really confused as a
02:04:20Caroline said there's a lot of tools now
02:04:22I actually built a tool called angel
02:04:25calc that's that's open and available it
02:04:28lets you very simply and quickly model
02:04:31what a safe conversion looks like
02:04:34because it's it's it's worse than just
02:04:37the fact of weather and by the way angel
02:04:39 always assumes it's in the
02:04:40pre-money because it's always in the
02:04:41pretty money now almost almost always
02:04:43and if it's not I can't remember I may
02:04:45have built something in to allow you to
02:04:47do it if it's not in the pre-money but
02:04:48it almost always is and there pre-money
02:04:50but it's much worse if there's multiple
02:04:52safes with multiple valuations multiple
02:04:56different discounts which is often not
02:04:59not uncommon now so as Caroline said the
02:05:04best thing to do is to model this is to
02:05:07see what it really looks like to work
02:05:11with the founders remember that the
02:05:14question is to you know what do you do
02:05:15if later investors try to screw you I
02:05:19actually wrote a post about this called
02:05:21transparency and startup investing and I
02:05:24think what you ought to do is you ought
02:05:25to ask for anything that you should
02:05:30actually provide a form that you can
02:05:31send to the founder and say or to the
02:05:33entire team sending you the update that
02:05:36says hey are any of my rights changed
02:05:39from my document and if they are then
02:05:41you should have a conversation not with
02:05:43the lawyer not with the VC with the
02:05:46founder who you know remember has a
02:05:50relationship with you I hope you are
02:05:51first best investor the person who
02:05:54believed in them before the rest it's
02:05:56gonna be hard for them to look you in
02:05:58the eye and say screw you I took away
02:05:59your pro rata again I think you need to
02:06:03be careful with these you don't want to
02:06:05screw up their deal and you want to be a
02:06:06great investor but it is fair and they
02:06:10have the power in almost every case
02:06:12almost every case to go back to their
02:06:14investors in to the lawyers and say why
02:06:15are you doing this you know
02:06:17Kirsti is a best investor I've had how
02:06:20are you taking away for pro rata the
02:06:25other thing I'll say about about
02:06:28lifestyle companies and why I think the
02:06:30safe is preferred in general - debt is
02:06:33because we've seen too many times where
02:06:35the fact that there's debt there is used
02:06:39to kill a company that didn't have to
02:06:40die and it's too easy for investors to
02:06:43call that debt when it's not payable and
02:06:47we tend to be on founder sides that
02:06:50might sound weird as investors but it
02:06:52turns out that if you end up on the
02:06:55founders side more often than not then
02:06:57your probability of getting in the one
02:06:58company that will make all those other
02:07:00investments irrelevant is much higher
02:07:03we're done today tomorrow we are going
02:07:06to be kicked off by Dalton Caldwell
02:07:08talking a lot about founder meetings
02:07:11which is going to be a great session I
02:07:12think and then after that we have two
02:07:15amazing prevent presenters Paul Buchheit
02:07:19is going to talk about in his sort of
02:07:23epic investing career what he's learned
02:07:24and then I'm gonna have a brief
02:07:27conversation with Michael Seibel the CEO
02:07:29of Y Combinator thank you all very much
02:07:31for coming you're live-streaming and
02:07:33we'll see you tomorrow
🎥 Related Videos
a16z Podcast | Things Come Together -- Truths about Tech in Africa
a16z Podcast | The Infrastructure of Total Health
The Robot Lawyer Resistance with Joshua Browder of DoNotPay
a16z Podcast | Bots and Beyond
Design Sprints as a Tool for Organizational Change
a16z Podcast | Valuing Today's Fast-Growing Software Companies
🔥 Recently Summarized Examples
![How To Succeed As A NEW & YOUNG Realtor [Deals Every Month + Luxury Listings]](/_next/image?url=https%3A%2F%2Fi.ytimg.com%2Fvi%2FrtrRghgTayc%2Fhqdefault.jpg&w=3840&q=75)
Former Priest REVEALS Jesus' MYSTICAL Lost Years & His Connection to BUDDHA! | Fr. Seán ÓLaoire
Kim Kardashian's Plastic Surgery Reversal: Is She Trying to Rewind Time?
How To Succeed As A NEW & YOUNG Realtor [Deals Every Month + Luxury Listings]
BITCOIN EMERGENCY: NEXT PRICE TARGETS REVEALED!! Bitcoin News Today & Ethereum Price Prediction!
Uncovering Ancient Atlantean Ruins: Exploring Evolutionary Pathways and Psychic Phenomenon