An Engineer's Guide to Investors Ft. Paul Graham

Founders, you can optimize your fundraising process by learning more about how investors think.

That's why I'm sharing this classic resource developed by Paul Graham 👇

Graham has been on all sides of the negotiation table as a founder, advisor, and investor, and he's had tremendous success in all three.

He co-founded YCombinator ($300+ billion portfolio) and was an early advisor to Airbnb ($3.378 billion revenue in 2020).

Graham's main thesis behind this guide:

Founders have a better chance of getting funded when they can identify what motivates and stimulates investors to act.

Read through this resource for 15 non-obvious takeaways that will help founders better understand their VCs at the negotiation table.

1. Angel Investors are the most Critical Most companies that VCs invest in would never have made it that far if angels hadn;t invested first. Angels are willing to fund riskier projects than VCs. They also give valuable advice, because (unlike VCs) many have been startup founders themselves.
2. Angels don't like publicity Angels don't need to market themselves to investors because they invest their own money. Nor do they want to market themselves to founders : they don't want random people pestering them with business plans. Actually, neither do VCs. Both angels and VCs get deals almost exclusively through personal introductions.
3. Most investors, especially VCs, are not like founders Some angels are, or were, hackers. But most VCs are a different type of people: they're dealmakers. Still, VCs are as expert in their world as you are in yours. What they're good at is reading people and making deals work to their advantage. Think twice before you try to beat them at that.
4. Most investors are Momentum Investors Investors generally don't understand what you're doing. They don;t try to look at something and predict whether it will take off. They win by noticing that something is taking off a little sooner than everyone else. When someone offers you a decent deal, just take it and get on with building the company. Startups win or lose based on the quality of their product, not the quality of their funding deals.
5. Most Investors are looking for big hits Venture investors like companies that could go public. That's where the big returns are. Angels are different in this respect. They're happy to invest in a company where the most liely outcome is a $20 million acquisition if they can do it at a low enough valuation. If you take VC money, you have to mean it, because the structure of VC deals prevents early acquisitions. If you take VC money, they won't let you sell early.
6. VCs want to invest large amounts VCs usually sit on boards of companies they fund. If the average deal size was $1Million, each partner would have to sit on 40 boards, which would not be fun. So they prefer bigger deals, where they can put a lot of money to work at once.
7. Valuations are fiction VCs admit that valuations are an artifact. They decide how much money you need and how much of the company they want and those two constraints yield a valuation. Since valuations are made up, founders shouldn't care too much about them. In fact, a high valuation can be a bad thing. If you take funding at a pre-money valuation of $10 Million, you won't be selling the company for 20. You'll have to sell for over 50 for the VCs to get even a 5x return, which is low to them.
8. Investors look for founders like the current stars Historically investors thought it was important for a founder to be an expert in business. So, they were willing to fund teams of MBAs who planned to use the money to pay programmers to build their product for them. What investors still do not get is how clueless and tentative great founders can seem at the very beginning.
9. The contribution of investors tends to be underestimated Investors do more for startups than give them money. They're helpful in doing deals and arranging introductions, and some of the smarter ones, particularly angels, can give good advice about the product. The goal of the investors is for the company to become valuable.
10. VCs are afraid of looking bad You can measure this fear in how much less risk VCs are willing to take. You can tell they won't make investments for their fund that they might be willing to make themselves as angels. Though it's not quite accurate to say that VCs are less willing to take risks. They're less willing to do things that might look bad. That's not the same thing.
11. Being turned down by investors doesn't mean much Investors will often reject you for what seem to be superficial reasons. The reason investors can get away with this is that they see so many deals. It doesn't matter if they underestimate you because of some surface imperfection, because the next best deal will be almost as good. Investors would be the first to admit they're often wrong. So when you get rejected by investors, don't think "we suck," but instead ask "do we suck?" Rejection is a question, not an answer.
12. Investors are emotional You'd expect them to be cold and calculating, or at least businesslike, but often they're not. I'm not sure if it's their position of power that makes them this way, or the large sums of money involved, but investment negotiations can easily turn personal. If you offend investors, they'll leave in a huff.
13. The negotiation never stops till the closing There's an initial phase of negotiation about the big questions. If this succeeds you get a term sheet, so called because it outlines the key terms of a deal. A term sheet is not legally binding, but it is a definite step. It's supposed to mean that a deal is going to happen, once the lawyers work out all the details. In theory these details are minor ones; by definition all the important points are supposed to be covered in the termsheet.
14. Investors like to co-invest You might think that if they found a good deal they'd want it all to themselves, but they seem positively eager to syndicate. This is understandable with angels; they invest on a smaller scale and don't like to have too much money tied up in any one deal. There is one rational reason to want multiple VCs in a deal: Any investor who co-invests with you is one less investor who could fund a competitor.
15. Investors don't like to say no The reason funding deals take so long to close is mainly that investors can't make up their minds. Most don't try to predict whether a startup will win, but to notice quickly that it already is winning. They care what the market thinks of you and what other VCs think of you. Because they're investing in things that change fast and they don't understand, a lot of investors will reject you in a way that can later be claimed not to have been a rejection. Here's a VC saying no: We're really excited about your project and we want to keep in close touch as you develop it further.