Carolynn Levy - Modern Startup Funding

Summary

This script discusses the evolution of startup financing, highlighting the shift from traditional methods like Series A preferred stock financing to modern approaches using convertible securities like SAFEs (Simple Agreement for Future Equity). The speaker emphasizes the importance of focusing on building the company rather than spending excessive time on fundraising. They also touch on the significance of communication with investors and the challenges of dilution tracking when using convertible securities for early-stage funding.

Takeaways

• 📚 The speaker has practiced law for 21 years and witnessed significant changes in the startup financing ecosystem, particularly influenced by Y Combinator (YC).
• 🏢 Forming a corporation is the first step for a startup as it creates a separate legal entity and protects founders from personal liability.
• 💼 Bootstrapping can be done initially, but for growth, startups typically need to raise funds, which often involves selling part of the company to investors.
• 🔄 Preferred stock is sold to investors instead of common stock, as it allows for raising meaningful amounts of capital for the startup.
• 🔑 Terms like 'financing round', 'preferred equity financing', 'series A financing', and 'seed financing' all refer to fundraising by selling preferred stock.
• 📈 The speaker highlights three major changes in startup financing: the structure of documents, access to these documents online, and a shift in focus towards faster, less distracting fundraising processes.
• 📝 The use of convertible securities like SAFEs (Simple Agreement for Future Equity) has modernized early-stage fundraising, making it faster and more flexible compared to traditional preferred stock financing.
• 🔗 SAFEs are particularly appealing because they are not debt, unlike convertible promissory notes, and they simplify the fundraising process by requiring less negotiation and legal involvement.
• 💡 The importance of communication with investors remains a constant, as it is crucial for building a relationship and ensuring transparency about the company's progress and challenges.
• 📉 Valuation and dilution are two critical aspects of fundraising that have not changed. Valuation determines the company's worth, and dilution refers to the reduction in founders' ownership as they sell parts of the company.
• 🤝 The speaker advises that modern early-stage financing using convertible securities like SAFEs allows founders to focus more on building their company rather than being consumed by the fundraising process.

Q & A

What significant changes have occurred in the startup ecosystem over the past 21 years according to the speaker?

The speaker has observed changes in the structure of early-stage fundraising documents, increased access to these documents online with annotations and signatures, and a shift in focus towards making the fundraising process faster and less distracting for founders.

Why did the speaker choose to discuss 'closing volumes' in the context of startup financing?

The speaker chose 'closing volumes' as a visual representation of the past practice where legal teams received bound volumes with all financing documents, symbolizing the transition from physical to digital documentation in the startup ecosystem.

What is the purpose of forming a corporation for a startup?

Forming a corporation creates a separate legal entity that protects the founders from personal liability, which is a crucial step for any startup looking to attract investment and grow.

Why can't a startup raise a meaningful amount of money by selling common stock?

Common stock is typically bought by founders at a very low price, representing full ownership of the company. Selling common stock to raise funds would dilute the founders' ownership too much, making it an impractical method for raising significant capital.

What is the difference between preferred stock and common stock in the context of startup financing?

Preferred stock is a different class of stock sold to investors at a higher price, offering certain advantages over common stock, such as priority in dividend payments and liquidation. Common stock represents the founders' ownership and is initially bought at a very low price.

What does the acronym SAFE stand for and what is its purpose?

SAFE stands for Simple Agreement for Future Equity. Its purpose is to provide a simple, convertible security that allows startups to raise funds without incurring debt, and it converts into stock when the company raises a priced round.

Why did Y Combinator (YC) create the SAFE instead of using convertible promissory notes?

YC created the SAFE to remove the debt component of convertible promissory notes, aligning better with the relationship between angel investors and startups, as both parties prefer to be stakeholders rather than creditors.

How have priced rounds evolved to become more modern and accessible?

Priced rounds have become more standardized and available online, making it easier for startups to access the necessary documents. Although they still involve legal representation, the process has been streamlined compared to the past.

What are the two most important aspects for investors and founders during the fundraising process?

The two most important aspects are valuation, which determines the value of the enterprise and the percentage of the company being sold, and dilution, which affects the founders' ownership stake after selling shares to investors.

What is the significance of communication with investors in the context of startup financing?

Communication with investors is crucial as it builds and maintains the relationship between the parties. It ensures that investors are informed about the progress and challenges of the startup, which is vital for their confidence and continued support.

What are some potential challenges with using convertible securities like SAFEs for early-stage fundraising?

While convertible securities offer flexibility and speed, they can lead to administrative challenges when many investors are involved, as each will need to provide consent for corporate actions. Additionally, smaller investments may result in less engagement from investors who are not yet stockholders.