But while founders will increasingly be able to stay on as CEO, they'll have to cede some power, because the board of directors will become more powerful. In the seed stage, the board is generally a formality; if you want to talk to the other board members, you just yell into the next room. This stops with VC-scale money. In a typical VC funding deal, the board of directors might be composed of two VCs, two founders, and one outside person acceptable to both. The board will have ultimate power, which means the founders now have to convince instead of commanding.
This is not as bad as it sounds, however. Bill Gates is in the same position; he doesn't have majority control of Microsoft; in principle he also has to convince instead of commanding. And yet he seems pretty commanding, doesn't he? As long as things are going smoothly, boards don't interfere much. The danger comes when there's a bump in the road, as happened to Steve Jobs at Apple.
Like angels, VCs prefer to invest in deals that come to them through people they know. So while nearly all VC funds have some address you can send your business plan to, VCs privately admit the chance of getting funding by this route is near zero. One recently told me that he did not know a single startup that got funded this way.
I suspect VCs accept business plans "over the transom" more as a way to keep tabs on industry trends than as a source of deals. In fact, I would strongly advise against mailing your business plan randomly to VCs, because they treat this as evidence of laziness. Do the extra work of getting personal introductions. As one VC put it:
I'm not hard to find. I know a lot of people. If you can't find some way to reach me, how are you going to create a successful company?
One of the most difficult problems for startup founders is deciding when to approach VCs. You really only get one chance, because they rely heavily on first impressions. And you can't approach some and save others for later, because (a) they ask who else you've talked to and when and (b) they talk among themselves. If you're talking to one VC and he finds out that you were rejected by another several months ago, you'll definitely seem shopworn.
So when do you approach VCs? When you can convince them. If the founders have impressive resumes and the idea isn't hard to understand, you could approach VCs quite early. Whereas if the founders are unknown and the idea is very novel, you might have to launch the thing and show that users loved it before VCs would be convinced.
If several VCs are interested in you, they will sometimes be willing to split the deal between them. They're more likely to do this if they're close in the VC pecking order. Such deals may be a net win for founders, because you get multiple VCs interested in your success, and you can ask each for advice about the other. One founder I know wrote:
Two-firm deals are great. It costs you a little more equity, but being able to play the two firms off each other (as well as ask one if the other is being out of line) is invaluable.
When you do negotiate with VCs, remember that they've done this a lot more than you have. They've invested in dozens of startups, whereas this is probably the first you've founded. But don't let them or the situation intimidate you. The average founder is smarter than the average VC. So just do what you'd do in any complex, unfamiliar situation: proceed deliberately, and question anything that seems odd.
It is, unfortunately, common for VCs to put terms in an agreement whose consequences surprise founders later, and also common for VCs to defend things they do by saying that they're standard in the industry. Standard, schmandard; the whole industry is only a few decades old, and rapidly evolving. The concept of "standard" is a useful one when you're operating on a small scale (Y Combinator uses identical terms for every deal because for tiny seed-stage investments it's not worth the overhead of negotiating individual deals), but it doesn't apply at the VC level. On that scale, every negotiation is unique.
Most successful startups get money from more than one of the preceding five sources. [6] And, confusingly, the names of funding sources also tend to be used as the names of different rounds. The best way to explain how it all works is to follow the case of a hypothetical startup.
Our startup begins when a group of three friends have an idea-- either an idea for something they might build, or simply the idea "let's start a company." Presumably they already have some source of food and shelter. But if you have food and shelter, you probably also have something you're supposed to be working on: either classwork, or a job. So if you want to work full-time on a startup, your money situation will probably change too.
A lot of startup founders say they started the company without any idea of what they planned to do. This is actually less common than it seems: many have to claim they thought of the idea after quitting because otherwise their former employer would own it.
The three friends decide to take the leap. Since most startups are in competitive businesses, you not only want to work full-time on them, but more than full-time. So some or all of the friends quit their jobs or leave school. (Some of the founders in a startup can stay in grad school, but at least one has to make the company his full-time job.)
They're going to run the company out of one of their apartments at first, and since they don't have any users they don't have to pay much for infrastructure. Their main expenses are setting up the company, which costs a couple thousand dollars in legal work and registration fees, and the living expenses of the founders.
The phrase "seed investment" covers a broad range. To some VC firms it means $500,000, but to most startups it means several months' living expenses. We'll suppose our group of friends start with $15,000 from their friend's rich uncle, who they give 5% of the company in return. There's only common stock at this stage. They leave 20% as an options pool for later employees (but they set things up so that they can issue this stock to themselves if they get bought early and most is still unissued), and the three founders each get 25%.
By living really cheaply they think they can make the remaining money last five months. When you have five months' runway left, how soon do you need to start looking for your next round? Answer: immediately. It takes time to find investors, and time (always more than you expect) for the deal to close even after they say yes. So if our group of founders know what they're doing they'll start sniffing around for angel investors right away. But of course their main job is to build version 1 of their software.
The friends might have liked to have more money in this first phase, but being slightly underfunded teaches them an important lesson. For a startup, cheapness is power. The lower your costs, the more options you have-- not just at this stage, but at every point till you're profitable. When you have a high "burn rate," you're always under time pressure, which means (a) you don't have time for your ideas to evolve, and (b) you're often forced to take deals you don't like.
Every startup's rule should be: spend little, and work fast.
After ten weeks' work the three friends have built a prototype that gives one a taste of what their product will do. It's not what they originally set out to do-- in the process of writing it, they had some new ideas. And it only does a fraction of what the finished product will do, but that fraction includes stuff that no one else has done before.
They've also written at least a skeleton business plan, addressing the five fundamental questions: what they're going to do, why users need it, how large the market is, how they'll make money, and who the competitors are and why this company is going to beat them. (That last has to be more specific than "they suck" or "we'll work really hard.")