Startup Fundraising Guide - Ep. #5 - Closing the Deal
John Coogan’s video (part 5 of a fundraising guide) explains how founders should close early-stage fundraising rounds. It emphasizes using a handshake deal protocol to lock verbal commitments, then executing standard legal documents—primarily YC-style SAFEs (Simple Agreements for Future Equity)—and discusses SAFE types, valuation caps, side letters, and practical tracking of dilution.
Hey everyone, I'm John Coogan and welcome to the fifth part of my guide to startup fundraising. In the last video I talked about how to pitch your company with an effective deck, and now I'm going to go through how to close a deal. Meeting with an investor is all about convincing them that you're building a great business. So once they agree that you are making customers happy, growing the customer base significantly every month, and are operating in a huge market, they will want to do a deal. Before you focus on any legal documents, you need to outline the terms of the deal, verbally or over email to make sure everyone is in agreement. The best way to do this is to follow what's called the Handshake Deal Protocol. Here's how it works. First, you define the offer. Something like an investor putting in $100,000 at a $5 million post money valuation, meaning that the money invested is included in the valuation of your company. Once the investor agrees and says I'm in for 100k at a $5 million post, you need to confirm by saying the exact offer back to them. So you're in for 100k at $5 million post. Then you need to send an email or a text message to the investor saying this is to confirm that you're in for 100k at a 5 million dollar post. Please confirm within 48 hours and agree to fund your investment within 10 business days. Once the investor confirms they are in the round and you now have an obligation to finalize the deal with them. This might seem cumbersome, but it's really important because of how messy fundraising can be. Oftentimes there are lots of conversations going on with investors simultaneously, and many investors like to wait as long as possible to make a final decision. You really want to avoid situations where an investor who you thought was out comes back to you just as you're closing the round and says that they expected to be included. I encourage you to read the full blog post by Y Combinator on the handshake deal protocol that I've linked below in order to really understand why it's effective. After you have investors committed, you'll need a legal document to confirm the transaction. Investments can be made as equity sales, debt agreements or SAFEs, which is what we're going to focus on today. The safe or simple Agreement for Future Equity was introduced by y Combinator in 2013 as a way to streamline early stage startup fundraising. Since then, it's exploded in popularity and almost entirely replaced the convertible notes that were popular before. Before we get into exactly what a safe is and how to use them effectively. Let's go over some startup history. In the first decade of the 2000s, most seed rounds were done via priced equity securities, but convertible notes took over in 2010 and became the dominant financing vehicle. They were much faster to execute than equity rounds, but because they were debt, they typically had interest payments attached that often became cumbersome for startups. Y Combinator has focused on reducing headaches for early stage companies so that they can focus on building great businesses. Investors have tons of experience doing deals, whereas first time founders don't typically have experience or know what to expect. I've heard lots of horror stories from founders who raised money early outside of Silicon Valley on non standard terms and wound up giving away over 50% of the equity before even getting to market. YC acts somewhat like a union for early stage founders. By publishing standard documents and outlining what founders should expect from investors, they level the playing field a bit and stop these terrible deals from happening. Predatory investors who insist on non standard investment terms are easier to identify when you can benchmark their demands against public documents available on YC's website. And it's not just startups that have been plagued by complex and harmful legal documents. Kanye west recently published all 10 of his Universal contracts in a massive series of tweets in an attempt to shine a light on how major labels can hurt musicians with complex agreements. He actually said that he wants to create a Y Combinator for the music industry to give artists more transparency and prevent lifelong deals from holding back promising careers. When it comes to creativity either in startups or the music industry, no legal contract should limit your ability to execute effectively. I hope that more industries start adopting standard contracts and publishing guidelines for how to close deals in a fair way. I recommend using safes when fundraising for a few key reasons. At five pages, the safe is very straightforward as far as financing documents go. Nearly every experienced startup investor has used a safe before. There aren't many points to negotiate since everything is so standardized. And lastly, it's not a debt instrument so investors can't ask for their money back or demand interest if you haven't raised a Series A yet. A standard safe contains just five sections. The first describes what happens in different situations like a series A acquisition, ipo or even bankruptcy. The second section outlines definitions for the contract. The third and the fourth are representations by the company and investors that essentially state that each side can legally participate in the investment. And the last section is just legal boilerplate. The entire document is very readable so I Recommend Reading all 5 pages before you fundraise. The SAFE is designed to standardize as much of the investment process as possible, so you should only need to be negotiating the amount of the investment and the valuation cap. The investment amount is how much the investor will actually be sending you, and the valuation cap is the maximum valuation that the safe will convert into equity at. If you wind up raising your next valuation below the valuation cap, your previous safe investors will get a larger portion of the company, so be aware of that. It's standard practice to use Post Money safes now, so that makes calculating the investment amount very straightforward. If an investor signs a Safe for a $1 million investment at a $5 million post money valuation cap, you have essentially just guaranteed them at least 20% of the company. Since most fundraising rounds will involve multiple investors, it's really important to keep track of what you've promised so you know how much equity you still own. You can do this in a spreadsheet or in a software like CapTable IO or Carta, but regardless of how you choose to track things, make sure you are always aware of how much you will own of the company. After fundraising, it's extremely easy to lose track of dilution, and there's really no way back to owning more of the company once you've executed safes with investors. The goal of the SAFE is to be simple and standardized, but there is some variety. First, the SAFE itself can be structured to have a valuation cap only, meaning meaning that the investor will know upfront what percent ownership of the business they are getting. Second, you can have a discount with no valuation cap, meaning that the investor will essentially be investing in the next round at a reduced price, but that valuation is dependent on the next round's price. Third, you can have both a valuation cap and a discount, meaning the investor gets whichever is most advantageous. And lastly, there is the Most Favored Nation safe, which lets investors start with an uncapped no discount safe, but convert to better terms if they are offered to other investors. Investors can also ask for side letters that give them extra rights beyond what the standard SAFE would. You need to be careful about these, since some side letters can have dramatic impacts. A side letter that grants information rights so an investor can report data to their limited partners is usually fine, but a side letter that grants a board seat or super pro rata could significantly change the relationship with this particular investor. Here are some examples of side letters that you will want to discuss with your team and potentially a lawyer if you don't fully understand the tradeoffs. Some of these can block your ability to sell your company down the road or make Series A investors less interested in funding the company. These clauses used to slip into financing agreements all the time without much oversight, but now that the safe is so common, founders have to explicitly understand what they are agreeing to. Part of what makes the safe so resilient to tricky additions is the second line. It basically says that both the company and the investor agree not to deviate from what YC has published on their website. If you ever see this line missing from a safe, you can be sure that the clauses below have been altered and you will need to review it very carefully. So to summarize, in most situations it's best to use a standard post money safe with a valuation cap and no discount. Once you're comfortable advancing from handshake deals to safe closings, you can start to deal with requests for side letters or different terms as they come in. If it's a big investor who you are really excited to work with, it might make sense to deviate from the standard terms, but always consider what that will mean for other investors. You don't want to wind up in a cascading situation where you keep giving extra favorable terms to more and more investors. In the next video, I'm going to talk about what changes for your business after closing a financing round, so be sure to hit the subscribe button and ring the bell if you want to be notified when that goes live. And if you think I left anything out, please leave me a comment below. Thanks for watching.
