The Funding Game: Mastering SAFE Notes, Board Seats & Control - E596

"In general, the more successful a startup is in the early stages and the faster they grow towards a unicorn, the more likely the founder is able to maintain majority control even all the way to exit. So if you look at, for example, Mark Zuckerberg—even though he has a minority share in terms of his economic rights, in terms of a percentage of the entire company—he has a special class of shares that gives him control and voting rights that allows him to have an outsized control versus his actual economic control. But that's a function of the fact that Facebook grew very fast and was very successful, and investors were willing to give him more control rights even though they were taking up economic rights for themselves to share in the risk and reward." - Jeremy Au, Host of BRAVE Southeast Asia Tech Podcast

"Anti-dilution provisions are basically saying that investors have the right to protect themselves from dilution over time. There's all kinds of versions of this—ratchet versus full weighted average—but they're quite significant, and they actually can be quite onerous in Southeast Asia, primarily because of the smaller size of outcomes historically to date, but also the less mature VC ecosystem. So this is something for you to be aware of. And lastly, of course, is the employee options pool size, which is how much of the economic pool we are saving for employees. Because you, as a VC, you're negotiating with the founder, but then the VC wants to make sure that there's enough economic upside to be shared with the key leadership team who are not the founders, so there is a third person in the room that is not being compensated for, and this is how they discuss and negotiate that." - Jeremy Au, Host of BRAVE Southeast Asia Tech Podcast

"Convertible notes and SAFEs are simpler instruments that were generated over time. So in the past, if you go back 30 to 40 years ago, all investments were done through priced equity rounds. But convertible notes came second, and what they were was that convertible notes were basically saying, 'How do I create a debt instrument that allows me to be protected as a debt instrument for the next, for example, two to three years, but at the right timing be able to convert into an equity type of outcome?' So it's meant to be a simpler document which uses a short-term interest rate as well as some other control mechanisms, but basically it looks like debt in the short term but converts into equity at a future date. Convertible notes were historically built to make it easier for early-stage startups to use less lawyer time, use less accountant time, and come to agreement about what needs to be done." - Jeremy Au, Host of BRAVE Southeast Asia Tech Podcast

Jeremy Au broke down the real stakes behind early-stage fundraising—where founders trade equity for survival, and investors negotiate for control. He explained how financing tools like SAFE notes, convertible notes, and priced rounds shape who gets rich, who gets a say, and who gets left behind. From legal traps to boardroom dynamics, this session reveals what every founder should know before signing a term sheet.

01:05 Understanding Startup Economics: Jeremy explains how startups face a "valley of death" where they burn cash before reaching profitability. He introduces the idea that funding always comes with tradeoffs in economic and control rights.

01:39 Debt vs. Equity: Key Differences: A breakdown of how debt requires repayment and protects ownership, while equity gives up a piece of the upside but doesn't need to be paid back if the startup fails.

03:23 Equity Financing: Preferred Stock, Convertible Notes, and SAFE Notes: Jeremy walks through the three common fundraising tools, how each works in early-stage rounds, and why SAFEs have become the global standard for speed and simplicity.

08:00 Control Rights and Board Dynamics: The discussion turns to how board control shifts as startups raise money. Jeremy explains why early governance decisions shape long-term power and influence over the company.

(00:50) Jeremy Au: So a next stage we're talking about is really about product market fit and experiments and scaling.

(00:55) And what we're seeing here is that we're moving into the economic and (01:00) components of this. 'cause previously I was talking about is the, setting up the company, how the founders come together. But the key thing we need to talk about and understand is that startups require money. And there's a value of death because they need a lot of cash to support them before they become truly successful and able to become profitable or break even.

(01:18) And the way to think about it is that investors provide capital for a price, right? And that price comes in two forms, economic rights as well as control rights. So that's how I would think about it. So economics in terms of what is the risk and reward that we share, and then the control rights is my ability to have a say or have a point of view about the future of this company.

(01:39) So in terms of economic rights, in general in terms of capital provision, there's two types of capital that's provided. There's either debt or equity. And debt obviously is what we all understand is credit card debt or bank loans or receivables financing.

(01:52) But very much basically saying is like I want to give you cash and you'll pay me back in cash. So that's pretty much a debt. (02:00) And because of that, I will have collateral, I have the rights to certain assets of yours in order to make sure that if you default, then I'll be able to pay myself back.

(02:08) And obviously there are many benefits to debt as a result. And then for equity, you're providing capital. But then because I provide that capital, I deserve a share of the future rewards in the company, right? The future profits of the company, the future dividends of the company.

(02:21) And as a result, I think there's a bit of a bifurcation in the general economic upside as well as the control rights are available. The first thing to understand is that obviously debt the benefit is that.

(02:31) You are able to maintain full ownership of the company over the long term. But of course, equity, if your company fails, you never have to pay back the debt, right? Like upside risk versus downside risk. Another thing that's of course is important is that equity financing is very much understood to be how home runs happen.

(02:47) So for example, as you move towards a home run, because you have that home run perspective, people want a share of that pot of gold, right? They don't really care about this debt perspective because they can always provide debt to companies that are much more, (03:00) stable and less risky. For example, an F&B chain or, some sort of basic, investment vehicle or property.

(03:06) So there's a bunch of different opportunities are there as well. And of course I think for debt, normally they will want collateral. There's their primary control mechanism versus for equity, they'll tend to use more advisory or board control rights to get supervision over the use of funds. Zooming into equity, I think there are three major components that you often hear.

(03:27) And again, this is not meant to be fully exhaustive, but there are three types for you to be taught that are either equity or equity linked. Preferred stock, there'll be a price round, convertible nodes and then as well as a safe note. So I. What I will try to explain this a little bit is that a preferred stock is your classic equity, buy percentage of your company.

(03:47) And for many of you, you also understand this from investing in the public markets. 'cause when you buy in public markets is a price round, you know what the price is. And so a lot is relatively straightforward. You as a retail investor, have investor protection (04:00) similar to a preferred stock shareholder because you are buying the company.

(04:04) The court does protect you with significant rights to say that, you must have investor rights, you need to have information and audited financials, things like that. But of course, for price equity, you do need to assess the price of the company.

(04:16) For public companies, obviously that's done by the supply and demand of what's available out there, but that can be quite difficult for a startup to value, right? So if you are a company, for example, that has. $10 million of revenue, your valuation is a hundred million dollars. Your technology is incredible and could create a unicorn company in two years, but you are three months away from dying as company.

(04:38) What is the price of that company, right? And that can be something that be subject to not only negotiation, but also a lot of debate. As well, convertible notes and saves are simpler instruments that were generated over time. So in the past, if you go back 30, 40 years ago, all investments were done through, price equity rounds, but convertible notes (05:00) came second.

(05:01) And what they were was that convertible notes were basically saying, how do I create a depth instrument? That allows me to be protected as a debt instrument for the next, for example, two to three years, but at the right timing, be able to convert into an equity type of outcome. So it's meant to be a simpler document which uses a short term interest rate as well as some other control mechanisms.

(05:25) But basically it looks like depth in the short term, but converts into equity at a future date. Convertible notes was historically built to make it easier for early stage startups to use, less lawyer time, use less accountant time, and come to agreement about what needs to be done. The Safe Note was created by Y Combinator and has been updated several times and is an even simpler version of the convertible note.

(05:48) And what they've done is they simplified and remove even more investor protections in the interest of making it easier for the founder to operate but also remove the interest component, which is a function of (06:00) debt but created for example, a valuation cap and discount. Which basically says that when there is a future price equity round this safe or comfortable note will convert at a certain percentage to the preferred stock equity round in future.

(06:14) So the safe node is the simplest version of the convertible node. For example, if you go back 10 years ago in the US in the West Coast, a lot of people using the YC Safe note and a lot of people in New York, for example, were very adamantly against using the safe. As angel investors 'cause they felt that safe noes were not protective for investors and so they're using convertible nodes.

(06:35) Imagine east coast startups are using convertible nodes and west coast startups are using safe notes. I'll say in today's age, 10 years down the road it's a very different world from when I used be fundraising as a founder. In today's world I think East Coast and West Coast predominantly use safe noes in the early stages.

(06:51) And I would say globally most people have started to use the safe note as a standard document as well in Singapore or different jurisdictions as (07:00) well. So when you do a price equity round, there are three major documents that will come up

(07:03) one is a stock subscription agreement. Second one is the shareholders' agreement, and the third is a stock purchase agreement. So the first for stock subscription agreement is really talking about the terms and conditions for purchasing the shares. The shareholders agreements is. Really like the obligation.

(07:18) So a little bit of the constitution about voting rights how things can be done. And then your stock purchase agreement is really about talking about the individual closing conditions for those purchases to be made. What I would say is really key is that whenever you make a decision and negotiate this cut around for price, equity round is something that's likely to be inherited by future shareholders.

(07:39) So it's very important that whether you're a founder or VC is you need to know that whatever you build is something that's going to be lasting for a very long time. So that's where I think some of the expenses rack up pretty quickly because people are very thoughtful about negotiating the best possible agreement even at the earliest stages.

(07:56) Last few slides that I'll say here is there are several components to think (08:00) about. One is of course, really about control. Rights is a big one. So control rights is that obviously once you have a price equity round, that would generally will be a board directors, which would be similar to other board directors for public companies.

(08:10) They would hire and can fire CEO, they can improve the budget, and the size we tend to grow over time. So obviously when a company's incorporated, it may be one or two people, maybe if a solo founder, it could be the solo founders, the board of directors, maybe there are two co-founders or two of them on the board of directors.

(08:25) But when your first seed startup comes up, they may open up that board and they will start the process of creating good corporate governance. So they may have, three to five bot seats in the early stages. And then growth stage startup may have five or seven. I've even seen 10 or 11 bot seats as well.

(08:43) Now obviously decisions tend to be majority or super majority depending on different conditions, and obviously there's a little bit of debate between the right proportion and mix of it. So at a start in the earliest stages, founders will have much more control. And then over time as investors come in, generally there'll be more and more (09:00) investors and they can eventually become the majority of the board.

(09:02) At the late stage startups sometimes the founders and investors may agree to nominate on independent board directors and independent board directors are supposed to serve as a bridge or as a neutral ground between both sides. Obviously there's a lot of debate that happens there as well. Now that being said what I would say is that in general, the more successful a startup is in the early stages and the faster they grow towards a unicorn, the more likely the founder is able to maintain majority control, even all the way to exit.

(09:29) So if you look at, for example, Mark Zuckerberg even though he has a minority share in terms of his, economic rights in terms of a percentage of the entire company. He has a special class of shares that gives him control and voting rights that allows him to have an outsize control versus his actual economic control.

(09:47) But there's a function of the fact that Facebook grew very fast. I was very successful and investors were willing to give him more control rights even though they were taking up economic rights for themselves to share in the risk and reward, the key economic terms (10:00) for you to understand. The second last slide here is in terms of equity rounds is the valuation, obviously.

(10:04) So how valuable is the company today when you negotiate price? The second is the investment quantum which is how much lead investors putting in versus how much capital other investors are allowed to put in. So how much capital is joining in this round? Obviously there's a pre-money versus post money valuation.

(10:21) So for example, your last round was a 10 million valuation. I now put in $10 million more to buy 20% company. So your company valuation is now 10 times five equals 50 million. The pre-money valuation is $40 million. And after adding cash of $10 million. The company is now worth post money, $50 million. So there's a pre versus post money.

(10:40) You just have be aware that these are different things and I've literally seen lawyers screw this up. And have people and investors argue about this one year to two years down the road about pre-money versus that post money. So I just wanna say this, that if you are founder or vc, you should not necessarily trust your lawyers to draft this because math can be (11:00) hard for lawyers.

(11:01) And I have seen tier one lawyers mess this up, so it's unbelievable. So make sure that you understand the difference here. Liquidation preferences also quite key. So for example, there's a liquidity waterfall. So for example, what does this means is that if you are at the top of the liquidity waterfall, your money comes out first.

(11:18) And if you're at the bottom of liquidity or the waterfall, you'll be paid last. So for example is, let's just say the last round valuation that you had was a hundred million dollars, but you sold to a strategic acquirer for only $50 million. All right, so you $50 million of proceeds, but valuation was a hundred million dollars for the last round.

(11:38) The 50 million will only compensate the top 50% of the shareholders. So it flows in and flows down. So normally what is that your latest round investors tend to be at the top of the liquidity waterfall, then your series B, then your series A, then your C investors, then your founders, and finally your employees.

(11:56) Then be at the bottom of this liquidity waterfall. So this is (12:00) the something for you to be quite thoughtful about. Anti-dilution provisions are basically saying that investors have the right to protect themselves from dilution over time. There's all kinds of versions of this ratchet versus full week to average.

(12:12) But they're quite significant and they actually can be quite onerous in Southeast Asia primarily because of the smaller size of outcomes historically to date, but also the less mature VC ecosystem. So there's something for you to be aware of. And lastly, of course, is the employee options pool size, which is how much of the economic pool are we saving for employees?

(12:32) 'cause you as a VC, you're negotiating with the founder, but then the VC wants to make sure that there's enough economic upside to be shared with the key leadership team who are not the founder. So there's a third person in the room that are not being compensated for, and this is how they discuss the negotiate that.