and the the way the course is organized is there's a lecture and then there's a QA afterwards so please hold your questions until the Q&A session at the end unless the an instructor explicitly says they want questions during their talk I will also take questions from the streaming audience too to ask a question please use the Twitter hash tag pound ycs is and will take as many of those
questions as we can time willing so there's a mixture here of watching a class of accredited and non-accredited investors for the accredited investors as most of you know we are going to be an extent going to be extending an invite to YC winter 2018 demo days which are March 19th and 20th it's a virtual invite you can watch it online but also as a cool little kicker we're going to
invite randomly ten of you to come in person to YC demo day which is which is kind of a pretty special occasion and and I hope I hope whoever comes enjoys it a lot so this is our first time teaching this class hopefully not the last we do ask you guys to give us feedback for what worked what didn't work what was too obvious or too subtle what was missing at the end of the class
will be a survey I'll say this again at the end but please do give us feedback you can also give us feedback real-time as you like you can email me at Jeff GE o FF at Y Combinator comm anytime you like honest opinions are great I want to start off also by pointing out I won't be up here very much it's mostly a bunch of instructors from inside and outside YC they're all volunteers and they're
very busy people and they've been gracious enough to donate their incredible experience and time to us and I'm I'm very grateful for everyone who said who agreed to do this before we get started I wanted to spend a couple of minutes saying why talking about why we're doing this how many of you have made angel investments before could you raise your hands so you don't need any of this crap
you guys have already done this okay so there's a lot of experience and we know there's a lot of experience but we're doing this for mainly two reasons one is that angel and seed investors are a critical part of this startup ecosystem it's the first money in usually it's what allows companies to actually take flight and and become real big interesting scalable companies it's also
a little self-serving we think that more great angel investors great seed investors are great for YC companies and we hope you will invest in YC companies the we also think it's good for you for people people who have all of you who have invested you know it's an amazing way to get a window into the to the future to be part of this future that that founders are really creating to get
a window into what's going to happen so so it's all good what are we hoping the outcomes will be venture investing has been around for hundreds of years but really the kind of venture investing that that we think of in Silicon Valley for the last 50 years this guy named George doriel made made a he was a VC he was an early VC this firm called AR DC
and he made what we'd consider a seed investment of $70,000 in 1957 until this new tiny computer company called Digital Equipment Corporation sometimes called digital often called DAC and that $70,000 turned into 35 million dollars which a lot of people found pretty interesting that led to what kick-started an incredible flowering of innovation and and a lot of wealth creation that that has never seen the
like in the world and we hope that some of y'all had that same experience hopefully investing in YC companies it's still possible and there's lots of examples and if we're lucky some of the folks who are gonna talk to you we'll give you some of those examples so we also hope that you all go to be better smarter investors after this course I'm sure that's why some of you
are here some of you are here to get some of those insights and I'm sure also that you will tell us if if we achieve that goal and lastly we want to create a permanent repository of this information so anyone can make use of it in future years so we hope to make the repository better and better and in fact if there's anything that you all you can you can look at this online that investors that
startup school.org and if there's anything you think we should add just mail it to start-up school at Y Combinator calm and well we'll look at it and if we like it we'll add it ok very briefly now we have four days about ten hours so we can only cover so much this is going to be about the fundamentals of startup investing there will be a few deeper dives but not
that many we want to hit the major points kind of like a an investing 101 I guess we will start off with fundamental questions of why how and which companies and that's today and then we'll talk about the mechanics of startup investing clearly many of you know these mechanics but I think we'll cover it perhaps in ways you haven't seen before then we're going to walk through some of the dance
that you have to do to make your decisions and to to talk with entrepreneurs and founders and and figure out which are the companies that are going to be part of of your investing future we're going to hear from a bunch of extraordinarily experienced and talented at least by the results investors during the course and and then we're going to complete with a
a little bit of context and and a little bit of a look towards the the future of startup investing startup investing has changed radically over the last decade and I think most of ex-us expect a lot more changes in the next decade as well and in the end we'll finish up with a conversation about the role that you all can and may want to play as you think about your role as an investor and what
that means I hope you all make it to the end I think it's going to be really useful and I think we have a pretty great lineup of instructors that'll be very relevant and useful to everyone so with that I'm going to turn it over to our first speaker Sam Altman the president of Y Combinator who actually had the original idea for this course so I'm pretty grateful for that and he's also the man
who has said you want to sound crazy but you want to actually be right Sam thank you Jeff and thank you all for coming this is it's cool to see so many people in the room so I want to talk about why how and and what to do to invest in startups I'm only gonna talk a little bit about why especially given how many of you already invest in startups but I did do something to get
ready for this class which was I asked some of the best investors I know why they invest in startups and I contract Oh Steven I think it's automatically advancing no problem so and then I compared that with reasons I've heard from other people who I don't think are as good and I think it is worth thinking about why the people who have sort of done the best in the field what their
motivations are to invest perfect this was one I heard from a few people these exact three words from a few different people and this resonates with me the thing that I like the most about investing in startups is that it's energizing I feel like I am constantly on working with people that are not burned out on the world at all they have unlimited energy they have new ideas and
they have the sort of the beauty of inexperience and they don't know they're your people that are doing things for the first time are willing to do things that anyone who has got a few more battle scars won't try and that is incredibly energizing to be around help shaping the future was something that the very best investors said again and again and as part of that the leverage
on time the ability to work on multiple things came up again and again and again most of the time you lose one extra money but occasionally you do get to make a hundred or a thousand decks and that for the same reason slot machines are so satisfying is incredibly addictive it's also satisfying because every once in a while a founder of a great company who is you know no super
famous will tell you hey that thing you did for me eight or ten years ago was this make or break difference to my entire career and that's that's deeply gratifying you get to be around some of the most talented people in the world there is this sense of just endless optimism around the future that is really important to my own personal happiness to be around and I haven't
found that in too many other places in the world besides startup founders it's incredibly humbling I write on the back of every stock certificate on a post-it note my confidence interval and what I thought was gonna happen with the company and you get used to being wrong a lot and that framework that mental adjustment that you know you're usually gonna be wrong that has been helpful to
me and everything else I've done in life you do learn a lot though and if you if you treat this as something that you're gonna try to get better at and sort of deliberately practice ah you can learn a lot and you can get better at this really quickly all right so now I want to move into the two main sections the how and the what the number one mistake that I used to make when I started
investing was actually not a misunderstanding of the power law the number one mistake was that I cared too much about what other investors thought and the sooner you can free yourself of this the better the I think this is a very common mistake that people make when they start investing you get very swayed by what previously successful investors think the first question that
most people ask why see startups is who else is invested in year round people totally outsource I would say 80% of investors outsource 80% of their decision-making to what other people think about an investment opportunity the problem is everyone does that and so there's this weird schooling effect where a company gets hot for no discernible reason or it fits a trend or whatever and then everybody wants to
invest in one company and it's just because a few people decided they liked it so the number one mistake I made was to be too swayed by what other investors thought good and bad about a company after I corrected for that the second biggest mistake I made was not investing the power and not understanding the power law the power law means that your single best investment will be worth
more to you in return than all of the rest of your investments put together your second best will be better than 3 through infinity put together and this is like a deeply true thing that most investors find and this is so counterintuitive that it means almost everyone invests the wrong way so the question that you should be thinking about the question that most people
think about when they start angel investing is can I hit a bunch of singles and in most other kinds of investing that's the right way to do it you know if you're going to invest in stocks or bonds or whatever that's how you do it you're just compounding singles for a long time but angel investing is a business of homeruns and you want to look for things that can be
potential homeruns and we're going to talk about that again and again through this but this is I think the most important thing to learn and the thing that most investors get wrong so it's all about it's all about the magnitude if your biggest success it is not about the failure rate most investors talk about their failure rate still you know when we have people that are trying to
build angel firms come talk the question the first question they ask is what is your failure rate what's an acceptable failure rate totally the wrong question totally the wrong way to think about angel investing you can have 95% of your investments fail if one of them returns a billion dollars and you'll be totally happy and so this is what you want to think about the first question that I
try to ask myself when I meet a start-up is not why is it going to fail it's not what could go wrong the first question is how big could this be if it works can I imagine this founder this idea this market supporting a you know massive massive company and then I think about all the things that could go wrong but I found that if I thought about what could go wrong first I filtered out the
companies that could be giant the companies that could be giant are at this intersection of sounds like a bad idea is a good idea and because that's a very narrow intersection and because they sound like a bad idea the best investments are the ones that are easiest to talk yourself out of if you start off thinking about why they could go wrong so then there's a question
about how do you find these companies how do you find the companies that can be the handful of companies that get started every decade that are responsible for almost all of the returns just to put some numbers on the power YC has funded I think around 1,600 companies maybe 1700 our top five companies represent about two-thirds of the value that we've created and our top
one company represents about one third so this is like a nearly one-third so this is like this very extreme very counterintuitive thing all right how do you find these companies another thing that I think is surprising is many of these companies that are sort of a generation-defining companies are started by people who are out of network who are not well-known who are not sort
of the people that you know can start a company and get a bunch of press right away and so you have to find these and that the best way to do that is from other founders this is part of what we try to do at YC is we try to get our founders to like us so much that they refer all of their friends to us because they say these you know YC creates so much more value than it takes you've got
to go work with them and we this idea of like word-of-mouth as the way to find companies to invest in has been great if you're just starting out I think what I have seen the most successful angel investors do is just start helping founders for free realizing they may not get to invest in those companies but that they'll get the referrals down the road and so much of
this is about people connecting you to other people that you don't know we talked about this at YC this value of an open network a lot of angel investors like to brag about how difficult it is to get a meeting with them how you have to have a connection otherwise they'll never take you seriously and it's got to be from like you know someone they worked with a bunch and you've got to be
well-known and experienced and we just make it really clear anyone in the world can go to our website click apply we try to respond to emails to people that email us we take people seriously that have no personal brand no reputation no network we ask people that are in our network to connect us to the most promising people they know that we don't already know but this idea that
were available and we're open I think this was in the two or three most important secrets of YC this was something that we did that was different other people hadn't done it before in fact people bragged about the opposite and we went totally other direction and I strongly recommend this be be open to that random email that comes in be open to the introduction of someone that on paper doesn't seem like
you know that there's someone you want to meet nine times out of ten you waste your time that other time makes it totally worth it so one big shift that's happened in the last ten years I'd say or maybe 15 even is there now way more people that want to invest in good startups than there are good startups and so it founders have really become in the driver's seat founders
founders of good companies have a lot of choice when it comes to investors and founders talk a lot now the network has gotten big enough that the asymmetry that used to exist where investors had a lot of leverage is gone and I don't think it will come back anytime soon your reputation matters a lot it is way more important to your future success as an investor that founders like you and
say that investor did the right thing by me than it is that you squeeze out you know a few drops of juice from a failing company the number of investors that I have seen do incredible long-term damage to their reputation by fighting over the carcass of a company that was never because of the power law going to matter to them anyway but try to get out you know ten thousand dollars or whatever
from a dying company if you're playing the long game that's not worth it reputation especially reputation when a company is going badly is super super important and I think that is the secret at this point in sort of 2018 Silicon Valley to doing deals the thing that we tell founders to do and the thing that founders do anyway when they're trying to choose between a number of investors
that all want to invest in their company is they they do reference checks on you just like you do on them and more and more the thing that I have seen founders use is the criteria to make the decision about which investors to work with is what the other founders that investor is fun to have to say and so I think this will this will continue to be important there are other things you can do I
think helping before you close the deal is good deciding quickly being clear about your reasoning being responsive being available all the things you want from a founder those all help to but but this reputation of being good to work with that goes a long way and people remember that for a long time the other question I get all the time is how do I get a good bargain like how do
I get a better term than they're better terms than everybody else we recently had a company they had let's say you know ten investors and that we're gonna join their seed round every one of the ten had asked for advisor shares every one of the ten had said well unlike all those other investors I really do work super hard you know I'm the only investor in a round that
usually gets advisor shares so you need to give them to participate and everybody asked for this all ten same thing I'm the only one I need advisor shares and I think you know a lot of people are just looking for a good deal because valuations feel high they have felt hi to me for eight seven years now I went back and looked at my destined us mminton vestments I've made have either
been a ridiculous deal because no one else wanted to invest or a deal that felt incredibly expensive the more I was willing to sort of overpay in my mind to invest in a company often the better it did and especially when I felt like I was getting screwed if it was like a huge opera months after some other round it was painful I did it anyway I think because the companies that work
sometimes work so fast and you're anchored to like what a fair deal is you got to watch out for this but my experience investing in startups is my best investments with one or two exceptions have been the deals that felt the most expensive to me and the one or two exceptions were companies where I understood something that no one else did and thus there was no competition
whatsoever other than that the company is where I like tried to value invest have not been as good I think value investing is not a winning strategy when it comes to being an angel investor most of the time all right I will try to go kind of fast to this to leave time for questions so there's a big question of what to invest in and here's the framework I use I will
consider anything that I believe could be a ten billion dollar company and that is such a tight criteria I have no other rules so I am willing to look at any stage I'm willing to look at any sector I am willing to look at any business model there are other investors who have this like oh I only do this one thing at this one stage and maybe they make that work I have never figured out how to do
that the good the great companies the companies that are in that number one spot on the power-law are so rare that I suggest you only select four things that can be there and other than that be really open-minded speaking of the really big companies I think I don't know if this was always true I suspect it may have been but I think today it is easier to start a hard company than an
easy company and this sounds super counterintuitive but if you're gonna build a really big company you got to convince people to come work with you to pay attention to you to write press articles about you to care about you to advise you and if you are starting the twenty two thousand the photo-sharing application it's really hard if you are starting a nuclear fusion company a lot
of people want to help with that and I think especially for the companies that end up breaking out this is really important you know this thing that is so interesting people proactively want to help you for free want to come be part of your team whatever this is something to look for so like is this a company that I believe will be able to recruit hundreds of really talented people who
could otherwise start their own companies is a super important filter that I don't think people think about enough one thing that we've learned at YC is to mostly pick the founders it is difficult to hear an idea at the very early stage and say yeah this idea has what it takes to be a ten billion dollar company you can say an idea doesn't have it which we'll talk about but it's
difficult to say this is for sure the big idea however I think you can with practice identify founders and I'm going to talk about how that have it have a chance at creating one of these companies Paul boo hi one of our partners made a list of the four traits that he thought founders that go on to create giant companies have and they are obsession focused formality and
love um he said this sort of in passing in a meeting like two or three years ago I've thought about it a lot since there's there's other obvious things that everyone screens for but pay attention to these speaking of the obvious things that everyone screens for intelligence is really important you can give a founder an idea and they can start a company the problem is they need
to come up with new ideas for a company basically like every week you have to come up with crazy new ideas big changes all the time we we tried an experiment once at YC we funded twenty teams of strong founders that didn't have ideas but were otherwise really good and what we learned they all failed and what we learned is that the good founders are the people that have ideas all the time
so there's an intelligence components to this there's a creativity component to this there is an ability to think independent thoughts component to this but whatever you want to call this this idea of this particular kind of intelligence that leads to seeing problems in different ways and thinking of ideas that don't yet exist but should you've got to have that in a founder
communication skills I think are one of the most important founder qualifications that people don't think about enough so so much of your job as a founder is about communication you are every time you hire someone every time you go raise money every time you try to sell the product every time you try and set a direction for the company you do it like a huge amount of a founders job
is being an evangelist for the company and if you don't have really strong communication skills or if you don't develop them quickly you're at a big disadvantage think about their there are obviously famous exceptions to this but if you think about it on the whole the founders of the really super successful companies tend to be great communicators execution speed there's a
lot of ways to measure this but and we talk about this a lot the need to sort of relentlessly execute as a founder this is incredibly correlated with success so one way we test this during YC is between office hours which we have every week or 10 days how much progress do the founders make how quickly do they take a new idea and try it and say hey I came back and I tried that this didn't
work but this other thing did in the process I had these three new ideas I tried those just this relentless cadence of execution is incredibly predictive of success and it we had a joke once where the there were all these founders who are incredible on paper they never actually quickly they always have great reasons for why they didn't but they still never go and be successful and
then there are these people who just like get an amazing amount of stuff done they their iteration speed the speed with which they can have a hypothesis tested and implement it is unbelievable that's really correlated with with huge success the rate of improvement of the founder so if you look at a founder who comes to meet you for a seed round and compare that founder to Brian Chesky you
will be disappointed 100% of the time that is the wrong comparison you will never write a check however just like startups you look at the growth rate you should look at the growth rate of the founder as well so one thing that we can often tell over the 10 weeks of YC is how fast a founder is improving this is different than how fast the business is improving and you know like humans
always underestimate exponential growth we're not we're not well evolved for that and so if you notice a founder who is improving incredibly quickly over the couple of months you get to know that founder pay a lot of attention again you won't you won't get Brian Chesky in a first meeting but you can find people who are on a trajectory to develop into a Brian
Chesky and that is super valuable this is one of those things where I have seen it you know maybe like 10 times in my career so far where I just knew that this founder was going to like develop into an incredible leader and it's basically been every time I felt it it's been right I really do trust this like this rate of improvement metric I think one thing you have to be increasingly
aware of are the wrong motivations so starting a startup is a very long-term commitment you know if it's gonna work it takes more than a decade it's really hard there are a lot of days where you just want to give up and there are a lot of people now who start a startup because they think it is a way to get rich quickly and unfortunately it's just not so as startups have become the new
default career trajectory for ambitious people there are a lot of people who are doing a start-up as a resume item or as a way to get rich quickly this does not work the amount of pain that you have to suffer for a start-up you realize at some point you know what I can do pretty well in any series of other jobs with much less risk and much less negative
effect on my life so you really do want to stay focused on the mission driven founders again if we look at our own success and failures in our portfolio of YC every time we thought a company was going to go really well and didn't the company the founder did not have this deep sense of mission so it's something we really look for as a primary motivation and then another way I used
to get tricked a lot is there were founders that I didn't think we're that good but they hate to stumble on a nice business or you know they had this metric that was growing pretty well or all of my other investor friends were investing and so I got scared and did it anyway but but I think this focus on truly exceptional founders like people that I'm like wow I want to go work for
him or her is really important I've I've I have never once made a lot of money backing a founder that I thought was only okay but a business that was otherwise good I talked a little about this but we have a word of YC called scenesters this is different than people who just want to make a lot of money there are increasing number of people who just like want to be around startups
and go to startup parties and talk about being a founder treat that as a red flag obviously low integrity people um that doesn't work out either okay um this is maybe the third biggest misunderstand you know I had and I think for many people it's their number one biggest misunderstanding people always say that what matters is not a startups current revenue but its growth rate and that's
true however in the same sentence investors will say but the only thing I care about is the size of the market today and this is obviously ridiculous on its face right like if you think about the biggest companies today ten years ago many of those markets did not exist if you think about the size of the social networking market when Facebook started if you think about the size of
ride-sharing apps when uber started that's a really bad metric and unfortunately it has become Dogma among investors that you know size of the market is the most important thing even really good investors say this I think they either I think they actually mean what they care about is the size of the market in ten years but they don't say it that way and what you should care about of course
is the size of the market in ten years if the market is huge today first of all you probably have a lot of big competitors already going after it big companies from doing that second of all you don't get to surf this wave of this new technological change that pulls startups along and creates a ton of value in a short period of time but you should prefer a small market growing
super quickly to a very large market today super counterintuitive if you chase the things that worked in the last set of companies which is what most investors do you know Facebook works they all want to fund more social networks uber works they want to fund more what ride-sharing apps that is much harder to do the second time it's far better but more difficult if you can identify
the next rapidly growing market and invest there this is where this is where independent thought is really important if this is not something where you can just sort of follow what everybody else says by definition you've got to learn to form your own thoughts about about what the next really big market is going to be one way that I like to do this one way that I like to say you know is the
market growing really quickly is to think about this question of whether something is a real trend or a fake trend and I'll talk about that in a second actually right now okay so it has almost become a joke to make fun of like angel investors moving like a school of fish after one you know declaring somebody's a hot trend and then two years later never talking about that
again and saying well that just didn't work but so there's this question but sometimes they're right you know investors in Silicon Valley as a whole for example got mobile right as a thing in a big way but then they got most other things in the last ten years wrong and I think every time someone talks about a big trend my first reaction is skepticism and I suggest yours is as
well okay but how do you differentiate between a real trend and a fake trend a real trend is one where although not that many people are participating yet the people who are use the platform a lot every day and tell their friends spontaneously how great it is so when the iPhone came out most of the mobile industry would make fun of it because Apple only sold a million or two million
whatever it was in the first year but if you talk to anyone who had an iPhone they would say this is the greatest piece of like you know technology I've ever had people used it like many hours every day they it was absolutely life-changing so even though the number of people that had it were small you could identify that as a real trend because the people who had it were not
only like daily active users but hourly active users and they were they were the best free advertising Apple could ever have hoped for because they told everyone like this is the future you've got if you contrast that to something like I got to pick on somebody I'll pick virtual reality if you contrast that to virtual reality everyone talks about it is the next trend it may be in the
future but today if you talk to people who have VR headsets they don't use them every hour they don't use them every day most of them don't use them every week they sit on shelves that has clearly not become a a real trend platform yet it may in the future and the point at which you know people that you know are a lot of people you know small number of people you know even start putting their
headset on for hours every day and telling all their friends they've got to buy one it's the greatest thing in the world that is the time to start investing heavily in VR so so this question you know are people actually using the platform I think is a really important one when you're trying to think about you know the next technology wave and you do want to try
to figure this out you do want to try to figure this out the certainly not all but most of the biggest technology companies get created soon after one of these massive platform shifts Sequoia says this thing that I've always liked which is you cannot create a technology wave that is well beyond the capability of a small company to do but you can surf one if you can find the wave and I
think that's really important and I think it's actually like if you use this framework pretty reasonable to evaluate ok so I mentioned this a little bit earlier what you are looking for are good ideas that look like bad ideas these are things that you can articulate there is a reason that this is going to be huge that most of the world is missing unfortunately what most people end up
chasing are bad ideas that look like good ideas I would say this is where like 90% of all angel capital and the startup ecosystem goes so this is something that is worth trying to avoid and the one very common way that people make this mistake bad ideas that look like good ideas are chasing the thing that worked 2 years ago and so if you ever find yourself doing that be very
skeptical if you find yourself tempted to invest in one company where there's hundreds of others working the same thing be very skeptical if you find yourself tempted to work on something that the founders work super hard to convince you is not going to be a long-term commodity be very skeptical the more people talk about like it is absolutely true that you want to something that has real pricing power
that comes from a network effect a moat a varied entry whatever it is but the more founders tried it like when that's true it's so obvious that the more founders try to sell you on why they're super differentiated and why they have this long-term competitive the more skeptical you should be but I have found this framework just trying to think about is this a good idea that
seems bad or is this a bad idea that seems good I found that has helped me make good decisions a bunch of times this is sort of ycs mantra but it's so important that I want to talk about it again the the best companies all have great products unfortunately the current fashion in Silicon Valley I think has gone a little bit too away from this and it's too much about growth hacking and
sales and marketing machines and everything else and that does work for a while you know you can get away actually for a pretty long while by executing really well to grow a mediocre product but you don't usually create like a Facebook size company by doing that and I think asking it become the companies often won't have a great product by the time you're making an angel investment
but if you don't believe they can't won't get there at some point it I don't think it'll be a huge company most of the time and and here is the very simple framework I use for this if I think about all of the most successful internet and mobile startups I heard about those because this is like true for enterprise and consumer apps I heard about those because they were so good
that one of my friends spontaneously told me about it they were not being incentivized to that was not they didn't mark it to me didn't advertise to me it was just like someone I trusted said you got to try this new thing it's amazing and if the startup is not gonna get there I think they will not be at that number one spot on your on your power-law of returns so
I think this is like a really important filter related to that and I mentioned this earlier a little bit human intuitions about exponential growth are terrible we clearly had no evolutionary need for this we can like visualize linear growth very well we can like you know visualize the trajectory of an arrow very well we very few people that I have met actually maybe none can sort of tell me what
you know like let's say 25% monthly growth 1.25 to the 36th power is say where well it's coming to be in 36 months it's really hard and it is how these companies get super valuable so I long ago learned to stop trying to trust my intuition on this now and I just model it out and I try to model the decay rate about how how much I think growth will slow down but I try to say
okay you know given that this company is growing by word of mouth how big can it be in five years and yeah I've learned not to trust my intuition on that I mentioned this a little bit earlier but I wanted to mention this near the end of the presentation there are a whole bunch of words a whole bunch of different ways that people talk about this this is one of the most important concepts in
start-up investing this is one of the things that differentiates investing in startups from investing in small businesses um you are looking for a company that gets more powerful as it gets bigger you are looking for a company that gets increasing pricing power as it gets bigger you were looking for a company that has an easier time getting more users as it gets bigger
that gets harder to compete with as it gets bigger and you know this is often fairly obvious sometimes it's not sometimes you really have to think hard but you know like once you do you can come up with a story for it this is something that a lot of people get wrong because they get caught up in oh this is going this is so cool today this company has discovered this wonderful thing
almost all of the value in a start-up is the you know revenue the earnings is going to generate in years 10 11 and 12 from now and so if you can't answer this be pretty skeptical and then finally one other question that I like to think through before making an investment is what do I understand that other people don't there can be a lot of answers to this but this is this comes back to not
basing your decision too much off the decision of other investors I like to understand in ax mum if I don't have an answer to this question I I don't feel like I have any competitive edge in there in that particular investment decision but and sometimes the answer this question is just like everyone's bullish on this company but I'm more bullish because I I
understand a specific thing about this market and and everyone thinks it's good I think it's even better so I'll pay this very high valuation but this is a question that I have found helpful for me in in many scenarios all right unfortunately I took all the time but maybe I can do like five minutes of questions we definitely have time for some questions I just wanted to remind
all the folks who are live-streaming that the hashtag for questions is is YC s is it's YC s is I think the beginning of the livestream might have missed that so please do send some questions and I you know we started a little late so perhaps running a little long and then we'll take a quick break Thanks all right yes what can a least age investors do to add a lot of value to founders almost all if you ask
founders this which you know they're the customer here I think that makes sense almost always the number one thing they want help with is hiring so helping them find really good people help them interview you know back when I was sort of an active angel investor before YC I would tell founders like you can use me as much as you want for interviews like you I will I will help recruit I will
help source people I well then I will help close I think people really like that help with future fundraising and then help with just sort of like everyone wants to like provide the big strategic advice and that is really valuable I think one of the things that I did well when I was an angel investor was I would just try to be available all the time for tactical advice so I would
meet for like the big strategic what can this become advice and that's fun but I think a lot of it'll you comes just from being available at 11 o'clock on a Friday night when a founder needs a two-minute phone call for some emergency so super availability for tactical advice I think is good what flaws are acceptable in a founder and a you know series cedar series a
stage um a lot I think like don't compromise on the things that don't get better like don't don't compromise on a boundary of integrity but if you think the founders improving fast I think I think a lot so I like I bucket this is traits that I believe can change and traits that I believe can't and if the founder is improving quickly and it's something that I think is changeable you
know we've had many many very unsophisticated founders but that we're smart I wanted to learn and were you know doing this for the right reasons super mission oriented come through this door these doors and they have just progressed really fast so you know they were founders who I think had like no domain-specific knowledge about like one funny thing is when you are negotiated
an investment a lot of the time a founder who's otherwise very good will have no idea because they've never done this before and it kind of spooks you you're like wow you don't know what like evaluation is and that's the kind of thing that's like that's a father that's okay how do you judge for integrity with a founder that comes out of network so in our experience we we've gotten this
wrong a handful of times but we have prevented ourselves from this mistake hundreds of times because even in our 10 minute interview if you give like a founder a chance to sort of tell you about the unethical things they do they will often do it and yet surprisingly often so I think the answer is you just listen to the decisions they've made so far in building the business and if you're like
that's not a decision I think is okay you can expect more of them in the future but just listen in the first few meetings and you'll be surprised we definitely have been fooled by plenty of people but we also make our decisions in 10 minutes results-based observations about when to exercise parada and when not to several venture firms have done very sophisticated studies of this and they
have all come to the following conclusion which is if the company is raising an up round led by a good VC say a top quartile VC you should always exercise pro rata and if you do that across their whole portfolio you'll be happy now this could change if the world really changes and but in the world today there's like very clear data on this what's pirata so often when you
invest in a company you will get not always but often you will get something called a pro rata right which is your right in future rounds to invest enough dollars in the new round to maintain your ownership level sure all right do I think security tokens and icos will change financings probably but not in the way that most people think I think this idea that like everyone is
going to just raise money from the crowd I like I think we'll find out that we have securities laws for a reason and that we want some level of that and that the level of you know I think like there are some incredibly important ICO is happening right now but they are dwarfed by the number of sort of things that are between just incompetence and scams however I do think that it's possible
that we just find a much better mechanical way to track the investments we do right now so that's possible a bad idea that seemed sorry a good idea that seemed like a bad idea you know this is like one of our darlings but I just like it's a it's an example that sticks with me so much because they were in my own YC class in 2005 was reddit so when reddit started I remember very clearly
like telling my friends about it because I was like oh there's this site and you know you can like find these links and and and I remember people looking at me like and they were good well-meaning people nice people that is the dumbest thing I've ever heard like there's all these things already on the Internet you know this one is just like pictures of cats or whatever it was at the time
and the in it and there's no way you will ever make money on this business so that's like there's other more famous examples but that is the one that for me resonates very deeply because I was I heard so directly from people I trusted so much and I remember like when they would say it I would just be like oh yeah I guess it's not a very good idea like I had all this conviction that
totally went away when people I trusted said said said something was bad there's another common version of this problem which is where there's an idea that seems good in the abstract but everyone assumes the big companies will crush you so Dropbox is an example of this where when when we funded them and when they were kind of getting going everyone was like oh it's a perfectly nice product
but you know Google Microsoft whatever guaranteed to crush them soon all right other questions yes um you know when uber was getting going there were there would be all of these articles that would come out it felt like every year where someone would say uber is not worth X the entire taxi market is only worth you know 10% of X and so and this just this kept going um
and that is really hard right because you don't you don't have a sense for exactly how big the market is because growing so quickly I think one thing you can do is look at like shifts in consumer behavior that are creating new markets so like if you thought of uber as a replacement for booking limo services that was one thing if you then started to realize that people had begun
to use it as a replacement for taxis and then public transit and then car ownership you could project forward Wow this market is actually going to be quite big because all of this other consumer behavior is going to shift here um all right a solo non-technical founder I wouldn't say I never would I've done it before I think it can work I do like it when
that founder learns enough to build an MVP where I've seen that go wrong the most often is then the ability to attract evaluate and retain technical talent and so we have a strong strong preference for founding teams that have at least one technical founder we also have a strong preference for teams that have at least two co-founders again none of these are absolutes because this is
all about the power law we are always willing to consider exceptions so I would never answer a question like that and sad would never but I would try to be clear like here's what I've seen work more often what is the next question Oh a good amount of self-awareness um I think I think a good amount of like willingness to take a feedback and a drive and a desire to improve is really
important but you know you you do also have to sort of believe that you can succeed in spite of all of your flaws and and so that that's almost more important to me than like someone who really spends a lot of time categorizing everything about it if they're willing to listen willing to improve I've usually found I can work with that founder one more question in the back
how do you think about evaluating your time and resources to different founders a self-indulgent way to do this but one that works is only fund founders that you want to allocate a lot of time to because if you don't and if you're like if the founder is like difficult to work with or doesn't listen or you're just not excited about the business a that's probably a red flag for their qualities
as a founder and be you then you won't spend time and you won't help them and you won't get this differentiated things so I like I won't fund a founder that I don't want to spend a lot of time helping and as that has always worked pretty well for me all right thank you all very much so just just a couple of quick notes Sam mentioned that you want to look for founders who understand that
startup success can take as long as a decade or more I think it should be obvious that the same thing is true for for you all investing investing is not again investing startups I should say is not a get-rich-quick scheme it requires both patience and passion the the the interest that that that is hopefully reciprocated by the founder and the second thing I will point out as someone
who has done a lot of angel investing and compares his results to sands that he's really really good at it so I hope you do listen quite carefully or have listened quite carefully to what he has to say we are going to take a short break so please try to be back here by 11:15 10 minutes and then Christine Carolyn are going to talk about investing fundamentals and mechanics thank you
No thank you and can we also just check the sides yeah I'm gonna turn up right now Hey oh you're doing a livestream yeah so you're our engine and then we're just gonna have to jostle for position on here okay [Music] cuz I I'll let him know hello hey hello everybody quick announcement in the spirit of having kinks apparently we have a couple of overflowing toilets the one in the
back is not working the one here is working if there is too long a line you may go across the street it's a 335 if you go right to the left when you go in there are toilets please feel free hello hello hello hello everybody please come take your seats we're gonna get started right away please thank you hello [Music] yes and they're not too particular about what kind of do
okay so first announcement is that apparently our toilets are closed here there's a there's a city problem but it stops here so you if you need to use the restroom please go across the street to 3:35 give it one sec for people to come in all right this next session is actually one of my very favorites because there's so much mystery in the fundamentals of how you actually do a
startup investment what it really means and how it works and there are no two people who are greater experts in that on the planet than my colleagues carolyn levy and christina who who who who have dealt with these issues with I guess thousands of companies now it's certainly all sixteen or seventeen hundred YC we should what is the actual number probably no nobody knows it anyway
hundreds of companies they know this stuff better than anyone Carolyn is the is the person who actually invented the safe she used to be attorney it it it will see any before coming here and Kirsty is the CFO of YC they too have have a couple of pithy quotes you can guess who said what because I don't know one said all investors who can help should do so asking for additional shares is just
asking for a freebie I'm guessing that's Kirsty but I'm not sure having money is very valuable but someone who helps with strategy and direction is priceless so choose wisely so with that I will give you Carolyn this is working okay yeah I have no idea which quote is mine and which one is Kirsty's and we were going to introduce ourselves but since Jeff just did it we will move right
along like Jeff said this is the mechanical part okay this presentation is about how to invest using Y Combinator's is my mic not on did people nine lights on just on low better better better better okay I think we're good okay so as I was saying this presentation is about how to invest using Y Combinator's safe which is the first thing I'm going to talk about and then Kirsty's gonna
describe how the safe converts in an equity financing I'm gonna talk about how the safe converts in other events quick word about process and then we had some advice that Sam kind of covered but will Tucker will just reiterate it because it's important okay so a lot of you raised your hand when Jeff asked or Sam asked how many people have already angel invested so I'm wondering how many
of you have already used the safe - oh that's a lot okay okay so um I'm gonna talk about the basics for some of you that's gonna be stuff you already know but for those of you who've never used it hopefully that will be helpful it will be helpful okay um we drafted the safe for very early stage startups so that means that the company maybe hasn't written or definitely hasn't raised a
price round doesn't have any preferred stock outstanding you absolutely can use the safe for companies that are later stage that have already raised a priced round and issued preferred stock in fact some of you may have already done that but we intended it for very early-stage startups a time when you may not want to use the safe as if you are looking at a
company that has already issued convertible promissory notes to earlier investors and if that's the case you're gonna want to go ahead and just use that same note not use the safe and that's because it's a lot less complicated for a company to have all of its investors on the same document and it's also more fair to have all the investors on the same footing so obviously if you find a
company you want to invest in and they are actually doing a priced round you're going to invest in that price round and buy preferred stock but for the vast majority of early-stage startup they don't have a lead investor they don't have a person setting the terms setting the price of the round and most the time for very early-stage startups they don't even know what they're doing yet and
that's where the safe comes in because for these very very early-stage companies they just want to raise a little bit of money from their friends and from family and from angels and with the safe they can do that very efficiently very quickly and very cheaply because neither the investors nor the company need to get legal counsel okay the safe is an acronym stands for a simple agreement for future
equity as I said before it is a convertible security it converts into shares of the company's stock the premise is very simple you the investor give money to the startup right now and at some point in the future you're going to get your stock one of the most important things I say this a lot the safe is not alone it is not debt it does not accrue interest there is no right to be repaid
at some point in the future at some maturity date so please don't call it a safe note that makes me really crabby okay what does it look like I brought one it's it's five pages long compare that to a set of financing documents which is about five documents and none of them are five pages long they're all much longer there are only two key terms I'm going to show you
this is what the intro paragraph of the safe looks like you can see that there are two blank spaces there the first one is the amount of money that you're going to invest in the startup and the second one is the valuation cap Kirstie's going to get into detail about what the valuation cap is when she speaks next but those are the only two things that you negotiate with the company it is
just that simple after the intro paragraph there is a whole section that describes the conversion events which we will get into in a minute there is a section of definitions because it's a legal document we always have to have definitions and then the rest of it is boilerplate and an example a boilerplate company makes reps and warranties to you about the status of the company you make
some representations to the company about being an accredited investor and then there's a really skinny miscellaneous section at the end I want to point out what is not in the safe for those of you who own preferred stock have made an investment and company and gotten preferred stock you will know about voting rights and information rights and liquidation rights those are
not in the safe because the safe is not yet stock when you're safe converts and you get preferred stock you will be piggybacking on all those same rights that the lead investor in the round has negotiated for the preferred stock so you won't find those things in the safe so um what you will find in the safe is pro rata and Sam conveniently defined that for some of you who don't know who
didn't know what it was before it's the right to buy more stock in future round so that you maintain your percentage ownership of the company the safe has a section that says that you will get those pro-rata rights in the next round not the conversion round but the next round so if you're safe converts in a series a preferred stock financing that document will bake in the right for you
to buy shares of this series B financing so that you can maintain your pro rata percentage okay so um what we are what I've been talking about is what we call the capped a f--- it's the one that has the target valuation Kirstie's gonna describe that in a lot more detail it's the most commonly used safe that we have but there are a couple of other versions of
the safe that I'll go over briefly there is something called a discount safe instead of negotiating that valuation cap in the intro paragraph you and the company will negotiate a discount rate and the discount rate will then apply to the shares when you convert the safe typical discount rate ranges in between ten and twenty percent so for example if this series a round that your safe is
converting in is the lead investor has priced it at $1 per share and you've negotiated a 20 percent discount your effective price is 80 cents share it's pretty simple there's also an uncapped safe which not as not not very common to use this has neither a target valuation nor a discount so really you're just converting your safe into the same price that the series a is paying there's no
reward for being the early money that's why it's a pretty unusual safe to have but occasionally a company has such great demand that they can get away with serving up an uncapped safe so just be on the lookout for that and then a third version is what we called the MF n safe MF n stands for most favored nation it's a it's a concept we borrowed from contract law
and there is no target valuation in this safe but there's this MF n paragraph that says that if a subsequent investor negotiates a target cap or rather target valuation or a discount you get to amend your safe to take the terms that that investor got so that so then your safe is no longer uncapped and now Chris all right so now we're going to talk about how the safe converts and we'll
cover how the valuation cap works the maths behind the safe converting so this is going to turn into a maths class and also how to understand your ownership so first of all the valuation cap this is one of the things that as Carolyn mentioned is one of the things that you will negotiate with the founders and you'll also hear it referred to not only as a valuation cap but a target
valuation or just simply a cap and the caps the highest valuation that your safe will convert at so if the priced round is lower than the valuation cap in the safe your safe will convert into shares at that priced round valuation and it's important to note that people get really confused with the cap they think it's a current valuation of the company that's really not what it is all it is is a way
for you to be rewarded for coming in at the earlier stage when in theory you're investing at a riskier stage it's it's the way to for you to get your rewards and your bonus and so ideally what you really should be thinking is if I'm putting money in at this cap then what do I think the series a price how much higher do I think the next price rounds price is going to be and ideally you
want that high because then your reward is better okay so your safe will convert into shares when the company completes and equity financing i priced round and different companies depending on the stage of the company that priced round might be called the series seed it might be a Series A or there might be some situations where they've already raised
the series a and there's some safes bridging them to the series B so it's just whatever the next price round is and we'll try to refer to it just as a priced around here but sometimes it just slips in this it's a Series A but it can be any price trend and in that equity financing the company the founders will negotiate with a lead investor in that round and will create a term sheet
that sets out the terms of that rant and those terms don't impact how your safe converts because that sets out in the safe itself but what it does impact is how many shares the safe converts into as we'll go over in a moment so when the priced round closes three things happen and in the documents they're all happening at the same time but in the calculations they actually go in order
and you'll see why in a moment so first of all an options pool is created or increased if the company already has one and usually the closing option pool which is negotiated as part of the term sheets negotiations it usually is around 10% of the post round shares and that's kind of what makes this calculation a little bit complicated as we'll see in a moment
next thing is that the safes convert into shares and although the safes themselves don't state this the term sheet will usually specify that the SIRT the safes convert in the pre-money and what that basically means is that this the shares that the safes have converted into are considered when the price per share for the lead investor is being calculated and again you'll see that in
an example in a moment and then thirdly the new money comes in so the lead investor and anybody else who's investing in the round at that time will invest their money and buy their shares okay here comes the mass so it's a very high level for any investor the number of shares that an investor will receive is the investment amount divided by a price per share and the price per share
is calculated by dividing evaluation by the shares issued by the company and the shares issued by the company is otherwise often or always referred to in the documents as the capitalization of the company and so for a safe holder the valuation is the cap and the capitalization is usually the issued shares plus the increased options pool for the new investor the valuation is the priced
round valuation and the capitalization is the issued shares the increase in the options pool and the shares that the safes have converted into alright here's an example so on the left over here we have an example situations so we have founders who have nine million shares issued and there's three founders in this example and they're all sharing the shares equally and at demo day in March
the company raises $800,000 on safes and they all have the same valuation cap they all have an eight million dollar cap then fast forward to November 2019 and it can take that long maybe even longer before a priced round happens and they raise a priced round which is where they raise four million dollars at a 16 million dollar pre-money valuation and the terms that are negotiated in the
term sheet as well are that the options pool will be increased to ten percent of the post money and the safes convert in the pre money and I'm not going to get into the calculation of how the option to pool increase number works because it gets very circular as I'll show you in a moment but just trust me that it's going to increase to this very not round number of just over one point four
million shares okay those are the details so the first thing that happens we've increased our options pool the next thing that happens is that our safes convert so the safe capitalization as defined in the safe is the issued shares plus the increase in the options pool so ten point four ten point four three million shares the safe conversion price is the valuation cap because the
cap is less than the priced round divided by that capitalization to give a conversion price of seventy seven cents so the as the safe investor buys our the $800,000 investments divided by this conversion price to give us just over 1 million shares everybody with me still ok good so then the next thing that happens is our new money calculation happens so this is the lead investor in
the price round so this time the capitalisation doesn't include just the issued shares and the increase in the options pool it also includes the shares that the safes have converted into so this time we have a capitalization of 11 point 4 million shares and then the price per share is calculated again using the price per share sorry their valuation from the term
sheet the 16 million divided by the eleven point four seven million shares to give a price per share of 139 and so those that four million dollars from the new money investors will buy two point eight seven million shares okay so bringing this all together this is a very simple cap table it's much prettier than cap tables normally look so for those of you that are not
familiar with cap tables how this works is it's just a way of explaining the ownership of the company and who owns what and in what proportions so here you can see that we have our three founders they own common shares their numbers haven't changed the number of shares that they have stays the same we have our increased options pool this is where the employees will be issued shares from
in the future and then we have our safe investor who has their 1 million approx shares and you have the price ground investor who has the 2.8 million shares and these safe investor and priced investor has preferred shares founders and employees have common shares so what you can see from here is that even though the safe investor has put in eight hundred thousand dollars of the total four point
eight million that the company raised proportionally between these two investors they actually have a much higher number of shares and that's that's the cap coming into play and that's how the safe investor gets the reward for their early investing so that's how that works it's also shows percentage ownership and you can see that my maths did work our options pool
is 10% of the total post post money shares which is the total of these two numbers now safe investors have quite a hard time of it because at the time that you actually sign your safe you don't really know how much ownership you're going to wind up with after the priced round and the reason for that is that even though the safe says how the safes going to convert it doesn't specify how
many shares it's going to convert into because that is dependent on the terms of the priced round and so in this example the safe investor has just over seven percent of the shares and the way you can think about it when you're signing you safe if you're thinking about ownership it's kind of a rule of thumb of $800,000 invested at an 8 million cap gives an eight point eight
million post-money valuation of the company so the safe investor would own approximately nine percent of that but that assumes that the safes convert immediately on signing and there's no money there's no new money and that's actually never happens so the reason why this 7 percent is not nine percent is why it's less is because the safes have been diluted by the new money coming in
and just as an example to just explain a little bit more if the of the priced rounds had all been exactly the same except that the investor had only put in two million dollars instead of four million dollars then the ownership here would be just over eight percent so that just tells you exactly you know you you really can't tell how much you're going to get until the price trend because that's
quite difficult it's important to do your own modeling and to think about how you you know what scenarios could happen to explain your ownership going forward and so there's a couple of things that we can that we have shared with you to help with that Jeff wherever he's gone has written some software called angel calc and that is modeling software that allows you to see
various different scenarios and there's also going to be a spreadsheet that I'm going to put on to the resources page at the investor school website so that you can see you can play around with the calculations and you can see how safes might convert in the future okay okay so suppose you've invested in a company and before it raises a price to round something else happens and
examples of what else could happen is that it could get acquired it could fail or nothing could happen so I'm going to talk about those okay I think it's easiest to understand what happens in the safe in a merger acquisition situation if you look at both extreme ends of the spectrum the first one extreme end would be you know a home run situation and buy home run effect I
think Sam mentioned this as well this term this is where an acquiring company is coming in and paying a lot of money for the startup you invested in so what happens to the safe well you are going to convert it into shares of common stock your gonna do that by using the target valuation to determine the number of shares of common stock you get and then you are gonna participate in the
proceeds of that merger along with the founders and the other common stockholders in that case you can expect a return that is well in excess of what you paid for your safe this is also what would happen in an IPO by the way so same same situation same result rather okay other end of the spectrum is the aqua hire and I don't know if this is a term that all of you in the room are
familiar with but this is a situation where an acquiring company is coming in and just taking the talent out of the startup that you invested in so the you know founders and key employees they are not paying money for the intellectual property or any other assets and these are deals where there is usually very little money in that situation you are going to elect to have your safe paid
off so the safe gives you the option and because you know most deals aren't at these two extremes of the spectrum they're somewhere in the middle what you need to do when you're confronted with this situation is actually do the math and figure out how you get the best result whether it's converting into shares of common stock and taking in merger proceeds or just getting paid back
okay so sometimes a company raises money from you and other angel investors and just can't make it work hopefully they try really hard but sometimes it just doesn't happen and they fail and when failure happens companies need to go through an actual dissolution process and part of the process requires that creditors be repaid in in a dissolution situation they need to pay off their trade debt
which is vendors and landlords and they obviously have to have to have to pay their salary any employees they have to have need to pay the salaries if there is any money left over the safe says that you are next in line so if there's money the safe holders and any other investors will get paid back often it's pennies on the dollar but they get something before stockholders get
anything and honestly in a dissolution situation not only is there never any money for stockholders but there's rarely enough to pay back investors either this is usually just a total failure and you know you can expect this to happen some of the time what happens if nothing happens so this would be a situation where the company has raised angel and you know raised from angels
and actually become self-sustaining you know profitable and they just putter along and suddenly they have no desire to raise a priced round and nobody's knocking at their door to acquire them so what happens well the safe doesn't address this and there's a reason why the safe doesn't address this situation number one when you try to draft for all these corner cases it stops being a
simple document and becomes a very complicated document in a very long document and number two this just doesn't happen very often this is in high-growth world this is extremely rare but if you want to fund lifestyle companies you definitely do not want to use the safe because then you're going to have this problem all the time if you have accidentally funded a lifestyle
company then I think our advice would be you go talk to the founders about it because hopefully you invested in really good people and they would want to do right by you and figure out how to make you whole that kind of goes back to Sam's point about being really careful about the founders you choose to put your money into Oh Curtis is going to talk about process okay so we've talked
about what safes are and how they convert but now let's talk about the process for actually signing the safe and then also for converting it into the shares so the first thing in this process is the handshake protocol and the reason why we created this is to help to avoid misunderstandings founders are by nature very optimistic and we've seen many situations where the investors
said something like yeah I'm interested meaning I'm interested in finding out more about the company and the founder hears this as I'm going to invest in your company q lots of misunderstandings and confusion so the handshake protocol is just simply a set of emails that sets out in writing the key terms and make sure that everybody is in agreement so the founder sends an email to the
investor and says just confirming that you're in for X dollars at Y cap and then you reply to the email to confirm and at this point there's a handshake deal and it's considered bad practice at this point to back out and again reputation is everything in this world so you know you don't want to be doing things like backing out because it can harm your reputation and on the flip
side the founders are under no obligation to take your money until that handshake deal is completed so especially in a hot deal where there's loads of people trying to get in you want to run through the handshake deal process so that you know that you're actually going to be able to get into the round and you can read more on this on our website as well there's a
slightly more detailed blog post about it but those are there those are the points most YC founders will use Clerke to send and sign safes and this is an online platform that uses the standard YC safe in a template form and then the founders add the specific details for your investment into that template and you'll you'll receive a signature request through Clerke where you can
review the details either in summary form or the full safe itself and you can assign the documents so you don't need to do it all in person the founders will also include wire details at that point so you have those handy as soon as you've signed sometimes the founders might use other platforms and especially non YC founders there's lots of options out there hello sign is
another assigning platform similar to DocuSign or simply they might just download them from our website which is this link and send them to you in an email to sign and send that way all of those work is just preference so when you receive a signature request through Clerke or whatever other means you should check the details in there are what you previously agreed to in
addition you should check that the name and signature block on the safe is correct particularly if you're investing through a trust or through a fund or you've created an LLC the founders won't always know the legal name if you haven't set that out specifically for them so you should make sure that those details are correct before you sign the safe don't sign the safe and then tell
the founders it needs changing and you should be ready to wire the money as soon as you sign the safe the safe isn't valid until the money is wired and one of the things that when we ask founders what makes a good investor one of the things that comes up a lot is that the investors sign and wire the money quickly you know it's important to the founders that raise their money and get back to work
and so fun so investors that delay the process or that say that they want to invest and then say to the founders oh but hang on because I just need to close my fund or I'm just this companies nearly exited and I'm just waiting for the transaction to happen so I can get some money really if those if that's the situation you should probably not be talking to invite two founders about
investing in their company until you actually have that money available now when your safes convert in the price trend you'll be asked to sign more documents and these documents will be the same documents that the lead investor has signed and will have be negotiated by the lead investors and their legal team and the company's legal team and you'll you'll receive an email
from either the founders or their lawyers asking you to sign some documents you may at this point need to ask them to send you the conversion calculations otherwise known as a pro forma cap table so that you can actually confirm how many shares your safes are converting into and see your post money ownership and you should definitely make sure to review that the the cap tables
that we see and we've now seen thousands of cap tables it's surprising how many times the lawyers actually get the conversions wrong so I really strongly recommend that you do review those cap tables and you make sure that you are happy with the calculations for how your safes convert and now sadly you might not actually have much time to review these documents and to review the cap
table you know the founders will be focusing on the lead investor they'll be negotiating with the lead investor and they'll have set a closing date and then they'll suddenly send you an e-mail out of the blue saying we need to close tomorrow here are the documents you have to sign and you know yes you want to be a good citizen and you don't want to hold up the closing but also you know
this is this is your investment and you need to make sure that you're happy and that you've reviewed the documents and that you you know accept the terms in there so don't don't sign until you are happy with those documents all right okay so as I mentioned Sam kind of already said some of the stuff hmm but I'll just reiterate because these are really important points the first
piece of advice and this is what we meant about think about the outs upside this is this is just Sam's power-law point if you believe in the power law and you invest that way you mean then what you're not gonna do is waste time negotiating downside protection because what you've realized is that eking out a one and a half x return on all these little investments is not worth it when
you're have the mindset that you're funding the next Google and that's gonna be your you know 100x return the next point you wanted to make is be helpful and Sam also touched on this a lot be helpful when the founders ask sometimes angels write checks and they completely disappear and sometimes angels write really really small checks and then they pester the heck out of founders forever
don't do that figure out be the kind of angel that just gives the right amount of help sometimes angels think that they need to ask to be on the board of directors in order to be officially helpful and you don't and please don't because it's actually not something the founders probably want sometimes I mean there's exceptions but usually they don't want early investors on their
board of directors and lastly tolerate failure I think that all the other speakers in this course are going to talk about this a lot I think it's really easy to get buyer's remorse when a company really starts to struggle and I think that gets even worse when the founders decide to pivot but you should expect and prepare for pivots and remember the safe is not alone you can't
go running in there and ask for your money back just because the founders start doing something different you need to tolerant you need to tolerate that and you need to be supportive and you need to give the founder as a chance okay so in conclusion we have covered quite a lot here and safes although on first glance look simple can get quite complex so if there's anything to take
away from this these are the key points so use the safe to invest it's the fastest and easiest method understand your rights as a safe holder and at the point of conversion I cannot stress this enough but understand your ownership and understand where that comes from and finally be patient you know this is this is a long game you're going to be with the company through highs and lows
and you know you need to you need to see it out so good luck to you all I hope you all make lots of great investments and I think we have some time for some questions you want us to take questions so the the the question is how do you make sure that you are fully rewarded is that what you were saying okay so so and the vulnerability of the cap to the subsequent money so you know the numbers
we're talking about here are an eight million dollar cap and a sixteen million dollar series a pre-money valuation if you're invested in the next Google you're going to exit at thirty billion dollars or whatever the number is so whether your cap is eight million and the Series A is 16 million or whether your cap is 10 million and the Series A is 14 million there is still a huge
amount of upside there so and that's and that's where you need to think that's you're still going to get that that upside because you still have that that ownership from having that early valuation investment and also you need to remember you do have pro-rata rights and member Sam made the point that you need to exercise those because yes you are gonna get really really really
diluted because you're the early money but if you can't afford it and you can keep putting more money in then when you have that liquidity event you should recognize all that upside I think the question was directed towards the safe itself as potentially vulnerable and I don't see that I I think that that's a misunderstanding of the way convertibles convertible debt or a safe actually
converted to shares of stock and and again as they said I will hearken back to Sam's idea that it won't matter in the end whether you invest in a safe a convertible note or equity if you invest it in air B&B at ten fifteen twenty or thirty million dollars you'll still have the sort of returns the Daurio saw with if you invest seventy million dollars you can do the math do the math of investing
seventy thousand dollars in a in a company that becomes worth ten twenty or thirty billion dollars at a valuation of ten or twenty million and it will be stunning let's go from here so the question was who controls how much money the founders raised on safes and what do you do as an investor if you sign a safe with let's say an eight million dollar cap today and then the
founder comes and racism signs another safe with another investor tomorrow at a five million dollar cap so the first part of the question the the founders decide how much they're going to raise on the safes and you know the advice that we give to the founders is to be very thoughtful about how much you actually raise on the safe because you are selling the company you know you're
selling part of the company and so we we cancel them to be very careful about dilution and to really think about that so whilst the investor doesn't have a huge amount to say in that the founders are thinking about how to how to make that work for them the second part of the question is about the cap and it's pretty unlikely that you will sign a safe with a valuation cap of 8 million
let's say and then the next day they'll sign a cap with 5 million usually you know like like Sam and Jeff have mentioned there is some elements of herd mentality going on in investing and so if if an 8 million cap works for other investors then you know the next investor is likely to take that as well maybe the situations where sometime further down the road they they might
raise money with a slightly lower cap and it's really circumstance dependent at that point you know there's there's there's there's nothing written into the documents to protect you from that unless you have the MF n provision in there but you know again we we advise founders to treat people fairly and you know if things have changed or something's happened then then you know
see what they can do to help their investors we see this happen all the time oh did everyone hear that question mm oh for the loaf right okay so what happens when the lead investor in this state let's say you have a safe and it's converting into a series a round and the lead investor is not respecting the rights and the safe for example the pro rata right you need to fight back on
this we see this happen all the time we we advocate we tell our founders all the time you do not get to ignore the rights and the safe this is a contractual right you're breaching the contract if you do not give the safe holders their pro rata right this goes back to something her she said - it kind of sucks when they only give you 24 hours to read these documents because you should immediately
be going through and making sure that they did give you these rights right and you should also be checking the cap table to make sure that they converted you're safe correctly but so the answer to the question in short is notice find it notice it tell them that's not okay push back on it make them honor their contract and oftentimes it's actually the lawyers who are who are trying to
make this more streamlined and the founders either don't know it's happening or they haven't really registered and so if you go and say to the founders hey look you know I'm I should have pro-rata rights here then then they'll be they'll be pretty willing to make that change in the documents their reputation matters - by the way not just yours so if they screw you out screw you over and don't give
you the right that you had that reflects poorly on them as well so the question was should we consider investing as an LLC or as an individual for tax considerations and various other things well so if you're immersed in an LLC they're pass-through entities anyway so that the taxes would still roll up into your personal tax returns and usually it just depends on circumstances
you know if you're investing your own money it usually makes sense to just invest directly or if you have a trust to be able to do it through that if you start to be pooling money together either amongst a number of investors or using other people's money to invest then it makes more sense to create an LLC or some kind of fund structure okay so the question is why is there no
pro rata in the conversion round and is there way to get it if you want it so the reason that we didn't put pro rata in the conversion round is because back at the time that we drafted the safe this goes back to about 2013 seed rounds looked a little different there was usually a shorter time in between the seed and the series a things have changed a lot in the last couple years
and so we are actually thinking about well maybe we need to rejigger things maybe it should look different because the timing is now very different but in the interim what a lot of angel investors do is they do just like you said they sign a side letter and they say that they they give themselves you know they negotiate with the company for a side letter to give themselves a pro
rata right to not only have their safe convert into Series A but then to purchase more shares on top of the conversion shares at the lead investor price so that does happen well you got it I mean if that works better for you then you should continue to use it because it's just kind of all about your investment strategy and sort of your approach to it I think in this
class you're gonna hear a lot about the approach that Sam described and for those kinds of investments we think the safe works really well but obviously you're all going to have different strategies and you need to use whatever instrument works best with your strategy I'll do the first so the question was do you need a ppm a private placement memorandum to do a safe and the answer
is emphatically no you don't even need a term sheet to do the safe you don't even need a ppm these days to do priced round nobody nobody really does those anymore safe is just one document that's all you need for priced round it's usually just a term sheet that's all you need so I don't I haven't seen a ppm in years that's the answer to that and then the
second question was dis a frown the world and in general the answer is yes but there are some situations where they don't necessarily work I know that we've heard some companies in India aren't able to use safe so I think it depends on the who the investor is they have to be on a certain list and also I think in the UK they have sort of rejiggered the safe a little bit to make it so that it
works more for the enterprise investment scheme relief that's available over there but it's you know if you are investing in other countries and you're investing in in companies in other countries then you should do your homework to make sure that it actually is a valid document in that country so the question is sometimes that this question has had safes that don't
converse in the pre-money and how common is that well so first of all it's it's getting less and less common that the safes convert at the same time as the round series a lead investors are guessing more clever about this and realizing that if the safes converse in the pre-money then the the lead investors getting less dilutions and really all that's happening is if the safes do converse in the round
they'll just massage the valuations to still get to the same place whether they want to be which is usually around 20% of the company post series a there was a second part to that question I will say that that exact point is exactly what this gentleman was saying about pro rata because that is more of a trend that we're seeing that sort of argues for going ahead and having the safes also
have a pro-rata in the conversion round so these things are all tied together and again I'll just go back you said the the Primmer doesn't do the math that way again 2013 when it was you have to you know things looked a little different and they've evolved and and so we are definitely talking about evolving the safe in certain ways and just to reiterate the safe itself doesn't
mention this it doesn't mention that it will be in the pre-money or it will be in the round all the safe says is how do you define the capitalisation to work out your conversion price for the safe itself yeah yeah so so the point there was that founders don't understand this either and that's absolutely right and you know again one of the things that I spend hours and hours with founders as they're
raising money at demo day and beyond is is explaining to them how this works and how to think about dilution and how to understand what conversing in the pre-money means and all these different terms and you know at the end of the day it's it's one of those things that there's only so much we can do and if the founders don't want to understand it then you know there isn't a lot there
that we can do for them there's so many resources though so maybe you know maybe everybody just needs to go to these resources if you do the math and you do the pro rata aren't starting off the pro rata the pro forma cap table and everyone agrees that what that looks like it is so much better it just you everyone just needs to take the time to model it out it eliminates so much
confusion if you take the time to do that okay the question is is there case law around investor liability when you're investing as an individual rather than through a legal entity there is tons of case law regarding an stockholder non liability for for bad things that the corporation does if the stockholders aren't liable then certainly if you go even further out the circle and you just
have people put money in for in exchange for a convertible security there's not it's not a problem so you're you're fine if I understand your question correctly okay so the question is what's the optimal legal structure for the startup so for YC we invest in mainly Delaware c-corporation in California or wherever else it might be obviously if you're investing in foreign companies then
you'll need to do a little bit more homework because we don't necessarily know what the how all the structures work in all the different countries we have seen some investments where people have invested into LLC's but it's we don't really understand how that happens so I would recommend that you you stick with c-cups high-growth companies are not LLC's our our MFN standard and safe
know they are in the safe the most favored nation that I discussed sort of in the middle of the presentation those are not standard those go along with the those are part of the safe that doesn't have a cap so what this what this person maybe ask me is can I get can I negotiate a target valuation or a discount rate with a company and also have an MF n so that if
someone gets something better I can amend my safe after the fact and get that better term it's kind of like what your question was what happens if I do eight million and next day and another angel does five million can I get the benefit of that we don't have that flavor of safe because I kind of feel like you make a bargain you live with it right you get the bet you and the
company negotiate the best bargain you can get the two of you and then that's what you live with so we don't we don't we don't have that flavor of safe up on our website you can you can drop an MF n into the safe if that's what you and the company agree is fair so it's possible you could just cut and paste that paragraph right into a capped or a discount safe if you want to I
wouldn't I would counsel founders that that's probably not the right way to go but you could try it [Applause] just a couple of quick things and then we're done for today so safes are weird and convertibles are weird I had done over a hundred investments and I decided not all safes but mostly in convertibles and I decided I better figure out what happens when they convert and I realized I had very
little ideas someone back there pointed out that that both investors and founders get really confused as a Caroline said there's a lot of tools now I actually built a tool called angel calc that's that's open and available it lets you very simply and quickly model what a safe conversion looks like because it's it's it's worse than just the fact of weather and by the way angel
always assumes it's in the pre-money because it's always in the pretty money now almost almost always and if it's not I can't remember I may have built something in to allow you to do it if it's not in the pre-money but it almost always is and there pre-money but it's much worse if there's multiple safes with multiple valuations multiple different discounts which is often not
not uncommon now so as Caroline said the best thing to do is to model this is to see what it really looks like to work with the founders remember that the question is to you know what do you do if later investors try to screw you I actually wrote a post about this called transparency and startup investing and I think what you ought to do is you ought to ask for anything that you should
actually provide a form that you can send to the founder and say or to the entire team sending you the update that says hey are any of my rights changed from my document and if they are then you should have a conversation not with the lawyer not with the VC with the founder who you know remember has a relationship with you I hope you are first best investor the person who
believed in them before the rest it's gonna be hard for them to look you in the eye and say screw you I took away your pro rata again I think you need to be careful with these you don't want to screw up their deal and you want to be a great investor but it is fair and they have the power in almost every case almost every case to go back to their investors in to the lawyers and say why
are you doing this you know Kirsti is a best investor I've had how are you taking away for pro rata the other thing I'll say about about lifestyle companies and why I think the safe is preferred in general - debt is because we've seen too many times where the fact that there's debt there is used to kill a company that didn't have to die and it's too easy for investors to
call that debt when it's not payable and we tend to be on founder sides that might sound weird as investors but it turns out that if you end up on the founders side more often than not then your probability of getting in the one company that will make all those other investments irrelevant is much higher we're done today tomorrow we are going to be kicked off by Dalton Caldwell
talking a lot about founder meetings which is going to be a great session I think and then after that we have two amazing prevent presenters Paul Buchheit is going to talk about in his sort of epic investing career what he's learned and then I'm gonna have a brief conversation with Michael Seibel the CEO of Y Combinator thank you all very much for coming you're live-streaming and we'll see you tomorrow