Hi everyone, before I get to the rest of the questions (I have a hard stop at 12:30, but I will do my best to address everyone's questions!!) I wanted to share what I prepared in advance of the chat. My feedback below may even address some questions people have. This is a list of key issues I see arise all of the time when raising capital. You probably have even more you could add, and I'd love to hear your feedback.
1. Cutting corners. This includes but is not limited to obtaining the necessary professional advice to lay the proper compliance, tax, financial, and legal framework to limit problem issues investors will point out during the due diligence phase of a capital raise. Dozens of times every year we have clients come to us who used online services and screwed up essential things during the formation stage. They then end up paying us 2-3x more than they would have paid had they worked with us from the beginning to resolve it as they're now under the gun to appease an investor.
2. Lack of a Data Room. Tied to #1 above is the failure to create an organized data room that holds all your files. A couple of solutions include services like Carta, but a hack we've come up with for our clients is to advise them to set up a company email that is dataroom@[startupname]. Then, whenever the company has signed contracts, scanned copies of corporate records, or financials, leadership can email it to the dataroom@ email and it should help prevent corporate records from slipping through the cracks. I had a CEO tell me he was up all night trying to close out a deal because he had to track down NDAs, signed employment agreements, confirmation of 83(b) elections, etc, that were required by the lead investor's counsel during due diligence.
If you're interested, feel free to reach out to me at alex@archetypelegal.com, and I'd be happy to share a sample due diligence request list so you can see topics investors will expect you to share in the data room.
3. Inability to Invest Enough Time. Raising capital can be a full-time job, and founders wear multiple hats. Finding an appropriate balance between product development, establishing the company culture, and making appropriate hires, all while also attempting to track down investment can be difficult.
4. No Track Record. The founders have a great idea but no track record. You learn a lot when it's not your first rodeo, and that includes making meaningful connections to help open doors. You may find InPeak (www.inpeak.xyz/) to be a helpful resource for generating knowledge and connections. It's also helpful to align with advisors who can open doors for you.
5. An Inability to Tell a Story. When raising capital, you're a salesperson convincing investors why this is a good investment and where the company is going. For example, startup founders come to me often and say, "I'm going to raise money using a SAFE; should it be a discount SAFE, or a valuation cap SAFE, I see these are the two popular options". When this happens, I encourage them to take a step back and ask first if a SAFE is even an intelligent vehicle to use.
The SAFE form was created by YCominbator, which is thought to be a prestigious incubator. Therefore, if you're a startup that is graduating from the program, you're going to have a lot of investors interested in taking a chance on your startup. However, tied to #4 above, if you have no track record, a SAFE may be a tough sell as (i) it has no interest rate, and (ii) there is no majority date." Therefore, I would argue that unless you're a hot startup with many interested investors, you may want to use a convertible note to make your offering even more attractive with the interest rate and maturity date.
Back to the original question of a discount versus a valuation cap, this ties back to your narrative and what you're selling. @Kurt Harrington, this may be related to what you're trying to do and the problems I see if trying to use a SAFE with BOTH a discount and a valuation cap. If your pitch is that you are raising a bridge fund to float you until a large, fixed price round in the next 3-6 months, then a discount is appropriate. You're selling investors that you'll offer a discount as a thank you for investing a few months before the preferred stock round. However, if you're pitch is that you're doing a SAFE round now and then a larger round in 12-18 months, then unless the discount is huge, investors will expect their investment to offer a more significant return than 10-25% increase in value during a period in which the money was tied up in a SAFE and not earning any interest. They'll want to lock in a valuation cap to achieve a higher reward as an early investor who invested when the company was at its most risky state.
Telling an appropriate story is tied to #1 above and having a good roster of professional advisors you can rely on, but it's also about putting your best foot forward when you have a chance to speak with investors. You may want to look into Potential.AI (www.potential.ai - @Rachel Weissman is a fellow member of the Carta Community) as a resource to help you tell your story.
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Alex King
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Original Message:
Sent: 11-16-2023 11:00
From: Alex King
Subject: Ask a Startup Lawyer Anything about Raising Capital
Hi everyone,
My name is Alex King, and I'm the founder of Archetype Legal, PC (www.archetypelegal.com). My firm serves entrepreneurs, startups, and small businesses as they grow and evolve. We believe the practice of law can be completed with a three-step approach: transparency, philanthropy, and sophistication. I'm excited to talk to you about raising capital for your business and share some insights that might help you get a leg up.
QUICK DISCLAIMER: This is a rapid-fire response, and my feedback and comments below are intended to be high-level thoughts without evaluating things like your corporate governance documents or having an opportunity to dive below the service and really know what is going on. Thus, no one who reads my feedback and comments should act or refrain from acting solely on what you read below. You are STRONGLY encouraged to speak with an attorney familiar with startups who can give you convicted advice.
With that as a backdrop, let's kick things off with a few questions that came in before this live chat started.
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Alex King
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