Posts from May 2019

Unsafe Notes

I was reminded yesterday how much of a shit show raising seed capital via SAFE notes is. I can’t and won’t get into why I was reminded of that, but let’s just say nobody wants to go there.

So I thought I’d repost the important parts of a post I wrote on this topic a couple years ago.


I have never been a fan of convertible notes. USV has done quite a few convertible and SAFE notes. 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 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 unfold 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 causes a lot of problems for everyone.

Outschooling

A few months ago I posted some data on this blog that showed the growth of homeschooling in the US with almost 5% of K12 students being schooled at home. I wrote at the end of that post:

This is a trend to watch and, possibly, to invest in

Well, invest in it we did.

Yesterday Rebecca posted our investment rationale for Outschool, a company that offers real time group classes taught largely by very experienced K12 teachers over live video.

I encourage all of you to click on that link and go read our investment rationale. There are a number of interesting trends we are betting on here and Rebecca articulates them well. There are also some examples of classes your kids can take that are amazing.

But what I want to talk about is how important services often start in the fringes and over time move into the mainstream. We are certainly betting that is the case with crypto-currencies. We have seen that with Airbnb (couch surfing>hotel alternative), Uber (ride sharing>car alternative), YouTube (video sharing>TV alternative), and so many other examples.

Homeschooling is a fringe market right now. But education is not.

Outschool can exist with excellent unit economics for the students, teachers, and company because there is a market of almost 2.5mm students in the US who need to learn things like Algebra, European History, Biology, etc, and will pay to do so.

But of course, there are over 50mm K12 students in the US and many more around the world who need to learn these subjects as well and often don’t learn them very well in the legacy schooling model.

When our kids were in school and struggled with a class/teacher/subject, we would get them a tutor to come to our home in the evenings. That is a 1%er solution and is not affordable for most families.

But the Outschool model, because of the scale it has reached in the homeschooling market, is driving down the cost of learning these subjects and can and does replace the high cost tutorial market for a number of families already. As its scale increases and economies kick in, it can reach more students and families desperate to master challenging material.

Great teachers are one of the most valuable resources we have in our society. I can trace much of what I know to a handful of these people.

But school buildings, classrooms, and the supporting Infrastructure for them are very much replaceable with new technology. Outschool is showing a way how to do that.

At USV, we seek to back trusted brands that can open up access to knowledge (and wellness and capital). Many (most?) of these brands start out on the fringes and move into the mainstream over time as they scale and the benefits become obvious to mainstream consumers. Outschool is squarely in the sweet spot of our thesis and I am excited to see what it can do for learners around the world in the coming years.

DefendCrypto.org

Over the last year, the SEC has been investigating a significant number of token offerings that took place in 2017. While some of those offerings were scams or worse, many of the ones that are being investigated by the SEC are serious projects, started by some of the top cryptographers and computer scientists in the world, and backed by the leading token funds and venture capital firms in the US and around the world.

Sadly, the SEC looks at crypto tokens and sees securities that they want to regulate as such. They cannot seem to understand that not all of these assets are securities, they cannot seem to understand that most are commodities, currencies, or utilities like frequent flyer miles. They cannot understand that crypto tokens are unlike any assets that have come before them and that crypto tokens need new regulatory structures. They cannot understand that their unwillingness to come up with new rules paired with their “regulate by enforcement” strategy is hurting the crypto sector, pushing it offshore, and is causing most of the new projects to raise capital outside of the US and/or put together legal structures that look like Frankenstein monsters.

I have seen this play out in multiple projects and also in the exchange sector, which I posted about over the weekend. For as long as I have been involved in the crypto sector, I have been advocating and advising that companies work with the SEC, cooperate with them, and educate them. But that has not worked. I am frustrated. So are many others. Even one of the SEC Commissioners has gone public with her frustrations.

One of the crypto projects that the SEC has been investigating, where I have had a front-row seat, is the Kin project that was birthed by USV’s portfolio company Kik, where I am on the Board.

Kin is a digital currency (not a security) that is in use in over 40 mobile apps now. Last month over 1mm users earned Kin in one of those mobile apps and over 300,000 users spent Kin in one of those mobile apps. Kin is one of the most used crypto currencies in the world.

And yet the SEC won’t agree to settle with Kin on reasonable terms. Instead they want to force Kin to become a security, which would decimate its appeal as a digital currency. Imagine that a user had to go to a securities brokerage firm like Schwab to purchase a token in order to be able to use Apple’s App Store. That is crazy and yet that is essentially what the SEC wants Kin and many other crypto projects to agree to do.

So today, Kin has launched DefendCrypto.org which is a crowdfunding effort to fight the SEC in court. Kin has contributed $5mm worth of BTC, ETH, and Kin to the effort. And others are contributing their crypto assets as well. You can do so here. I have contributed a number of my crypto tokens to the effort this morning.

Whatever funds are raised by DefendCrypto.org will be used by Kin to fight the SEC in court, to help secure a favorable ruling that could well set a precedent for the entire sector. Any funds that are left after this legal battle will be set aside for other similar legal efforts in the crypto sector.

It is my hope, and Kin’s hope, that DefendCrypto.org will be an inspiration for the many other important crypto projects that are silently battling with the SEC to come public and raise capital from the crypto sector for their fights.

The SEC is regulating by enforcement, not new rulemaking, and worse, they have taken a divide and conquer strategy. It is time for the crypto industry to come together and fight back. I hope that Kin’s efforts with DefendCrypto.org represent a watershed moment/movement that will pressure the SEC to think and act differently toward this important new sector.

Remembering

It is Memorial Day, the most solemn of our national holidays.

Let’s all take a moment some time today to remember our fallen soldiers.

Funding Friday: Planetary Blocks

I backed this project to make a block toys for kids based on the planetary system a few weeks ago.

I am into anything that makes learning fun for kids and this definitely does that.

You can back it here.

Sick Day

I woke up sick this morning and could not fly to Toronto where I was planning to do a session at Collision with Matt Glotzbach, CEO of our portfolio company Quizlet.

I sent some emails to let people know I could not make it and went back to bed and slept for another few hours and I feel a bit better.

I do this to myself a few times a year when life gets hectic. The good news is that Memorial Day Weekend is upon us and that means some much needed R&R.

Speaking of Matt Glotzbach, here is a video that Matt and Quizlet’s founder Andrew Sutherland did three years ago to introduce Matt to the Quizlet community. It does a great job of showcasing Matt’s personality and strengths (and Andrew’s too).

Sofar

Andy wrote about our investment in Sofar yesterday on the USV blog.

That is our practice. We publish our investment rationale on our blog every time we make an investment. It creates a permanent record of why we made the investment. It is interesting to go back and read them five or ten years later, regardless of whether they worked out or not.

Sofar is a company we have been following for seven years. We have been intrigued by this global community that has been building around the themes of meeting others in the real world, a shared love of music, and intimate spaces (often personal homes).

The Sofar community is large and sprawling.

The scale of the Sofar community, to us, is an example of “unspoken” value that Sofar has created for over one million people in 430 cities across 65 countries including London, Paris, New York, Sydney, Bangalore, Buenos Aires, Cape Town, and Seoul. In fact, more people will attend a Sofar in 2019 than will attend Bonnaroo, Glastonbury, and Coachella combined (also, 13 Sofar artists are playing at Coachella this year).

https://www.usv.com/blog/sofar

I just took a look at Sofar to see what events are happening in NYC in the coming weeks:

You can see the Sofars in the coming weeks near you by going here.

Sofar reminds me of our investment in Meetup, which we made twelve years ago. As Scott Heiferman, the founder of Meetup likes to say “use the internet to get off the internet.”

Sofar adds the element of music, performance, and intimate spaces. Andy describes all of this as the “Sofar container”:

Each Sofar has a few known constraints that make the show feel familiar: it will be in a unique space where you wouldn’t expect to see live music, an MC with a loose script will encourage you to get to know your neighbors, three performers will each play three to four songs, the address will only be revealed a day before the show, and the show will end early, by around 10:30 pm. This is what we call “the Sofar container”. The natural outcomes of the container are less tangible; for example, you will hear great music, you will feel safe and comfortable, you might make a new friend or you can attend solo, you won’t be judged. By bringing people together and creating spaces where music matters, Sofar broadens access to well-being – a core part of our investment thesis.
The beauty of creating a simple container, with known constraints, is that what goes into the container is dynamic. You don’t know who the artists are, who you’ll be sitting next to or what the venue will be like, but we believe that the essence of Sofar lies in trusting the container.

https://www.usv.com/blog/sofar

At USV, we are drawn to bottom-up networks instead of top-down centralized services; Etsy not Amazon, SoundCloud not Spotify, Wattpad not Kindle, Crypto not Fiat, and now Sofar not LiveNation.

I am excited that we finally found our way into the inside of this company/movement/experience. It feels so USV to me.