C2V May Notes From The Trenches
Welcome friends! And happy spring, that magical time of year when allergies kick in, your car is constantly covered in yellow tree detritus, all but one major sport has ended, and it rains constantly. Hashtag Fall4Eva.
We have a shorter version of the newsletter this month (so only 3x longer than every other newsletter you read), as we have no new company to announce. But never fear, we have three new companies in late DD and Matt’s already working on a 3,500-word opener with tons of math for next month. Until then…
Defending the SAFE (Mostly)
No star performer with a truly impressive track record has taken more flak for a handful of minor flaws recently than the SAFE (other than maybe Jayson Tatum). We’re not sure exactly when everyone turned on SAFEs or who started it, but it seems to be all over the place now, including as one of the topics of the PrimeTime VC event Chris recently participated in (see below).
Anyone not familiar with SAFEs can head here for a quick tutorial. Since Y Combinator created them in 2013, SAFEs have become almost the default format for Pre-Seed rounds, making up (according to Carta) 89% of Pre-Seed funding in Q4 of last year.
High-Level
SAFEs are not without their flaws, but as long as investors and founders understand what they do and don’t get in a SAFE funding, we generally find them to be a perfectly fine (not to mention quick and easy) way to finance an early-stage deal.
Of our 49 initial investments (all Seed and Pre-Seed rounds):
45% were SAFEs (61% of Pre-Seed rounds, 36% of Seed rounds)
18% were convertible notes (Pre-Seed: 28%; Seed: 13%)
37% were priced (preferred) rounds (Pre-Seed: 11%; Seed: 52%)
SAFEs are also now commonly used for bridge rounds that follow a priced Seed round (2/3s of bridge rounds we’ve participated in have been via SAFE, the rest via notes).
Plusses
The main selling point for SAFEs is their simplicity. The standard YC SAFE is 6 pages long (vs. hundreds of pages across multiple documents for a priced round), costs next to nothing in legal advice (vs. $20k - 40k for a priced round), and can be closed very quickly and on a rolling basis (vs. a 30- to 90-day, all-in-one priced close).
Minuses
For founders:
The biggest drawback is dilution/ownership ambiguity, though this is easily addressed with a standard pro forma cap table spreadsheet (every startup lawyer has one), where you can input various priced round valuations and see how they impact ownership and dilution.
One other thing to watch out for (with both SAFEs and notes) is how your first priced round lead treats the converting instruments with respect to pre- and post-money valuation calcs, specifically whether they’re being included as part of the “new money” bucket.
For example, a VC tells you they’re willing to lead a $3mm round at a $15mm post-money valuation, you naturally assume your dilution and price bump is based on $12mm pre-money, but then the VC lumps your $2.5mm worth of SAFEs into the “new money” bucket, and suddenly your pre-money number is only $9.5mm In our opinion, this is an intentionally deceptive (and moderately dirty) practice and thankfully most VCs don’t do it, but some do, so keep those heads on a swivel.
For investors:
Your rights and protections are virtually non-existent compared to what you generally receive in priced rounds (pro-rata rights, information rights, ROFRs, anti-dilution provisions, etc.).
If things go badly for the company and investors are left deciding what to do about it, being neither voting equity (as you would be with preferred shares) nor a creditor (as you would be with a convertible note), you basically don’t exist from a legal standpoint, regardless of the size of your investment.
This last point is important to consider in certain circumstances. For a pre-seed round, it probably doesn’t matter—if a company fails before managing to raise a priced round, there probably isn’t much to argue over (just write it off and move on), but this can become problematic for investors who bought SAFEs in a bridge round that followed one or more priced rounds.
It doesn’t come up often, but we’ve been in one distressed situation where the largest investor in the company had all of their capital in the form of a Pre-A SAFE, and when there were material disagreements among the various stakeholders, being neither shareholder nor creditor, this investor, despite having provided something like 35% of the total capital raised, had no say in any of it (other than some gallows humor about the irony of the term “SAFE”).
A Couple of Specific Criticisms Floating Around the Ventureverse
Liquidation Preference & “The Paragraph”
At issue here is a version of a convertible note in which converting investors receive a 1x liquidation preference equal to the price of the funding round rather than the price at which they converted, which would give them a multiple on their initial investment rather than just a return of principle for the new investors.
This being problematic certainly makes sense to us. The only problems are: 1) the original complaint (subsequently reposted in the above link) was directed at convertible notes, not SAFEs, and 2) we’ve never seen this type of conversion language in either type of document, so if you still see this frequently, we’re not sure what to tell you; maybe move out of the Bay Area?
Post-Money SAFEs & “Extreme Anti-Dilution Protection”
Leaving aside that nothing having to do with startup funding documentation should make anyone this mad,1 we find this whole line of critique to be absurd.
The gist of the argument here is 1) the post-money SAFE template is “the equivalent of ‘full ratchet’ anti-dilution” (by including all converting securities in its conversion calculation, including from “any SAFEs or notes that you issue after the post-money SAFE round”), and 2) standard convertible notes don’t do this.
First of all, SAFEs don’t have “rounds”; that’s kind of the point - you don’t need to spend months collecting verbal commitments to be signed and funded on some future date. If an investor wants in, you can close them immediately, then move on to the next investor, rinse and repeat.
Second, unlike priced rounds and convertible notes, SAFEs have no cap on how much can be raised in that or any future round. That cap is an anti dilution provision, something that pre-money SAFEs simply don’t have.
Third, sure, “full ratchet” anti-dilution provisions have generally disappeared, but that doesn’t mean that preferred shareholders have no anti-dilution protection at all. Every single priced round requires preferred shareholder consent for any future issuance of stock in any form, including instruments that can be converted to stock (and again, SAFE holders have no control over subsequent funding).
Fourth, if after your first batch of pre-seed SAFE funding, you find yourself once again out of cash, and you can’t raise either a priced round or at least less-dilutive (i.e., higher capped) SAFEs, you have bigger problems than dilution to worry about.
This Vitriol Toward Angel Investors in General
What are we doing here? These people are called “angels” for good reason. If you find a flaw in a form document that’s inadvertently giving them unfairly preferential terms, sure, let’s go ahead and fix it, but can we dial it back with rhetoric like “I’m so tired of seeing young entrepreneurs get screwed by their angel investors” (the opening line from one of the blog posts on the liquidation pref topic).
If angels are getting such a great deal, why haven’t you jumped into the pre-seed pool with them? The temperature definitely takes some getting used to, the water isn’t especially buoyant (you really need to work to keep your head above it), and if you’re not careful, you might get sucked into a filter, never to be heard from again… but there’s plenty of room.
Try not to forget that without these benevolent (and maybe slightly crazy) souls, you wouldn’t have a business in the first place. It would be awfully hard to find good Series A/B/C companies to invest in if no one were willing to fund them when all they had was a half-built product and an infinite supply of irrational optimism.
Do you really want to pick a fight about who screws who the most often (and most egregiously)? Because we could fill about five newsletters with the number of scummy things we’ve seen later-stage investors do to angels and other early-stage folks. Trust us, this is not the hill you want to die on.
One VC’s Opinion
To summarize:
SAFEs are generally a great way to get your first financing done, and any downside for founders or investors is massively outweighed by the speed, ease, and (lack of) cost.
As companies gain traction, size, and complexity, though, priced rounds and the legal parameters they establish are better for everyone.
While priced rounds aren’t great for bridge financings (where the whole point is to close a quick, generally all-insider funding so you can get to that next priced round), neither are SAFEs, so we strongly recommend you go with convertible notes here instead.
C2V Watercooler
Chris was very happy to be part of TechDay HQ 2024! The PrimeTime VC championship with Charlie Stephens was superb! Huge congrats to Aubrie Pagano from Alpaca VC, the new champion. The contenders were all strong, and there were a lot of incredible people in one place!
The past 18 months have seen a dry spell in the tech sector's M&A activity, PE buyouts, and IPOs. While some predict a return to liquidity later this year, others look towards 2025. When the M&A market reopens, it will unleash a wave of capital for fund managers like us and founders raising money.
This is good news for founders: They will have easier access to capital. As VCs generate returns for LPs, they recycle capital into new investments. In the meantime, maintain momentum, keep those chips on the table, and extend your runway. Things will soon become a little easier.
Portfolio Highlights
C2V portfolio company StepOne Tech is meeting big milestones in the USA and India
StepOne Tech Ltd. is a Finland-based cleantech company on a mission to enable sustainable driving for all. The company does this with eFlexFuel technology that allows almost any gasoline or hybrid vehicle to be updated to run on renewable or synthetic ethanol instead of fossil gasoline. The solution has over 60,000 happy customers in over 30 countries and over 40 US states. C2 Ventures participated in 2020 StepOne Tech Ltd.'s seed funding round. Company HQ and production are located in Finland, with sales offices in the USA, France, Sweden, and a new one opening in India.
Now, the company is making significant progress in the US market. After many years of emission testing, the company has met a large set of criteria for EPA compliance and will start selling products on the US market for on-road use for many popular gasoline and hybrid vehicles this summer. Renewable Fuels Association conducted a comprehensive study at the University of California about implementing eFlexFuel on a new Ford Escape plug-in hybrid vehicle. The study finds that eFlexFuel equipped plug-in hybrid vehicle has very low particulate emissions on renewable ethanol compared to gasoline and can compete with electric vehicles on well-to-wheel emissions comparison.
StepOne Tech is making fast progress in India and has signed a MoU regarding a distribution pilot with one of India's biggest oil & biofuel corporations. The Indian government is seeking significant growth in renewable fuels to decrease the country's dependence on imported oil. eFlexFuel technology can significantly influence India's energy transformation more sustainably. India's vehicle fleet grows by approximately 20 Million new ICE-vehicles annually, so the impact potential via StepOne Tech's offering is enormous.
Max Echeverría met with the Ambassador of Chile.
Max Echeverria met with the Ambassador of Chile to the United States and other Chilean American companies at a Business Roundtable in Atlanta, GA, hosted by the Metro Atlanta Chamber.
They were excited to share our insights on trade opportunities between Chile and the US and how Eskuad provides solutions in field operations for teams across the globe.
Read the full article.
In other news, Eskaud is officially servicing Boise Cascade in its certification efforts nationally. The regional teams are using Eskuad to collect, transform, and distribute information related to sourcing raw materials to maintain their SFI certification.
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Job Opportunities
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Seriously, poster, what is it you’re really upset about? It can’t possibly be a change in SAFE terms that’s making you this angry,