This story happens every day.
Suppose a startup is raising a small angel round. The investors put money in. In return they get a piece of paper which they hope will be worth a lot of money one day. But what exactly is that piece of paper? Is it a convertible note? A plain old stock certificate for ordinary shares? A warrant? A KISS? A SAFE? A Series Seed? There are dozens of ways to skin this cat. When Brad Feld posted about Proliferation of Standardized Seed Financing Documents it was 2010. Since then, many new sets of docs have come up: 500 Startups released their KISS, and Y Combinator published a sequel to their Series AA in the form of a SAFE. This is called the XKCD/927 problem.
Y Combinator’s SAFE comes in four flavors. 500 Startups’s KISS comes in two versions, debt and equity. They’re slightly different to a standard convertible note, which is again different to a basic common-stock investment. You can see where this is going: if you don’t keep your eye on the prize, the paradox of choice could strangle your deal even before it gets out of the starting gate.
A conversation between first-time founders and tyro investors often has the feel of two teenagers trying to make it past second base: the earnestness greatly exceeds the understanding of the mechanics. “Hey, I love what your startup is doing. I want to put some money in,” says the Newbie Angel. “Send me the paperwork.”
“Awesome!” reply the euphoric founders. “We’ll get right on it.”
Somebody on Quora recommends the Wilson Sonsini Term Sheet generator. Six pages into the 43-page wizard, the founders realize they didn’t ask the investor – let’s call her “Investor A” – a few important questions, like: how much money do you want to put in?
So they go back to the angel. “Hey, er, how much money do you want to put in?”
“How about fifty thousand? For a third of the company?”
“Wait, that seems like a lot. That means the pre-money valuation is only $100,000.”
“Okay, make it a fifth of the company.”
“A fifth sounds good, but we’ve decided we want to raise at least $100,000 to keep us going for a few months.”
“Okay, I’ll put in $50,000 toward your $100,000 raise, and if you get the full amount, then the $100,000 will be a fifth of the company.”
“Great! We’ll send you the paperwork! Common stock, right?”
The founders give up on the WSGR term sheet generator, and download a Subscription Agreement for Common Stock, or Ordinary Shares, off the Internet. And they go hunting for other people to make up the other $50,000.
One investor – investor “B” – says, “Sure, I’ll put in $25k. And this is going to be equity, right?”
“Yeah, we negotiated a valuation of $400,000 with our lead investor.”
“Sounds good. Send me your cap table and the paperwork you want me to sign. If it helps, here’s a link to the Equity KISS. We used that for my last deal and I thought it was pretty good.”
Another investor – investor “C” – says, “You’re only $25k short? Fine, I’ll take it. Are you doing a SAFE or a convertible note?”
Nonplussed, the founders look at each other before saying, “Yes, we think so.”
Laughing inside, Investor C says, “Okay, look, I think you’re still too early for a priced round. To be fair to both sides, let’s go with the usual convertible note, with a 20% discount on the next round or a $400,000 cap.”
The founders aren’t really sure what that means, but two alternatives sounds fairer than just one. Thinking “we really need that $25k to unlock the $100k round”, the founders say, “sure! Sounds great!”
They go back to Investor A, saying “we found other investors. One wants to use an Equity SAFE and the other wants a 20% discount.”
Investor A says, “OK, well, send me the paperwork and I’ll take a look at it. And by the way, I’ll want you to take care of your vesting and ESOP at some point.”
What have the founders gotten themselves into? In three short conversations, they have spanned ordinary shares, warrants, and convertible debt. They now need to understand discounts, caps, and conversion. Mark Suster will be the first to point out that the founders are walking into a minefield – and they haven’t even gotten into the option pool shuffle or founder vesting.
The founders consult their mentor, who says, “maybe you should take a week off work and educate yourselves by reading Brad Feld’s blog/book, Wilmerding’s Term Sheets & Valuations and Deal Terms, and Wasserman’s Founder’s Dilemmas.”
The founders say, “we just launched and we’re growing 25% week-on-week. We can’t afford a week to go learn this stuff. There are so many templates out there. Can’t we just choose something that works for all three investors?”
This is where Legalese comes in.
Because the terms of a given deal reside in the spreadsheet, Legalese is aware of the semantics of your deal. Because Legalese already contains all the standard templates, you can switch from one to the next just by changing one config option. If you take a snapshot of your latest negotiation and put it into Legalese, the system will automatically pick the template that fits best. If the negotiation evolves, Legalese takes changes in stride: by changing a single cell, you can switch from a Debt KISS to a Cap-and-Discount SAFE. Two more clicks recompile the documents and send them out to investors for review.
Legalese keeps your deal configuration in Google Spreadsheets, not in a one-off wizard, so you can fiddle with it until it works.