Press play to listen, or check it out on your favorite platform:

YouTube | Apple Podcasts | Spotify | Google Podcasts | iHeartRadio | Amazon Podcasts | Spreaker 

About Benjamin David Novak

1. Why the default early fundraising path founders copy can accidentally shut them out of whole investor groups
2. The one SAFE detail founders almost never model, then discover the hard way at the first priced round
3. Why “simple” fundraising paperwork can create the most painful misunderstandings later
4. The difference between raising what you can get vs raising what actually gets you to the next value jump
5. The most common term sheet mistake founders make because they are relieved to finally have one
6. Two questions that tell you if your round is a real bridge or just buying time
7. What angels mean when they say “we don’t do SAFEs” and why founders misread it
8. Why trying to get “creative” on terms usually backfires even when you think you are being smart
9. The reputation mistakes founders make during a raise without realizing it
10. The cap table problem that looks fine on paper until a Series A lead starts doing the math
11. What it actually means to “run a process” as a founder without acting like an investment banker
12. The investor diligence step founders skip, then regret once the board dynamic kicks in

Links and resources

• Ben’s Website
• Delaware Crossing Investor Group (DCIG) – An angel investment group Ben belongs to that focuses primarily on Mid-Atlantic startups and follows a structured screening and diligence process.
• Morgan Lewis – A large international law firm where Ben is a partner, advising startups and venture investors on corporate and financing matters.
• Angel Capital Association (ACA) – A professional organization for angel investors where Ben serves and contributes within the startup investment ecosystem.
• Carta – A widely used cap table management and equity platform that Ben recommends and works with for managing startup ownership and investor records.
• Y Combinator – A startup accelerator that created and popularized standardized SAFE financing documents used in early-stage fundraising.

The opinions shared in this episode are personal to the guest and not those of their firm or affiliated organizations. This content is for informational purposes only and should not be considered legal, tax, or investment advice. Please seek advice from qualified professionals before making business or financing decisions.

Interview Transcript

Shubha K. Chakravarthy: Good afternoon, Ben. We’re so excited to have you here. Thanks for taking the time to talk to us today.

Benjamin David Novak: Absolutely, Shubha. Thank you so much for the invitation. Happy to be here.

Shubha K. Chakravarthy: So you’re one of our special guests because you’re one of those rare people who plays on both sides of the table, so to speak, in a good way. You’re a lawyer for startups, but then you’re also an experienced angel investor who’s actively been investing in startups for a long time.

So when you look at a startup financing round, I want to understand, or I want to get an insight into how that combined lens changes what you look at, what you notice, versus just being a lawyer only or an investor only. And what kind of insights has that led you to?

Benjamin David Novak: Sounds good. I will break that into lots of different questions, if that’s cool with you, because I have thoughts on each of them. You could keep me honest if I forget to answer any of them.

To your first point about wearing multiple hats, you know, like many people in the startup community here, I wear lots of different hats.

So, as you know, I’m a partner at a large international law firm. I’ve been an active angel investor for over 12 years now. I serve on a number of different boards of directors and boards of advisors, which is how we originally met through the Angel Capital Association.

So I guess my answers to a lot of these questions depend on which hat that I’m wearing, but I will say there’s lots of synergy having the experience from different sides of the table, like you were mentioning.

So two of the main hats, you know, sometimes I joke I spend half of my life as an attorney, half of my life as an investor, and half of my life as a musician, and the last half doing various other things. And the only way it works is because they all overlap. So yeah.

Sometimes I think it should be illegal to be able to invest in these startup companies without having a decade of experience being a venture capital attorney, but also it should be illegal to represent venture capital funds and startup companies without having a decade of investing your own capital.

Fortunately I’ve had the opportunity to be doing both for a couple of decades now. And there really is a lot of synergy. I guess to your comment about lawyers, often I think people think lawyers don’t make the best angel investors because they tend to be kind of risk-averse.

They tend to be the people who maybe have a disproportionate perspective of how things are going to play out because in their day jobs as attorneys, they’re just dealing with problems and fixing problems the best that they can. I like to think that maybe that doesn’t fit exactly my experience, in that the type of attorney that I am is a little bit different than most attorneys.

As a partner at a large international law firm working in our corporate group and specifically in our ECVC group, our Emerging Company and Venture Capital practice, I really have the opportunity to serve as outside general counsel for these companies.

So I represent startups and investors in startups, and for the startups that I represent, I’m not just the guy that forms the company or finances the company or deals with some problem or some issue. A big part of my role here is to kind of translate the business strategy into the legal strategy, to kind of be the go-between, be the person where they come to me and say, “Hey, should we use you on this? Should we use your firm? Should we use lawyers? Should we not use lawyers? Should we use your firm or a different firm? Should we punt legal projects?”

So a big part of my role isn’t just seeing kind of the downside of like, “Oh, we get hit with litigation. Let’s figure out how to deal with it.” It’s kind of as much upside as it is downside. They come to me with the opportunities of, “Hey, we’re looking to seize on this commercial opportunity. What should I be thinking about? How do I structure a partnership to accomplish this business objective?”

But also a part of my job is, you know, when things don’t work out and you get hit with litigation or some adversarial matter, they also come to me. So I like to think that I have somewhat of a reasonable background, and I’m not overly risk-averse, but seeing how these things play out after doing them hundreds and hundreds of times certainly does give you an eye to kind of look for potential issues early on, which I think helps with screening.

Screening and Diligence in Angel Investing

Benjamin David Novak: So, as you know, one of my primary investment groups that I’m with is DCIG, Delaware Crossing Investor Group. I’ve served on the screening committee there over a decade. One of the things that I get to contribute to that group is that experience. By doing these deals, working with so many hundreds of companies over the decades, I really feel like I do have a unique skill set that allows me to pre-screen and screen and diligence companies with that unique background. All right, how many did I answer? You asked a couple of questions. Did I miss any of them?

Shubha K. Chakravarthy: I am going to zoom right in and I’m going to ask you specifically: from a founder’s perspective, how you screen a deal, how is that influenced by the fact that you’re both an angel investor and a lawyer? Can you maybe give us an anonymized story or an example of what you’re really looking for that brings both of those halves or hats into play when you’re looking at a deal?

Benjamin David Novak: Sure. So one of the reasons I like angel groups is because it’s a collection of different people that have different backgrounds and kind of bring different resources to bear. And so one of the nice things about joining an angel group is that you don’t have to know everything, but you can contribute what you contribute.

I think I was mentioning this earlier, that one of the things that I add at Delaware Crossing by serving on the screening committee is the ability to kind of have that experience, be able to use pattern recognition to kind of find those soft spots that I can dig into early on.

And so what they are kind of varies. So we kind of break it up at Delaware Crossing between pre-screening, screening, selection, and diligence. And the questions that we ask are pretty different at those different stages. So for pre-screening, we’re largely just looking to see if these companies fit our investment thesis. So like, do they fit the industries that we invest in? Do they fit the stage that we invest in? Are they in our geography? We have a geographical limitation at Delaware Crossing that not all angel groups have. So pre-screening is mostly just like, is this the right type of company that we should look at?

Screening is where we spend a lot of time. I contrast it with diligence in that for screening purposes, we assume everything they say is true, right? So if they tell me it’s a $20 billion market, I trust that it’s a $20 billion market. And throughout the whole pitch, I’m kind of trusting what they say. And if, based on that, this is something that kind of fits our investment thesis at Delaware Crossing and we think the group would be interested in, they kind of get moved through the process to present at a full meeting.

At the meeting is actually where we make our individual investment decision. So we get a go or no-go decision at the actual meeting that the company pitches at. And at that time we kind of assign a deal lead and sometimes a diligence team, and then diligence begins, right? And so diligence is the other side of the coin. It is not assuming everything they’re saying is true. It is verifying the things that they said to confirm whether it’s true or not.

One other thing that I’ll mention is that not only is it great that angel groups are made up of different people with different skill sets, but a lot of the deals that we do aren’t just one angel group. There might be three or six or 12 different angel groups that are all participating in that round. And one of the things that I like about Delaware Crossing is that there’s flexibility in our model. So sometimes we have a really robust diligence process. Sometimes I’m on a team and we’ll spend months meeting with the company, talking to customers, meeting in person, like on the legal side, going through contracts, things like that.

Other times, if the deal’s being led by one of our sister organizations or somebody that we know at another angel group, it’s more of an abbreviated diligence process. So we might read their diligence report, kind of rely on that, not technically use that but use that as a starting point of where we’re going to poke.

Diligence really depends on the company and the industry and the stage. So it’s not just a set playbook. We all have our due diligence request list and we all kind of have our things that we ask all companies, but the specific things that we ask really are kind of unique to each company and what they’re trying to accomplish.

Shubha K. Chakravarthy: Got it. And that’s a fantastic overview.

Deal Structure and Terms

Shubha K. Chakravarthy: One of the things that we’ve heard kind of over and over again is, you know, from you and from other investors, is just this importance of the deal structure and the terms and all of that good stuff. So when you’re looking at how a deal is structured, are there kind of high-level benchmarks, landmarks, or foundational pillars that you’re looking for that are either a must-have or a must-not-have that perhaps you don’t see founders being as aware of?

Benjamin David Novak: The negotiation of terms really follows structure. And so often people kind of jump into a structure and then start negotiating terms without asking the question, is this the right structure? And what the right structure is really kind of depends on the company and the offering.

How much are they raising? How much is committed? How many people are they raising from? What’s the stage of the company? So one structure is not right for everyone. A SAFE is not right for everyone. A preferred stock round is not right for everybody. But I do think it is important for a company in their financing process to really think first about structure. What is the right structure for what I’m trying to accomplish? What’s going to align incentives between the founders, the company, and the investors? And then, once you have the structure, get into the terms.

So everybody kind of has different things that they look for in a company. So we often say if you ask 10 angel investors the same question, you’ll get 11 different answers. So we all have our own investment thesis. We all have our own things that we care more or less about, things that we weigh more or less in our decision-making process as to who we’re going to invest in. But one of the things that I maybe weigh more than your typical angel investor is terms.

So I think all of us, or almost all of us, say the team is paramount. Especially if you’re a pre-seed or seed-stage investor, you’re investing in the people. And I agree with that. So personally, I’m looking mostly at three Ts. So I’m looking at the team, I’m looking at the traction, maybe that’s tied to the product, and I’m looking at the terms. And I think a lot of people kind of look at the team and maybe the product and the traction. They don’t always focus on the terms.

And so after seeing this play out a couple hundred, maybe a couple thousand times, that third T is pretty important. Quick example: I’ve seen lots of people who have invested in SAFEs that have picked the successful company. They were right. They came in early. They were the first check into this company that blew up.

They’re not necessarily getting a great return. So depending on what plays out, if that SAFE never converts, you’re along for the ride. If you have an uncapped SAFE, guess what? You’re just going to get a discount to that crazy great valuation down the road. So to me, I think terms are particularly important if you’re a profit-motivated investor and you’re looking to maximize your returns. But it’s not just the terms. You have to make sure that the structure’s appropriate first.

Shubha K. Chakravarthy: And when you talk about structure, I know that you have a very specific meaning in mind. And to a founder who’s maybe not familiar with the terminology, what does structure mean to you? And how should I, as a founder, be thinking about the right structure for the right stage and the right investor?

Benjamin David Novak: So, great point. So I guess there’s four key financing structures that we regularly use when we’re investing in early-stage companies. There’s common stock. Common stock is what the founders typically have. So they have common stock, and sometimes a common stock round to investors is appropriate.

A situation in which it’s appropriate is maybe if your mom or your grandmother is investing $25,000 into your startup. You probably don’t want to overcomplicate it. Your grandmother’s probably not deciding between you and 999 other founders. Your grandmother’s looking to support you. Maybe terms aren’t as important. Maybe there’s some trust both ways there. You’re going to treat your grandmother fairly. So, in a friends-and-family, really early, really small round, something like common stock may make sense.

On the other end of the spectrum, where I spend a lot of my time, is in the preferred stock realm. So working with those NVCA model documents — the National Venture Capital Association’s model documents for Series A financing. They are comprehensive. Those are the rights that venture capitalists demand. They are 272 pages of really robust rights, which makes sense that VCs want that. And personally, I think a lot of angels should want that as well.

When I’m personally investing in a company, I’m generally giving a preference to preferred stock, and it’s because it comes along with a lot of these rights that help kind of align incentives. However, for companies that are in between that $25K check from your grandmother and raising a couple million dollars from VCs, there needs to be a middle ground.

And so that’s where we start to see other types of deal structures like convertible securities, the two most popular of which are convertible notes and SAFEs. So common on one end, preferred on the other. In between, you kind of have notes and SAFEs. We’ll talk about SAFEs separately.

What notes generally are is pretty helpful for those sub-million-dollar rounds, sub-$2 million rounds, where you don’t want to spend the time and the money and the brain damage on your attorneys and the other side’s attorneys negotiating 272 pages of docs for a $100K check. And so I get that. The risk to the investor is, in a note, you don’t know what your rights are. You’re just trusting that you’re going to convert into rights that future people negotiate. So there’s trade-offs on both sides. It often makes sense if the terms are right.

But you shouldn’t be raising on a SAFE if you’re raising $100 million. You shouldn’t be raising a preferred stock round on NVCA docs if you’re raising $25K. This also is kind of tied to the stage of the company and the valuation of the company. So there’s a lot of things that kind of go into the decision of, do I do preferred stock, common stock, a note, a SAFE, or something else?

Shubha K. Chakravarthy: And I don’t want to belabor this because there’s plenty of conversation around this, but Peter Walker of Carta put out some data that said for the pre-seed round, the overwhelming security — I don’t even know if it’s a security — but the overwhelming instrument is a SAFE. Whereas, as you start to get into seed and beyond, it starts to get into convertible and more of the priced rounds.

SAFE vs Convertible Notes

Shubha K. Chakravarthy: Now, from a founder’s perspective, the temptation is to go for a SAFE because it’s cheap, it’s safe, right? And it kind of kicks the can down the road. What do you counsel your startup clients — not your investor side, but the startup founder side — in terms of SAFE versus maybe a convertible note or a priced round?

Benjamin David Novak: So I agree with some of the things you said, and I disagree with some of the things you said. So first, the gentleman you referenced at Carta is a good friend, puts out great content. I’m a big fan of the Carta platform. By the way, I probably should give my lawyerly disclaimer.

Shubha K. Chakravarthy: Yes, we will put it.

Benjamin David Novak: The views that I’m expressing are my own personal views and not the views of Morgan Lewis, Delaware Crossing, ACA, or anybody else.

But I think Carta’s an excellent platform. I work with Carta personally. The majority of my individual angel portfolios are on Carta. Through Morgan Lewis, probably a majority of my tech startup clients use Carta. So, great platform, great content, a lot of great resources.

So let’s talk about SAFEs. I think some of the SAFE data that’s out there is misleading. And sometimes when people say, “Oh, a majority of the deals that closed this week are SAFEs,” while that might be true for certain companies at certain stages, sometimes that data counts that $25K check from your grandmother as a SAFE, and a $25K check from your mom as a second SAFE closing, and a $25K check from your dad as a third SAFE closing, and then a $4 million convertible note as one closing.

And it says, “Oh, 75% of the deals that closed today were SAFEs instead of notes. So SAFEs are clearly the answer for all companies.” And SAFEs have their place. The one thing I’ll vehemently disagree with that you said is that SAFEs are safe, right? So SAFEs are definitely not safe. They’re one of the most precarious places to be as an investor. They are not debt securities. They’re not equity securities. I joke that they’re an insecurity as an investor when you’re investing on a SAFE, because there are a lot of holes and a lot of opportunities for there to be misalignment of incentives.

Shubha K. Chakravarthy: I love that. So I’m just going to press you on one little thing on that, because I hear this so much from founders, which is, I hear a lot of “I want to raise on a SAFE.” If you were talking to a founder, what counsel would you give them in terms of a mental flip or a mental model on how they should be thinking about SAFE versus convertible note and how they should make a smarter decision for that first outside round?

Benjamin David Novak: So I’ll give you kind of two examples. The first is sometimes SAFEs are completely appropriate. So if an investor comes to you and they like a SAFE — once again, some investors are comfortable with SAFEs. There are an increasing number of investors overall that are comfortable with SAFEs. Sometimes there’s a bifurcation between the sophisticated investors and the unsophisticated investors. But there are both sophisticated and unsophisticated investors out there that are comfortable with SAFEs.

So if an investor comes to you and says, “Hey, I want to invest a million bucks on a post-money SAFE with a $20 million valuation cap,” that’s a good fact pattern for a SAFE. It’s a very company-favorable instrument. So as the founder, you’re not really giving up a lot by giving the investor the SAFE. This investor specifically requested it. It might be a streamlined negotiation. It might not. It might involve side letters; it might not. But there are certainly fact patterns where SAFEs are appropriate.

However, what I often see is a founder, especially an East Coast–based founder, that says, “Oh, I’m raising a million bucks on a SAFE.” And the reason they’re doing that is because their mom’s putting in $25K on a SAFE, and then they start pitching all these investors that might be interested in their company.

And one of two things happens, right? Either they get pre-screened out. Many of the angel groups I work with don’t consider SAFE deals. We don’t invest in SAFEs, so it’s not worth going through the process if we don’t invest in SAFEs and you’re set on a SAFE. So we pre-screen them out. So these founders say, “Oh, I can’t get capital anywhere. I applied to 300 angel groups and only four of them wrote me back.” It’s because you’re pitching something that they don’t buy, right?

They’re not buying your product. They’re buying a piece of your company, and the specific piece of the company that you’re selling them is a SAFE. And if they don’t buy SAFEs, you’re chopping off your feet here.

The second thing is, either you get pre-screened out or you get in, right? So some groups will consider SAFEs even though they don’t like SAFEs, and then you’re spending a lot of their time and they’re spending a lot of your time, and you go through the process, and at the end it kind of doesn’t get critical mass and the deal doesn’t move forward. But if it was on a note with similar terms, maybe it would’ve moved forward.

So if you have a committed round, you’re a hot company, things are going great for you, and everybody’s banging down your door to give you a term sheet, a SAFE might be appropriate. However, if you’re looking to patch together a couple checks in the hundreds of thousands of dollars to get to that million-dollar round, it’ll be a much more streamlined process if you use a more market deal structure, like a note.

But once again, it depends on who you’re talking to. So there’s a little bit of an East Coast, West Coast divide, right? East Coast investors generally are a little less into SAFEs. West Coast or Silicon Valley–based investors often are comfortable with SAFEs. It’s also kind of a Y Combinator thing. So if there’s a Y Combinator in town, often the investors in that local ecosystem are comfortable with SAFEs.

Shubha K. Chakravarthy: Fantastic. This is awesome. So we talked about structure, and then one of the other things you said earlier is you care about the terms, right? And we’ve heard a lot of this market swinging between investor-friendly versus founder-friendly terms. There are clearly arguments to be made to make sure that it’s equitable to the founder and it’s also equitable to the investor.

What are the kinds of factors that you would consider lines in the sand that you would draw in terms of where one stops and the other starts? And what kind of counsel would you give to founders to make sure that they’re not trying to push the envelope too far or at some crazy valuation, whatever the case might be?

That they have to be fair – the investor’s taking a lot of risk, especially in the pre-seed and the seed stage but at the same time, the founder’s putting in their life for God knows what kind of outcome in five or 10 years, right? So just curious in terms of what kind of a mental model should a founder have as they think about founder-friendly versus investor-friendly terms?

Benjamin David Novak: So it is a great question. How I’ll answer it is, I think it’s important to recognize that there’s a range of market for each of these deal structures, each of these terms. There’s a range of market, right? The interest rate that we use, the majority of the discount rate on a note, a 20% discount has become incredibly market. Nineteen and twenty-one are used infinitely less than a 20% discount, right?

And same with 15 to 25 and so forth, right? So there’s a range of what’s reasonable. There’s a range of what’s market. Then there’s things that are off-market company-favorable, off-market investor-favorable. Regardless of whether I am representing a company, regardless of whether I’m representing an investor, or whether it’s me as the investor, almost always it’s appropriate for everybody to be within the range of market.

And yes, there’s swing. So maybe the company wants a more company-favorable interest rate, like 6%, and I want a more investor-favorable interest rate, like 8%, and we compromise at seven or whatever, right? There’s some swing, but if you’re in the 6% to 8% range, the deal probably works for everybody.

A core part of my thesis, and maybe something I’ve learned a little bit the hard way, is that you should, as an investor, find the companies, find the best companies, find the companies that you believe in, and try to negotiate reasonable terms within the range of market. Whether it’s on the investor-favorable end or the company-favorable end matters less. There are no terms so sweet, so good, that turn a bad company into a good one.

Shubha K. Chakravarthy: That’s a great point.

Benjamin David Novak: Find the best companies, try to negotiate a reasonable deal, and in my opinion, that tends to result in a better fact pattern for everybody than negotiating for egregiously investor-favorable terms, or the other way around.

Shubha K. Chakravarthy: So if I flip that advice on its head and look at it as a founder, what’s the learning for the founder here? What’s the lesson for the founder to make sure, as they’re getting into terms, they’ve done everything they can. Obviously, build a great company and build a company that investors are beating down the door. But then, given that you are where you are, what is that marginal thing you should be doing as a founder to better your prospects?

Benjamin David Novak: One of the challenges of being a founder is you don’t know what you don’t know. So the good founders are the people that have a core skill set and then surround themselves with the right employees and independent contractors and advisors, the right people on the board, the right people on the board of advisors.

I think one of the most important things with respect to this whole process of financing is, if you have somebody who has a background in this. If the CEO, if the founder of the company has a background in this, if they’re a former venture capital attorney — great. They probably know what they don’t know and know what they know, and can go pretty far without a lot of outside advice.

However, if this is the founder’s first company, if they’ve never raised capital before, it’s like learning a foreign language here. And so, having the right advisors to help you understand what you should understand at each stage of this process is pretty important and pretty valuable.

So often we see founders or investors giving up things in a negotiation just because they didn’t appreciate it, right? Sometimes in a pitch, somebody in an angel group will say, “Oh, is this participating preferred stock or non-participating preferred stock?” And inevitably, if the founder doesn’t know, they’ll say, “Oh, it’s participating preferred stock.” Even though that’s off market. Nobody wants to re-trade a deal, so once you agree to something, you try not to change it.

I see people give up a lot of really impactful things just because they don’t appreciate the question and they don’t want to look like they don’t understand. So, surrounding yourself with the right advisors to arm you. You don’t need to be a venture capital attorney, but you need to have access to somebody who has this experience, whether it’s your attorney or somebody else can help you appreciate what you’re selling and what you’re giving away.

Because it’s really impactful. If you’re going to spend, as a founder, three or five or seven or ten plus years of your life at this company, you want to make sure that you’re doing things right along the way, because a lot of the decisions you make early on last for the life of the company. You’re stuck with a lot of these decisions, for better or worse. So the earlier you can get some help to make good decisions, generally the better for you as a founder.

Shubha K. Chakravarthy: So now we’ve talked quite a bit about term and structure and things like that. One of the things that I see a lot of confusion with first-time founders is this idea of the term sheet, right? Are you supposed to walk in with a term sheet? And if nobody’s given you a term sheet, are you supposed to make up terms yourself? Are you just supposed to go hunt for a lead investor? Where’s the sweet spot?

Financing Strategy for Founders

Benjamin David Novak: So it depends. A big thing that a lot of founders skip is financing strategy, right? Talking to their counsel: What’s the right structure? What are the right terms? Should we draft terms? Should we not draft terms? What should I put in my slide deck? What should I not? What’s open for negotiation? What’s not? It’s tough.

If I could give founders one bit of advice, it’s: be strategic about these decisions. There are various right answers, but don’t just jump to an answer because you haven’t gone through that strategic process.

There’s what we call term sheet makers and term sheet takers. If you’re pitching a Series A round to a bunch of venture capital funds that lead Series A rounds, those VCs tend to be term sheet makers. They will provide you a term sheet that is likely based on the National Venture Capital Association’s model term sheet, but they will provide you with a term sheet telling you what they think you’re worth, whether they’re going to get participating preferred or not, dividends or not, whether they’re going to get a board seat or two or zero. All the details around their round.

They will make a proposal in writing, typically, and then you’ll respond to that. One of the biggest mistakes I sometimes see founders make is they’re so excited to get that term sheet that they sign and return it and then engage counsel to negotiate their round. It’s like, oh my god, the bulk of the value we could’ve added would’ve been helping you negotiate this term sheet, not just the documents that reflect and affect the term sheet.

VCs tend to be term sheet makers. Other people tend to be term sheet takers. If you’re pitching dozens of different angel groups and it’s a $2 million round and each angel group has a typical check size of $100K or $200K or $500K, they may not want to lead the round. They may not want to engage separate counsel and due diligence and negotiate the terms. They might prefer that you, as a founder, give them a term sheet saying, “This is what I think the round is going to look like. What do you say?” A lot of angel groups are built to accept that.

At Delaware Crossing, for example, if it’s a $2 million round and our average check size is a couple hundred thousand, if you already have a lead investor that negotiated terms on a term sheet for the first million bucks, we’ll look at it. If it’s reasonable, we generally play ball and don’t negotiate anything unless there’s something egregious, off market, or outside of our thesis. However, if we look at it and the terms are horrible, we also walk. We’re not going to renegotiate the terms if a majority of the round is already committed.

I think it’s important to be deliberate. It’s important to be strategic. It’s important to know who you’re talking to and whether they expect a term sheet or not. It is a common follow-up, if an angel group likes your pitch, to ask for the term sheet. You’ll want to be ready and either quickly have your counsel put together the term sheet to send to them, or have the term sheet ready to send following your pitch.

It’s generally not something they ask for in a pitch. As you’re going through prescreening and screening and pitching a group, you’re generally not giving them your term sheet. But if there’s interest following the pitch and they start getting into diligence, that’s a customary time where you are expected, as a founder, to be able to turn up a term sheet.

It really depends on the company and who you’re talking to, but it’s worth being deliberate. What you don’t want to do is go into a VC and turn up a SAFE, if they don’t invest in SAFEs. If you turn up a SAFE term sheet, they’re pretty quickly going to say no, we’re not seeing eye to eye. So you want to be mindful about how you do it.

Shubha K. Chakravarthy: Got it. They say time kills all deals, right? I get your point about being thoughtful and not bringing the term sheet too early, but you don’t have a lot of time. If there’s interest, you want to jump in on it. And also this point you made around wanting to be strategic about what your financing strategy is. Many founders I’ve spoken to are not familiar with that term. What do you mean when you say you should have a financing strategy? What are the hallmarks of a good financing strategy? And what are some of the things that you, as a founder especially going out for your first round, pre-seed or seed  need to keep in mind?

Benjamin David Novak: There are different ways to do this. A lot of my experience is as company counsel. Often a team of founders or a sole founder will engage me really early on, before maybe there’s even a company. We might form the company, then create a financing strategy, and then go into a financing and do all the other potential legal projects.

Other times, founders jump right in, get their term sheet, and then engage counsel. If you have counsel involved early on, it helps your chances of getting financed and protects the things that make sense to protect, and not protect the things that don’t make sense to protect. There are other people who can help you with financing strategy too — advisors who are not lawyers but have expertise in the startup financing space.

In my experience, you have a much higher chance of success. Of course there’s an out-of-pocket cost to like bring in advisors early on before you have the capital. But there’s a much higher chance of success of getting your foot in the door at the angel group, turning up terms that they invest in, proceeding through that process.

Shubha K. Chakravarthy: If you were to ask a founder, “What’s your financing strategy?” What kind of answer should they have? What are the components of that financing strategy?

Benjamin David Novak: I would say the result of a financing strategy is structure and terms, but it is more than that, right? I guess the ultimate result of a financing strategy is succeeding on your strategy and selling the million dollars’ worth of convertible notes to the right types of investors.

So it tends to start with like, okay, what’s your business? What’s your stage? What are you trying to accomplish? What’s your burn? What’s the right amount to raise? What’s not the right amount to raise? Once you understand kind of the right amount to raise, that gets you 12 to 18 to 24 months, then you start saying, okay, if it’s half a million dollars that I need to get to a bunch of critical milestones 18 months from now.

I’m going to be talking to angels. If it’s $50 million that you need to get to your next critical milestone within the next 18 months, you’re probably not talking to angels, right? So like who you’re talking to, when you’re talking to them, how much you raise, how that ties to your burn, all of that is kind of part of your financing strategy.

Part of your financing strategy too might not just be one financing. It might be, hey, we’re raising a million dollars on a convertible note, and then 18 months from now we’re raising a four or six or $8 million Series E or Series A or whatever it is.

So like how much you’re raising, when you’re raising, how are you going to hit your critical milestones? Because nobody wants to spend the million dollars, not hit their critical milestones, and then have to go out and pitch investors saying, we inefficiently spent a million dollars and now we’re asking for four.

So you kind of think about this early on. What are those critical milestones? How long is it going to take you to get there? What’s the right amount of money? Who gives that type of money? And okay, if you’re going to get this amount of money from that type of person, what are they going to expect in return? And so that’s kind of how you back into the deal structure and from there, terms and so.

Shubha K. Chakravarthy: Love it. So early on, you know, when you talk about pre-seed, seed, clearly there are some boxes that are laid by the market. I mean, you typically raise this kind of money in a pre-seed or this kind of money in a seed round. But there’s also this question of out of how much, right? Is it 1 million out of five or 1 million out of 50?

To your point, what are the biggest mistakes you see founders making? Especially I’m talking about deep tech, STEM, capital-intensive kinds of startups, you know, life sciences, whatever the case might be, and what is there something that you would ask them to do differently or you’d advise them to do differently? What are the biggest mistakes? Like where are the blind spots? I’m just trying to get to the heart of that.

Benjamin David Novak: So if they’re asked the right questions at the right time, they tend to have reasonable answers and make reasonable decisions. I think a big part of the problem is just they’re not thinking. What are my critical milestones? How much cash do I need to get there? You know, like sometimes they’re saying, I’m going to raise a million dollars because that’s my access to capital, and I’m just going to make it work with a million dollars.

Or my uncle’s throwing in 400K, I got to figure out how to build a company for 400K, right? Like they’re doing it backwards rather than like, here’s this great business opportunity, this is what I need to succeed on it, and here’s the optimal amount of capital. And there’s flex and things change, right?

So often what we’ll do is we’ll say we’re raising up to 1.5 million. And hey, if you only get to 1.3 and you want to close and move forward, great. You close on 1.3 and, you know, you have one or two fewer months of burn, right? So there’s flex and facts change, but I think the challenge is you got to really be thinking about the right things at the right time to make the best decision today based on the information that you have today.

So, I see all different types of problems. Founders raise too much. The problem with raising too much is disproportionate dilution. If you are right, this is the next big thing, and you’re going to skyrocket in valuation, you don’t want to sell more now than you have to, right? Assuming there’s a cap on a note or a cap on a SAFE or valuation in the common stock or a preferred stock round, you’d rather take that extra dollar in the future when your company’s worth way more and you’re giving away less.

So sometimes I see founders raise too much. More commonly, I see them raise too little. Sometimes that’s an access to capital issue that they just can’t find people willing to invest in them. This is where lawyers and other advisors can be helpful. If you have a coherent strategy and you need the million dollars, often you can get introductions to the right people that could get you to a million dollars if everything else lines up.

So there’s a wide range of problems I see, from the wrong structures to the wrong terms to too much, too little. A super common fact pattern is just you don’t have a target amount in mind. You kind of take what’s available. Another big problem I see is you take it on different terms.

So, okay, this guy is willing to take an $8 million SAFE. The next guy, for some reason, is willing to take an $80 million SAFE. Great, I’ll take his money. And then the third guy’s on the $30 million SAFE, and, you know, it really starts to misalign incentives when you’re taking capital from different people at drastically different valuations.

So unfortunately that’s the less fun part of my job, trying to kind of clean up the messes that founders sometimes make. But the hope is you have advisors early on that can kind of guide you through this process to help minimize those issues.

Shubha K. Chakravarthy: And I love the point you made. If you’re asked the right questions, you tend to have the right answer. So it’s more a question of being triggered to think about the things. So let’s say you are an advisor to a founder and you were advising them on financing strategy. Are there like maybe three questions, four questions that you would prompt them so that those listening can take those and try to cover the right answers themselves?

Benjamin David Novak: Yeah. So a lot of some of the things that I mentioned, right, what are your critical milestones? And when I say critical milestone, I’m talking about an inflection in value. So it might be getting a prototype. It might be getting your product in market. It might be having your first customer, having your first paid customer, having a million users, 10 downloads, whatever the metric is.

Before having a product in market, you’re probably worth less than having a product in market. And then, you can figure out the different traction points and the different KPIs that matter to you and your business. But there tend to be these kind of inflection points where, okay, prior to profitability I’m worth less. Then okay, I’m break-even. Now I’m making money. Now I’m worth more, right?

So figure out what your critical milestones are. Often your critical milestones are critical because they’re kind of on the way to something else. So for example, talk to the people that would be investing in your next round 24 months from now and say, hey, in order for you to invest in me, I know you’ve been saying I’m too early. When am I going to not be too early?

Understanding Investor Expectations

Benjamin David Novak: And usually investors are pretty clear about this, especially VCs. They might say things like, we need a product in market. We need this amount of traction. We want to see a hundred thousand downloads. We want to see whatever it is. They’re usually pretty specific about like, if you’re less than that, not worth our time. If you’re more than that, that’s interesting, come back to me.

So understand what the next people want and try to build towards that. And as I mentioned earlier, you don’t want to fall on your face. You don’t want to burn through your capital just before you get to that critical milestone and then be at a standstill.

This is kind of like the bridge to nowhere problem. Lots of times people raise a bridge round that just gets them not to where they need to be. So you need a bridge — bridge an A to a B. Make sure they use that capital efficiently to get to that B round. If you raise an A and burn it, and then raise a bridge and burn it, and you still don’t have the metrics that you need to raise your next round, you’re in a really tough spot. Either you can’t raise capital, or if you can raise capital, you’re talking about where it’s like cram down and pay to play and recap and down.

Shubha K. Chakravarthy: Bad words.

Benjamin David Novak: Not fun words.

Shubha K. Chakravarthy: We don’t want to hear those words.

So, one last thing on the term sheet, which you talked about ideally we’d like to have more than one term sheet, although it might be hard.

Benjamin David Novak: The only thing better than one term sheet is two.

Shubha K. Chakravarthy: Okay.

Benjamin David Novak: So you’re only worth what somebody’s willing to pay for you. And often it’s hard to know what somebody’s willing to pay for you. And even when you get that first offer, you have one offer. Is there flex in that? As soon as you have two term sheets, you really could kind of negotiate them against one another, such that you could really figure out what you’re worth.

Shubha K. Chakravarthy: So to that point, if somebody were to get their first term sheet, what counsel would you give to a founder to say, should you now try to go get another term sheet? Holistically, I’m trying to figure out what’s a good strategy for them so that they don’t lose out on the value.

Managing the Fundraising Process

Benjamin David Novak: And so this gets to kind of process management that’s part of your financing strategy, right? And when I say running a process, I don’t mean you bring in an investment banker to raise your first million bucks. And they reach out to 5,000 people and then they get some indications of interest and go. That would be great.

If investment bankers are free, yeah, bring in an investment banker and get 101 indications of interest and then pare it down to the one investor that you’re going to take capital from, or the three. But yeah, that’s kind of cost prohibitive.

So when I say run a process, you’re being deliberate about who you’re talking to, when you’re talking to them. You’re being open that you’re talking to multiple investors. You know, it depends on who you’re talking to, but if you’re pitching angels, they’re likely happy that you’re talking to other angels.

If it’s a $2 million round and your group does a $250,000 check, they don’t want to invest $250K if you’re telling them you need $2 million. They’re going to say, get commitments for the $2 million and then I’ll give you my $250K.

So it’s not a problem that you’re talking to multiple investors, but you kind of want to manage that process. Sometimes you have really hot companies where they get to a million and then one-five and then they’re really close to two, and it’s important that they kind of communicate to people: we’re getting close on commitments. There may or may not be room for you. Are we going to upsize? Are we not going to upsize?

It’s one thing to kind of manage that process, keep your investors updated, and then say, sorry, we closed the round without you, versus somebody being really excited to invest and then saying, sorry, we closed yesterday and forgot to tell you.

So the terms and the negotiation are part of that. If you’re lucky enough to have a lead and that lead gives you a term sheet, if you’re in the process with other potential leads, communicate that to them if you can.

If you already signed the term sheet and you’re subject to confidentiality, you might not be able to tell them that you just got a term sheet. But prior to signing anything, you might want to indicate to other people in your pipeline: Hey, I pitched your group a month ago. We just got our first term sheet. We’re evaluating it. If you’re interested in making a competing offer, now’s the time.

And then it’s a balance between competing offers versus overlapping offers. When you’re dealing with Series A VCs that might want to eat up a whole round or the majority of the round, it is a little bit more competitive, where if one VC gives you a term sheet, somebody else might give you a competing term sheet where that VC is getting the board seat and whatever.

In the angel space, it’s a little more collaborative in that if somebody told me they got a term sheet, the first thing I would say is, oh great, send it over. We’ll look at it and evaluate if it’s a good fit. And maybe we make a competing offer or maybe we don’t. Or maybe we say, hey, these terms are reasonable. Give us a board observer. And we’re in for $250K or $500K or whatever. You know, it’s not a one-size-fits-all, which is why it makes it tough to ask ChatGPT the answers to these questions, because it all kind of depends.

Sometimes I’ll ask ChatGPT a question, it’ll give me a very clear answer — B, not A. But then I’ll give it more information and then it’ll be like, actually A, not B, definitely A. And then I’ll give it more information and it says, actually, you know, let me think about this again. Maybe B still is the best. So you have to really be armed with the right information to get the right conclusion here.

The last thing I’ll say on this point is, all of this is a relationship game. So how you handle yourself throughout this fundraising process is another thing that will help form your reputation in the industry and will have long-lasting effects. So if you do burn people in your pre-seed round, that could have ramifications when you’re raising your next round and talking to the same people or similar people or different people, because it’s a pretty small sandbox.

So, as a founder, I think your credibility is important. Your integrity is really important. I’ve seen a couple of times over the years where founders have done things in a fundraising process that just were not appropriate, and that caused a real chilling effect on that round and future rounds.

Common Mistakes Founders Make

Shubha K. Chakravarthy: Are there unintentional mistakes that founders make where they’re basically shooting themselves in the foot?

Benjamin David Novak: Constantly. I mean, geez, how do I even pick one? Obviously, most of the mistakes are not intentional. I have seen one or two cases of just straight-out lying, right? But that’s the exception. Generally, founders don’t come in to defraud investors. That’s a real extreme fringe part of the market that we try to pre-screen out. Anything like that. But it’s imperfect.

Shubha K. Chakravarthy: You talked about reputation and managing the relationship, right? And I was talking specifically to that, where it’s not about the company, it’s not about the fact that you don’t like the terms or anything like that, but something about the relationship that maybe was a blind spot for them, but that turned you off of them as an investor. Like things that they’re not aware of.

Benjamin David Novak: Yeah. So there’s things they don’t know, right?

So like, do you have any competition? We don’t have any competitors. That’s probably the wrong answer. You probably do have competitors, unless you define your competitors to the most narrow scope and then say, oh, of the 422 companies, they’re indirect competition. They’re not doing the exact same thing as us. We don’t have any competitors in our tiny-level space that doesn’t exist yet. It’s white space. So there’s a lot of those unintentional things, or just maybe they don’t know.

You know, I think the things that really harm your reputation are the intentional things, right? When you get caught in a lie. So I’ll share one story, and I’ve got to be careful of confidentiality, but this one shouldn’t be confidential.

I was watching a pitch one time in a group, and the person who was pitching me didn’t know that I was a partner at Morgan Lewis. And they pull up their slide saying, we’re a Morgan Lewis client and this is our partner at Morgan Lewis and we love Morgan Lewis and blah, blah, blah. And I’m looking at the slide and I’m like, I don’t know this guy.

But long story short, he’s not a Morgan Lewis client. He’s working with an attorney at a completely different law firm that worked one year at Morgan Lewis 15 years ago. And it’s one thing to be like, oh, we worked with an attorney that had one year of experience at Morgan. That’s one thing.

But he had the Morgan Lewis logo on his slide deck saying he’s a Morgan Lewis client in his pitch deck. And he very much is not. Stuff like that, it’s like, geez, if he’s exaggerating that much about this largely irrelevant thing, what else are you lying about? I’m not going to spend the time to try to uncover all the other things that you’re deliberately lying about. So as soon as you catch them in one pretty overt lie in a pitch, you just say it’s over

Shubha K. Chakravarthy: So I’m getting the message. Clearly there’s a bright red line in terms of don’t go into things that cross the ethical or integrity line. But I’m also hearing from what you’re saying that naivete and not having a sharp business view and having that business acumen might also come back to bite you. Not because you’re a bad person, but that you might be a bad commercial bet for the investor to make.

Benjamin David Novak: Oh yeah. Most of the people that don’t get funded are great people, right? There are lots of great people out there that are not going to get funded, and it’s not because they’re not a great person. It’s just, if you’re trying to get cash from somebody on the theory that I’m going to return 20 or 30 times your capital, for that to be credible, I need to see that you’re de-risking the whole model. How could you possibly contingency plan if you don’t even know the industry, you don’t know your competitors, you don’t know your space?

There’s the white lie, reasonable exaggeration. Like when you say your market is $50 trillion or whatever — sure, fine, it’s a big market. There are things like that. Or like, we’re going to go from $0 in revenue to $50 million next year. Yeah, maybe. Almost everybody has a hockey stick, and very few of those companies actually have the hockey stick in fact, right? So those types of future projections that are wrong — no problem there.

But you also want to be realistic, right? I want a hockey stick, but a hockey stick that makes sense. If it goes from zero to a million next year and it’s because you’re closing a million now and you have a plan of how you’re going to go to a million and then to $4 million, great. If you say you’re going from zero to a billion, it’s like, hey, how are you going to do that? Great, you’re going to close 62 customers today, call me tomorrow and let me know how that went, and then we’ll continue the process.

So you kind of want to walk that line where it’s reasonable to be optimistic about the future. Different investors have different preferences as to how optimistic they want their founders. Some like the visionary, pie-in-the-sky, “I’m going to blow up overnight,” and they like that. Others lean toward, we’re trying to build a big company, but here’s 72 risks, and I’m mindful of those risks.

Personally, I think having a balance of those two is right like being mindful and being deliberate but still taking risks. It’s okay to take risks if you’re reasonably mitigating them. I kind of like somebody in between, but I know some investors that get really turned off by the overly optimistic or the overly pessimistic founder.

Shubha K. Chakravarthy: Great.

So we’ve talked a lot about getting your first round, the structure. Let’s say it’s a SAFE or convertible, let’s say it’s anything other than a priced round, right? But at some point, presumably you’ll go into your first priced round, Series A, whatever the case might be.

Preparing for a Priced Round

Shubha K. Chakravarthy: At that point, what are the biggest surprises or the biggest blind spots that you see founders facing, and how should they be thinking about and preparing themselves for a priced round when they’re earlier on raising on SAFEs or convertible notes? Any thoughts on that?

Benjamin David Novak: Sure. There are a lot of blind spots. I guess one big category of blind spots is just how your cap table looks coming out of your Series A. Many founders take a somewhat simplistic view of, I want the highest pre-money valuation possible. Okay, I get this, this is the right amount of money that I need. Okay, that’s only going to be this amount of dilution.

Yes, but if you have a bunch of SAFEs and notes outstanding, it’s not just going to be giving away 20% or 25% or 30% of your company. It could be drastically more depending on the terms of those individual securities. And if you have a blend of SAFEs and notes, it’s even more confusing. And if you have a blend of SAFEs and notes and they have different terms, like a pre-money SAFE with a discount and no cap, and a post-money SAFE with a cap and no discount, you really have to do some pretty complicated math.

Doing the math is not the hard part. It’s finding out the decisions that you made years ago have real consequences, right? If you’re working with post-money SAFEs and you continue to raise on another SAFE and another SAFE and another SAFE, you’re really drastically diluting yourself. And you may not appreciate how much that dilution is until you get to that priced round and you do all the math to figure out exactly how many shares each person is going to have walking away.

You can negotiate with the new-money investors, but you’ve already given away those rights to the convertible security holders. The note holders, the SAFE holders have already locked in their rights. It’s pretty hard to renegotiate with them when you’re negotiating with a Series A lead.

I’m not saying you need to model out every possible scenario, but as soon as you go from one financing structure to folding in a second, you do want to not just think about this round, but think about what happens if our Series A is at $10 million pre, $20 million pre, $100 million pre. How does everything else play into that?

Another category of blind spots is the things that you’ve done early on could really complicate a Series A round or potentially kill it. Say you’ve given away things that you didn’t realize you were giving away. You took a million dollars on a post-money SAFE with a $2 million cap or something, and you didn’t realize that you were giving away half of the company going into the next round.

So you gave away half your company to this guy. Now the new investor is diluting them down. The new investor doesn’t want to be diluted by the stakeholders, so they disproportionately dilute the founder. There are all kinds of problems that might result in the investors saying, we can’t work with this cap table, or we need to recap the company in order for us to come in.

And that’s just painful, to have those conversations with early investors. You’re going to your grandmother’s house and telling her why you’re changing the cap on her note to make it work for her. Nobody wants to do that.

So this goes back to financing strategy and being deliberate. You want to have these things all line up. One thing leads to the next thing. One of the questions I often get asked in podcasts like this is, what’s the differentiation between the companies you see that are successful and those that are not successful?

One of my go-to answers for this question is basically the companies that do this well and get to the really successful exits where the founders and the investors do well are the founders that raise a limited pool, use whatever resources they have to get to another limited pool of resources, to get to another limited pool of resources, and so on and so forth, to ultimately get to a nice exit.

When you don’t get to that, when you have that bridge to nowhere, where when you run out of capital you’ve kind of built a company that nobody wants to continue to fund and you’re not making money, that’s a really tough spot to be in. The founders that think through not just today’s step, but think about this as a chess game and what’s their next move and what’s their move after that, those are the ones that tend to do particularly well.

Shubha K. Chakravarthy: And how common is it? I know the $2 million cap was a very extreme example, and I’m sure that you’re making it for illustrative purposes but how common is it that you see really significant problems coming into a priced round where people didn’t think ?

Benjamin David Novak: So, once again, my motto here is not “engage counsel on day one.” You could choose to do that or not do that. But I do see a big divide between those that were well advised, either by legal counsel or otherwise early on, versus those that were not.

You wouldn’t believe how many founders I’ve asked to explain the difference between a pre-money cap and a post-money cap, and how many of them get it right. It is a very small number. I’ve heard all different types of answers, and probably outside the scope of this presentation how to calculate that. But if you’re a founder and you’re raising on a note or a SAFE, you should know whether the cap is a pre-money or a post-money cap, you should know what that means, and you should understand the implications of that in the future. Very few founders appreciate that.

Shubha K. Chakravarthy: I will write a note to myself. We need a guest to go talk about that. So if you have somebody to recommend, I’d definitely be willing to talk to them.

Benjamin David Novak: This is another issue about SAFEs quickly. It’s a simple agreement for future equity. Obviously, a SAFE is not safe, it’s just an acronym for simple agreement for future equity. I kind of object a little bit to this being called a simple agreement. I’ll get on board with it being a short agreement. So if we want to call this a short agreement for future equity, fine. But I don’t really think it’s a simple agreement for future equity.

The way it’s drafted, the current three post-money SAFEs that Y Combinator endorses basically have definitions and definitions that are pretty cumbersome to understand. Even if you’re an attorney, if you don’t do SAFE financings all the time, it’s very difficult for you to understand what your rights are as a SAFE holder.

What happens at the next round? What if it’s a big round? What if it’s a small round? What happens if it’s preferred stock? What happens if it’s common stock? What happens if there’s a convertible note that’s raised in between my SAFE and the next round? What happens if there’s a SAFE? What if it’s a higher cap or a lower cap? Can they do that? Can they not do that? What happens if the company sells before my SAFE converts?

It’s important to understand those things. As an investor, I certainly want to understand what my rights are if the company sells before my SAFE converts. But so many people I see on both sides of it, where the founders don’t really know what would happen and the investors often don’t know what would happen. And if you don’t have advisors to explain that to you, it just sometimes results in mismatched expectations.

And that results in all kinds of problems. I’ve seen lots and lots of SAFE litigations, and we’ve helped multiple companies on the company side or the investor side suing each other over disputes related to this very short agreement. And unfortunately, very often it’s expensive litigation because the six-page document didn’t contemplate the specific fact pattern. Because it’s only six pages. So I see SAFEs all the time kind of blowing up because one or both of the parties that signed the contract don’t really understand its terms. So short agreement, but I don’t know if it’s simple.

Shubha K. Chakravarthy: I’m just loving this conversation. One other thing I want to talk about is, you talked about this dilution, you talked about board rights, you talked about a bunch of different things outside of just pure money that is coming and changing hands in a fundraising.

Post-Fundraising Changes and Expectations

Shubha K. Chakravarthy: Can you talk at a high level in terms of what founders should be aware of and prepared for after fundraising, in terms of how life changes for them, in terms of how they manage the company? Just at a high level, what should I be prepared for as a founder?

Benjamin David Novak: Yeah, so a couple of things. First thing to recognize is, the day you take outside capital is the day you’re up for sale, right? You can’t take somebody’s money saying, I’m going to return your money or more money, without having a plan to kind of work toward doing that.

For most of these startups, it’s not turning into a profitable business, it’s driving toward some exit event, like a sale of the company or an IPO. And you can look at the statistics, but the chances of an IPO are really small. So let’s say 90-something percent of the time, the hope is you’re going to sell this company.

And so it’s important to understand that if you want to do a lifestyle business where you’re going to be the CEO and own this company for the next 40 years, great. Don’t raise capital from outside investors, right? It’s a different game plan — being a lifestyle business versus a scalable startup company.

So the first thing to appreciate is if you’re taking capital from anybody, you have a fiduciary duty here to serve those people. And part of that might be working toward an exit in the foreseeable future or some sort of liquidity event for those investors. Specifically to your question though of what things change, a lot of it kind of depends on who’s coming in and what their negotiated or expected rights are.

As a SAFE investor, if they just get a SAFE and you don’t have a side letter, not a whole lot changes as a founder in that you don’t have to give away a board seat, you don’t have to give away a stock seat, you don’t have to give them information rights or inspection rights or preemptive rights or anything. If they just sign a SAFE. If they sign a side letter, there may be other expectations in there.

On the other end of the spectrum, with a preferred stock round, a lot of things change, right? So if a VC is coming in, or any sophisticated investor that’s negotiating a Series C or a Series A round, they’re probably asking for a board seat, at least one board seat.

And so if they come on board, there’s going to be more discipline imposed, and that’s not necessarily a bad thing. Very often it’s a good thing that they’re imposing this discipline. You’ll have more regular reporting. It’s customary to give the Series A investors quarterly financial statements, annual statements, sometimes audits depending on the stage of the company. You’re probably going to be having quarterly board meetings.

So a number of things kind of change, not necessarily in a bad way, and how burdensome or not burdensome they are kind of depends on how it plays out, regardless of what the contractual rights are. I think one of the most important things in taking capital though is just really getting to understand your investor and make sure you’re seeing eye to eye, right? So if your investor is planning on being a super active investor and plans on attending board meetings or meeting with you monthly or weekly or who knows what their expectations are, you want to make sure that they’re aligned with what you want.

You may want this person to be on your board, even if they don’t have the contractual right to do so. Or your investor may be really passive, and you may want a more active investor that can be more actively involved in introducing you to your next hire or bringing in the next customer.

So there’s not one right type of investor or wrong type of investor. There aren’t good investors or bad investors. A lot of it really comes down to fit. What does the company need? What is the company looking for? And is the investor somebody that can offer that?

This gets back to kind of the multiple term sheets. In the end, it’s not just like, is this a higher valuation or is this a higher valuation? What are the terms of the offers? Who is the person? How are they envisioning this relationship? What’s the force multiplier? Are they going to come in and then give us access to 42,000 customers because of whatever they have that the other VC doesn’t have?

So what are they bringing to the table apart from the money? I feel like sometimes that gets overlooked. People see the big pre-money valuation, and they say, well, we’re clearly going forward with this term sheet. And sometimes that makes sense and sometimes it doesn’t.

Shubha K. Chakravarthy: So again, do you see a clear divide between the founders who have managed that transition well to post-funding and I’m thinking more like the sophisticated investor side and less about the SAFE investor side, what are they doing and at what point did they start preparing for that? What are they doing differently so that transition to post-funding and managing sophisticated investors happens more seamlessly and successfully?

Benjamin David Novak: It really depends on a lot of different variables here. But what I would say is you’ll want to understand what the investor expects before you take their check, right? And whether it’s written in the contract that you’ll have a monthly call or not written in the contract, if they’re expecting a monthly call, you should agree to that or not take their money basically. There’s the statistic out there that the average time from a seed-stage investment to exit is longer than the average marriage in the United States.

Shubha K. Chakravarthy: I’ve heard that, yeah.

Benjamin David Novak: These are people you’re going to be stuck with for a long time. So make sure you’re picking the right person. Don’t just pick the person that offers you the best deal, because it’s really going to have a high impact on your quality of life.

As a CEO, you report to the board. When the founder is the sole director, it’s easy to report to yourself and you don’t give yourself a hard time. When you’re reporting to an outside person, it’s a different dynamic, and you need to see if your vision for the company is the same or not. If they’re pushing to sell in the next three years and you plan to not entertain any offers for the next 10, that’s going to cause a lot of problems and mismatch and could result in all kinds of issues for the company that harm everybody.

Aligning Incentives with Investors

Benjamin David Novak: One of the things that I like about my job is that it’s all about aligning incentives. It’s less of, I propose six and they propose eight and we compromise on seven. That’s a very small part of my job. A larger part of my job is structuring things where we all can succeed together.

If I’m company counsel, giving the things to the investor that make sense for the investor to have, and the investor giving to the company the things that make sense for the company to have kind of creative problem-solving and coming to a place where everybody can succeed together.

And that’s one of the things that I like more about my job than I probably would not enjoy being a litigator or most other jobs in the law. I probably would not love those zero-sum games of if I give you a dollar, you get a dollar and I lose a dollar. Most of my job is really about creating efficiencies and synergies and creating value and aligning incentives.

Shubha K. Chakravarthy: This is a great point. I just want to ask you one tactical question on that. So you’ve been on the other side as an investor, negotiating deals, you know the lawyer’s point of view. How does this happen? In a very simple vignette, in terms of aligning what the expectations are between, let’s say you’re about to sign a check to a founder. These little things about how active am I going to be with your company, how do those agreements get made? How do those expectations get set for someone who’s not familiar?

Benjamin David Novak: I’d say it’s formally and informally. The lawyers will draft into these documents covenants. There’ll be specific promises that you will do certain things in the future. So in a typical Series A, there’ll be information rights. The company will deliver to certain investors quarterly or monthly or annually financials, maybe a budget, maybe other reports. Some of it’s written down saying you covenant that you will do these things.

And that pretty clearly sets the expectation. When you negotiate and the investor says, I want monthly financials and you say annual and you compromise on quarterly, it’s pretty clear that you signed a contract saying you’ll give quarterly financials. So they expect that and you have to do it.

Other times, a lot of it’s more soft, right? Like the active versus the passive. One of the best ways to diligence your investors, if you have the luxury of doing so as a founder, is to speak to other CEOs that they work with. It is very reasonable if a VC is giving you a term sheet for a Series A financing to say, I’d like to speak with a couple of the CEOs of the companies that you’ve invested in, specifically ones where you serve on the board.

And I’d talk to those CEOs and say, hey, what’s this person like on the board? All different types of things come out of those calls. Generally the three CEOs that they’ll connect you to are their favorite, best relationships, and they don’t have horrible things to say, but I’ve seen all kinds of things come up.

They’re not just going to say he’s a horrible person and don’t take his money, but they might say he’s a lot more active than I thought. He expects this. I wasn’t expecting that. He shows up at Thanksgiving dinner or whatever. You’ll find out more when you talk to other companies that they’ve invested in.

In my opinion, it’s completely reasonable and appropriate to ask for that. And similarly, it doesn’t need to be a person taking a board seat, a VC. It could be Delaware Crossing Investor Group. We’ve had CEOs that we’ve offered a sizable check to, and especially if we’re getting a board seat, and somebody said, can you connect me to some of the other CEOs of boards that you serve on just so I can do my diligence on you?

Once again, not good or bad, it’s just is it a good fit? Do you want them active? Do you want them passive? Do they have the right network? Do they have the right industry expertise? There’s lots of different things that you can do. We always talk about the diligence that the investors do on the company, and I feel like we do not pay enough attention to the diligence that the companies should do on the investors.

Shubha K. Chakravarthy: But isn’t there also a process where I am kind of soft-negotiating some understanding with you. I’m the founder, you’re the investor and we need to come to some kind of terms? Because each relationship with each company is different, because every company and every founder is different. How does that process work the best? And what counsel would you give to the founder to set up that relationship for the best?

Benjamin David Novak: I think it’s kind of crazy that people sometimes invest in CEOs that they’ve never met in person. I personally like meeting with my CEOs, going to a bar, grabbing a drink, getting a coffee, breaking bread with them. I think that is a really good opportunity to get to know each other.

And yeah, we’re not going to be going through financial projections over a drink at the bar, but we’re going to be getting to know each other and things outside of the company, your family, what’s important to you, your life goals. Those things all kind of impact the relationship. So just understanding who you each are as people is really helpful in determining if the investment is a good fit or not.

So I would say, on both sides, it’s really important to get to know one another inside and outside of work to assess fit. Because once again, these are people that you’re going to be regularly communicating with on very important things for a decade. So it’s important that you pick the right person.

And yeah, sometimes that means saying no to your only term sheet, hoping a second one comes. You have to be a little brave to do that. It depends on the situation. I’m not saying that’s always a great idea. And many founders don’t have the luxury of picking their investors. But it is very important to make sure that you see eye to eye, because it really leads to things that are effectively company killers if we start misaligning incentives like that.

Shubha K. Chakravarthy: I’ve heard of investors inviting founders to go out to dinner or whatever, but I haven’t heard as much about founders inviting investors to go to dinner. So if the investor wants to be passive or you don’t know enough about them as an investor, are there things that founders can do to get a better sense of what it’s like to work with you?

Benjamin David Novak: I personally never say no to that opportunity. If it’s somebody who’s raising on a SAFE in a life science company, you know, somebody who I’m 100% not a good fit for, maybe I don’t spend a couple hours breaking bread with them always. But if it’s somebody who pitched us and we’re interested in investing and they’re in the pipeline, yeah. If they invite me out for a drink, I would happily take an hour or two to go out for a drink.

And vice versa. I think it’s an important part of the diligence process to get to know these people. And I like doing some of that in person. Part of why we have a geographic limitation at Delaware Crossing is we want to be able to meet with our CEOs in person. At Delaware Crossing, we invest primarily in Mid-Atlantic–based companies that we define as Boston to DC, Pittsburgh to the ocean, which makes it pretty easy for us to drive within that geography to meet with people in person.

Not saying that’s right for everybody. And I totally appreciate why other groups don’t have geographical limitations. But the people who are part of DCIG like that we can get pitched in person and meet in person pretty regularly.

Shubha K. Chakravarthy: Fantastic.

Final Thoughts and Key Takeaways

Shubha K. Chakravarthy: You’ve given us an enormous amount of insight. So if you had to boil it all down, the things that we’ve talked about in terms of maybe a few key principles or actions that a founder who’s not done this before, not super familiar, going out for their first outside round should keep in mind, what would that be?

Benjamin David Novak: So the one thing I haven’t mentioned yet, and maybe I should have started with this, is listen to everybody, but don’t take everybody’s advice. So listen to me, listen to brilliant people like Shubha, listen to your business advisors, but don’t take everybody’s advice.

Back to that adage of ask 10 angel investors the same question, you’ll get 11 different answers. Not everybody has the right information or wants to convey the right information or has experience in your specific facts. Talk to lots of people, get lots of input, get lots of information.

But you, as the CEO of this startup company, you’re the founder. You get to make the calls, and ultimately the success or failure largely rests on your shoulders. So be well informed. But just because somebody says move your team slide to the last slide, move it to the first slide, don’t worry less about that stuff. Everybody has a lot of strong opinions on things that aren’t particularly important. Listen to people, make them feel heard, but then it’s up to you whether you actually take their advice or not.

Other than that, I think be deliberate, be strategic. People don’t build ridiculously successful companies by accident. This takes two different things. Sometimes I joke that it’s really easy, really, really easy to build a successful scalable company. You just need to do two things. The first thing is always do everything right. And then two is get lucky.

And unfortunately, one of them is not enough. If you do everything right, you definitely are not guaranteed to be successful. If you get lucky, you are definitely not guaranteed to be successful. But if you do everything right always and forever and get lucky, you could build a successful company. So just focus on those two things.

Shubha K. Chakravarthy: Okay, we’ll do our best to do that. Is there anything that I should have asked you but I didn’t?

Benjamin David Novak: Oh, that’s a great question. Nothing comes to mind. Thank you so much for the opportunity to do this. I very much have an open door to you and anyone in your network. You’ve been a great friend and colleague to me over the years, and if there’s anything I can do for you or anybody in your ecosystem, please feel free to reach out.

Shubha K. Chakravarthy: Thank you. And Ben, you have been amazing both in my work at the ACA, and you’ve been so generous in sharing your insight. I loved all the stories, I love the points. I know that founders will appreciate this. So we really want to thank you for being here and taking time. I know a lawyer’s time is very valuable. You’ve taken an hour and a half. So I really appreciate your time, and thank you very much for doing this for us.