Post Category → Houston

Should Non-SV Founders Use SAFEs in Seed Rounds?

Nutshell: Because of the golden rule (whoever has the gold…), probably not – at least not for now.

Background Reading:

For some time now, there have been people in the general startup ecosystem who have dreamt that, some day, investment (or at least early-stage investment) in startups will become so standardized and high velocity that there will be no negotiation on anything but the core economic terms. Fill in a few numbers, click a few buttons, and boom – you’ve closed the round.  No questions about the rest of the language in the document. For the .1% of startups with so much pull that they really can dictate terms to investors (YC startups included), this is in fact the case.  But then there’s the other 99.9%, much of which lies outside of Silicon Valley.

Much has been written about how SAFEs were an ‘upgrade’ on the convertible note structure, and in many ways they are.  But anyone who works in technology knows that there’s a lot more to achieving mass adoption than being technically superior, including the “stickiness” of the current market leader (switching costs) and whether the marginal improvements on features make those costs a non-issue. And any good lawyer knows that when a client asks you whether she should use X or Y, she’s not paying you for theory. You dropped that sh** on your way out of law school.

This isn’t California

From the perspective of founders and startups outside of California, which are the focus of SHL, the reality is that going with a SAFE investment structure is very rarely worth the cost of educating/convincing Texas angel investors on why they shouldn’t worry and just sign the dotted line. The entire point of the convertible note structure, which by far dominates Texas seed rounds, is to keep friction/negotiation to a minimum.  Yes, there are many reasons why equity is technically superior, but that’s not the point.  You agree on the core terms (preferably via a term sheet), draft a note, they quickly review it to make sure it looks kosher, and you close.  You worry about the rest later, when you’ve built more momentum.  Professional angels know what convertible notes are, and how they should look. They also know how to tweak them.  In Texas, many of them still do not know what a SAFE is. 

And, in truth, many Texas angels and seed VCs who do in fact know what a SAFE is simply aren’t willing to sign one. The core benefit of SAFEs to startups is that they don’t mature, and hence founders without cash can’t be forced to pay them back or liquidate.  To many California investors, this isn’t a big deal, because they’ve always viewed maturity as a gun with no bullets.  But Texas investors don’t see it that way.  Many find comfort in knowing that, before their equity position is solidified, they have a sharp object to point at founders in case things go haywire. I’ve seen a few founders who rounded up one or two seasoned angels willing to sign SAFEs, only to have to re-do their seed docs when #3 or #4 showed up and required a convertible note to close. It’s not worth the hassle, unless you have your entire seed round fully subscribed and OK with SAFEs

Just Tweak Your Notes

The smarter route to dealing with the TX/CO/GA and similar market funding environment is to simply build mechanics into your notes that give a lot of the same benefits as SAFEs. A summary:

  • Use a very low interest rate, like 1-2%. – Many local angels tend to favor higher interest rates (seeing 4-8%) than west and east coast seed investors. But if you can get a very low rate, it’s more like a SAFE.
  • Use a very long maturity period, like 36 months. – 18-24 months seems to have become more acceptable in TX, which is usually more than enough time to close an equity round, or at least get enough traction that your debt-holders will keep the weapons in their pockets.  But if you can get 36 months, go for it.
  • Have the Notes automatically convert at maturity –  This gets you as close to a SAFE as possible, and we’ve seen many angels accept it. If you run out of time and hit maturity, either the angels extend, or the Notes convert, often into common stock at either a pre-determined valuation (like the valuation cap, or a discount on the cap), or at a valuation determined at the conversion time.

How successful you’ll be at getting the above is just a matter of bargaining power and the composition of your investor base. Austin investors, who think more (but not completely) like California investors, tend to be more OK with these kinds of terms.  In Houston, Dallas, or San Antonio, you’ll likely get a bit more pushback.  But that pushback will almost certainly be less than what you’d get from handing someone a SAFE.

Closing Summary: There isn’t, and likely will never be, a national standard for seed investment documentation.  Every ecosystem has its nuances, and working with people who know those nuances will save you a lot of headaches. In Texas, the convertible note, however suboptimal, reigns supreme. Respect that reality, and work within it to get what you want.

The Texas Startup Ecosystem: Curated & Connected

Nutshell: You can’t build a startup alone. Find your city’s startup “watering hole,” and start drinking.  But remember: that watering hole is not a charity.

In a world of abundance, including abundance of noise, curation becomes incredibly valuable.  Few people have the time to sort through hundreds of duds (products, information, people) before finding something or someone that they truly need. Curation is actually one of the main points of this blog; particularly the Learn the Essentials section. Undercapitalized Texas founders need information on basic startup law and finance.  That information has historically either been locked up in expensive silos (law firms), or spread out over the web alongside loads of crap.  I help them avoid the noise.

If you (just) build it, they won’t come.

When I run into very green founders, my first piece of advice is always simple and direct: get plugged in. By that I mean find people who “do” startups: either as  founders, developers, investors, advisors, etc. – and start making connections. It’s great to rely on your friends and business associates for general advice, but unless they work specifically in startups, it will not be good enough.  The challenges you encounter as a founder of a tech startup (business, legal, financial, etc.) will be very different from those that people outside of that space have experienced.  You need specialized advice, and that means specialized people.

And founders absolutely need to dispel any “if you build it, they will come” (just focus on the product) thinking. No, they won’t come. You probably don’t know how to build it in the first place. And even if you do, distribution matters.  You or someone working for your startup needs to be out there building relationships. Every startup needs at least one hustler. 

The Noise

Naturally, the number of these specialized “startup people” is a tiny fraction of the general business community in any particular city; especially in large cities with relatively small (but growing) startup communities.  But as startups have become much more of a “hot” topic (evidenced by political campaigns and a boom in angel investing among non-tech people), everyone and their mother has suddenly decided to bill themselves as a startup consultant, mentor, advisor, founder, whatever.  You see this in the legal field, where lots of general business lawyers have suddenly become ‘startup lawyers’ overnight. There are also a lot of business executives trying to mentor startups, with zero experience having actually worked with one.

So knowing that they need to find good startup advice, but there are a lot of duds out there, what are founders to do?

People, Curated

As the Texas startup ecosystem continues to mature, in each major city we’re seeing startup “hubs” emerge: places where the signal-to-noise ratio of real, valuable startup experience v. ‘everything else’ is orders of magnitude better than throughout the rest of the city. They’re like watering holes for the founderati. Startup people, curated for you. You’ll find far more jeans and sneakers than slacks and loafers in these places.  That’s a very good thing.

To help Texas founders get plugged in , I’ve created lists for Austin, Houston, and San Antonio (cities where the majority of our client base is) of the key startup locations, events, and even people in each city.  While every incubator, meetup, and person that I list on those pages is a great resource, there are stand-out “core” places that, in my opinion, any new founder should use as a starting point for plugging in – by following their posts, attending events, etc.

In Austin, Capital Factory has by far emerged as the largest “hub” of the startup community. Tech Ranch, while somewhat less well known, is also an important player. While not physical spaces, Austin Open Coffee and Austin Lean Startup Circle are also regular meetups whose attendees pack a significant amount of startup experience.

In San Antonio, Geekdom is hands-down the epicenter of the startup community. I’ve yet to encounter a serious startup out of San Antonio that has not connected with Geekdom in some way.  SA New Tech, a regular meetup, also has a solid attendance.

In Houston, the Houston Technology Center (HTC) appears to be evolving into a core of Houston’s startup community. Not exactly a cultural/social hub (yet) the way CF is for Austin or Geekdom is for SA, but an important player. The Houston Lean Startup Circle  is also very well attended by experienced startup folks.

Dallas is noticeably absent from this list. I frankly don’t work a lot with Dallas startups, and I only write about what I know. Also, there are a lot of very important players in these cities that I didn’t mention (accelerators, investors, etc.) simply because the point of this list is to emphasize how very early-stage founders should get ‘plugged in’ to their startup ecosystem. A brand new founder shouldn’t be “plugging in” to accelerators or investors.

Eyes Wide Open

Texas founders benefit enormously from the above institutions.  The connectedness and collaboration that result from their “dense” environments of startup activity are absolutely essential to a thriving Texas startup ecosystem.  All that being side, founders need to understand that these are not charities, and the people running these organizations (while great) are not Mother Teresa.

A number of the “startup hubs” in any city are either for-profit themselves, or connected to/run by very for-profit investors. The density that they provide is not strictly for the public good: it’s a way to pool resources and systematically reduce the search costs for (i) investors looking to invest in great startups, and (ii) executives looking to join startups on the rise.

There’s certainly nothing wrong with this. Doing well by doing good is awesome. I “do well” by this blog just the same. But founders should avoid becoming naively enamored and approach these institutions for what they are: very useful players in a profitable market for influence.  That market is competitive (incubators, accelerators, co-working spaces, etc. are in competition), and the players are incentivized to do and say things that maintain their influence, but aren’t always in the best interest of founders.  Founders should absolutely plug themselves in, but keep their eyes wide open in doing so.

 

Why incorporating your Texas startup is cheaper in Delaware (than in Texas).

Background:  When incorporating your Texas-based startup, one of the first questions you’ll have to ask yourself is: Should I incorporate in Texas or in Delaware? While it’s well-known that a startup intending to raise professional venture capital should eventually be a Delaware corporation, conventional wisdom is that it’s cheaper (by maybe $1-2K) to incorporate in Texas because of a few fees that Delaware entities have to pay for being “foreign” entities.  You’ll end up paying more later on to convert into a Delaware corporation in connection with a financing, but if your startup never reaches that stage, you’ve saved some $ on fees – or so the thought goes.

While it’s true that you will pay fewer state fees by incorporating in Texas, this argument fails to account for the differences in legal fees associated with a Delaware v. a Texas corporation.

  • Typical legal fees for a basic startup formation (incorporating, issuing stock with vesting, IP assignment by founders) will run around $2,500-3,500 if you rely on a competent, but efficient startup lawyer.  Many firms charge twice that or more.
  • As I’ve written before, quality automated startup formations can be done for ~$500.
  • But an automated (Clerky) formation is available only for Delaware corporations, not Texas.
  • Therefore, for an automated formation, you can save ~$2K+ on legal fees by going with Delaware, more than making up for the state fees.

Yes, I’m a lawyer, and I’m telling you that you should prefer paying fees to a state government over paying them to a lawyer: because the state is at least delivering something you can’t get elsewhere for less money.

This, of course, assumes you go with an automated formation, which may not be appropriate if you have some unique circumstances that can’t fit into standard formation terms.  But it’s important to keep in mind that post-formation legal documentation for Delaware corporations (option plans, seed round, random startup transactions) also tends to be far more standardized than it is for Texas corps, simply because of the volume of Delaware startups that are formed. So being a Delaware corp. will also save legal fees down the road because less drafting will be required.

Nutshell: Conventional wisdom is that incorporating your Texas startup in Texas (instead of Delaware), will save you some money.  But when you account for the legal fees that it takes to properly form your startup, Delaware will almost always come out cheaper (if you do an automated formation).  Even for a non-automated formation, the legal fee savings likely make it a wash.