Post-stirring the pot about post-money caps

Two weeks ago my intro musing about post-money caps sparked some interesting responses. I also stirred the pot a bit via a short social media post.

Reflecting back, I realize I might have taken an overly founder-friendly perspective…certainly with my social media post as well as with my initial newsletter post.

DISCLAIMER: I’m not a VC hater - I used to be a venture capital investor!

So, while I relate more strongly with the founder point of view, I still deeply appreciate the role that investors play and the risks they take. So with all that said, I'd like to take a stab at outlining where I think post-money caps work and where they concern me. I think I can do this as objectively as possible because I have seen the bad side as an advisor to founders (as recently as last month). And as an investor, I saw many situations where VCs got the short end of the stick.

In my opinion, post-money caps are really great when expectations are extremely clear. This is especially true for founders, who are normally the less sophisticated party when it comes to investment structures. When an entrepreneur can confidently say,

“I would like to raise up to x million dollars on a note and no more... UNTIL I raise my next significant tranche of capital, which I will likely do as a priced equity round!“

…then the post-money cap is amazing. In this situation, it’s very clear how much ownership each party involved will own and the SAFE itself is much less complicated / costs less to execute.

In fact, when there is a clear MAX amount that the founder would raise, the post-money cap could skew in favor of the founder. Here’s how: if a post-money safe is set up with the expectation of up to X million dollars raised and the founder decides to raise less than the X million dollars. That deal will end up being better for the founder than if they had set a pre-money cap (for clarification, see the graphic from my previous post on caps).

All that said, if the founder agrees to a post-money cap based on a target amount of money raised and gets convinced to raise more money (either on the same SAFE or in a subsequent SAFE), then the post-money cap becomes punitive to the founder. If you remember the illustration I shared last week, raising more essentially lowers the pre-money valuation of the company. Founders need to know that if they close that post-money safe and later raise more money on anything but a priced equity round, those investment dollars essentially make the initial dollars from the initial SAFE more dilutive! It essentially makes it feel like the previous SAFE was raised at a lower valuation.

My warning to founders is this: they will likely fail to predict exactly how much capital they'll raise and when. Because of that, post-money caps can be difficult to manage. An investor friend of mine mentioned the solution to all this might be to have founders normalize raising priced equity rounds anytime they want capital after having raised a SAFE. This is easier said than done because there are so many situations where a quick note would be preferable, but we can all dream.

Till then...understand the different types of caps so you can make the right decisions no matter which one you end up with.  

Ok, on to the fieldnotes for this week!

We’re raising in a hot space with competitors that have already been funded. What do we say?

In all fundraising scenarios, but particularly in competitive spaces, it is incredibly important to sharpen your pencil around your story.  Your vision for why your company exists, what the future that you are trying to create looks like, and why your team will achieve this needs to be incredibly specific.

It's important to be able to tell a story that says “yes, people are playing in a similar space, but no one is thinking about the market the way our very talented and unique team is.”

In this scenario, competition is just an indication that the market is large. Investors need to realize that even if other companies have been funded, the future has not been written. There is still a race to run.

I’m not sure why it’s been so hard this time...

I was advising a founder on final negotiations and strategy for a Series B fundraise a few weeks back. The company had impressive growth, a repeat entrepreneur at the helm, and a great story. But things were not closing as easily as the founder had hoped.

We had two conversations in one week, with very little time between them. In the first, he described how incredulous he was that the round was so difficult. He spoke to more funds than he did in his Series A, had a better story with fantastic numbers, built an awesome deck, and constructed a flawless data room. All the moving pieces were in way better shape than the last time he raised. Despite that, he told me in a very exasperated tone, “there is a very real, non-zero chance that all of my leads will pass.”

A few days after the first conversation, we caught up again. This time he was ecstatic having just secured an amazing term sheet. However, he was also perplexed. Why had this raise been so challenging despite his superior level of preparation? What could he have improved?

The fact of the matter is that all fundraises with lofty expectations around valuation and terms always end up like this. Remarkable outcomes don’t come easy.

It’s worth noting that this founder’s fundraise, with massive terms from a brand name fund, will seem like a massive success that was easy as pie from the outside, even though the end was quite harrowing. I hope this is both sobering and comforting for founders who are preparing for a raise or in the middle of one. For those preparing, get ready for a battle. For those in the heat of the battle, don’t worry, it’s hard for everyone so keep fighting.

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