Hey, this is Michael Seibel with Dalton Caldwell and welcome to Rookie Mistakes. We've asked YC founders for their Rookie Mistakes so we can share them with you and help you avoid them.

Here's the last note written in by a YC founder.

I think that investors are aware that founders want high valuations and they want the press release about, you know, they raised a lot of dollars or they raise it a high valuation or whatever. And so they're very aware of this. And so one of the ways that you sometimes see investors take advantage of this need on the part of founders is to say, great, we'll give you your ask around valuation or amount. But you need to give us all this other stuff. And often the things they asked for are sort of jargon filled inside baseball. When I was a founder, I wasn't familiar with what participating preferred mentor, super pro rata. And we sometimes see founders give up those terms without totally understanding what they mean. And wow, is this bad. Another example is board control. You can, I've seen founders give up control of their boards such that they could be fired and are fired to raise a million dollars.

As a founder, like, here's the trick. You're not gonna be as good at this as the person you're negotiating against if they're an investor who invests in a bunch of companies and you're a first time founder. So by using standard paperwork, by using a lawyer who actually has done a lot of startup work, you prevent yourself from getting screwed.

And so this is one advantage of, um, trying to raise money from people that have a track record of public companies. Cause you know, they're optimizing for you to build a really big company versus some investors optimized for your company is going to sell for 10 or $20 million. And so they structure their entire documents around that kind of outcome.

This happens a lot internationally. And once again, I don't think the investors are being evil. I think that they're basically saying, well, I've never seen a deal that's become a billion dollar company. And so I've gotta optimize for these base hits. I gotta figure out if this thing only sells for 20 million, how does my fund not die? And I think that's like so unfortunate, because I think investors oftentimes wanna pitch, oh, we've got our local experience, we have this, we have that, but like when you're a founder, It's way easier to get better terms from someone who's passed on a billion dollar company.

Here's the last kind of interesting way I've seen these terms versus valuation. I give you a term sheet at a great valuation, but the term is, oh, I'm going to only put in $1 million, and the term sheet's for $3 million. So you got to go out and find two more million somewhere else, where it's like, oh, this isn't this great. Like I've got a term sheet and it's like, Kinda. I've got a deal. Kinda you have a deal. But what is the investor really doing when they give you an offer like that? What's really going on?

This surprises a lot of people in YC. But this whole, hey, this is great. We love to invest when you find a lead. Just come back when you find a lead. If I translate that out of VC speak, actually means no. And founders are like, what? That means no, here's why. To the extent that you are in a position where you did have a lead investor, it is very common that the lead investor would want to put in the entire amount of money to hit their ownership target. And so they would not want you to give more of the round to someone else, right? Not to mention if you had the lead investor already lined up, there'd be a lot of other people that would love to invest alongside the lead investor.

And so when someone says, oh, this is great, come back to us when you find a lead, you know, give us an allocation in there, what they're actually getting is a free option to invest in the future If you find an investor that they are impressed by, it costs them nothing to say that, right? And if you don't find a lead, they just managed to pass on your company while being very nice to you to your face. Right like this like no we don't want to invest but if you somehow find a great lead investor and you come back to us let's talk about it then and and the founder walks away from that conversation like wow they're really interested they want to invest we have offers. When in fact they just did this ninja move where they said no but that's how you interpret it isn't that wild.

It's almost as if they have to do this because this is their job. It's almost as if they get to run this game every day with multiple companies and all you're trying to do is raise money and get back to work. Of course they're going to be better at it. Of course they're going to have the cool lines. Of course they're going to tie you into knots.

It's like you apply to a job at Facebook and they're like this is great. come back to us with your job offer from Google and Apple, and we'll go from there. So just let us know how it goes, right? That's not a job offer.

Consider this a provisional job offer, assuming that you can get an offer from Google and Apple. And even better, sign something. Yeah, we'll sign something or we'll give you something that looks official.

And again, to be clear, maybe someone will see this and be like, oh, but what about this? What about that? Sometimes there are cases of investors that can't write big checks and they want to invest alongside other people. This happens sometimes. That is possible. So we're not suggesting this is all things in all universes. We're just saying a lot of YC companies hear this line and what it usually means in our experience is no.

Let's talk about investor incentives. Do you believe investors are incentivized to tell companies to raise more money or less money and why?

I think it depends on the stage that the company is at. I think for tiny startups, investors aren't going to fund them anyway. And so saying what they want to hear, like saying smart thing that captures mindshare so that when you do get successful, they'll want to come talk to you, not a bad idea. And so I don't know what to pursue that. I think for companies that they actually want to fund, or perhaps they've already funded, I think it is reasonable as an investor to want the company to get huge. Investors are going for huge outcomes, so still with me, right? And so that often looks like you should be growing faster. Oh, your revenue looks flat. You should be spending more on sales. You should be spending more on marketing. And so coming from a good place from their perspective, you might have a misalignment of incentives sometimes where the investor, the worst thing you do for an investor is like, be profitable but not grow fast enough for them versus if you're a founder, that ain't so bad.

Well, I think what I've seen is the investment community has changed a lot. And I think that 10 years ago, we were seeing a lot more very small funds and a lot more angels investing in companies. And I would argue that they were less professional. And I don't mean professional in a good way. I actually mean professional in a bad way. Their interests were a lot more aligned with the founder. I think that as there have been more and more professional seed funds being built up, now those seed funds have obligations to their LPs, to their investors. They have kind of internal goals about how much of your company they want to own to make sure their business works. And as the seed funding world professionalizes, it opens up doors for there to be a misalignment of incentives. I've seen a lot of situations where a fund wants the founder, wants the founder to take more money, not because they think more monies can help the company, but because they have an ownership target, because they want to own 10%.

And so I think that nowadays that there's so much money out there. Investors have a lot more incentive to convince founders they need more money right money is what the investors are selling when there's a lot of money out there and a lot of investors out there. the easiest way to compete is like, Hey, I'll give you more money. You need more money. Let me try to make you afraid that you don't have enough money. So you'll take my money. And I think this is the best founders understand that investors have incentives on their own, not bad or good. They're not evil or like angels.

We're investors too, Michael. Yeah, it's our agenda here.

Like I just think that like a smart founder understands that people they're negotiating with have their own goals and incentives and they take a second to think about those incentives when they're hearing the sales pitch, as opposed to just kind of believe things blindly.