Convertible and SAFE Notes

Angel/seed rounds used to be done via priced equity securities, either common or preferred. Then, starting about ten years ago, we started to see convertible debt being used in the angel and seed rounds. By 2010 this was the norm and Paul Graham tweeted this in Aug 2010:

Which led me to write this blog post here on AVC. I was not a fan of convertible notes then and I am not a fan of them now. USV has done a number of convertible and SAFE notes since then. I would guess that we have done a dozen or more of them in seed and angel rounds we have participated in. We are not opposed to convertible and SAFE notes and will not let the form of security the founder wants to use get between us and investing in a company that we like.

But I continue to think that convertible and SAFE notes are not in the best interests of the founder(s).

Here is why:

  1. They defer the issue of valuation and, more importantly, dilution, until a later date. I think dilution is way too important of an issue to defer, for even a second.
  2. They obfuscate the amount of dilution the founder(s) is taking. I think many investors actually like this. I do not. I believe a founding team should know exactly how much of the company they own at every second of the journey. Notes hide this from them, particularly the less sophisticated founders.
  3. They can build up, like a house of cards, on top of each other and then come crashing down on the founder(s) at some point when a priced round actually happens. This is the worst thing about notes and doing more than one is almost always a problem in the making.
  4. They put the founder in the difficult position of promising an amount of ownership to an angel/seed investor that they cannot actually deliver down the round when the notes convert. I cannot tell you how many angry pissed off angel investors I have had to talk off the ledge when we are leading a priced round and they see the cap table and they own a LOT less than they thought they did. And they blame the founder(s) or us for it and it is honestly not anyone’s fault other than the harebrained structure (notes) they used to finance their company.

The Series A focused VC firms that often lead the first priced rounds get to see this nightmare fold out all the time. The company has been around for a few years and has financed itself along the way with all sorts of various notes at various caps (or no cap) and finally the whole fucking mess is resolved and nobody owns anywhere near as much as they had thought. Sometimes we get blamed for leading such a dilutive round, but I don’t care so much about that, I care about the fact that we are allowing these young companies to finance themselves in a way that allows such a thing to happen.

Here are some suggestions for the entire angel/seed sector (founders, angel investors, seed investors, lawyers):

  1. Do priced equity rounds instead of notes. As I wrote seven years ago, the cost of doing a simple seed equity deal has come way down. It can easily be done for less than $5k in a few days and we do that quite often.
  2. The first convertible or SAFE note issued in a company should have a cap on the total amount of notes than can be issued. A number like $1mm or max $2mm sounds right to me.
  3. Don’t do multiple rounds of notes with multiple caps. It always ends badly for everyone, including the founder.
  4. Founders should insist that their lawyers publish, to them and the angel/seed investors, a “pro-forma” cap table at the closing of the note that shows how much of the company each of them would own if the note converted immediately at different prices. This “pro-forma” cap table should be updated each and every time another note is isssued. Most importantly, we cannot and should not continue to allow founders to issue notes to investors and not understand how much dilution they are taking on each time they do it. This is WRONG.

Honestly, I wish the whole scourge of notes would go away and we could go back to the way things were done for the first twenty years I was in the venture capital business. I think it would be a better thing for everyone. But if we can’t put the genie back in the bottle, we can at least bottle it up a bit better. Because it is causing a lot of problems for everyone.

Audio Of The Week: Amanda Kludt and Eater

The Gotham Gal‘s first angel investment, back in 2007, was Curbed, a network of three lifestyle blogs; Curbed, Eater, and Racked, all of which have become “must reads” in their categories (respectively real estate, food/dining, and shopping/commerce). Of the three, the Gotham Gal has always had a sweet spot for Eater and in this podcast, she talks to Amanda Kludt who has been at Eater from the very early days and now is the managing editor of the entire site. It’s a great conversation about what is happening in online media, the food business, and more.

Feature Friday: Learn Mode

Our portfolio company Quizlet, which is the world’s most popular studying tool, launched learn mode yesterday.

Here’s how it works:

The team at Quizlet has built a way to go from cramming to studying, delivered via technology that’s in our pockets. Well done.

Learn mode is available on Quizlet’s iOS app and it is in closed beta on Android and coming soon to the web.

Tap

Our portfolio company Wattpad, which allows people to write and read stories on their phones, recently launched an entirely new mobile reading (and writing) experience called Tap. In Tap, the stories unfold like you are watching someone text with you. It’s an entirely new way of writing and reading stories and I haven’t seen anything take off like this in a while.

In just a couple weeks since launching, Tap has achieved all of this:

  • Over 100 million taps in the first week

  • 25,000 user-generated Tap stories created in the first weekend

  • 40 Tap by Wattpad stories already have more than 1 million taps each

  • #2 – Top Free Apps (Books Category) in the U.S. App Store (and as high as #1 in the books category and Top 40 overall)

  • #7 – Top Free Apps (Books & Reference Category)  in the U.S. Google Play Store

While Wattpad replicated the feeling of writing and reading traditional stories (like books) on a phone with its Wattpad app, the Tap storytelling is an entirely new experience and replicates how people communicate on phones. It will be interesting to see how the two separate experiences (Wattpad and Tap) perform over time and whether there is any movement by writers and readers back and forth between the two.

Gender Diversity

Today is International Women’s Day and I thought I would recognize it by writing about gender diversity, a challenging topic for many in the startup/tech sector.

I believe that diversity of all kinds results in better companies, better performance, better culture and better workplaces. It is challenging for many small tech companies to build diverse teams, particularly in the early stages of their development when they are hiring for very specific skills. But the longer you wait to build a diverse team, the harder it gets. Scott Heiferman, Founder and CEO of our portfolio company Meetup, which has women running both product and engineering, explained to our CEO Summit a couple years ago that once you have a male-heavy team, it becomes very difficult to recruit women to join it. His advice was to build diversity into your hiring from the very start.

In addition to Meetup, I work with a few companies that have done this incredibly well. Etsy reported in their diversity report last year that:

people who identify as women comprise roughly 54% of our staff (compared to 51% in 2014), which makes us an outlier among tech companies in the U.S. and NYC where we are headquartered. Women managers increased by 14%, (to roughly 50% from 44%) and women in leadership roles increased by 35% (to 50% from 37%), which means people who identify as women comprise half of the leadership and management positions at Etsy. As of today, a third of our board of directors are women, and if the directors nominated for election at our annual meeting of stockholders are elected, half of our board of directors will be women. Roughly one-third of our technical roles are held by women or people with gender identities other than male.

Kickstarter reported in their recent PBC report that:

As of December 31, 2016, our team was majority women (53%), as was 61% of our Senior Team and half of our Executive Team.

I am sure there are other USV portfolio companies with similar statistics, but these are ones with which I am intimately familiar.

This kind of gender diversity does not happen unless your company makes it a priority in hiring, retention, and culture. It takes a comprehensive approach and it is not easy, particularly if you have a highly technical team.

Little things matter a lot. Having a separate bathroom for people who identify as women is an example of something that many very small companies don’t do/can’t do. But it sends a pretty loud signal.

Then there are the big things. What is your parental leave policy? What is covered in your healthcare policy? Do you give time off for things that matter to women, like today’s A Day Without Women?

You can take that extra step, go that extra mile, to let the women in your company (and the women you want to join it) know that you support them and you are committed to the fight for gender equality.  There are many fights to fight, especially at this time, but women make up half of the global population, half of our workforce, and so women’s rights are an important cause that you can and should get behind.

This is a place where strong leadership in HR makes a difference. The commitment has to start at the top with the founder and CEO, but having a strong leader in HR who is in tune with gender (and all) diversity and can advise on and implement the right policies will make a huge difference.

Finally, I would be remiss if I didn’t mention the lack of gender (and all) diversity in the partner team at USV. We have gender diversity in our firm (we have four women on our investment team who shape our investment strategy), but the five partners at USV are all white middle aged men. As Andy and I mentioned on stage at the Upfront Summit this year, we are well aware of this issue and are actively working to address it.

So we can all use today’s International Women’s Day as an opportunity to commit/recommit ourselves to diversity in our companies and to take and sustain the actions that will lead to diversity. It’s important and, as some leading companies have shown, it is very much possible to do it.

Grammarly

I have never had anyone edit my blog posts here at AVC. I write the posts, hit publish, and go off on my day and let the conversation follow. Often readers will send to me copy edits; typos, misspellings, grammar errors, etc. I am always very thankful for these reader-generated edits and almost always go make the changes and fix the post. This is how AVC gets copy edited. It works but there are issues. The emails that go out are based on the initial post and so they often have the errors in them.

Yesterday, I took a step in the direction of better-written posts by adding the Grammarly chrome extension to my browser. Grammarly works just like a spell checker but it is focused on making me (and all of their users) a better writer.

Grammarly works in any writing application that runs in my browser, so I benefit from it in WordPress, Gmail, Google Docs, Twitter, and anywhere else I write on the web.

So far, I like it quite a bit. I plan to keep using it. And I hope that you will all see the improvement in my writing as a result.

Code To Success

Five years ago this month, we were recruiting the first class of students to enter The Academy For Software Engineering (AFSE), NYC’s first public high school dedicated to studying software engineering. A lot has happened in those five years; AFSE opened, AFSE attracted a great faculty and student body, AFSE built a modern curriculum to teach software engineering to a diverse student body, AFSE became one of the best performing high schools in NYC, AFSE inspired NYC to do CS4All, and, last spring, AFSE graduated its first class.

To say that AFSE has been a success would be an understatement. It is one of the finest high schools in NYC, often competing for students with the likes of Stuyvesant, Brooklyn Tech, and Bronx Science.

The initial funding for AFSE came from the Gotham Gal and me. Then, when we started CSNYC, it took over supporting AFSE. Last year, AFSE took over the responsibility of raising funds for itself and did its first fundraiser.

It’s second annual fundraiser, called Code To Success, will be held on Thursday, March 16 from 7-10pm at Yext’s NYC Offices. I am hoping some of you would like to attend and support this incredible high school.

The school has set a goal of raising $100,000 which will allow AFSE to continue to provide the following resources which are not funded by the NYC Department of Education to its students:

  • Each student is matched with a professional, college-educated mentor from iMentor for all 4 years of high school. This means an email each week, an in-person meeting each month,  and a go-to person for each phase of high school. In the past, mentors have been a key resource for assisting AFSE students with SAT preparation, completing college applications, and applying for financial aid, which many of our students are the first in their families to apply for.
  • Each student receives personalized college counseling through junior and senior year, as well as financial support for SAT/ACT exams, public and private college application fees, college visits and college deposits.
  • Each student who is on track for high school graduation but not on track for college graduation is invited to participate in an intensive OneGoal course for the last two years of high school and first year of college.
  • Each student has access to job shadowing, internships, and other work-based learning experiences to build their personal resumes and apply their learning in a real world context.

The Gotham Gal and I are supporting this fundraiser and we hope some of you will choose to do the same. Visit fundAFSE.splashthat.com to buy your tickets or donate and help AFSE continue to succeed.

Cultural Differences

A friend of mine likes to say that “culture is destiny.”  You can get everything else right but if you get your culture wrong, you are going to have problems.

As I look across our portfolio, I see many different cultures, some very strong and obvious even to outsiders. Some cultures are more nuanced and you have to work inside the company for a while to understand them.

Some cultures are extremely supportive and welcoming. Other cultures are more mercenary.

The truth is that these cultures are set very early on, largely by the founders and the early team they surround themselves with.

Once you create a culture it is incredibly hard to change it. 

I have seen leaders, often new leaders, evolve the culture but not completely change it. 

I have also seen cultures reject leaders who tired to change things too quickly.

All of this leads me to believe that the decisions a founder or founding team makes in the first few months of a company’s life are among the biggest decisions and that they are setting their destiny in place, often without even realizing it.

Funding Friday: The Ollie Chair

The Gotham Gal is an investor and Board member of Rock Paper Robot, which designs and manufactures furniture for modern living environments. Their newest design, The Ollie Chair, is coming to market this year and they are running a Kickstarter campaign to pay for the manufacturing of the chair. It launched this week and has already passed it’s initial goal of $80k, but I know that they would like to raise more than that, and they already have. It’s an awesome chair and an awesome company. If you want to get an Ollie Chair and/or support this campaign, the Kickstarter is here.

Here’s the video. It’s great and well worth the 3mins.