Fundraising: Valuations, SAFEs, & Investor equity

So Adam, let's kick this off with, you know, some questions regarding fundraising for early-stage startups. You know, how do you think early-stage entrepreneurs should approach the valuation question, especially at the pre-seed or seed round?

Totally. So I'm laughing a little bit because valuations are very much a function of essentially what you can get in the market. It really, it all depends. So it depends on Who you are, what have you done in the past, who you know, and then if you can create a sense of sort of excitement around your deal itself. So can you essentially sell the idea of what you're doing in that deal in a way that gets people really excited? So once again, like, valuations really just depend on a number of those factors. So if you're at the really earliest stages, you're a sole— let's say you're a solo founder, non-technical solo founder, doesn't have a lot of connections, or know folks who have access to money, and you don't have, let's say, an amazing background, you didn't work at Google for the past 10 years in some amazing role there, things like that, your valuation's probably going to be low. But that's sort of the market speaking to some extent that you don't have a lot of proof points that you are going to be a success. So there's no way for people to really know that you are actually going to be really successful. So there aren't— the signals don't exist. But as you get further along, And you start adding more and more signals that investors can actually look at and use to justify the valuation that you might want, that pricing changes or the valuation changes. So once you get your company off the ground and you start having some customers, and then how quickly are you adding those customers? I mean, how much are they paying? All of those go into sort of a formula in investors' minds to say, okay, well, this company sounds pretty interesting. It's starting to achieve certain levels of metrics and goals that really lead to real growth and excitement. Or you have other things like you are a part of, you're a part of, let's say, Y Combinator or other startup founding places, things like that, that really lead to newer or better outcomes. So it's, once again, it's a function of signals and how good you can make those signals, essentially, how good you can play those signals into a higher valuation. I'll add one other part, which is there does come a question of, how high a price you want to put on yourself as well. You don't want to overdo it because that's a real issue too. Since every raise that you do, you also have to think that you are setting yourself up for future raises. So the price point that you put on yourself, someone's going to look to double that. You want to double that price or more in the next 12 to 18 months. So if you put your price on yourself that is really, really high, Then you need to make sure you can justify that in 12 to 18 months. And if you can't, then it's actually going to hurt your company long-term more than it will help.

Are there any signs where, you know, you can get some feedback on, okay, I've selected a, you know, decent valuation number, this makes sense at this stage?

So there aren't like— really, the signs are pretty simple. In this way, it's very much like a free market, which is, uh, the signs are that, are investors willing to put money into you at that price point? Are they willing to— so once again, like, to reiterate the point, if you say you're worth $10 million, are they— are you willing— are you able to raise a decent amount of money at that price point from people who are somewhat sophisticated, right? Raising a bit of money from your friends and family at that price point isn't a very good signal because your friends and family would back you no matter what, we hope— I hope. And but raising $10 million from— or raising, raising a $10 million valuation from top-tier investors who know what they're doing Is a whole different sort of signal. So it really depends on how much you can raise at the right price and what stage you're at.

Got it, makes sense. And then when it comes to talking about distributing equity to investors, how do you think startups should approach this, especially at a seed stage?

When you say distributing equity, what do you mean exactly?

Supposing you're planning a fundraise and, you know, you've kind of Now you're going back and forth with investors on how much equity to give them. How do you sort of think through that? Are there any guardrails to keep in mind?

Yep. Yeah, so look, the amount of equity that investors get is a function of the question you just were asking, which is a function of your price and how much money the company— so if you're doing a $10 million— if you're valued at $10 million and you raise $2 million, you just gave them 20% of your company. It's pretty standard at a lot of different stages as well, that at your seed, Series A, and so on, you'll keep giving 20%, but obviously the value of the company has gone up a lot. So it's still a win. The overall pie has gotten larger, so it's a win for almost everyone involved. But really, look, the amount of equity once again is really just a function of what I just mentioned, is how much is the company worth and how much do investors want to put in. And so essentially that's the ownership percentage that they get. Now, this depends a little bit. There's a few other differences around whether it's on a SAFE note or it's a priced round, things like that. That's how to think about equity is investors are essentially buying a portion of your company in a sense, but they're also buying those future value. Right. So if I say that I started a company today and my company's worth $10 million, who says it's worth $10 million besides myself and investors who want to put money in? Even when investors put money in, That's almost the nature of an investor. They are making a bet for future value. Is their goal— that's where their focus is, on the future value of the company and where that leads to.

Right, right. Makes sense.

No company is going to go buy my $10 million company today just because I say it's worth $10 million. It's not like I'm going to get an offer from someone to go purchase it for $10 million. But investors might say, well, given your track record, given a bunch of— given the idea, given the team you're building, I could see that someday in the future, this could be worth $10 million and I'll get a nice return on my— well, if it gets bought for $10 million and they invested $10 million, they won't make a return, but they could see the future value where maybe it's worth $20 million or $100 million, and then they get a real return.

Makes sense. Now, when it comes to scouting for investors, supposing, you know, you're trying to raise around, are there best practices in how to sort of reach the right investors? For your fundraise?

Yeah, there are a bunch of best practices. Number one is you want to spend time going through essentially like LinkedIn and venture capitalists, like LinkedIn pages, or their, obviously their venture firm's page and just About Us page and see a few things. What do they say they like to invest in? Right. They might say, I like to invest in enterprise B2B SaaS, or I like direct-to-consumer companies. They invest in, in that sense. Like, so they'll tell you off the bat like what their thesis is, what they're interested in, who they're focused on. They will pay attention to that. You should pay attention to that is number one. Number 2, I would look at all the companies that are in my general competitive space, right? So you might say, well, I don't have any competitors, which isn't ever totally true, but you could say like, I don't have a lot of like direct competitors. Well, that's cool. But you still have people who are in your general space that you're working in. Who's invested in companies in your space? Ideally, even not directly competitive, but companies just in your space. Go find those folks, and you can look on Crunchbase or a few other sites to see who— what investments people have done to understand what VCs to put money into. And so you do that research, go figure it out, and then it gives you— you should start being able to build a list of, hey, these are people who invest in my types of companies. There's a whole process for how you reach out, which maybe we can talk about as well. But at the high level, first, just identify the people who are going to care. I mean, I get sometimes just cold emails from people saying, oh, I see you're an investor. Please invest in my company. I'm like, why should I? I don't even know you at all. The better emails are from people who say, oh, look, I see we went to the same college, or I saw you invested in this company and I love that company. we're doing the next generation version of this, but it's not competitive, right? So you got to be clear because I don't want to obviously make big investments in things that I'm already competitive, that I already have an investment in, if possible. Um, but that's the way to start doing it, is start identifying the investors who understand your space as much as possible.

Makes sense. And actually, like, you touched on this already, but, you know, what are the best practices in reaching out? Because a lot of these could be cold emails. And so how do you stand out from, I'm sure, like hundreds of emails investors receive quite often?

It's the same as with sales in a sense that writing a cold email is really tough. It's an art. It's a little bit of a science if you do it really well. Go read about how salespeople do the best cold outreach emails. That's one way, although it's hard. I think a cold email can be really difficult for someone to respond to, at least for me. I try to read every email I receive though, but I don't always respond. A better way is go follow me on Twitter and see what I'm tweeting about, or message me there. I tend to be more responsive. Frankly, a lot of VCs are more responsive on Twitter than a lot of other places. So those can be great places to reach out as well, kind of alternative to email. But part of why, part of why people respond better on a lot of social media platforms versus email is because the social media platforms don't have a way you can really automate the messaging all that easily, whereas email, you I can go buy a list of 1,000 investors and send an email to all 1,000 of them that seems like mildly customized because it says, you know, hey, first name, and they just drop Adam into it and now it's customized.

Right.

I know that's what people do for email, so I'm more likely to ignore it. Whereas on Twitter, you DM me, I need to actually— like, you actually put effort into that DM, so I'm much more likely to read it, which means of course I get many fewer DMs than I do random emails. But truly the highest signal way to get in front of an investor and get them excited is by having an introduction, by receiving a warm introduction from folks who are— who know your business, either ideally investors, so they can say, I'm already an investor, I love this company for these reasons, the founder is fantastic, here's why I invested, they're doing another round, I told them that you either are amazing or they told me they'd love to talk, would you be willing to chat? And that is by far the highest signal way that I, I'll take an intro from pretty much anybody who I'm friends with and I trust, right? If they tell me someone is worthwhile, I will, even if anything, just out of a favor to them because they're someone I really do trust, I will take that call.

Fair enough. I think that makes sense and probably standard in sales too. All right, so I think you touched upon this already, but, you know, just for those that are wondering, you know, are there some kind of metrics or benchmarks that Your startup should aim to hit when you're thinking about raising a formal seed round?

So once again, it a little depends on who you are, who you know, and where you've been and what you've done in the past. With that said, for most sort of pre-seed or seed stage funding rounds, they tend to be really vision raises. So what I mean by a vision raise is that they are a raise that is focused on, this is your— here's who I am. So here's myself, my team. And here's my goal for what I'm building as a company. So my vision is X, and here's why I think the world has this wrong, right? No one has built this in the world. I'm going to be crazy and I'm going to go build this. Totally crazy idea, but here's this vision and why I think the world should be different and hopefully better when I get my product out there. So it's really a vision. Raise is what you're pushing into. There aren't really metrics as much as really, it's like when I do seed or pre-seed investments, it's essentially— who are the founders? Like, are they really impressive? Are they people that I'd want to— if I were going to start another company, are they people I'd want to go work with because they're so smart, they're so hardworking, they're so dedicated, and they're so knowledgeable about their industry? So I did an investment a little while ago in a company. It was a fairly high price, and the founders were just so compelling, so knowledgeable about their space. And they had a really good history of stuff they've done in the past that it made it a really easy investment overall about it, because they explained really clearly why the world was wrong, why it needed their product in the market, I mean, how they were going to go create it. So it was a very impressive team and discussion that way. But yeah, there aren't any real metrics beyond team and idea.

Got it. Makes sense. And when it comes to founders' backgrounds, like, what exactly do you look for? At least in terms of getting credibility that, okay, I'm going to, I trust you, I'm going to make this investment.

Totally. So it's a few things, right? When you're where, I think kind of number one is, are they knowledgeable about the space and why? Either, I don't, it doesn't mean it's been a formal education about the space. It doesn't mean like, oh, I went to school for 4 years and I have a PhD in machine learning or something. It can also be, You had a personal family tragedy or personal something happened in your life that led you to this situation. So one of my investments, BetterUp, which is a fantastically successful company now, Alexei, the CEO, and I sat down when they were really early seed stage. No money was in the door actually for them. Wasn't an expert in the space from an education standpoint, but he had been through this same sort of pain that they were solving for. in a variety of really personal ways. And so he explained that in really personal terms and explained the research and in-depth work he had

done

to understand the problem space and why this hadn't been solved before, but why it could be solved with the technology that they wanted to build. So that was number one. And then number two, he as an individual and his co-founder were both super impressive people and had done some really impressive things in the past. And so their burning desire and passion to make BetterUp a success was pretty evident as well. So it's sort of a combination of this knowledge and passion for the topic, and it's just belief, this utter clear belief, despite all evidence to the contrary, that in this case, BetterUp should exist in the world.

Fair, that's really nicely said. I guess we covered this a little bit earlier on, But I do want to cover SAFEs as well, because this does seem very relevant, at least at very early stages. So what are SAFEs and how do they work?

Yeah, totally. So, look, a SAFE is a Simple Agreement for Future Equity, right? So the idea there, they actually came out from Y Combinator. I forget how many years ago they came out with SAFEs, but it was essentially a way to really simplify the fundraising process early on. Because the challenge that companies have is kind of this whole discussion, what are you actually valued at? No one really knows at the earliest stage, because it is really just a vision raise plus team. And no acquirer, in most cases, are going to buy you just for your vision and team. It does happen, but it's pretty rare and you have to be a really spectacular team to have that occur. So they're not going to buy you for that. What is the right valuation? Well, it's hard to know. So a SAFE essentially allows people to invest in your company without actually putting a real valuation on it. Now, there are pieces of information within a SAFE that enable you to approximate a valuation. So you might say that you're investing at a cap rate, basically, which basically means the rate at which the approximate price that you would expect it to go at. And then if the investment later, when the terms convert is for less or for more, it changes up the overall kind of return to the investors. So there might be a discount on the SAFE as well. So they might say, well, when it converts— so when it converts, it means it's like when you do an actual financing round that is priced, so priced financing round, then when that SAFE converts into it, which is a technical part of the SAFE itself that says it converts at this valuation based on what it says. So to give you an example, when the conversion, if you have a 50% discount, which I've seen SAFEs with that, right? They say, we don't know what our valuation is, but this SAFE has a 50% discount and will convert in our financing round. The danger of that, there's 2 dangers there, but like the danger would be, well, not a danger, but what would happen is let's say then the financing round is at $50 million. So you actually have a price round that says the company's worth, so let's Lead VC comes in, says the company's worth $50 million. You have a SAFE that says it converts at a 50% discount. That means that you get essentially— the money you put in converts at a valuation of $25 million instead of $50 million. So to put it another way, if you invested $2.5 million on a SAFE note with a 50% discount, and that company gets a priced round at $50 million, your $2.5 million converts at a $25 million valuation, which means you actually own 10% of the company at that $25 million valuation, which actually, in a sense, like— so it actually is like a pretty good deal for you because the company is actually worth double that, but you own 10% of it. So it's a pretty big win for companies in that sense. But of course, it can take a long time to get there, and there's a bunch of reasons why there's dangers to it as well. But a SAFE is by far the standard way to do pre-seed and seed investing today.

Interesting. And would you recommend SAFEs for specific type of startups, or is this sort of any startup at a seed stage?

Any startup that's raising money at a seed stage should use a SAFE. It's great. It's a well-used vehicle. Don't try to reinvent the wheel. It's just going to make things confusing. Investors are used to it. You don't gain— You will not, unless you are like a financial or legal startup, you're not going to win brownie points for trying to reinvent the wheel for investing stuff. Right. Y Combinator did this a few years ago and they were able to because they're Y Combinator. Yeah. And it became the default because it was legitimately better. But the only type of company I can ever imagine even not using a SAFE is if you're already generating so much cash that you actually don't need to raise money. Right. Like if you're not raising money, or I should put it a different way, if you are, if you're not raising, if you don't need the money, then you probably don't need a SAFE. Maybe what you would do is you just go to a bank, just get a loan. There's also special financing out there. So Pipe is a company that's gotten a lot of, um, in the press recently.

Mm-hmm.

And it's a way of funding your company based on revenue. So if I can let Pipe give me money based on my projected, forward projected earnings, that's a huge win for me as a business. I don't actually need to go out and give up ownership in my company. I can instead just go have it financed via Pipe or banks are, are a little bit harder in some cases, but Either one, there are alternatives to doing a SAFE or really any venture investing whatsoever, just by using the new terms that are coming out, new tools that are coming out there today. So that's the only time I can imagine is if you already are generating a lot of revenue, then yeah, you might not even need to do a venture financing round.

Got it. And I mean, you mentioned debt financing. So, you know, why don't more startups choose that route where you can actually Protect your equity and potentially still fundraise through that means versus going the VC route?

Yeah. I mean, well, so a few things there. I mean, like one, I don't think technically SAFEs are actually debt anymore. Previously to SAFEs, there used to be kind of debt basically that you're giving out to people and you're paying them interest and things like that, or on paper interest to folks. Today, it just isn't standard. So you have SAFEs that are really good for early-stage venture financing, Or once again, to answer your question specifically, Saachi, the— you need to actually have revenues to get debt generally, right? The other option, of course, you could take a personal line of credit. So I could— lots of people start their companies on a credit card. Right. You can absolutely go use a credit card or go to your local bank if you have good relationships there and get a loan. It'd probably just be a personal loan. You'd be a personal signatory. You'd be personally liable. You could absolutely do that. And that is what a lot of startups do early on. If you don't have wealthy family members and you don't know a lot of investors, then yeah, like, but you believe your idea and truly believe it should exist in the world. Yeah, it's a little bit expensive to go do it on a credit card, but you know what? That's okay. If you wanted to go prove that your idea had legs, then go, go do it on a credit card. And then 6 months, 12 months, you might rack up some credit card fees, but you know, you'll prove enough that your idea really matters and you're a team who knows how to build it, in which case VCs will pile on and