There’s never been a better time for raising startup capital, but this makes things increasingly complex for founders.
Venture financing is always evolving, and 2017-18 has been no different.
A company’s future — and the stake of the founders — can be made or squandered during this crucial period.
Given our unique insight into the startup fundraising environment, we wanted to distill and share our learnings for current and aspiring founders. High-level summary:
- It’s getting easier to raise money at higher valuations
- These big opportunities lead to complications and room for error
- The fundraising process must adapt to match the complexity and pace of the transaction
I selected 9 big takeaways from helping clients raise over half a billion dollars since 2017.
1. Valuations are going up and up
This is a very stark contrast to when I was a junior lawyer, when the average series A valuation was in the ballpark of $10MM and the average company seemed to raise $2MM – 3MM.
Now, I’m routinely seeing valuations of $50MM+. What was previously an amazing valuation, somewhere in the $20MM – $30MM range, is now more middle-of-the-pack. This has been written about extensively, but it still bears repeating.
It means we’re in an excellent market to raise money. Valuations are high and there’s more cash being deployed than ever before.
Which leads to . . .
2. Founders have more leverage than ever before
Macroeconomic trends are, for better or worse, the single biggest determinant of a company’s ability to raise money.
Companies that previously would have had to go all-out for a chance at decent capital can now negotiate like never before.
Lots of companies have multiple offers.
All of this means that founders have promore leverage than ever. As a legal and fundraising partner, it’s part of our job to alert startups to — and help them use — this leverage so we can maximize it with a favorable term sheet.
3. Founders have more ways to use that leverage
There are tools and levers today that simply didn’t exist 3, 5, 10 years ago.
a) Dual Class Structure
Take, for instance, dual class structure. A company has Class A and Class B common stock:
- Class A would have 10x voting rights
- Class B has 1x or no voting rights
This allows for founders to control the company, through an IPO, in a way that previously wasn’t available.
b) Founders Preferred Stock
This mechanism enables founders to get liquidity at the time of an equity financing, by converting some of their shares to the series of preferred stock being sold at the financing. Investors can then purchase these shares directly from the founders rather than from the company.
Founders always had the option to sell some of their common stock to investors; however common stock lacks the rights, preferences and privileges of preferred stock, making this approach less desirable from an investor perspective.
Historically VCs frowned on tools like dual-class stock and founders preferred stock. They could just require founders to do away with those kinds of structures, because the ball was in their court and founders simply didn’t have the option to dig their heels in.
But the times have changed. Now, it is not unusual to regularly see companies getting dual-class stock structures approved by VCs.
Dual-class and founders preferred stock are two of many ways that founders are using their leverage. They can now push for better valuations, better Series A legal terms, and more favorable cap numbers — and it all stems from the investing environment and the leverage afforded them as a result of that.
4. SAFEs are an amazing tool (when managed properly)
SAFEs have really taken off as the primary vehicle for raising seed money — and for good reason. It’s an easy way to raise a seed round, with minimal friction. It’s almost hard to imagine that 5 years ago, the SAFE didn’t even exist.
Our clients now have an average of 20-30 SAFEs outstanding, and upwards of 60-70+ in some cases.
Like anything good, there are potential downsides: namely, the management headache it causes when you have a large number of “cooks in the kitchen” so to speak.
If you have anywhere from 20-60 investors with SAFEs, that means 20-60 stakeholders to manage when it comes time for your Series A. We’ve seen companies have their fundraising efforts greatly hindered simply due to the logistics of getting signatures from all their SAFE holders.
We use systemized processes and special tools to greatly relieve these headaches, which goes a long way to minimizing the wasted time.
5. Technology can make the Series A process much more efficient
Atrium was launched by seasoned founders, including Justin Kan (our CEO), who had been through the fundraising process and saw firsthand how the inefficiencies were problematic for both investors and startups alike.
We strongly felt that technology would streamline the process and save everyone time and money. But like any hypothesis, it had to be validated.
It’s gone even better than we could have hoped.
For example, we use the Deal Tools platform. This allows us to create, distribute, and track signature pages — particularly useful when you have dozens of SAFE holders to wrangle up.
To the tech-savvy people in the startup world, this might sound like table stakes. But I remember a time not too long ago, when the process was broken down into painful steps:
- Create all the signature blocks and pages in Word
- Convert to PDF
- Send by email
- Track all of it in an Excel sheet
And that’s just one of many processes that a company needs to do during fundraising. We use a combination of proprietary and existing tools, and then build workflows around them.
This is very different than the traditional way, where you end up paying high hourly fees for people to toil through inefficient processes like the one above.
Which leads to . . .
6. Financings can be done on a fixed fee basis
This is another fundamental hypothesis behind Atrium that we were glad to validate.
Traditionally, a founder goes to a law firm and gets an estimate based on the number of billable hours they estimate.
Spoiler: the estimates are always lower than the final bill.
It was very normal for startups to assume this projection was somewhat accurate, then get a final bill from the law firm that made them jump out of their seat.
It all comes back to incentives. Associates at key firms are evaluated based on “billable hours” – their bonus depends on it. That means their incentive is to always bill more time, which obviously costs more and delays the completion date.
We wanted to change that by giving clients a flat-rate quote going into their fundraising. If there are any complications, it’s in our interest to resolve them in an efficient manner; not come up with 10 more hours of billable work, which drags the process along and leads to sticker shock when the final bill arrives.
Our incentives are aligned to the client’s: get the financing done with the best terms, as quickly as possible. It’s worked out well for us, and for the clients.
7. Specialized teams are better than generalists
Traditionally, you get one lawyer who handles the whole fundraising process. It doesn’t matter what their strengths or experience are: they do it all.
We built a different system, consisting of specialists for venture financing.
Why specialize in venture finance? It is hard to truly become an expert when you are being pulled in different directions (M&A, capital markets, etc.), which is what happens at traditional law firms.
There are also supporting teams, such as intake, that make each one of these specialties operate smoother.
The typical fundraising process started like this:
- Client provides the files to an investor and their lawyer in a disorganized manner
- The records contain errors or aren’t accurate, or there are gaps
- This causes more extensive and longer due-diligence review period
- The transaction is delayed (or in some cases, derailed)
Our intake team solves for this by getting everything in order from the beginning. We ingest all of your documents so that they can be easily referenced (and any gaps can be filled), and we produce a vetted cap table to ensure records actually reflect what the client thinks the capitalization is.
Overall, specialization enables our team to optimize and improve every part of the process.
8. More leverage = more complications = more room for error
This tremendous fundraising environment and increased number of levers for founders to use has fantastic upside . . . with an equally precipitous downside.
Here are 3 examples of complications that arise from these otherwise positive circumstances:
a) Juggling multiple offers
Let’s say you get a term sheet from Investor A, but you know you can parlay that into a likely better term sheet from Investor B.
How do you keep Investor A warm while waiting for an offer from Investor B? You can screw up both opportunities if you don’t manage it properly.
b) Lack of transparency
With more investors and more terms comes a natural decline in transparency. What’s been sent to different investors? Which have viewed? Have there been follow ups?
Oddly enough, founders normally had little visibility into all of this. By simply having regular status call and routinely communicating this information, founders know where they’re at and have less guesswork.
c) Necessity to move fast, at the expense of quality decision making
Term sheets are complicated math problems. For example:
- Term sheet 1 has a $30MM valuation, $5MM round with 10 percent option pool
- Term sheet 2 has a $35MM valuation, $5MM round with 15 percent option pool
How much do the founders own in each scenario?
This used to require a series of calculations that would take hours (or days, when dealing with partners and associates with limited bandwidth) to produce a definitive answer, depending on the number of term sheets/scenarios and complexity.
We solved for this by building a pro forma generator that tells founders their dilution in several scenarios – within minutes. This was previously not possible.
9. A law firm can provide more than just basic legal services
It’s one thing to process documents and just do the job.
We discovered early on that clients often appreciate strategic guidance just as much throughout their fundraising. As we learned this, we began to structure our services and teams to be more of an advisor and partner — more than the normal lawyer.
When companies are fundraising and facing challenges like the one above on how to manage multiple investors, they want all the help and advice they can get. Our team provides advice on the best course of action in tricky situations like this.
With programs like Atrium Scale, we actually connect you with investors and help you prepare your pitch. This has never been seen as the role of a law firm, but we figured out that clients appreciate the help and built it into our process.
Conclusion: It’s a great time to start a (great) company
I’ve had the good fortune of working with some of the most exciting startups in the world and can confirm that (as Sam Altman says) there’s never been a better time to start a great company.
As a founder, view the upside with cautious optimism: you have more opportunity at your disposal than ever before, but it’s easier to make bad decisions.