Startup Investor School Day 1 Live Stream

And the the way the course is organized is there's a lecture and then there's a Q&A afterwards. So please hold your questions until the Q&A session at the end unless the 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. We 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 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 kind of a pretty special occasion, and 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, there 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, G-E-O-F-F, at Y Combinator dot com 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. They've been gracious enough to donate their incredible experience and time to us, and I'm very grateful for everyone 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 become real big interesting scalable companies.

It's also a little self-serving. We think that more great angel investors and great seed investors are great for YC companies, and we hope you will invest in YC companies. We also think it's good for you—for people, all of you who have invested. You know it's an amazing way to get a window into the future, to be part of this future that founders are really creating; to get a window into what's going to happen. 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 we think of in Silicon Valley for the last 50 years—this guy named George Doriot made a—he was a VC. He was an early VC at this firm called A.R.D.C. 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 DEC. That $70,000 turned into $35 million, which a lot of people found pretty interesting. That led to what kick-started an incredible flowering of innovation and a lot of wealth creation 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 are lots of examples, and if we're lucky, some of the folks who are going to talk to you will 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. I'm sure also that you will tell us if we achieve that goal.

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. In fact, if there's anything that you all can—look at this online, that investors at startup school dot org. And if there's anything you think we should add, just email it to startup school at Y Combinator dot com and we'll look at it, and if we like it, we'll add it.

Okay, 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 an investing 101, I guess. We will start off with fundamental questions of why, how, and which companies—and that's today. 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 talk with entrepreneurs and founders and figure out which are the companies that are going to be part of your investing future. We're going to hear from a bunch of extraordinarily experienced and talented investors during the course, and then we're going to complete with a little bit of context and a little bit of a look towards the future of startup investing.

Startup investing has changed radically over the last decade, and I think most of us expect a lot more changes in the next decade as well. 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.

Sam Altman: Thank you, Jeff, and thank you all for coming. It's cool to see so many people in the room. So I want to talk about why, how, 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 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 beauty of inexperience. And they don't know—there are people 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 hacks, 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 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 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. That framework, that mental adjustment, that you know you're usually gonna be wrong, has been helpful to me and everything else I've done in life.

You do learn a lot, though, and if you treat this as something that you're gonna try to get better at and sort of deliberately practice, you can learn a lot and you can get better at this really quickly. Alright, 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. 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 YC startups is who else is invested in the 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 in the power—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 three through infinity put together, and this is like a deeply true thing that most investors find.

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? 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 home runs, and you want to look for things that can be potential home runs. 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 the magnitude. If your biggest success—it is not about the failure rate. Most investors talk about their failure rate. Still, when we have people that are trying to build angel firms come talk, 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 startup 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 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 1,700. 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; this is like this very extreme, very counterintuitive thing.

Alright, how do you find these companies? Another thing that I think is surprising is many of these companies that are sort of 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 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 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—the 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. 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 we're 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 in the other direction. I strongly recommend this: 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, 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 are now way more people that want to invest in good startups than there are good startups.

So founders have really become in the driver's seat. Founders of good companies have a lot of choice when it comes to investors. Founders talk a lot now, and 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 any time 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 trying 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 do reference checks on you just like you do on them.

And more and more, the thing that I have seen founders use as the criteria to make the decision about which investors to work with is what the other founders that investor has funded have to say, and so I think 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 too. But this reputation of being good to work with 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 better terms than everybody else? We recently had a company that had, let's say, ten investors, and that were going to 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 high to me for eight, seven years now. I went back and looked at my destination investments. 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've 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 companies 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. Alright, I will try to go kind of fast 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've 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 going to build a really big company, you've 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 22,000 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? This 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 that 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 a chance at creating one of these companies. Paul Buchheit, 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, focus, formality, and love.

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 are 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 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 is that the good founders are the people that have ideas all the time. So there's an intelligence component 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 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 founder's 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 the—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, 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 ten 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.

We had a joke once where 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 get an amazing amount of stuff done—their iteration speed, the speed with which they can have a hypothesis tested and implemented is unbelievable—that's really correlated 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 ten 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 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 get Brian Chesky in a first meeting, but you can find people who are on a trajectory to developing into a Brian Chesky, and that is super valuable. This is one of those things where I have seen it—you know, maybe like ten times in my career so far, where I just knew that this founder was going to develop into an incredible leader, and it's basically been every time I felt it; it's been right.

I really do trust this rate of improvement metric. I think one thing you have to be increasingly aware of are the wrong motivations. 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 startup as a resume item or as a way to get rich quickly. This does not work. The amount of pain you have to suffer for a startup; 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 were that good, but they had stumbled 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 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 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 at YC called “scenesters.” This is different from people who just want to make a lot of money. There are an increasing number of people who just 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—that doesn't work out either.

Okay, this is maybe the third biggest misunderstanding I had, and I think for many people it's their number one biggest misunderstanding. People always say that what matters is not a startup's 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 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 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 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 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 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 or 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 technology I've ever had." People used it for many hours every day; 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 the best free advertising Apple could ever have hoped for because they told everyone like, "This is the future; you've got to try this new thing."

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 as 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 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, 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 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. 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." I think that's really important, and I think it's actually—like if you use this framework, it's pretty reasonable to evaluate.

Okay, 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, is chasing the thing that worked two 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 are hundreds of others working the same thing, be very skeptical. If you find yourself tempted to work on something that the founders worked super hard to convince you is not going to be a long-term commodity, be very skeptical.

The more people talk about it—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 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 YC’s mantra, but it's so important that I want to talk about it again. 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-sized company by doing that. And I think asked—it became 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, I don't think it'll be a huge company most of the time.

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 market 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 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 visualize the trajectory of an arrow very well. 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 where 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 much I think growth will slow down. But I try to say, "Okay, 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 startup investing. This is one of the things that differentiates investing in startups from investing in small businesses.

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 are 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 startup is the, you know, revenue, the earnings, it's going to generate in years 10, 11, and 12 from now.

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 comes back to not basing your decision too much off the decision of other investors.

I like to understand in axiom. If I don't have an answer to this question, I don't feel like I have any competitive edge in that particular investment decision. But—and sometimes the answer to this question is just like everyone's bullish on this company, but I'm more bullish because I understand a specific thing about this market, 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 many scenarios. Alright, 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 YCS—is YCS. I think the beginning of the livestream might have missed that, so please do send some questions.

And 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 at 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, "You can use me as much as you want for interviews." Like, I will help recruit; I will help source people; 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 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 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, you know, a series C or series A stage? A lot, I think. Like, don’t compromise on the things that don't get better—like don't compromise on a boundary of integrity. But if you think the founder is improving fast, 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 were smart, wanted to learn and were, you know, doing this for the right reasons, super mission-oriented, come through these doors, and they have just progressed really fast.

So there were founders who I think had like no domain-specific knowledge about—like one funny thing is when you are negotiating 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 flaw—but that's okay.

How do you judge for integrity with a founder that comes out of network? So in our experience, we’ve gotten this wrong a handful of times, but we have prevented ourselves from this mistake hundreds of times. Because even in our ten-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 ten minutes.

Results-based observations about when to exercise pro rata 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, but in the world today, there's like very clear data on this.

What's pro rata? 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. Alright, 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 ICOs 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—I 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 telling my friends about it because I was like, "Oh, there's this site and you know you can like find these links." 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. This one is just like pictures of cats or whatever it was at the time, 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 heard so directly from people I trusted so much, and I remember 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 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 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."

Alright, other questions? Yes, you know when Uber was getting going, 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—this just kept going.

That is really hard, right? Because you don't—you don't have a sense for exactly how big the market is because it's 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."

Alright. 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 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—the same would never—but I would try to be clear; here's what I've seen work more often.

What is the next question? Oh, a good amount of self-awareness. I think a good amount of like willingness to take feedback and a drive and a desire to improve is really important, but you know, you do also have to sort of believe that you can succeed in spite of all of your flaws. And so that—it'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 B, you then 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 that has always worked pretty well for me. Alright, thank you all very much.

So 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 you all investing. Investing is not—a get-rich-quick scheme; it requires both patience and passion—the interest 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 Sam's—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] 'cause 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 to 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 city problem, but it stops here.

So you—if you need to use the restroom, please go across the street to 335. Give it one sec for people to come in. Alright, 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 have dealt with these issues with I guess thousands of companies now; certainly all sixteen or seventeen hundred YC companies. What is the actual number? Probably no—nobody knows it, anyway. Hundreds of companies—they know this stuff better than anyone.

Carolyn is the person who actually invented the safe; she used to be attorney at Wilson Sonsini before coming here, and Kirsti is the CFO of YC. They too 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 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 going to talk about how the SAFE converts in other events, a quick word about process, and then we had some advice that Sam kind of covered, but we’ll 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, so 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, we drafted the SAFE for very early stage startups. So that means that the company maybe hasn't raised 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 is 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 priced round and buy preferred stock.

But for the vast majority of early-stage startups, they don't have a lead investor; they don't have a person setting the terms, setting the price of the round, and most of 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—it 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 a loan; 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 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.

Kirsty's gonna 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 in a 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 your 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 didn't know what it was before. It’s the right to buy more stock in future rounds 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 your 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've been talking about is what we call the capped SAFE. It's the one that has the target valuation; Kirsty'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 are 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% discount, your effective price is 80 cents a share. It's pretty simple.

There's also an uncapped SAFE, which is 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 call the MFN SAFE. MFN stands for "most favored nation." It's a concept we borrowed from contract law, and there is no target valuation in this SAFE, but there's this MFN 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 Kirsti. Alright, so now we're going to talk about how the SAFE converts, and we'll cover how the valuation cap works, the mathematics behind the SAFE converting, 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.

The cap's 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 the way to—and 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 priced round's 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 an equity financing—or a 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 priced round is, and we'll try to refer to it just as a priced round here, but sometimes it just slips in—it's a Series A, but it can be any priced round.

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 sheet 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 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. 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 math! 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 a valuation 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 money 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 situation. So we have founders who have 9 million shares issued, and there are 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 $8 million 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 $4 million at a $16 million pre-money valuation. And the terms that are negotiated in the term sheet as well are that the options pool will be increased to 10% of the post-money, and the SAFEs convert in the pre-money.

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 1.4 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 10.43 million shares.

The SAFE conversion price is the valuation cap, because the cap is less than the priced round. Divided by that capitalization gives a conversion price of $0.77. The SAFE investor buys our—the $800,000 investment divided by this conversion price gives us just over 1 million shares.

Everybody with me still? Okay, good. So then the next thing that happens is our new money calculation happens. So this is the lead investor in the priced round. So this time, the capitalization 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 11.47 million shares, and then the price per share is calculated again using the price per share. Sorry, the valuation from the term sheet—the $16 million divided by the 11.47 million shares—to give a price per share of $1.39.

And so those, that $4 million from the new money investors, will buy 2.87 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 priced round investor who has the 2.87 million shares.

And these SAFE investor and priced investor have 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 $800,000 of the total $4.8 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 also shows percentage ownership, and you can see that my math did work. Our options pool is 10% of the total 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 7% of the shares. And the way you can think about it when you're signing your 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 $8.8 million post-money valuation of the company. So the SAFE investor would own approximately 9% of that.

But that assumes that the SAFEs convert immediately on signing and there's no new money. There's no new money, and that actually never happens. So the reason why this 7% is not 9% 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 priced rounds had all been exactly the same except that the investor had only put in $2 million instead of $4 million, then the ownership here would be just over 8%. So that just tells you exactly, you know, you really can't tell how much you're going to get until the priced round 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 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 priced 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 by 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. You're 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—same situation, same result, rather.

Okay, the 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 a dissolution situation, they need to pay off their trade debt—which is vendors and landlords—and they obviously have to pay their salaries. Any employees they have maintain 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 can expect this to happen sometimes.

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 and a very long document.

Number two, this just doesn't happen very often. This is—in a 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, Kirsti 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.

The first thing in this process is the handshake protocol, and the reason why we created this is to help 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; 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 makes 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. 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 are 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 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 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 are lots of options out there—HelloSign is another signing 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; it's 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 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