In this blog, we explore the early fundraising rounds of Airbnb, how its founders sold cereal to fund the business, raised a seed round from Sequoia Capital and convinced Reid Hoffman (LinkedIn founder) to invest within 2 minutes. We examine the importance of selecting investors who can provide value beyond just funding, and the risks and rewards of equity and control dilution.
Airbnb’s Seed Round
In 2007 Airbnb co-founders Brian Chesky and Joe Gebbia, were struggling to pay their rent, so they setup a literal airbed in their living room and tried to find someone to rent it online. This idea quickly grew into a platform where anyone could rent out a space for short-term rentals.
Failing to get angel investors
As Airbnb grew, they realized they needed external funding to scale. But despite their best efforts, the team just couldn’t convince investors to part with their capital.
They asked prospective angel investors for $150k at a $1.5m valuation (a position worth circa $10bn when they IPO’d).
Here is Brian talking about the difficulties they faced along with some genuine rejection emails he got from prospective investors at the time:
The company grew increasingly strapped for cash, forcing the founders to become creative.
Reluctant to take a loan or take on more credit card debt, the founders pounced on the presidential election, which was generating a lot of excitement at the time. The ground-breaking idea the team had was to create and sell special edition election themed cereal for both main candidates: Obama O’s and Cap’n McCains.
Here are these custom cereals:
The team were able to sell 500 of these cereal boxes for $40 a piece!
Brian tells the story well here:
It was the teams’ ability to be entrepreneurial that gained the attention of Paul Graham. He was perplexed that anyone would pay $40 for a box of cereal. The ability for the founders to sell them in such volume impressed him.
Just to put things into perspective, at the time Airbnb was only generating $200 a week in nightly commissions. The whole concept of Airbnb was focused on renting air mattresses on the floor of people’s apartments. Paul Graham himself remembers thinking that the idea was: “terrible”, but he also loved that the founders had the right qualities that meant “they just won’t die” and “are very imaginative”.
When compared to a hotel room or a spare room in someone’s home, this proposition was so alien to VCs and angels that they struggled to believe in the vision of Airbnb. Investors were focused on what the team were doing at the time rather than what it could become.
Anyway, the hard work and determination of the Airbnb team paid dividends. For example, they recognised that the quality of photos for rental apartments in 2007 was terrible:
Many listings had no images at all, and the ones that did were often very low quality and not useful to prospective tenants. The iPhone had only just launched and the prevalence of high-quality cameras on phones was non-existent.
Rather than sending out emails to their customers, teaching them how to use a camera or take photos of their own apartment, the founders rented a $5k camera and went door to door offering to take professional photos of apartments for free.
Within one month, the revenue Airbnb was generating in New York had doubled. And this effect was not short term, the founders saw that repeat bookings for apartments with good photos was 2.5x the normal rate.
With this knowledge and the capital of their investors, Airbnb scaled this growth tactic quickly and by 2012 they employed more than 2k freelance photographers all round the world.
Y Combinator
Consequently, Paul invited the team to join Y Combinator’s winter cohort (Y Combinator is one of the most successful startup accelerator programs in the world). As part of this offer, Y Combinator invested $20k into Airbnb for a 6% stake.
In Paul’s blog, he dug out the original email exchange he had between himself and Fred Destin, who ultimately decided not to invest into Airbnb, I think it’s a fascinating read:
Seed Round
This was closely followed by a $600k seed round by Sequoia Capital and Y Ventures for a 10% equity stake.
At this time, Airbnb was generating revenue and had 10k users. Here is their original pitch deck:
Airbnb pitched to seed investors asking for $500k. They told angel investors that they intended to spend this capital to fund 80k trips on the platform, which would equate to $2m in revenue. This is poor framing. And not very exciting for an investor to hear.
Why:
- Investors will assume that you are being overly optimistic and that you will miss your targets
- $2m in revenue wouldn’t prove that Airbnb was able to raise their next round of capital
- They needed to listen closer to the reservation of investors. They were concerned about the potential for rape and death. At the time, the site had limited protections against these crimes.
- You need to show your investors how their capital will grow over time. Make it easy for them.
The team could have re-framed this point in a better way. Such as: Your capital ($500k) will be spent entirely on marketing, not product development. Our current CPA is $6.25, but we expect to optimise this with a larger marketing spend.
Framing the investment in this way allows an investor to see that the opportunity is significanlty de-risked, as every dollar invested will go into growth vs product, which may never be released or finished.
The Airbnb team were able to convince Sequoia Capital, one of the most prominent venture capital firms in Silicon Valley to invest. Sequoia was known for its successful investments in companies such as Apple, Google, and PayPal. Airbnb’s founders knew that Sequoia’s reputation could give Airbnb credibility and attract other investors to the company.
In addition to the funding, Sequoia provided Airbnb with valuable advice and mentorship. Sequoia partner, Alfred Lin, joined Airbnb’s board and helped the company with its growth strategy and financial planning. The investment from Sequoia also helped Airbnb raise additional funding from other investors.
Airbnb’s Series A
With the seed funding and the advice and mentorship they received, Airbnb was able to rapidly grow its platform. By 2010 their momentum enabled the team to raise a series A at a $70 million valuation. This round of investment also included several famous investors including: Elad Gil, Aston Kutcher and Reid Hoffman (the founder of LinkedIn who was working as a VC for Greylock Partners).
Joe Gebbia explained at the time that the team wanted a VC with practical experience “someone who was an entrepreneur”. They had previously identified Reid Hoffman as a good potential investor given the success he had at LinkedIn. The founders valued his experience of exponential growth and the problems that come from growing so quickly.
However, the team didn’t know that Reid had already passed on the opportunity to invest into Airbnb once before and had categorised the idea as something “not interesting at all”.
A friend had told Reid about Airbnb, but had framed the opportunity as follows:
“It’s renting couches. Everyone has couches, and now you can rent them.”
When the idea was explained like that, Reid determined that it was similar to couch surfing, which is a bad experience. You have no privacy as a host or tenant.
It was another friend that was able to re-ignite Reid’s interest in Airbnb, as they were able to communicate to Reid that Airbnb was far more than just couch surfing. With his interest reignited, Reid began calling around his network asking for references on the founding team of Airbnb.
“I got really strong references”
All the hard work and grit the founding team had was beginning to pay dividends. It was establishing their reputation as good startup founders that were extremely driven and capable to create a future unicorn.
In an interview at Greylock in 2020 Reid Hoffman reflected on their investment into Airbnb. I love this part where he explains how the first meeting went:
They came to Greylock’s offices on a Sunday to meet me. Literally two minutes into the pitch, I told the:
Look, I’m going to make you an offer to invest. Let’s make the rest of the session a working session. At the end of the session, I asked them to come back the next day and present to the entire partnership.
Of course, a lot of work took place before those two minutes that went into my decision.
I’d checked references on the founders before I met with them. If I’m going to find out that a set of founders lack integrity, don’t behave like partners, take on unacceptable risks that might harm their customers or society, or simply aren’t the kinds of people I want to spend a decade with, I want to know those facts before I start down the path of evaluating that investment. And if the reference checks come back positively, then if I believe at startup is a good opportunity, I can lean in right away.
The other reason I could decide so quickly is that I really know networks and marketplaces. There are a few people who know as much as I do on that topic, but there probably aren’t any that know more.
When the Airbnb founders walked me through their model, how the hosts were also guests, how their community was developing, and what they’d learned from different markets like Barcelona and New York, it showed me that they were on top of Airbnb’s key business challenge, which is to build powerful marketplace dynamics.
Their marketplace was still very small, but it seemed like it was enroute to becoming something big. That’s what convinced me that they could achieve an epic outcome.
Reid goes on to explain how another General Partner at
Greylock, didn’t believe in Airbnb’s potential. In fact, this VC was the very
same VC that had invested into Reid at LinkedIn. He had also invested into Facebook
early on, so Reid was quite taken aback when he was told:
After we discussed the risks and rewards associated with
Airbnb, David Sze looked at me and said: Every venture capitalist has to have a
deal that they can fail on. Airbnb can be yours. David was probably looking at
the growth data of Airbnb. For many years it looked rather unimpressive to a VC
fund. It’s user growth metrics were growing, and the percentage growth month on
month was okay, but not yet showing signs of exponential growth that VCs live
for.
Eventually, once Airbnb was able to get the networking
effects running at full force, it experienced this exponential growth, as you
can see in this user growth graph:
In addition to the unspectacular growth metrics of Airbnb, the VCs still debated the potential risks of murders and rapes occurring as a result of connecting strangers together.
Other partners within Greylock agreed with Reid, so there was enough belief within Greylock that allowed the deal to go through. The growth potential was huge and they saw a future where Airbnb could turn into a global juggernaut.
This excerpt gives founders a good insight into how VCs make deals and discuss them internally. The VC who you deal with will become your champion inside the VC firm. They will more than likely need to convince their partners that you have a business they should invest into.
Some VC funds require a unanimous decision before an investment can go ahead. Others let individual partners make the final call. It is a good question you as a founder can ask your preferred funds. How do they make investment decisions?
Equity and Control Dilution
As Airbnb raised more funding, its founders had to balance their desire to maintain control of the company with the need for additional capital. Like Facebook, Airbnb’s founders decided to engineer a dual-class share structure that allowed them to retain control of the company while diluting their equity.
Covid nearly killed Airbnb
When COVID started, Airbnb saw their revenues drop over 80% overnight. The stock price collapsed by nearly 50% from $31bn to $18bn.
The team reacted quickly, they were forced to cut their costs and this resulted in the decision to let go of 25% of their staff (1,900 employees).
Millions of travellers had already paid for Airbnb stays that they would no longer be able to use; clearly, they would want their payments refunded. But the millions of hosts who were counting on those payments to help them pay rents and mortgages would want those payments to stay in their accounts. They agreed to pay $250m in cancellation fees on behalf of users who had cancelld their trips despite having no legal obligation to do so.
Even in times of existential crisis, the Airbnb team found a way to grow trust with their users and hosts.
Lessons Learned from Airbnb’s Early Fundraising Rounds
In conclusion, Airbnb’s early fundraising rounds highlight the importance of persistence, creativity, and selecting the right investors. The company’s founders faced numerous rejections before finally securing funding.
Overall, Airbnb’s early fundraising rounds serve as an inspiration to entrepreneurs on the power of persistence, creativity, and selecting the right investors to achieve success.
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