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About Liz Sigety

Liz is a Partner at Fox Rothschild LLP, a national law firm with approximately 1000 attorneys and 30 offices coast to coast. She is Chair of the firm’s National Emerging Companies & Venture Finance Practice and founder and past chair of the firm’s Franchising, Licensing and Distribution Practice She directs the Fox Launchpad program within Fox Rothschild, a virtual incubator for startup companies. She earned her J.D. from the University of Chicago Law School and her B.A., cum laude, from Yale College.

Liz is also Executive & Managing Director and Co-Founder of Delaware Crossing Investor Group, an angel investor network which invests in companies located in Pennsylvania, New Jersey, New York, Connecticut and Delaware. In this capacity, she has been investing and advising start-up companies in the Northeast region for over 20 years and has invested in over 60 emerging companies. She is also a frequent speaker and writer, especially on issues facing emerging businesses, franchised businesses and women-led businesses and has served on numerous boards and committees including the Angel Capital Association, the Angel Venture Fair, the Philadelphia Alliance for Capital and Technologies (PACT), the Hepatitis B Foundation, Startup Bucks, Doylestown Health and the Pennsylvania Angel Network. She has received the Pennsylvania Biotechnology Center Entrepreneur Champion Award and is ranked in Chambers USA as a leading attorney nationwide in the area of Startups & Emerging Companies.

Episode Highlights

The critical factors that drive your choice of funding vehicle
Primary differences between SAFEs and convertible notes
How legal fees impact your choice of funding vehicle, and what to keep in mind
The little known tax issue that can make or break your deal for investors
Why tax matters for you as a founder, and how to minimize your tax risk
How the ACA’s new Model Convertible Note changes the game for founders and investors
The make or break features of your convertible note: discounts, valuation caps and maturity
The “iceberg” factors of convertible notes: early sale, board representation, information rights and more
How to put together a foolproof term sheet as a first time founder
Insider tips for women founders in STEM from an experienced angel and attorney

Links and resources

Fox Rothschild’s Emerging Companies and Venture Capital Practice – A legal practice specializing in advising fast-growth companies and venture capital clients across the U.S.
Delaware Crossing Investor Group – An angel investor network in the Mid-Atlantic region, supporting startups with funding and expertise.
Angel Capital Association (ACA) – A national organization that connects and supports angel investors and promotes entrepreneurial investment opportunities.

Featured Link:

ACA’s Model Convertible Note and Term Sheet Template: The new model template released by the ACA for use by startups and early stage investors

Interview Transcript

Shubha K. Chakravarthy: Hello Liz. Welcome to Invisible Ink. We’re so happy to have you here today.

Liz Sigety: I’m happy to be here. Thank you for inviting me.

Shubha K. Chakravarthy: My pleasure. I know we’ve got a ton of interesting stuff to talk about but just to get us started, can you just tell us a little bit of your backstory, both professionally and in terms of your investing background?

Liz Sigety: I have a few different roles in this environment. One is my day job, which is that I am the chair of Fox Rothschild’s emerging companies and venture capital practice. It’s a large law firm. We have about 120 lawyers affiliated with the practice across the country. It’s very interesting and fun to be able to represent and work with companies from all over the United States.

I also started a virtual incubator within the firm called the Fox Launchpad for startup companies. It’s a special way we work with startups that are approaching the fast-growth, outside-funded, venture-capital-type funded companies. And that’s worked out really well.

I’m also managing director and co-founder of Delaware Crossing Investor Group, which is an angel investor network in the Mid-Atlantic region. We are about to celebrate our 20th birthday. I have invested personally—I actually don’t even know anymore how many companies, probably over 70, over the course of the last 20 years. I like to say I put my money where my mouth is with my profession, and I really enjoy that and being involved with the Angel Capital Association, which I think is one of the ways I met you. I’m on some committees there, as we’ll talk about later. I’m from an entrepreneurial family as well and really love working in this field.

Shubha K. Chakravarthy: Congratulations. That’s a lot of hats to be juggling, you know, with two hands. One quick question. On the launchpad, do you have any specific focus like regional versus industry or anything like that?

Liz Sigety: Not really. It really is meant for and built for companies that are fast-growth models that will want to receive venture capital financing. So most of the companies we register as Delaware corporations. So it’s not for a company that’s already well established, and it’s not for a company that really isn’t planning to grow tremendously.

So most of them are life science and technology companies or have some sort of intellectual property. The firm has a really strong intellectual property practice, so it’s very helpful for that. After they’ve raised a substantial amount of outside funding, they graduate from the program and, hopefully we can continue to grow Fox Rothschild and can continue to grow together.

Choosing the Right Funding Vehicle

Shubha K. Chakravarthy: Awesome. Talking of venture capital, we’ve come to one of my favorite topics, which is funding and funding vehicles. If you’re a first-time founder going out to the market for the first time, there’s a lot of chatter around: should you go the way of SAFEs, or should you go the way of convertible notes? This question of what instrument to pick is not something founders are very familiar with. So, to start off high level, can you just talk about what are the key factors that a founder should keep in mind when they’re selecting whatever the right funding vehicle is for their first outside raise?

Liz Sigety: The first question I ask a client when they are coming to me and asking what to do is, who are you selling to? I think about it almost like a product. Who are you selling to? Who’s your audience? Because that matters as far as what type of security you are picking. If you are really early and you are just doing it for some friends and family and trying to get maybe less than 100K, I would definitely say that a SAFE is a good option.

Those SAFEs are now used for much larger rounds. As you probably know, the SAFE form has been modified in the last few years to suit much larger rounds, but still there are certain investors that don’t like to invest in SAFEs. And some of those are angel groups. So if you’ve done your friends and family and you’re going to angels, you need to be careful, maybe especially on the East Coast, that they may not view that type of security as favorably. And when they’re looking at 30 companies and some are equity and convertible notes, and some are SAFEs, that could be the factor that gives you a little bit of a disadvantage in getting the money.

So I would say it’s the stage of the company—how early or later are you? But you will hear of SAFE rounds that are very large. What are your future funding needs? So what will the SAFE or the convertible note convert into? And also, who are you marketing to? There’s a lot more than that, but that’s sort of the first question.

Shubha K. Chakravarthy: So kind of reading between the lines of what you said, right, what I’m hearing, and correct me if I’m wrong, is the earlier you are, in general, the smaller round and the more West Coast oriented you are. You’re probably better off. You’re probably going to go down the route of SAFE versus the more East Coast, the larger the round or the later the round, at least before equity priced rounds. Convertible note may be the right instrument to pick. I know we’ll get into the nuances, but that’s like the high-level flavor I’m picking up from what you just said.

Liz Sigety: Yes, and some will say sadly because of so many companies using SAFEs. Some of the angel groups are starting to accept them somewhat begrudgingly sometimes. But for example, my group is a network; we’re not a fund. So some people in my group will not invest in SAFEs. It doesn’t matter what the opportunity is; others, if it’s an amazing opportunity, they’ll invest in the SAFE. But it has to be even better than a company coming in with equity or a convertible note. So it’s just that kind of a thing.

Convertible Notes vs SAFEs

Shubha K. Chakravarthy: So then, just at a high level, what would you say are the main differences between a convertible note and a SAFE from both the founders and investors perspective?

Liz Sigety: So a SAFE is a contract. It’s a security. Don’t get me wrong. So when you are offering a security and an investment, and I can talk a little more about that later. But it’s a contract that says you get equity someday if things go right. A convertible note is an actual debt security, so there’s a few things about that that founders may not like as much as SAFEs and that investors may like more.

One is that it has a maturity date. So maybe it’s 18 months. Maybe it’s three years. You should look at the maturity date. You should say when do you think you’re going to raise your next round of equity and then add a few months because it always takes longer than you think it will. But there’s a day of reckoning where the note will mature and technically the company will either have to pay back or convert that note.

Founders don’t like the deadline but I can tell you that most of the time if things are going well, angels will extend that maturity date. Now, what an angel investor or an early-stage investor likes is that there is a day where they have a conversation with the company. So there’s a checkpoint.

And I’m not saying that no investor won’t want their money back but I have not seen that very often if things are going well. And if the company’s not doing well, usually it doesn’t have money to pay it back anyway. So that day of reckoning is really important to investors but can be a little daunting for founders.

Also, debt is a priority to equity. So if things aren’t going well, the debt gets paid first. Once again, I haven’t seen that out very often in an early-stage company because most of the time, if you’re getting to a point where they can’t raise more money and they are saying they can’t pay back their note, usually there’s salaries and a few other obligations that would be senior to the convertible note anyway. But still, it gives the investor some sort of assurance. There’s also interest, though I don’t know if that’s a big deal, to be honest, because that is sort of part and parcel of the discount that’s usually offered in a note.

Legal and Cost Considerations

Shubha K. Chakravarthy: Got it. So from a cost perspective, right? Obviously, founders are quite cash-strapped. Legal costs as valuable as they are, can get high pretty quickly. Are there significant differences in terms of what it costs for me as a founder to go via the SAFE route versus a convertible note? Because cost tends to be like the first thing I hear about when I talk to founders, and it’s not as much of an issue from an investor perspective. What’s your take on that?

Liz Sigety: Yes, it’s certainly SAFEs are simpler. It’s shorter just as far as the number of pages. There is an established form out there is the Y combinator form of post-money SAFE that is usually used. There was an old form called a pre-money SAFE. I don’t see that so much anymore, but it is very simple to be able to take that form and turn it into a SAFE.

Sometimes they pair it with a subscription agreement or a side letter, but still it is less from a legal cost point of view and for an investor to be able to just mark the SAFE against the form that they’re familiar with. It actually does sometimes make it easier for them as well. And contrast that to an equity round. Now, of course, investors love equity because everybody can agree on evaluation and they know exactly what they’re buying.

That’s the National Venture Capital Association form, NVCA. You can get it online. Pull it right off the web but those are pages and pages, but still you can mark it against the form. And that’s what your attorney would do to review the document. There hasn’t been, we’ll talk about it later, but there has not been a form for the convertible notes. So you get all sorts of stuff. And I have seen both as an investor and a lawyer, a lot of junk out there. With just a lot of people assuming a convertible note is a convertible note, and there’s really not much difference, but there’s a huge amount of difference between them. And that’s been one of the issues.

Tax Implications for Investors

Shubha K. Chakravarthy: Got it. That was pretty helpful in terms of understanding the level of legal time involved and how that relates to costs. One other important factor that, from an investor standpoint, is really important is the tax implications, right?

Can you talk briefly about Section 1202, which is pretty important? I don’t know how many founders are aware of that. What are the tax implications from an investor standpoint that might influence how excited I am to choose a SAFE or a convertible note as an investor between those two forms? And can you talk about what a founder should be aware of before they go in to pick a security?

Liz Sigety: So 1202 qualified small business stock is a federal exemption to not have to pay capital gains tax. If you’ve held equity in a corporation, not a limited liability company, in a corporation, not an S company, not an S corp, has to be a C corp, for five years. So if you hold equity in a corporation for five years and it exits in an emerging company, not a service company, then you don’t have to pay capital gains. I’ve had this wonderful experience. It is great when they pay you a certain amount of money and you get to keep it all. And I will say from personal experience, it does encourage me to view that return as something I can reinvest in emerging companies. So some, I’ve heard some skepticism about that, but I’ll tell you from personal experience that indeed it makes it a lot easier to continue to be an early stage investor.

Now the issue here is whether an investment in a convertible note or in a SAFE starts that five year period. So in a convertible note right now it does not. So the five year period starts when the convertible note converts into stock. So the convertible note, the principal of interest, is used to buy, at least that’s the way the IRS would look at it, stock and then start the five year period. So you might still get the 1202, but the amount of time you held the convertible note wouldn’t count. For the SAFE, there is language in the SAFE that says for taxpayer purposes, for 1202 this is equity. And then it says somewhere else in the SAFE, but for any other reason it’s not equity.

So I am not yet aware. So the position of most people is that the SAFE when you invest in it will start the five year term, but I’m not aware of the IRS that being challenged or the IRS actually saying anything about that so the industry is basically saying, okay, we’re going to just claim that the five year period starts when the SAFE is invested in. I don’t know if that’s going to stick or not. And I’m waiting for somebody. Maybe you’ve heard the IRS has made a pronouncement, but I haven’t heard it yet.

Shubha K. Chakravarthy: I haven’t either. So I’m very curious just on that one thing before we move on. You said there’s a lot of money, and I’ve heard it too, that a lot of money is being invested in SAFEs. I’m sure there’ve been exits, maybe sizable ones, where this question of whether that holding period was included or not has come up. Has there been any case law at all that you can go off of? How would I feel comfortable, either as an investor or as a founder, banking on that? And how does that play into this whole equation?

Liz Sigety: I don’t know if it’d be case law; I think it would be more the IRS saying you don’t get, you know—it wouldn’t be an IRS ruling that somebody doesn’t get the capital gains exemption. So I’m not aware of that being challenged. SAFEs haven’t been around for as long but at this point, they have been around for five years.

So, I really don’t know. I do know that the Angel Capital Association is working on the Hill to try to get convertible notes to be included in the five-year term. That’s not happened yet. We’ll see if they have any luck. I think that would be fabulous, and I think absolutely it should be included. It’s as risky as equity or anything else, so we’ll see.

Shubha K. Chakravarthy: Let’s see, fingers crossed.

Liz Sigety: One thing to be really careful about in SAFE notes is don’t stick a maturity there. Well, first of all, I just said it. It’s not a note. A SAFE is not a note. The term SAFE note is wrong. It’s not a note. If you stick a maturity date in there, you may change everything. It’s going to turn into debt. So when you’re modifying the SAFE, just be careful.

Common Misconceptions and Advice for Founders

Shubha K. Chakravarthy: Got it. Good points and thanks for that. Before we round out this section, are there any common misconceptions you’ve seen among founders in terms of SAFEs and convertible notes that might trip them up?

Liz Sigety: Yeah, so I represent and work with founders of all types—some of them just coming out of college, or in some cases dropping out of college to do startup companies. I think some of the danger of SAFEs is the perception that, and I know I’m a lawyer, so everybody would be skeptical that I’m just promoting my profession, but I’ve seen it so many times that they can do it by themselves. They just take the Y Combinator form, fill it in, and send it out like candy, and they get money, and it’s all great.

I have seen people dilute their own equity out without having any idea that they’ve done it. I’ve seen people put different caps on different SAFEs, so they end up with all different types of securities and preferred stock when they convert. I’ve seen people not file securities law exemptions when they should. I would just say, I know you’re going to have to pay your lawyer a little bit but please do that.

That’s why we have the Fox Launchpad—to encourage people to set themselves up right from the beginning. The tax problems that can result if you don’t do things correctly from the beginning for the founders can be really pretty disastrous.

Shubha K. Chakravarthy: Can you share a little bit of light on what the tax consequences might be for founders from not doing it right?

Liz Sigety: Well, this is a little outside of SAFEs and convertible notes but just issuing founder equity correctly, issuing options correctly. If you’re bringing on some people into the founding team after a few months, just making sure that you have handled the tax relating to issuance of the founder of stock correctly.

Shubha K. Chakravarthy: And then last thing on that is, is there anything special that you would suggest to STEM founders? You know, those that are more capital intensive and needing to get more money down the line than maybe other sectors in terms of if they had a preference which way should they go and what, should they think about in terms of selecting a security?

Liz Sigety: Well, you do have to sort of project out for what money you’re going to be needing. And of course, you’re not going to be completely right. It’s more of an art than a science. We all know that, the sort of the valuation game, how much of the company do you give up at any certain time?

Understanding your cap table. And I know a lot of founders are more technologists or scientists or creative people, but you need to try to educate yourself. I’ve been an attorney for a while, you know 15-20 years ago it was rare that the attorneys were actually doing the cap tables.

Now I find that founders really just don’t want to get involved with it. Really important to understand this and to look into the future. Even if you are a STEM founder, it’s really more the IP and the technology that you understand, to at least have someone on your team, but also for you to have a rudimentary understanding of how this will affect your ownership of your company. You should be sticking in the early stages, the first round or two, you should still have a majority of your company. Angels shouldn’t be coming in, early stage VC shouldn’t be coming in and taking over your company.

Introduction to the New Convertible Note Template

Shubha K. Chakravarthy: Excellent counsel. Thanks for that. I want to kind of change gears a little bit and start talking about convertible notes. So I know that you are one of the prime players in authoring the new convertible note template. So can you just tell us what led to it? What is the driving philosophy? And what problem are you trying to solve by coming up with this template?

Liz Sigety: So, as I briefly mentioned before, SAFE has the Y Combinator form. The equity has the NVCA National Venture Capital Association form and also the series C forms. There are a couple other forms out there that are fairly well known for equity, but convertible note didn’t have one. And it was a main reason why people often weren’t using that because there wasn’t a standard. There wasn’t something that they could point to when you have a form that’s well established and it’s very easy for people to review. You can just do a black line, you can just tell what the changes are and it just makes it a lot easier.

The other thing is, I had seen that a lot of mistakes were made both by investors and companies in drafting convertible notes. This convertible note is similar to Angel Capital Association form, is very similar to the NVCA form in that it has explanatory footnotes to try to help educate founders and investors alike about why certain provisions can be picked, and it has alternatives. So it’s not just one form like the SAFE form. It does have alternatives in it.

So, I’ve had the pleasure of a few of my clients using it. It’s very new just from the summer and version 1.2 was just released and updated. So now it’s all cleaned up as well. And it’s worked out really well. So my clients will take the form and they’ll read it through and they’ll make decisions. And sometimes they’ll even come back to me with an edited version. And then we’ll talk through the term sheet. There’s a term sheet and there’s a note. And it’s been a great way for them to understand the terms as well as make decisions about it. So when investors ask questions, they can answer them. And I find as an investor that sometimes the company’s CEO doesn’t really understand what’s in. It’s a little, it’s a knock against the CEO or whoever’s presenting if they can’t answer questions about the offering.

Shubha K. Chakravarthy: So just to clarify what you said, clearly it standardizes, evens the playing field, gives something- a common ground for people to start working from. Are you seeing an improvement in kind of the level of the founder’s knowledge? Has that helped? And also, have you seen from your client’s perspective, meaning the founders that you’re trying to get help funded,? Are you seeing that going through more smoothly just as a result of this template?

Liz Sigety: So, on the second question, yes. The few times because as I say, it’s very new that my clients have been using this, it really smooths out the process. And I was so pleased the first few times I did this to see how much easier it was to put together the note and to feel really comfortable about what the terms were. So that has been a real advantage and has worked out really well. And I can’t remember the first.

Shubha K. Chakravarthy: The first one was: Is it helping from a fund, you know, especially the STEM founders are more technology comfortable than finance comfortable? Are you seeing them able to get up to speed faster on what the terms are with a convertible note with this new template versus kind of struggling through maybe before when there’s a hodgepodge of potential templates?

Liz Sigety: Yes because if they have to go through it and look at the footnotes and make a choice between this and another provision, then they understand what’s in it. It sort of forces them to do that. Now can a lawyer just sort of ask them a few questions and put it together and throw it at them? Yes, absolutely. They can do it that way too. But I think that my clients, you know, giving them the form to look at while we’re putting it together has been very helpful.

Shubha K. Chakravarthy: So in theory, the second order effect should be that it should also streamline their legal fees, right? Because there’s less to talk about.

Liz Sigety: Oh yeah no. It was really great. Because every firm has their own form or somebody’s grabbing something off the web and you have to go through it from the start and then negotiate back and forth.

I’m not saying there’s no negotiation but if there is usually the alternative language is already in the form as well. And the other thing that the form has is we try to combine the three usual documents that the note encompasses into one. So usually there’s a subscription agreement, there’s a note, and then there’s often a side letter because every angel group has its own or VC wants its own side letter terms, we put them all into one note so the note looks a little long, but it’s one document.

And the task force is a committee that did this. It wasn’t just me. It was other lawyers from small, regional and large firms. There were a couple academics. There were people that were head of angel groups on the committee. So it was a bunch of people. And it was quite a process. It took a good year to do this.

Shubha K. Chakravarthy: Great. I want to just flesh out a couple of things you said. You said there are three parts, right? A subscription agreement, the note itself, and the side letter. For those of our founders who are not familiar, can you just walk us through what those three terms mean? And what’s in each of those?

Liz Sigety: So there’s a couple ways that notes have been done in the past. One is that there’s an agreement and then a short form note and one is that there’s a long form note. So a subscription agreement usually contains representations by the company and by the investors because the investors have to be accredited investors. They have to do certain things to comply with securities laws exemptions that are very important to the company.

So if those aren’t in the note it would have to be in a separate subscription agreement. So the subscription agreement would describe the round, you know, we’re doing a 2 million round of convertible notes with a 20 percent discount and a cap. And we’ll I’m sure we’re going to get to talking about all of that stuff in the general terms and then it would have representation by the company and it would have representations by the investors and sometimes other rights like participation rights and information rights.

The side letter often would have participation rights and information rights other things that the investors want. And then what happens is and I see this as a lawyer the company has a different side letter with every different investor and they think that’ll be easy to keep track of but when you have all different provisions for all different investors it really doesn’t work well in the long run. So to try to just cut that out in the beginning put you know if you want those rights into the note and hopefully not have the investors not asking for those separate rights. Anyway it just makes it easier for everybody to have one provision, one form to comply with.

Shubha K. Chakravarthy: Great, thank you. So now that we’ve got that all cleared up, I want to dive into the actual template and the note itself. And I’m wondering if you can walk us through what are, in your view, the most important terms in the template? What do they mean? And how have you incorporated them into this template? We can walk through them one by one.

Understanding Discounts in Convertible Notes

Liz Sigety: So the main provision and a couple of these. For example, a cap or a discount, also apply to a SAFE. So the discount basically has to do with the conversion. If you buy a 100 SAFE, let’s say, and you’re converting into a priced equity round, and the shares are 1 a share and you have a 20 percent discount, you get those shares for 0.80. That is the holder of the note.

So that compensates the holder for the additional risk they’ve taken by investing earlier. Also as angels you need to remember sometimes people say, Oh I’ll just invest later at the big round. Well you don’t always have that opportunity. You know the VCs will be taking that round. The angels aren’t then again asked unless they’ve already invested in a prior round. So you got to be a little careful. This may be your opportunity to get in if you think it’s a good investment.

The Importance of Valuation Caps

Liz Sigety: The next thing is a cap and for sophisticated investors, this is a super important provision. Often we get approached with notes or SAFEs that don’t have a cap. A cap is a valuation cap. It’s not a present valuation, but often people use SAFEs or notes in order to avoid the valuation discussion because usually, the company thinks it’s worth more than the investors think. And when you have equity, you have to have a solid valuation.

So, a cap is a bit of a protection for the investor. If the next round has a crazy high valuation, they would get to convert whatever capped valuation was negotiated in the note. That is really important. My angel group will not invest in an uncapped note. Very important.

Then there’s the maturity of the note. Be super careful if you’re the company not to be overly aggressive. Everybody thinks they can raise money faster than they do, especially these days when things have been a little tight as far as investments. So, maturity for a note is usually 18 months to three years out. It’s usually not longer because it is expected. The investor looks at the note as equity, really equity. They want the upside of equity. They don’t want the 5 percent interest back. That’s not what they’re looking for. So, they want to convert.

So, what happens at maturity? Sometimes at maturity, there’s an option to convert at a set valuation instead of being paid back. That’s something that can be negotiated, and there’s automatic conversion at a certain level. If the company has an equity investment of 4 million, for example, then there’s an automatic conversion. The investors don’t have any say; it’s going to convert at the discount or the cap, whatever’s better for them. Those are some of the big provisions, but I would want to point out if I have time, maybe one or two others that are often.

Early Sale and Board Observer Rights

Liz Sigety: If the company is sold early and I see this all the time I’ve actually seen notes that say that the holder of the note just gets its principal amount and interest in the securities of the you know during the acquisition. That’s not what investors are looking at. Either usually they get at least you know the better of twice their investment back or they get what they would get if their shares converted immediately prior to the sale.

So that’s something that I think is often overlooked. Usually these companies aren’t being sold that soon so maybe people don’t care about that. But I’ve seen people be burned by that. Also you can put things like board observer rights into the note. where the lead investor of the convertible note round gets to sit in on board meetings. Sometimes there’s an actual board seat but rarely. I would just say to founders out there part of the Fox Launch pad is that we agree to sit in on board meetings for a while for free.

A board observer can be so helpful if they’re sitting there and they’re an investor and they really know the industry because usually somebody who knows the industry is picked. They can be a really great resource. So I would not be too shy about letting somebody you like, I mean do your due diligence, sit in on board meetings because they’ll be more vested in the company and be more vested in helping the company.

Participation and Information Rights

Liz Sigety: Usually, I’m not telling you there aren’t disasters out there, but just think about being open to that. And then I guess participation rights, meaning that the investors can participate in the next round as an investor. I feel that is incredibly important in case there’s a VC who’s coming in and getting a really good deal. I want to participate in that next round and that to me as an investor. So investors out there, participation rights are really important. Information rights instead of having side letter with 10 million different information rights. Just put them in the note.

Shubha K. Chakravarthy: And can you just elucidate on what the normal or conventional and the basic information rights terms would be?

Liz Sigety: Yeah. I mean, generally the minimal is, annual financial statements, maybe some quarterly, less complete financial statements, just internally prepared. I do not see audited financial statements for very early stage companies. Usually they don’t want to waste money on something like that. Upon request and updated cap table. I think it’s really important. And, we always like to see at Delaware Crossing, just a report from the company. What’s been going on? You know, just an update, a management report. So, generally financials, just a quarterly informal update, cap table and usually inspection rights. If something goes wrong that they can come in and examine corporate records.

Most Favored Nations Clause

Liz Sigety: This is sometimes in SAFEs and in notes is a most favored nations clause, that is, a great thing for an investor. But just be a little bit careful about that. Look at your plans for future investments. I don’t see it in most investments, but it is something certainly the Y Combinator SAFE has a form for that and it is an option in the note as well.

Shubha K. Chakravarthy: What does it give the investor and what does it mean to the founder to have a most favored nation clause in the note?

Liz Sigety: So what it means is, if you’re doing one offs, if you’re just sending out SAFEs as a one off and it’s not a round- same thing with the note- then as an investor, I might want a Most Favored Nations clause. Let’s say you’re selling notes for 20 percent discount, 6 percent interest. Then somebody else comes in and says, No, I want 25 percent or I want a different cap. You know, let’s say it’s 10,000,000 cap and they say, No, I want a 7,000,000 cap. Most favored nations clause would give the prior note those terms as well. Everything would be amended to adopt to those terms.

Shubha K. Chakravarthy: And does it typically mean that you get the most favorable terms only for other notes, right? Because then the moment you have a priced round, everything’s out of the table and only the notes terms would matter for the conversion.

Liz Sigety: So all the notes would get the best if they all had most favored nations.Whatever note had the best terms, they would all be amended to that and they convert in at those best terms.

Shubha K. Chakravarthy: Got it. Yeah, thanks. Other terms?

Liz Sigety: Well, there are others but that’s sort of what my main ones on my list.

Setting Terms and Negotiation Tips

Shubha K. Chakravarthy: So, you did an excellent walkthrough of here are all the things that are in the convertible note. So now the founder knows, “Okay, these are the things I need to be worrying about”. So it is still up to the founder and their lawyer to figure out what the exact value is, right? So which means that you’re still relying on smart people, insiders who know the deal to make sure that you’re setting those parameters at the right level. So that’s still on you as a founder to make sure that you’re getting those right, right?

Liz Sigety: Sometimes the lead investor will set the terms. If you have somebody who’s going to come in and take over half the round, they may want to, you’ll be negotiating it with them and then others will follow along.

Shubha K. Chakravarthy: But even in that case, is it recommended for the founder to go in with a template that says these are the terms I’m offering you? Or should I just walk because founders seem to think that they just go to the investor and the investor is going to tell them, here’s what I want.

Versus, it’s probably better for the founder to go in if, for nothing else other than to know what the baseline is to say, here’s what I’m offering and then have the lead or whoever come in and say, I don’t want a 20 percent discount, I want a 25 percent discount or whatever the case might be.

Liz Sigety: Yeah especially if you’re going out and marketing to a bunch of angel groups and you don’t have the lead investor immediately in mind. I mean some repeat entrepreneurs sort of already know where they’re going then yes absolutely, I think it is a good idea for you to educate yourself and get a sense of what your expectations but do say that you are open to negotiation if you haven’t established the lead investor.

If you go in and say I’m going to have, in your startup, I have a 20 million valuation and it’s a 5 percent discount and whatever. I mean people just won’t even talk to you unless you indicate some flexibility and you know you might want to be at the higher end of the valuation but make sure you’re within something that’s not crazy. Because if you’re coming in with crazy terms people aren’t going to listen to its talk to your advisors and people who have been through this before.

Advice for First-Time Founders

Shubha K. Chakravarthy: Got it. Have one question on that. I know we’re going to get into a little bit more, but there are founders who have more access into these circles and who know how things are done and what’s normal and what’s not normal, and then there’s a whole bunch of others, whether maybe they’re first time founders, maybe they come from groups that don’t have a lot of other founders that they can reach out to. How do you find out the right levels for these things?

How do you find the right parameters so that you don’t get taken for a ride? You know, part one is getting the right lawyers. What else can a founder do to make sure that they’re not like way out of the market or doing themselves a disservice by setting terms that are too unfavorable to them?

Liz Sigety: Taking advice from people who know and there’s a bunch of different types of people who know. First of all, if you do have someone that you can pair up with, who’s been a founder before. And I would advise people to do background checks, by the way, part of the Fox Launchpad is some free background checks. If you’ve somebody wants to come in and co-found with you and you don’t know them well, check on them because in this in the entrepreneurial space, there’s a lot of characters, right? So just make sure there’s a lot of incubators some great programs out there.

They also can be very helpful with guiding you into these types of provisions and networking and everything else. So there’s some really great programs. And if you’re a first-time founder and you know, you have to leave your job usually and really immerse yourself, but that is a great way to start out. Once again, do your due diligence and check to make sure there’s some programs out there that aren’t too stable, and there’s others that are really well-established and really great. Look into it. Lawyers, financial advisors. I know the big firms are really daunting. Most of them have some sort of program.

Of course, I love my launch pad but there’s a lot of them who really play in this space and the attorneys have been, like me, over 30 years working with startups and seeing how everything they know a lot. Once your client, they’ll introduce you to people and try to give you an idea. And there are a lot of even accounting firms who are used to working with entrepreneurs. So get people who work in this space and listen. You got to be decisive and make decisions. But one of the main things any angel group or V.C. investor experienced investor will tell you is that it is really important for a founder to be able to listen to advice and to consider it and not be a closed book when it comes to something like.

Shubha K. Chakravarthy: I want to ask you the question, is there any story or stories that come to mind of something particularly egregious or really noteworthy where maybe founders just dug themselves into a grave or did something so not beneficial to them that it came back to bite them in a bad way?

Liz Sigety: Let’s see, I have to pick one.

Shubha K. Chakravarthy: You can pick more than one.

Liz Sigety: No, it’s just, there’s, you know, there’s founders that extend themselves too much on the financial side. I think one thing I’ve seen that I find to be very upsetting is that somebody will come to us and already they’re cooked and they have a great business. They have a great idea, but for example, and I hate to say it, but I’ve seen this for women more than men, where they’ve diluted themselves down equity wise to too small a position.

If you’re already at 20 or 30 percent and you’re in your first or second round of funding. By the time the VCs come in, you’re going to have next to nothing and the incentive to work your butt off to get this company to be successful is going to be very small. And then they want to know how, and this happens to guys too, I’m not saying it’s just women. So please don’t take that the wrong way. But, and then they want to know how they can get more equity. And then there’s all sorts of tax issues.

If you get equity for services, the value of that equity is taxable as income. So that’s where the problem comes. You’ve got to do this right up front, because you’re going to end up in a knot. You can only give so many options to somebody. You can’t give 50 percent of the company out to a founder and options to fix a cap table problem. So, that’s something that I really worry about. And that’s why I tell everybody to do your pro forma cap tables to understand. They’re much more complicated than you think to really understand the financial and equity side of the company.

Shubha K. Chakravarthy: So if somebody comes to you before the first time they come to you, are there things that you would advise or seen good founders do that don’t cook themselves before they’ve had a chance to see a lawyer? Are there like high level things that you would advise that they do?

Liz Sigety: Before they see, they should see a lawyer in the very beginning. That’s why we did the launch pad. The launch pad is basically most of the time companies aren’t even created. I prefer it. I prefer to create the company and start it from scratch because otherwise we have to fix it later. And that takes a lot more time and money.

Shubha K. Chakravarthy: Okay, and one last question on this whole convertible note process, and we have many founders listening who have never done this before. They’re starting from absolute scratch. So, I know I have to raise a fund, or I have to raise a round. I know that I want to go down the path of a convertible note, so I know how much I’m going to raise.

Let’s call it 750,000 or a million dollars. What is the process that I engage with you as a lawyer? How does it go through it so that I come up with a template for this is security I want to go out with, or these are the terms I want to offer. Can you just walk through at a tactical level how that typically happens with a founder and a lawyer?

Liz Sigety: Obviously you have to project your expenses. Usually when you do a round of investment, you want it to last at least a year, if possible, unless you’re just doing a couple SAFEs to get you through the next six months, because you want to de-risk the company to be able to sell the company securities at as high evaluation as possible to give away as little equity as possible. That’s the founders view of it. Of course, the investor will want to get as much of the company’s possible for as little money as possible. But in any case, you want to make sure you have enough runway. And the investors are going to want to look at this.

They’re going to want to look at your projections. And projections, once again, aren’t not a science. We know it’s not going to happen exactly as you project, but how much money do you need to get to your next milestone? So if it’s a life science to get through, safety studies or a technology to get your first beta into a potential customer? To get some patents filed. How much money would patents can be expensive? How much money do you need to get to that next milestone that will increase the valuation of your company that will allow you to hire the new marketing person, and get out there at least maybe 12 months from now? Because you don’t want to be raising money all the time. Raising money is so time consuming.

It is just not a pleasant experience. I mean, you’ll meet some great people along the way, but you want to be able to focus on your company. And building your product. So I would say that you should, get that budget, figure out what your run rate is, how long the money will last, what you’re trying to get to, what are the steps for that.

Shubha K. Chakravarthy: So everything starts with the, I projected it out, I need at least, I don’t know, whatever that bogey is. It’s a million dollars, whatever it is, then I come to you, and then what happens?

Liz Sigety: Well then we talk about who you’re going to be approaching as investors who you’re going to be selling the security too, if it’s a really small raise, it’s 100,000, a couple hundred thousand dollars, I would always say just to do a SAFE and let’s keep it simple. If it’s a bridge round between two equity rounds, sometimes also it could be a convertible note, I would say at that point. But, we go through a term sheet.

We put together a term sheet. We talk strategically about how this would work between this round and the next round and what you’re going for, who you’re talking to. And we put together a term sheet. Often people just use a term sheet to start marketing to the few initial investors, to talk to people, see if this looks like it might work out, sort of test the waters, and I think that’s how we would start. I do want to remind people that’s whether SAFEs or notes. These are securities and you do have to file Securities Act exemptions, which are not that hard to do as long as you have a only accredited investors in your round.

Shubha K. Chakravarthy: And that’s something you would help with the filings too?

Liz Sigety: Yeah. So I’m not a paralegal. I would not be doing that at a partner rate, but yes, we have a paralegal who can do all.

Shubha K. Chakravarthy: Meaning that their legal firm would alert them to it and would make sure that they took care of it, right? Like they hired Fox, for example, then your firm would be able to support them through them. Awesome. Thanks for that.

Women Founders in STEM

Shubha K. Chakravarthy: So then I want to move to one topic that’s very close to my heart and I know it is to yours which is women founders in STEM. You’ve mentioned that you worked with, you know, you’ve invested in 70 companies, you’ve worked with countless founders. From that unique perspective as both an investor and a lawyer, what are you seeing observations in terms of women, especially those founding companies in STEM that stand out to you? I’m not saying good, bad or indifferent, but what are the things that stand out to you?

Liz Sigety: I work with a lot of women founders. I’ve invested in a lot of women founders. I’m blessed in the sense that we’re near the Philadelphia region and my group invests in a lot of life science companies and a lot of those companies are actually led by women, at least in this region. So it’s been really great. I find that women founders and men too sometimes this is all a horrible generalization but they are very careful and responsive.

And open to advice and learning very sort of collegial team players. and I really love that. Sometimes, I find that the men are more aggressive in promoting themselves. There have been studies actually about that. So I would encourage people, women within the realm of truth to be, do not be afraid to promote, to speak in ways that are very promotional rather than being defensive. Women can be a little more risk averse and a little bit more afraid than men to sort of push to the next level. Sometimes that hurts men because they may push to the next level a little too fast before setting the groundwork. But you know, as I say, I have some women clients who are worse than the guys in this sense.

And I have some guys that are too careful and you wonder why they’re an entrepreneur as well. So it goes both ways, but these are just some very generalizations. For any, as I said before, for any scientist or creative person or academic, and sometimes, a little more for women than men to get into the finances of it. Please do not be afraid. You’re going to have to teach yourself some of it. Hopefully you can get a good CFO by your side. One of my best CFO entrepreneurs is a woman. So this, as I say, she’s fabulous. And so these are generalizations but you really need to get a basic understanding of those issues.

Shubha K. Chakravarthy: So one thing I want to pick up on that, which is connected to something you said earlier, which is you sometimes see entrepreneurs, especially women coming in. And they’re already diluted to a point where it’s really going to be hard to bring them back to something more equitable. So that combined with what you just said, which is yes, collegiality is all fine and dandy.

I’m going to push you a little bit here and say, but it can also, you can be collegial to a fault, you can be open and receptive to feedback to a fault to a point where it actually starts to backfire on your own financial outcomes, where does that balance. What have you seen women doing well where they can continue to have that image of collegiality or being collaborative, because it can backfire on women if they start to imitate masculine behaviors, which would be acceptable in men?

It would not be acceptable in women. And yet they have to protect themselves. Now, I know as a lawyer, you negotiate. So what are the tips, actionable tips that you would give to women founders, especially if they’re uncomfortable putting themselves out that can actually help them end up in better places financially and otherwise?

Liz Sigety: Yeah, I mean, I think women are inclined to be a little more generous to others. Whereas, when I talk to men about giving equity to the new people coming into the company, there was like, Oh, they’re going to get 0.001%. And the women are like, I’m going to get them 10%. No, I mean, I’m exaggerating horribly. I’m just making a joke. But nonetheless, I do think that women really give other people credit and sometimes can overdo it and we have to always remember when we’re granting equity for services that it needs to vest over time.

You don’t give everything away up front, we never do that. And any lawyer will tell you that you talk to. You just have to be firm. You can be nice. I mean, my favorite way to negotiate as a lawyer is to be as nice as possible while being firm. So, I’ve never had too much of an issue with that, but you do have to be careful about. You don’t want to imitate somebody else, whether it’s a guy. You have to be yourself. You have to be genuine to yourself but you need to be, if you’re going to go into the entrepreneurial space. You need to be prepared to be firm and to draw a line and know where that line is going in.

Shubha K. Chakravarthy: So, from everything that you observed, both as a lawyer, as an investor in this space, especially when it comes to early stage STEM, how would you boil it all down into maybe three actionable takeaways for women to build successful startups and make sure that they get their fair share off the outcomes for all the work that they put in.

Liz Sigety: Well, for women and for men, you do have to project into the future, understand cap table, understand dilution, understand what you think you’re going to need to build your company, do a ton of research, and it’s a lot of work. So, surround yourself with people who know but be clear that you’re the leader of this project. I have had a female, two things in the last week. One this morning where she promised to give up her salary if the VCs did certain things and now they’re not doing what they want to do and she wants her salary back.

So you just have to be really clear and you have to document things. You have to get it in writing. Be careful about handshakes. It’s just really important in that sense. And, I had another person who also just didn’t write down the deal. You really need to have a record of everything that’s going on. Also, I mean, there are a lot of resources out there that 10 years ago weren’t there for women. Take advantage of the many groups and VCs that invest in women-led companies.

Look around for that because there are a lot of resources also at the state level, state programs, look at your school, the college you went to. Every college now has something for alumni, not every, but a lot. There’s a lot of resources out there for women. So I would really encourage women-led companies and co-led companies to look into those resources. But don’t limit yourself to them either. I really believe that it’s good to have a diverse leadership, you know, diversity in all respects to have a lot of the same kind of person. I don’t think really helps the company very much, whether it’s all women or all men or all, whatever. I think it’s good to have a lot of different people at the table. So that’s just my personal opinion.

Shubha K. Chakravarthy: Great. I think that there’s some really good gems in there that we can all benefit from. So we’ve covered a lot and you’ve been extremely helpful, especially in terms of convertible notes that many of us haven’t seen before. Thank you for that. Before I leave, is there anything that I should have asked you but I didn’t?

Liz Sigety: I don’t think so. I think you covered we’ve covered a lot of ground.

I was, I was just talking to my son yesterday, who’s a senior in college in computer science, and he and his friend are deciding that instead of doing an independent study, they’re going to start a company.

And what I told him, which was what I guess I’ll tell the podcast, is that it sounds like a lot of fun. And in some ways it is a lot of fun, but you are dedicating your life to this. Entrepreneurs, whether they’re stretching out their credit cards, usually not getting a salary for some time. Once you’re in this game, the investors are going to expect that you’re not at another job at the same time. They’re going to want you to be 100 percent in. It’s a lot of work. It’s a lot of stress. It takes a certain type of person to really succeed and I respect it. I love it. There’s so many wonderful things coming out of the entrepreneurial world in the U.S. and it’s just really fun to see everything that’s developed, which is why I left Wall Street and do this instead. So, good luck and be strong.

Shubha K. Chakravarthy: Thank you very much, Liz. This has been an extremely helpful conversation. I really appreciate the time that you took to share all of these perspectives. Thank you so much.

Liz Sigety: Thank you.