Post Category → Seed Rounds

The Carta SAFE for Seed Rounds

Background reading:

As I’ve written in various places (see above), a significant problem that has emerged in startup ecosystems involves certain investor organizations pushing startups to adopt their preferred financing templates. Predictably those templates are often riddled with issues that favor the interests of the money. Of course these organizations are far too clever to come out and state transparently, “we want you to use this document because it makes us and other investors more money,” so they spin other narratives about saving founders time, or reducing legal fees; even though the “cost” to founders is often orders of magnitude higher than whatever they might be “saving” by mindlessly signing the templates.

This dynamic was most visible with YC’s announcement of the Post-Money SAFE, which implemented economic concepts exorbitantly favorable to seed investors (including YC of course), but was marketed as a way to (air quotes) “help” founders have more “clarity” about their cap table. YC, their long list of positive impacts on the ecosystem notwithstanding, is still an investor with lots of mouths to feed. No one should’ve been surprised that it would use its brand leverage to push a more investor-favorable document onto startups, particularly now that, with its brand having significantly matured, it no longer needs to rely as much on “founder friendliness” to attract startups.

Carta, the incumbent capitalization SaaS used by startups, recently announced that it is enabling automated SAFE financing on its platform. Interesting news, and I’m sure it’ll save teams planning on closing SAFE financings a bit of hassle. But automated SAFE closings have been available on other platforms, like Clerky, for some time, and realistically the technology behind it is hardly earth-shattering. Given that SAFEs are utilized far more in California than in the rest of the market, that’s probably where the automation will have the most impact.

What I find much more interesting, and relevant to topics I write about, is that Carta chose to tweak the YC SAFE docs and create a “Carta SAFE.” Companies can still close on YC’s Pre-Money or Post-Money SAFE templates, but they also have the option of a Pre-Money or Post-Money “Carta SAFE.” The changes themselves are fairly innocuous, but helpful and balanced. More importantly, I think it’s worth recognizing the valuable role that an organization like Carta could play in promoting various template financing structures to startups.

YC is a venture capitalist, and thus highly biased in the terms it purports to offer as “standard.” They lost tremendous credibility among the legal and startup community – although surely gained favor among VCs – with their 180 on the Post-Money SAFE. They absolutely deserve respect for their track record of picking successful startups, but lines have been crossed with respect to any facade of “founder friendliness” in their template standards.

Carta, however, is a technology company that (as far as I know) is not investing in dozens of startups every year. Carta has far less reason to favor an investor-biased document, and thus potentially has far more credibility in swaying market “standards” in a more balanced direction. This is visible in how they’ve implemented their automated seed financings and templates, relative to how YC pushed out the Post-money SAFE.

Go to YC’s website, and you can’t even find the old pre-money SAFEs with more company-favorable economics and terms. All you have is the new (profoundly investor-biased) Post-Money docs for download. This simple fact has actually caused huge confusion among inexperienced founders, who often aren’t even aware that YC dramatically changed their forms and economics, and thus (thinking they are doing themselves favors) simply download and execute the forms on YC’s site. YC could’ve very easily offered up the new Post-Money SAFEs, while leaving the old forms also available for download, with clear prompting to founders to work with advisors to decide which form they prefer. Instead, YC consciously chose to promote only the new forms, signaling a clear desire to change the market “standard” in favor of investors.

Contrast that with Carta. The Pre-Money v. Post-Money distinction is front and center in their UI, with both types of forms easily accessible to startups, and with helpful tools for comparing dilution from the different structures. This is a far more honest and transparent way for helpful templates to be offered to startup teams, without shady gimmicks or marketing spin to nudge them in favor of the money. It should be applauded.

Of course, I’m not going to wrap up this post without acknowledging that Carta still has bias. Who doesn’t? As an automation tech company, they are obviously biased toward automation and templates that enable automation. There are countless ways in which financing documents can (and often should) be negotiated and tweaked to make them a better fit for the unique context of a particular company raising money from particular investors. Sometimes convertible notes of various flavors make more sense. Other times seed equity. Other times the full suite of NVCA equity docs.

Despite growing traction among public templates, an enormous amount of investors and startups still take advantage of flexibility and customization in their deal docs, because the stakes are so high, the context and people involved so nuanced, and the terms so permanent, that it’s worth doing a bit of negotiation. If a few thousand dollars of legal fees can save you a few million in the long-run on your cap table, it doesn’t take advanced calculus to arrive at a decision.

In saying that, I’m obviously reflecting my own bias as company counsel to startups (and not investors). My job is to ensure startup teams are aware of all the options on the table for their financings and corporate governance. That of course includes bringing up when an automated template might make sense. Sometimes it does, often times it doesn’t. We can all stop pretending that serious lawyers are in any way threatened by tools like Carta or Clerky. I love these tools, because the last thing I enjoy spending my time on is shuffling cookie-cutter forms. Use the cookie-cutter when it makes sense, but make sure you really understand the tradeoffs and limitations, because a lot of very smart teams decide to put the cookie-cutter down and take a more “custom fit.”

Venture capitalists, together with Startups, are biased in favor of their own bank statements. Automation tech companies, like Carta, are biased in favor of hyper-standardization and automation. And high-end ECVC (Startup) lawyers, like me, are biased in favor of flexibility and customization. There’s no need to hide any of this. Every party has an important role to play in the ecosystem, and the interaction of all the moving parts ensures we all arrive at a reasonable equilibrium.

Moving (Too) Fast and Breaking Startup Cap Tables

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As I’ve written many times before, the “move fast and break things” ethos, which makes absolute sense in a software environment where fixing “bugs” is quite easy and low-stakes, becomes monstrously expensive and reckless when applied to areas where the cost of a mistake is orders of magnitude higher to fix (if it’s fixable at all). Silicon Valley got a very visible and expensive (to investors in terms of capital, and founders in terms of legal errors and terrible legal advice) lesson in this reality a while back with a very well-funded (but ultimately failed) legal startup heavily promoted as enabling (via over-hyped vaporware) startups to “move faster” and save significant costs. That legal startup was, perhaps unsurprisingly, controlled by money players with all kinds of reasons to profit from startups (that they invest in) getting weak legal and negotiation guidance. No one wants an in-experienced founder to move fast and mindlessly do what investors want more than… those investors.

That fundamental point is one that inexperienced founders need to keep their eye on throughout their entire fundraising and growth strategy. Notice how, for example, certain Silicon Valley groups adamantly argue that SV’s exorbitant rents and salaries are nevertheless worth spending capital on, and yet simultaneously they will howl about how essential it is that startups minimize their legal spend (a small fraction of what is spent on rent and salaries) in fundraising, and move as quickly as possible; usually by mindlessly signing some template the investors created? Why? Because they know that the one set of advisors most capable of “equalizing” the playing field between inexperienced startup teams and their far more seasoned investors is experienced, independent counsel. Aggressive (and clever) investors say they want you to adopt their preferred automation tools and templates because they care so much about saving you money, but the real chess strategy is to remove your best advisors from the table so that the money can then, without “friction,” leverage its experience and knowledge advantage.

At some obvious level, technology is an excellent tool for preventing errors, especially at scale when the amount of data and complexity simply overwhelms any kind of skilled labor-driven quality control mechanism. But there is a point at which people who sell the technology can, for obvious financial incentives, over-sell things so much that they encourage buyers to become over-dependent on it, or adopt it too early, under the delusion that it is far more powerful than it really is. This drive to over-sell and over-adopt tech for “moving really fast” is driven by the imbalance in who bears the cost of fixing “broken things.”

Ultimately the technology seller still gets paid, and puts all kinds of impenetrable CYA language in their terms of service to ensure that no one can sue them when users zealously over-rely on their products in ways clearly implied as safe by the tech’s marketing. Founders and companies are the ones who pay the (sometimes permanent) costs of a poorly negotiated deal or contract, or in the case of cap tables incorrect calculations and promises to employees or investors.

In the world of cap tables, automation and tracking tools like Carta (the dominant player, justifiably, by far) are enormously valuable, and doubtlessly worth their cost, in helping the skilled people who manage the cap tables keep numbers “clean.” In the early days of Carta’s growth (once called eShares), there was a general understanding that cap tables rarely “break” before the number of people on the table exceeds maybe 20-30 stakeholders as long as someone skilled at managing cap tables (in excel) is overseeing things. That last part about someone skilled is key.

There are in fact two broad sources of cap table errors:

  • Using Excel for too long, which creates version control problems as the number of stakeholders grows; and
  • Management of cap tables by people who are simply too inexperienced, or moving too quickly, to appreciate nuances and avoid errors.

Technology is the solution to the first one. But today it’s increasingly becoming the cause of the second one. The competitive advantage of technology is speed and efficiency at processing large amounts of formulaic data. But the advantage of highly-trained people is flexibility and ability to safely navigate nuanced contexts that simply don’t fit within the narrow parameters of an algorithm. In the extremely human, and therefore subjective and nuanced, world of forming, recruiting, and funding startups in complex labor and investor markets, pretending that software will do what it simply can’t do –  delusionally over-confident engineers notwithstanding – is a recipe for disaster. The combination of new software and skilled expertise, however, is where the magic happens.

The Carta folks have been at this game long enough to have seen how often over-dependance on automation software, and under-utilization of highly trained and experienced people in managing that software, can magnify cap table problems, because it creates a false sense of security in founders that leads them to continue flying solo for far too long. Sell your cap table software as some kind of auto-pilot, when the actual engineering behind it doesn’t at all replace all the things skilled experts do and know to prevent errors, and you can easily expect ugly crashes.

That’s why Carta very quickly stopped promoting itself as a DIY “manage your cap table by yourself and stop wasting money on experts” tool and evolved to highly integrate outside cap table management expertise, like emerging companies/vc law firms and CFOs; who spend all day dealing with cap table math. They realized that the value proposition of their tool was sufficiently high that they didn’t need to over-sell it as some reckless “you can manage cap tables all by yourself!” nonsense to inexperienced teams who’ve never touched a cap table before. The teams that use Carta effectively and efficiently see it as a tool to be leveraged by and with law firms, because startup teams are rarely connected to anyone who is as experienced and trustworthy (conflicts of interest matter) in managing complex cap table math better than their startup/vc law firm.

But as is often the case, the cap table management software market has its own “race to the bottom” dynamics – but a better name may be the “race to free and DIY.” If I’m a company like Carta, and I know that truthfully very few companies need my tool before maybe a seed or Series A round (excel is perfectly fine, flexible, and simple until then), I’m still extremely worried that someone will use the time period before seed/Series A to get a foothold in the market and then squeeze me out as their users grow. That someone is almost always a “move fast and break things” bottom-feeder that will, once again, over-sell founders on the idea that their magical lower-cost DIY software is so powerful that founders should adopt it from day 1 to save so much money by no longer paying for expertise they don’t need.

Thus Carta has to create a free slimmed down version, and they did. But they’ve stuck to their guns that cap tables are extremely high-stakes, and even the best software is still extremely prone to high-cost errors if utilized solely by inexperienced founders. That’s why Carta Launch has heavy ties to a network of startup-specialized law firms. It’s free as in beer, but honest people know that it still needs to be used responsibly by people who fully understand the specific context in which it’s being used, and how to apply it to that context.

But the bottom-feeders of cap table management are of course showing up, with funding from the same people who were previously happy to impose costs (errors, cleanup) on inexperienced teams as long as their software gets adopted and their influence over the ecosystem therefore grows. The playbook is tired and predictable.

Why are you using that other (widely adopted and respected) technology that still relies (horror of horrors) on skilled humans? It’s 2020, you need :: something something automation, machine learning, AI, etc. etc. :: to stop wasting money and move even faster. Our new lower-cost, whiz-bang-pow software lets you save even more time and manage your cap table on your own, like the bad ass genius that you are.

We know where this is going. Many of us already have our popcorn ready. While before I might run into startups who handled only a formation on their own, and show up with a fairly basic and hard-to-screw-up cap table, I’m increasingly seeing startups who arrive with seed rounds closed on a fully DIY basis, and totally screwed up cap tables involving investors and real money. They also often have given up more dilution than they should’ve, because no independent, skilled expertise was used to help them choose and negotiate what funding structure to use. Clean-up is always 10x of what it costs to have simply done it right, with a thoughtfully chosen (responsible) mix of technology and skilled people, on Day 1.

Technology is wonderful. It makes our lives as startup/vc lawyers so much better, by allowing us to focus on more interesting things than tracking numbers or inputting data. The stale narrative that all VC lawyers are anti-technology really gets old. We were one of the first firms to adopt and promote Carta, along with numerous other legal tech tools. Not a single serious law firm views helping their clients manage cap tables as a significant money driver. But that’s like saying no serious medical practice views X or Y low-$ medical service as a significant money driver. Something can be a small part of a professional’s expertise, and yet still way too contextual, nuanced, and high-stakes to leave to a piece of software pretending to be an auto-pilot.

When the cost of fixing something is low, move as fast as you want and break whatever necessary. But that’s not contracts, and it’s not cap tables. In those areas, technology is a tool to be utilized by still-experienced people who regularly integrate new technology into their workflows, while maintaining skilled oversight over it. Be mindful of software companies, and the clever investors behind them, who are more than happy to encourage you to break your entire company and cap table as long as you utilize their half-baked faux-DIY tool. Their profit is your – often much larger than whatever money you thought you were saving – loss.

Bundled v. Unbundled Startup Capital

TL;DR: The market for early-stage startup financing has reached a level of fragmentation and hyper-competition (among capitalists) never seen before. This competition has led to an increasingly atomized market, with a multitude of players offering different takes on the traditional “bundled” offering of smart venture capital. Startups and founders should understand the reasons behind the marketing narratives pushed by each of these players, so they don’t get too swept up in an overly simplistic strategy for how to raise capital. The best strategy is to diversify your capital sources, while still allowing room for smart leads writing large enough checks to provide real value add.

The world of early-stage startup financing looks extremely different today than it did even 5 years ago, and completely unrecognizable to the market of a decade ago. The reasons are fairly straightforward. Near-zero interest rates and slowing of international economic growth, together with government policies of quantitative easing (which inflate traditional asset prices and make further returns harder to achieve) have produced a surge in the amount of capital seeking any kind of “alpha” in the seemingly “final frontier” of early-stage startups. There is far more money chasing startups than perhaps any time in history.

This surge in early capital naturally produces a surge in competition among early capitalists. In order to navigate that competition, capitalists, just like any other service provider, seek ways to differentiate themselves in the market to avoid appearing too much like a commodity. It’s this need for early capitalists to differentiate themselves that has produced the “atomization” or unbundling of startup finance that is increasingly visible in the market. The point of this post is to help founders and early teams understand that unbundling in assessing their own financing strategies.

To speak of unbundling of course requires first understanding the original bundle. Historically, conventional venture capitalists “sold” the following bundle to startups:

  • Green cash money (obvious)
  • Signal – a brand that credibly signaled “eliteness” to the market (de-risking to an early startup), making it easier to further attract capital, employees, commercial partners, etc.
  • Network – a deep rolodex/LinkedIn network of contacts to leverage in recruiting and expansion
  • Advisory – active involvement on Boards and “coaching” to inexperienced executive teams.

In the very early days of conventional venture capital, VC was very scarce. In many markets there was quite literally one, maybe two funds, who served as gatekeepers to the market; and unhesitatingly used their market dominance to squeeze teams on valuation and corporate governance power. This “asshole” behavior inevitably produced demand for alternatives.

Enter the new “friendly” venture capitalists. Very large VC funds started to break up because the personal brands of high-profile VCs incentivized them to form their own funds with fewer mouths to feed. Growing interest in early-stage also brought in new market entrants. As the VC market evolved from a more oligopolistic structure to an increasingly fragmented and competitive market, the need for differentiation increased. “Friendliness” (or at least the well-calculated appearance of it) became a successful way to achieve that differentiation. You now had VCs actually competing with each other based on their reputation. But the general bundle offered by those VCs largely remained the same.

Another successful form of differentiation in this era involved going deep on “value add” services. Particularly in SV but now also in other markets, VC funds began to hire non-partner staff whose purpose was to, completely apart from providing money and Board service, help CEOs with recruiting, marketing, sales, etc. as a kind of external extension of their internal team. All that extra staff naturally costs money, and increases the overhead structure of the fund, which then increases their pressure to achieve highly outsized returns and avoid overly generous valuations.

So in the initial era of startup funding growth, VCs became “friendlier” (though caveats are worth emphasizing, see Trust, “Friendliness,” and Zero-Sum Startup Games) – and bulkier. But the flood of new capital kept on coming. VCs continued splintering off and forming micro-funds. More entrants arrived. Successful exits produced new, younger teams interested in trying their luck at the VC game. What to do with the VC market becoming even more competitive? Differentiate even further.

Enter accelerators and seed funds, and eventually pre-seed funds. As the true Series A market became increasingly crowded, continued competition among capitalists led many to conclude that the new way to avoid commoditization was to go earlier in the life cycle, closer to the territory once filled exclusively by angels (named as such because of their willingness to take risks once deemed off the table for professional investors). Rather than continuing the game of bulking up and emphasizing the “full package” bundle of traditional VCs, these new institutions sought differentiation by slimming down, and emphasizing their ability and willingness to move fast and early. Those old-school VCs are slow and over-bearing, the marketing content says. They don’t really provide any value-add. Take our cheaper, faster, “friendlier” money instead.

We are now entering a new era where “solo capitalists” are the hot topic. New in some ways, but the same dynamics of market competition and necessary differentiation are quite old. Why take money from a fund at all, when you can just raise from a set of successful solo founders? They’re super friendly, don’t care about a board seat, and will move lightning fast without pestering you with “negotiation” or other trivialities. Their ultra-low overhead also means they can pay higher valuations. And of course they’re enabled by new tech platforms for raising and distributing capital that are very much invested in the increasing atomization of startup capital, which increases demand for technology to coordinate and facilitate that atomization.

In 2020, the market of very early-stage funding for startups now looks like this:

  • Solo angel investors
  • Angel networks
  • Angel “syndicates”
  • Accelerators of various flavors
  • Scout money from “bulky” traditional VCs
  • Pre-seed funds
  • Seed funds
  • Series A funds that invest in seed rounds
  • Solo VCs
  • “Lean” startup lenders

Throw in the reality that geography is hardly a barrier to capital flows now – especially in the COVID era – and the early-stage funding market has reached a level of hyper-fragmentation and competition that was unimaginable a decade ago. Within a particular market, the number of players has shot up dramatically, and now those players are increasingly happy to cross state lines.

This is undeniably a fantastic environment for top-tier teams looking to raise early funding. It’s also undeniably a far more stressful environment to be a startup investor. Ten years ago being a VC meant everyone came to you, very warm intro required, and you called the shots. Now VCs hustle so hard for visibility some are even engaging production studios to help them create polished youtube channels. Others don’t even require intros anymore and have opened their DMs on twitter. There are even jokes about VCs trying to create viral memes to get eyeballs. Life comes at you fast.

The important message for startup teams is to understand why the landscape now looks the way it does, and the incentives behind why any particular type of investor markets itself the way it does. Accelerators, for example, now face far more competition than they did in their golden era, particularly from seed funds with legitimate “value add” offerings. See: Why Accelerators Compete with Smart Money. Because the “bundle” of an accelerator is heavily weighted toward its network and signaling value, accelerators have for some time been incentivized to promote a narrative of “dumbing down” early capital that doesn’t have its own competing network, thus keeping the accelerator’s value proposition somewhat relevant.

Similarly, ultra-lean funds and Solo VCs lack by design the resources of larger funds, and thus they are incentivized to push a narrative that traditional “hands on” VCs don’t really add value. The new lean players don’t have the time or the resources to add value themselves, so best to talk as if that particular part of the traditional bundle isn’t that meaningful anyway.  This all, of course, is easily disproven by the number of founders in the market who credibly testify to the value (in advisory, network, deep long-term pockets) in having a large fund with full skin-in-the-game on your Board and cap table. Some (not all) large funds really do provide significant added value.

And of course, traditional VC funds talk their own books with the exact opposite story. The fragmented lean investors are all spray-and-pray “dumb money” looking for party rounds. Teams need value add from seasoned, steady hands willing to roll up their sleeves on Boards. You need more than atomized money. You need a trusted “partner” to shepherd you toward success.

There is absolutely no need to take sides in all of these narratives. Why should you? Every player in the market offers a grain of truth, but also exaggeration and over-simplification, in what they’re saying. The most important thing is not to get too swept up in moralizing or marketing. Understand what each player is selling, and understand what your particular needs are.

Often times the smartest teams do a bit of “shopping” across various aisles in the new VC supermarket. Team up with a reputable seed fund, but use your optionality to ensure the terms are reasonable. Let them write a large enough check to be emotionally invested, but fill the rest of the round with smaller high-signal checks that will also be motivated to connect you with their networks. For good measure, if you have interest from a traditional Series A VC fund, let them write a small check in your seed round to keep the connection warm when Series A discussions start. The fact that they know how well networked you are (thanks to the other players on your cap table) will ensure good behavior at the Series A term sheet stage.

Contexts will vary and team needs will vary, so the particular mix of early capital any particular startup takes will naturally vary as well. Stay flexible and avoid rigid theories about the (air quotes) “right” way to raise funding. But in all cases, make an effort to diversify your network and capital sources. Nothing ensures good behavior from the money better than making it crystal clear that you are well-networked and happy to take someone else’s check if your current investors don’t play ball. You can do so while still building strong connections with your investors, demonstrating that you value their relationship. This is a great time to be an entrepreneur, whether in or outside of Silicon Valley. In navigating the new early-stage funding market, don’t drink too much of anyone’s kool-aid, and shop wisely.