# Dalton & Michael: Understanding investor terms and incentives

**Author:** Dalton Caldwell, Michael Seibel
**Type:** Video
**URL:** https://www.ycombinator.com/library/DX-dalton-michael-understanding-investor-terms-and-incentives
**YouTube ID:** wnyI7ZM_Mrk

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Dalton Caldwell and Michael Seibel talk about investor terms and incentives.   
  
To create Rookies Mistakes we asked YC founders: Is there a simple fact you wish you knew when you started your company
or a rookie mistake you wish you could take back?

## Transcript

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 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 by a yc founder you should care just as much about the terms of your fundraise as you should care about the economics the valuation and the amount of money you raise

there are lots of rights there are lots of terms inside of a funding deal that can screw you no matter how high the valuation is 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 raised at 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 ask for are sort of jargon filled inside baseball that i when i was a founder i wasn't familiar with what participating preferred meant or super pro rada and we sometimes see founders give up those terms without totally understanding what they mean and wow is this bad um another example is board control you can i've seen founders give up

control of their board 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 going to 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 um you prevent yourself from getting screwed and so this is one advantage of trying to raise money from people that

have a track record of public companies because you know they're optimizing for you to build a really big company versus some investors optimize for your company is going to sell for 10 or 20 million dollars and so they structure their entire documents around that kind of outcome this happens a lot internationally and 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 on a pitch oh we've got our local experience so 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 than 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 dollars and the term sheets for 3 million so you got to go out and find 2 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 like 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 means no here's why to the extent that you were 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 manage to pass on your company while being very nice to you to your face yep right like it's 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 not how you interpreted 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 and we'll we'll can 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 like and and like even better like sign something like like yeah like we'll we'll sign something or we'll give you something that looks official but and again to be clear maybe maybe someone will see this and be like oh but that's you know what about this what about that like 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 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 mean you know what

it 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 mind share so that when you do get successful they'll want to come talk to you not a bad idea and so i don't i

don't know what to perceive 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 a huge outcome 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 you know 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

in a good way i actually mean professional in a bad way like their interests were a lot more aligned with the founder i think that as there have been more and more kind of 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 moneys can help the company but because they have an ownership target because they want to own 10 percent 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 that's the best founders understand that investors have incentives on their own not bad or good they're not evil or like angels it's just more like we're investors too michael yeah that'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 you
