How Founders Master the Art of Investor Relationships

Ben Su 

Thank you, Hessie. Happy to join. 

Hessie Jones 

This is a great this is a great topic because I’ve been receiving a lot of questions from founders every time there is a critical conversation with a potentially new investor or a new advisor or a new co-founder, it always. Delves into what is good for me and legally. What can I do? So let’s start off with. You and your background as someone who went to law school and now you’re a startup founder. Please take us through that journey and how that’s kind of shaped where you are today. 

Ben Su 

Yeah, absolutely. So I was actually a startup founder before I went to law school for brief. I was I I I started a biotech company in the last year of my undergrad. I was studying biochemistry and I got into the biotech world. And yeah, I got to work on male infertility diagnostics. I got to see the whole process. You know, licensing the pan to a farm. And then getting some exit out of it. And then I went to law school precisely because of that founder experience. I hated having to deal with the new black box and the complexity associated with legal. So that’s why I chose to go to law school. One of the reasons why I chose to go to law school. Yeah. And after law school, I I I worked in House, uh in startups big and small. The biggest startup I worked with was the new Stock Exchange listed company that manufacturers about couple 100 thousands of electric vehicles and develops full self driving technology. Yeah. And also I sat on both investor side and founder side in terms of venture financing deals. So I got to see you know the different objectives or the similar objectives from both sides of the negotiation table. So that kind of like opened up my what view. In terms of, you know, the unique role that. Lawyers play in the venture technology world, which led me to Co found Capita. We’re trying to reinvent the legal services industry for startup entrepreneurs using technologies like AI. 

Hessie Jones 

OK, so you you. Just sent me a little story about yourself earlier. You had a bit of a run in with the law and that has really shaped your thinking. Can you tell us a little bit about that? 

Ben Su 

Yeah, absolutely. So I was unlawfully detained by by the Toronto police. Nervous and it went down, the whole thing went down for another additional 2 years of malicious prosecution. Eventually all the charges were withdrawn by the Crown prosecutors. 30 seconds into the trial. In the whole interaction with the police, I never once mentioned I was a lawyer because I was actually curious, you know, like, I read about all these things. That happen on the news article. I want to see if it’s real and also at the same time like I had experiences representing clients at the Human Rights Tribunal. I was a national award winner for my pre critique on the Supreme Court’s decision on the Charter of Rights and Freedom. So yeah, like I want to see as like kind of like a hobby. I wanted to find out about where the police could take this. And surprisingly, the news articles. True and and and I I think it was it provided me some unique perspective on this in a way that you know if if it wasn’t without if I didn’t have access to the premium subscription of ChatGPT Gem 9 and Deep Sea. I would not have gotten out of the situation. I found myself in, yeah. 

Hessie Jones 

Now, can I ask, can I ask even without that you you’ve already had the skills of a lawyer. So understanding what? What the process was, what documents you need to access. For somebody who is in your exact same situation but doesn’t have that legal background, they’re already at a loss. And the outcomes would have been different. 

Ben Su 

Yeah, absolutely. And I would say my outcome would mean different even if you know, I was even, even though I am a lawyer and the outcome would be different if I didn’t have access to AI. The reason is because I didn’t have the time to dig through the jurisprudence. And draft all these, you know, documents for judges to see. Right? And AI essentially made it possible for me. To you know, look in the pictures Buddhas formulate a legal argument and even design a legal strategy to to navigate through this whole mess. Right? And and I actually published an article on Law 360 saying that, you know, when the system came for me. My Co counsel was AI and. If I were to kind of like make an example or analogy that resonates with the tech world, it’s like, you know, you’re an awesome Google engineer, but it doesn’t mean you’re good at building an app for your family to use to, you know, to allocate yours, for example. But with now with AI. Maybe in 20 minutes the yeah, I can spit out the codes for you and give you a usable product, and that’s what I did for me. You know, in 20 minutes I was able to interact with the AI and actually draft the application at the Human Rights Tribunal against the Toronto Police and. And and but the the. The caveat is that I I am legally trained, I am knowledgeable of the constitutional law about the human rights law. I was able to see some of the hallucination that people talk about in AI. I don’t think AI is usable by a regular. Consumer yet to, you know, replace lawyer at this stage. But I do think like the unique position I was in, you know, I was a lawyer. I I know about the constitutional law. I was able to use AI as an amplifier of my power. 

Hessie Jones 

Mm-hmm. OK. I I would say and and because of this unique experience, there are people, let’s say startup founders, who may actually go to some of these DLL’s or sorry agentic technologies, they think as they call now and ask these questions, but not necessarily know whether or not that’s the right question. To ask. And so that’s why I say you have a unique perspective on it. So that leads me to the next question because. I would say that there isn’t a balance right now between startup founders and investors. At the outset. When it comes to negotiation, we know that that this power balance imbalance favors the investor and you as a founder may see capital will see. Capital as a way to achieve growth through your company, but investors see it very differently and because they take a look at it from a risk perspective and they will only really. Invest if they see some some certain signals that allow them to to know that they’re probably going to get some good size returns within five to seven years. So tell me about some of the circumstances in in those early discussions with investors and founders and the moments. When startups don’t really have the knowledge to go head to head with investors. 

Ben Su 

Yeah, absolutely. So I think like everything else in the legal industry, the black box of the knowledge of law can be weaponized against people who don’t have resources, especially financial resources, by those who do have resources. You’re seeing that in criminal law contexts. 

You’re seeing, certainly in corporate legal context when they predatory, you know investor try to enforce predatory terms on a founder who’s just fresh out of college or university, right. So we see quite a bit of those. Uh phenomenon going on in the tech world and sometimes in Canada, I would say we’re very polite people. We don’t like to call people out. But you know, when you’re not calling people out, you’re being silent on these predatory practices that. New first time founders will find themselves in and the most typical predatory practices that we’re seeing is. You know, for example, incubators will ask uh equity, uh stakes in the companies by overly inflating the value of their incubation service. For example, some incubator would say hey, by joining our incubation program, you recognize the value of this service is to be $400,000, which can be converted into your equity into the equity of your company based on the safe that we’re also writing. But the safe is only a 25,000. Dollar check. So you see. A lot of these predatory practices going on and. Precisely, that’s one of the reasons that I wanted to profound capital is I wanted to Dewey Panizza the complexity of the new black box for the startup entrepreneurs. 

Hessie Jones 

OK, this is this is good because like a lot of the things that you’re talking about, we’re, we’re, we’re probably going to get into a little bit more of the details when we talk. About the red. Flags. But let’s start with the earliest point at the start of journey, where you’re form forming a company and you could. Maybe be at, let’s say the third or fourth months and you have a Co founder relationship you’re bringing in potentially a new advisors and you’re having discussions with vendors and partners. So you’re going to have to enter into into legal. Contracts with each of these entities. Right. Advisors may ask for equity in exchange for time that they spend with you, your co-founder, who will be putting in what equity? What does that mean in terms of how, how and when does it get compensated and at what rate does he own the company? And same thing with. With vendors, especially in the beginning when you require specific let’s say components or services that they have to offer, what are some of the thing what does? It look like. In the beginning, when you’re entering into these types of specific discussions that that actually I think for founders, they’re starting to learn about, you know, how to build their company effectively to protect themselves and protect the company. 

Ben Su 

So the way you build a startup is very similar to how you play a game of chess. You can’t just think about what the next step will look like. You have to think about maybe the next 345 steps, right. And in this scenario, when you’re just founding your company in the early days, you have to think about well. Six months ahead of our schedule where we would be and if we’re raising around, how do we put ourselves in a position of success. And this is where you know the alignment of interests of investors and star founders come in, for example. Investors know that 65% of starter failures are due to co-founder relationship breakdown, right. So the simplest thing you can derisk for your investor. Is to make sure that doesn’t happen. And one of the ways to make sure that it doesn’t happen is, you know you have a Silicon Valley VC Compliance Style co-founder shareholder agreement which addresses the scenario that would take place if you guys cannot agree on how you should run the company, right? So. That’s I’d say. That’s one thing that they need to consider in the beginning and also. 

Hessie Jones 

Can I  ask what is the Silicon Valey style shareholder agreement looks like. 

Ben Su 

Yeah, that’s a great question. So we actually took over quite a bit of a startup users from the Big Bay St. law firms. And Big Bay St. law firms because they’re quite generalized, you know, some of them, although you know, you hear them as like this one of the Seven Sisters of the oldest Canadian law firms. But they don’t have, I would say, a specialized venture and technology practice. So typically what it will look like is. In comparison to your traditional brick and mortar business, 99% of the value that the stock is generating. Is in the future. Of the company, right. I would say even for capital we’ve been, we’ve been around for three years now. We raised around back by some new BBC’s in the US, and I would say 99.9% of the value of Capas to be realized probably five years from now. Right. So now that with that in mind, how you’re drafting the shareholder agreement, how you’re structuring the equity, the incentives for the founders, for the advisors and for the early employees can be quite different. Right. So one of the most common things that we’re seeing that a Silicon Valley style startup would have that a restaurant down rail wouldn’t have would be this thing called founder reverse vesting. Right. So what that is, is that hey, if a co-founder leaves the company before the cofounder before the company hit a certain. Age. Then there needs to be a mechanism for the company to repurchase the shares of the cofounder that’s living. The reason you want that is because you don’t want that weight on your cap table, especially when 99.9% of value is to be realized is to be built in the future. It would not be fair for the early employees, the founders, that are remaining on the board and your investor. Come in and say, hey, look, what’s this person holding 30% of shares in your company and they’re doing nothing? Right. So that’s a a very practical example of how Silicon Valley style startups are different from a corporate loss perspective in comparison to your traditional brick and mortar business. 

Hessie Jones 

OK, So what about vendors? So you as you as a startup may have other parts of your business that will fulfill the thing end to end service that you’re offering to to your clients? I think one one of the things that I’ve heard from some companies is try to diversify your your vendor base, your your the services that you offer so that you’re not, you’re not beholden to 1 vendor should anything ever happen. Is there something in your legal agreements that you have to that you should write in so you don’t get stuck? Or on the wrong side when you know push comes to shove. 

Ben Su 

Yeah. So I think this question is most relevant for the first time founders who are, I would say most likely to become victims of predatory terms from vendors. So in the start of world, the most common scenario I would say would be a vendor that’s providing you know, contract development services. To build the technology for that startup. And yeah, like because the first time founders their negotiation, knowledge and power are not on the, I would say the market standard. So the vendors try to get away with a lot of things, especially in terms of like exclusivity, exclusive ownership of the IP. And it’s a common practice in the software development world where if I build a tech for this client and the client uses that for to run their app now. Another another similar startup comes down the road in my pipeline. I can repurpose a lot of the codes that I already wrote for that startup client, right? So that’s kind of like the downside of having an external vendor to build your technology for you in the early stage. And to be honest. I think. There’s nothing. There’s not much. That a lawyer can do to improve that experience. But rather it’s it’s. About letting the founders know that, hey, look, when you’re about to go raise around the lawyers on your VC’s team, they’re going to have to look at your IP assignment. They’re going to have to look at do you have any vulnerabilities or potential disputes that could arise with the technology that you already built? Right. So I think those are some of the considerations that early stage founders need to realize. 

Hessie Jones 

OK, so let let’s dive into the now the legal agreements that a founder will get into as they develop some of the foundations of their relationships with investors, right? You are now a founder that’s ready to to have serious discussions about invest. And and some early stage founders and you mentioned this earlier, they’re looking to lead investors and they look at states as an expedient way to get investment without without valuations. So let’s, I want you to explain what a safe is and why and what do investors think of saves? In general, and why does it does it? Does it favor the investor or the founder? 

Ben Su 

So I actually have quite a. Insights to share about this because when we raise our reason around, we raised from this Android network. Uh, that is probably the biggest Android network in Canada in terms of deal value on an annual basis and we were their first safe investment in history. So the reason why I want to bring this up. Is that I? Think there’s a lot of misunderstanding about saves in the Canadian venture investment market? The reason is because first of all, safe, simple agreement for future equity with this new investment instrument that was invented by Paul Graham, YC, the idea is. You know when. In the typical YC type of investment strategy, you are investing in 100 companies. And based on the power law return formula of venture capital, ten of those 100 companies will generate the entire return of your investment. Right. And that’s how your typical Silicon Valley when Dakota work now in Canada because all quite a bit of our Angel investors, our members of the Android Investor community, they’ve never become a part of that journey, right, either on the start up side as an early employee. Our founder or an investor that invested in a typical, you know, YC company, right, so. What the end result is investors feel unsafe, pun intended, when they’re asked to invest in a safe round. And the reason is because of uncertainties that they have, right or I would say the lack of understanding of the legal instrument. I think first thing. That the investors need to know is that. Uh, yes, you prefer to invest in a seed share purchase agreement. Uh, yeah. Like you would have a lot of like, the corporate law legislation protected the shareholder rights that is typical safe holder or safe investor wouldn’t have. But the problem that they with that logic logical reasoning is that. You are not investing in your traditional business, you’re in. You’re investing in a startup that generates power, law, type of return for venture capital investor. And typically these startups, the outcome can be binary, meaning it’s a 0 or it’s a lottery. Ticket type of win winning, right? So if you try to invest in a company through a share purchase agreement and the company say you know they have a six and Z or YC on the CAP. You will never, never ever be able to participate in those opportunities. That’s number one. And #2 is the investors don’t know that safe actually has this anti dilutive effect especially with the valuation cap safe. So what a valuation. App safe is you can think of it as a call option. I I gave you $1,000,000 you as startup for the right to convert that $1,000,000 into equity in your company when some event happens. Usually it’s when you go out and raise the price round. Now the conversion formula would be. I get to convert equity into your company at a price of no more than typically for a PC company would be 5 to $10 million. Right. So you have a maximum conversion amount. This means that even if. The If the startups went out to, you know, issue or dilute additional shares to bring on, you know, super talented engineers, your your valuation cap stays constant. So that provides some sort of like anti dilutive effect. That’s number one and #2 is that in a typical high growth startup in, in this early stage, it’s very typical for you for the startup to pivot. Right. And if you’re investing in a share purchase agreement, uh, you have even like a seat on the board. You’re taking away the agility of the company to make pivots, and because we’re not going to do a shareholder vote and get a resolution to pivot from a B2B SaaS company into a B2C SaaS company, right, startups need to move fast and break things. So I am anti investing in startups using share purchase agreements or typical price route before the start up head Series A. And the Carter data shows that. I don’t know. If you get to edit this, but like pull up the graph from Carter, I think it shows that more than 70% or like 90% of pre seat rounds in the states are done through a safe. Right. And there’s a reason behind that. It’s not simply just, oh, it’s a founder friendly instrument. No, as it has some investor friendly features built in as. 

Hessie Jones 

Well, OK. I wanted to to just straight up ask you this is a question that somebody had had asked me. He is a company that’s developing. This this amazing technology. And potential investor said. I love it. I want to go in early. He hasn’t gotten any revenue yet. He’s it. The concept is there, but it’s not a working prototype as of yet. So he wants to invest $500,000 for 30% of the company. What’s your take on this? What should he do? 

Ben Su 

I think. Like, you know, $500,000 is quite meaningful amount of money and it it would be quite ludicrous for a lot of founder, for many founders to turn it down. But the catch is that that 30% equity is a catch. The reason why I’m saying that is to bring to scale a company from pre revenue to say a Unicorn stage company that generates a billion dollars in annual recurring revenue. You might have to go. With several rounds of financing down the road and no disrespect, but the person that’s offering this type of deal finally pay for 30% equity. It signals to me that the investor is actually not sophisticated venture technology investor. Right. And if you have someone only that type of the, the reason why I’m saying they’re not sophisticated because this is simply not the type of it doesn’t make sense. It doesn’t make a lot of sense for, you know, A16Z or YC to do that type of deal. Right. And it’s. It’s very deviated from the market standard. Now the risk that the investor is creating for himself and for the start of entrepreneur. That later on the technology does well, you have some like super great early attractions and you go to Silicon Valley, you talk to initialized Capital, you talk to 86 and Z. And they’re saying oh. Who is this Joe Schmo on this cap table that’s holding 30% of your company? What did they know about this technology? And so. So it means like I have to deal with this person. That may be. In a way, or that has the capacity to be in the way. In terms of, you know, deciding how the company should be run, so that creates more, I would say downside risk than upside incentive in that type of deal is that your CAP table is going to be a huge factor in terms of convincing. The Super sophisticated, the Super capable, the Super powerful venture capital investors that could really bring your company to the next level and if someone and the founder needs to know that if someone’s willing to write a check. 

He’s not the only person that will. Be willing to. Write a check in this world. You can go shop around. There’s no. Law that says. You can only take, uh, you know, $500,000 from individual ABC. I think if you’re building a compelling technology that solves A genuine problem, then there’s many options out there that could, you know, give you a better deal. 

Hessie Jones 

Yeah. Now. But let’s assume that this guy comes in and he’s the very first person that you talked to. And you know what they say? A bird in hand is worth 2. In the Bush. So the the other thing that the founder doesn’t. Really understand at this point yet is how this affects dilution down the road and you’ve talked about a little bit about it, but now that we have a concrete example, he wants 30% in your company, $500,000, what does this mean to the founder ownership overtime? 

Ben Su 

Right, so it creates unnecessary dilution in the beginning. The reason is because you have. If you look at the long term perspective of the company. I think uh, it’s ideal for the founders to work towards owning 50% of share of equity in the company when they raise a shares a. Right now, when you’re already getting 30% away before the technology even hit the market before the technology even demonstrates any traction. You don’t have much room left to play with right on your cap. Table. And yeah, and I think that if you take a look at the annual statistics from Carter. That 500K for 30%. Like that is not market standard. And I would say to that founder, go back to that investor and ask the investor to justify why should you get the non market standard of treatment because there’s this misconception in the Canadian startup world that you need to hit whatever AR. MRR, in order to raise your first 500K. That cannot be further from the truth. To I don’t have to offer an anecdotal example of capital because we did raise our first $1,000,000 with no product with no revenue, but it’s actually common for founders to go out and raise from venture capital investors on the concept of founder problem fit. For example, the Managing Director at Khosla Ventures, Keith Raboy Lebaugh he actually mentioned, you know, unlike growth stage company investing where like financial metrics play an important role in preceded C stage and early stage investing. It’s more about a vibe check. Right. Are you the right type of founder solving the problem that you’re working on? Because, uh, the because even if you have the most amazing idea, the most amazing business plan. No plants survive. After the first contact with the enemy. So you’re going to have to pivot. You’re going to have to use your the data input that you’re going to collect to change your strategy to adapt, right? So my advice to that founder is. Like there are great options out there for you to choose, and you’re not limited to just that one investor or to that one Angel network in your city. 

Hessie Jones 

OK, that’s great. That’s great. That’s good to know. I think that if somebody is already showing interest, then you know that you have something right and you don’t have to put all your eggs in one basket. So let’s talk about the term sheet because this is where a lot of that negotiation may happen. First of all tell me a little bit about it, like what’s included in it and and whether or not it’s a binding document. 

Ben Su 

Well, typically time sheets are not binding. It basically spells out you know, the general terms that the investor will invest in your company with. Now typically it’s the the the check size and you know the type of valuation cap or if it’s a price round, the type of equity, the percentage of equity that they’re looking for, right. And sometimes in the I would say. A very formal venture capital investment round. The meeting master would put on other terms in a term sheet. For example, it requires all the all the all the other investors to follow the rules that the leading investors has designed. Right. So the small the investors writing smaller checks, they don’t get to have a say? The reason is because they don’t. They’re not writing $1,000,000 check, they don’t have any power, right? So term sheet usually is non binding and what founders? I’m not saying that this is what founders should do, but what a lot of founders do is they use a term sheet they give from 1 VC to leverage against the other VCs. Now you have to do it in a totally, I would say ethical way, because if someone’s showing love to you in the early days, right, you have to show them love back so. But. I have seen founders just using term sheets to shop around, but hey, you know, they know what they’re playing with sometimes, you know, reputation matters more to some people than other people. That’s all I have to. Say about that.  

Hessie Jones 

OK, so sometimes people put stuff into term sheets that are questionable and I want to get into some of those red flags that founders need to be aware of when they’re actually reviewing the term sheet. 

Can You talk about some of those red flags. 

Ben Su 

Right. So in the Super early stage of TOS, some of the red flags that we’re seeing is, for example, an accelerator that’s writing a $25,000 check or $100,000 check. And they would. They would ask the founder to recognize the incubation servers that they’re giving to the startup. As an in kind contribution. That that could be valued. At $450,000. Right. So they would say, hey, here’s a $25,000 check for safe investment valuation cap will be 5 million, but you also recognizing that the incubation service is costing is a has a fair market value of 450,000. So in the end, uh, they’re safe investment amount. The purchase amount in the safe would not be just 25,000, it would be 25,000 + 450,000. Right. So that’s one of the most typical red flags that we’re seeing coming from the incubators. 

Hessie Jones 

Can I just say I just want to say that Altitude Accelerator does not take equity for any of the programs that we offer and nor will we in the future. So that’s an important. 

Ben Su 

Yeah, I I think that’s the way to do it. And also there are other red flags in terms of incubators giving our services or access to resources and they will ask in return for 2.5% warrant to convert. You know their service fair market value into equity in the company right now. The catch here is that it’s convert the conversion will take place at a price ramp. So if your typical start up following the. Three of you know Silicon Valley style of financing round that 2.5% gets converted at Series A. So what that means is that for the debts that they’re offering you for the coffee that they’re offering you at the office, they get to have 2.5%. I Series A. Now. I’m not saying like that’s a bad deal. It is. It is a bad. Deal. But more importantly, that would signal to your future investors that you lack the judgment skill. Of running a company that they’re investing in. To be honest, like if I was an investor, I would ask the founder, why did you make that decision for some free coffee for some free desk so that someone can own your company for 2.5% and then they don’t get diluted in your early safe and convertible. Right for what so? I would caution founders with the following statement. You’re going to have that conversation with your needing master some sometime down the road when you’re racing around. So you got to be able to justify your choices so that you know people can actually trust you with their money to run the company that they’re investing in. 

Hessie Jones 

OK, so there is some other things I want you to talk about, like in, in some terms trees. I’ve seen things like excessive control provisions and this is where if you are an investor and you want, for example, to have a say in who gets hired. He gets a board seat, even approval of the budget is that that is a red flag, correct. 

Ben Su 

Absolutely. And I would say sometimes these terms are probably mandated by the investor themselves and sometimes it’s probably mandated by the lawyer of the invest. Sure. Right. Uh, because the typical incent incentive structure for lawyers. Is that the lawyer doesn’t care if the investor makes 100 X return on this company. They cared that, hey, look, Mr. Investor, Mr. Client, I’m doing all these wonderful things for you. Getting all, getting you all these investor rights. But there’s no punishment for the lawyers if those investor rights are at the expense of the future success of the company. 

So so I think like those uh. Those terms and. That seemingly on the surface, is protecting the investors could actually destroy a company simply because, like I said. 99% of a startup’s value creation is to be done in the future, and that means you need to be agile. That means you need to be flexible. That means you need to make the best judgment, and sometimes the judgment could be anti common sense. Right. And if you have to navigate through the shareholder votes for the budget approval or the board approval for the, you know the pivot that you’re about to do. 

You’re never going to make it, and if the message for the investors is that you know. Protecting your whatever 10% of a small pie. May sometimes give you may turn a small pie into a $0.00 value pie. Right. So you’re better off to let the founder to let the experts sit in the driver’s seat and they take the car to the best possible direction and you get to just like, you know, strap down for the. 

Hessie Jones 

Yeah, yeah, I agree. 

Ben Su 

Because the question is if you cannot trust the founder to make good decisions, and you have to step in to substitute their decision making right, you probably investing in the wrong person. 

Hessie Jones 

Absolutely. And from a founder perspective, you obviously have the wrong person. Who who wants more control? Who wants more certainty? And so I just want to mention a couple of other things that that could be red flags. They could ask for unrealistic deadlines, they unrealistic milestones. They may want you to report more often. And this this actually constrains the time of the founder, who will spend more time trying to appease the investor as opposed to putting time in the company as. You’re talking about. 

Ben Su 

And I think like that’s, that’s a signal that the investor has never participated in a legitimate. And check out their investment around. That’s a signal that the investor doesn’t know anything about. Venture capital companies, and there’s a signal for the founder to stay away from that investor because they will only create friction for you because when you’re raising capital. 

It’s not just like raising money, it’s more about the access to the resources, to the knowledge, to the expertise that the investor can bring to the table. And cap, we had the benefit of not only getting investments but also getting investments from people who soak their companies to Facebook for $150 million. So we can call them and say, hey, look like we’re running into this problem. What was your experience like, what would you do if you’re in the founder seat? So those people, they. Would never ask for a board seat. They would never ask for milestone deadlines or whatever information right, or reporting requirement or auditing requirements. They just say hey, just go build. This is going to be a binary outcome. You either make me super rich or you turn my investment to nothing and I’m totally. OK, with that? 

Hessie Jones 

1. OK. So let’s, let’s come. Let’s, let’s dive down into the term sheet because when it comes to valuation, this is the the point of contention for many founders because there is no real, I guess it could be a gut check in the beginning. To to understand what your valuation is. What? All of the I wouldn’t say standard, but what are the types of methodologies that investors may use to determine the value of a company and what should what should founders look out for when they’re when they’re presented with a hey, your company is worth $50,000 at this stage. What? What does that really mean? In terms of how did we get to that number?

Ben Su 

Yeah, great question. Well, like like Warren Buffett says, hey, the best way to value your company is based on the discount cash flow model. But the problem with early stage startups is that many of them. Are probably pre revenue, so the traditional finance sector DCF model does not work. Right. Like one of the things that I think just like. Makes absolutely no logical sense to me. It would be investors requiring a pre revenue startup to do a financial projection. Well, typically if you’re an accountant, your financial projection would need to be based on past historical performances, right? And so you would need to have some factual foundation. To project this is the amount of revenue we’re looking at two years. Down the road. But when I go to these pitch competitions, I see all these stars putting up a slide. Yeah, we’re we generate $0.00 so far, but we’re looking at generating $5,000,000 AR in two. That is not based on reason that is not based on facts, and that is not based on the the whole financial sectors. You know guidelines, right. But sadly that’s what you see a lot of these pitch competitions. So how do you selves get valued? In my opinion, like I was saying. And and you have a lot of other early stage investors that are investing in the people. So what they do is there’s like a market standard for pre revenue that’s companies. 

Ben Su 

So I  just said like I just I I think I finished saying how not to value a company which is based on DCF. But how do you value your company? Well, investors make decisions based on the founder problem fit of an early stage startup, right? Many Silicon Valley startups, they don’t even have a single dollar of transaction when they raise a couple $1,000,000, right. And I’m not saying that’s an. Anecdote, I’m saying that is a norm. Right. Maybe it’s not a norm in Canada, but in Silicon Valley, it’s not uncommon for Jason calcaneus to write a whatever $25,000 check that he writes through launch fund to bunch of college students that are pre C, right? So I think the way you the the way I’ve seen investors valuing company is they go on, they use a market standard. You know if you’re pre revenue SAS company or fintech company. The the industry standard is 5 to $10 million of valuation cap in the safe and you know it’s not based on financial metrics, but it’s more based on this is what everybody else is doing and therefore that’s what we’re doing now. There’s some reasoning behind that is because. The market determines determines a final price. Of anything that you ever buy, either being, you know, equity in a company or this cup of coffee right, it’s just like if you’re offering lower valuation then the founder can go somewhere else and some other participants in the market will write a check. So I think in the early stage. Uh. Of a startup, the founder needs to subscribe to Cardas annual report. Just, you know, because Carter manages the cap table of these companies. They have first hand insights into a company that’s in your stage. What type of terms that they’re raising on? What type of variation they’re raising on? How? Much they are raising. 

Hessie Jones 

OK, OK, that’s cool. I think the other thing and you mentioned this earlier, if you could. Just. Talk a little bit about some of these anti dilution terms and how that could be problematic for the founder. 

Ben Su 

Yeah. So the I think in the early stage, the most anti dilution terms that we’re seeing from the investor side is. You know, they ask for shared warrants that that could be converted at a qualified financing round. OK, it’s very common for uh accelerators incubators. I know altitude doesn’t do it, love it. But a lot of accelerators, what they do is they say to the founders that in order for you to be a part of our program and receive our service, you agree to give us 2.5% in your company. 

When you raise a qualified financing round now you read through the pages in the document and you look for the definition of a qualified financing round. So a qualified financing round would be you’re raising a price round. Meaning, like you know, you’re issuing shares at a certain price, uh, for investors and you’re raising sometimes it’s 250K to $1,000,000. Now the problem with that is if you’re following the typical trajectory of a Silicon Valley startup, you’re first precedent. Seed are raised on saves and convertibles, right? Those those investments will convert based on their valuation cap or whatever discount rate. That you’re offering. But uh. 

The 2.5% that you agreed to the accelerator. They don’t get the dilution. That you would get as a founder. Right. So they’re asking for 2.5% at the qualified financing round. Typically it’s a series eight round. And. 

Hessie Jones 

Can I can I? Ask if if they had it, let’s say that there wasn’t any anti dilution term. What would that 2.5% look like at that time? If if they were the antidote? 

Ben Su 

Yeah, well, so that will look like, well, you, you would need the specific numbers order to look at like how, how that 2.5% will be diluted. But what I can tell you for fact is that that 2.5% will be diluted that what we diluted just like everyone else is shares in the company. Just like the employees, the founders, the early investors, right or the advisors. But hey, just. Because they had that share or that’s exercisable at a qualified financing. Now they get to skip. Skip all. All of that dilution. 

Hessie Jones 

Yeah. So that’s. Something to definitely look look for when, when in the term sheet. OK, let’s move to a post that I actually saw on LinkedIn and I I sent this to you and this is the about, this is the scenario where you are an employee that. Actually works for a new startup company. You took a pay cut as a, let’s say, a product ahead of product at the company. That you are also getting a 1% equity in in in favor of that pay cut. So what does that 1% equity mean to you as an employee as you move through like the growth of the company? Especially when you get a $2,000,000 initial injection from from a investor, what? How does that impact you? Let’s assume five years down the road when there is some kind of liquidation in. 

Ben Su 

Yeah, absolutely. So I think, uh. The way I like to look at this question is when you make the decision of leaving your half $1,000,000 salary at Google to work for a scrappy little startup, that decision needs to be. A disciplined decision and it needs to. You need you. Need to think like a venture capital investor because you’re actually making an investment. Right. The opportunity cost, I will argue that’s a an investment, right? So a typical venture capital investor, they think in the following, they think about their option scenarios in the following three ways scenario. Number one, this company goes to 0, everything, every dollar they put in becomes 0 scenario #2. This becomes an outsized you know Unicorn. Type of ******. And they get to write a LinkedIn and Twitter post to congratulate themselves for hitting that jackpot. In scenario #3 is uh, it becomes a mediocre return. Like, yeah, you’re doing, you’re doing exactly like a private equity type of company. You’re generating S&P 500 type of, you know annualized 15% return, right. But the problem with option #3. Is that when startups go out and raise capital, especially in Series A series B stages. It’s not atypical or I. Should say in normal human. Words. It’s common for VCs to get liquidation preference. Sometimes it’s like what that means is that hey, in order for anyone on the CAP table to be paid. I have to be paid 2 times of the input of the money that I gave you. Right, so, uh, you know, so you have to think about that type of sophisticated investors being on the CAP table as well to factoring in your, you know, reward calculation as an employee, as an early station employee who gave up a super awesome salary at WSJ to work for a startup. So I think what this engineers or talents what you think is they need to think like a venture capital investor when they make this type of decision. This thing, do you think that this needs to be a type of return that generates 100X in value creation? If not, it’s a write off in your book because that’s what our VC’s told us. The VC’s expect. Everything will check that they’re writing. In a startup to return the whole fund.  

So for example $100 million fund a mid size VC in Boston and you’re writing $1,000,000. Check to the early stage company. You will want everything. So when you make the investment decision. You’re calculating that. This company would turn that $1,000,000 for me into $100 million. Right. Anything less than that is a write off that’s just like the typical venture capital power law return law. And and we need to think. 

1. So that so that when we translate that into the perspective of that employee, the reality means that he probably will. Not get anything for that 1% equity is that?

Right. If it’s a mediocre return, they’d probably be better off. 

Just work at Manulife as a data scientist and then put their Manulife salary on the S. And P400. 

Hessie Jones 

OK, so he’s probably taking just as much risk. The the good side about this is that he’s actually at least earning some salary, even though it’s much below, let’s say, the market rate. But from that perspective, realistically he will not get anything. Out of it. 

Ben Su 

Yeah, yeah, correct. And I you say that there are these hidden black boxes that sophisticated, the two investors would know. And I think like this, this type of information needs to be democratized widely so people know what they’re getting themselves into. 

Hessie Jones 

Into. Yeah, I I agree with that. And I think that’s why I wanted to have this session with you, because I find that. That there, there is so much power and balance here that the startups themselves are kind of flying blindly, and unless they actually are, I don’t know. They’re lucky to have access to some of those conversations with startups that that actually have made it. And they can give them some sage advice. A lot of it is like, you know, how do I know if if what I’m being told is actually truthful or fair, so let if that gets me to the next question is that throughout this whole. Process. Once you engage with the investor, and once they’re all in and let’s say three to five years later in that whole process, you’re going to make have to make sure that you have like sound legal counsel and they’re going to be pivotal in, in how you go as a company. So tell me about what that. What that looks like in terms of even finding like the right legal services for you to ensure that you’re being protected in the growth of your company. 

Ben Su 

Yeah, I mean I’m I’m going to try my hardest not to make this a sales pitch about capital because that’s like the whole that we built our company Capita. 

We call this founder empathy of a lawyer. It’s because if you never had to, as a lawyer, if you never had to sit in the driver’s seat of going out and raise a seat round. If you never had to go out and negotiate. And and and. Try to push away into a venture capital portfolio. It’s very difficult for you to understand some of the things that need to take place ahead of those scenarios, right? And so the reality of the matter is that there’s a lot of perceived value assigned to the big, basically law firms. By the star founders, or even by like, say, the experts, the investors in the startup world. The problem is that when you are early stage company, when you become a client of a typical Bay St. law firm. You get staff with a first year, second year. Third year associates. Now these associates never got to see what the Series 8 round would look like. They they they never got to participate in the negotiation stage of a $10 million venture capital investment deal, right. So I’ll give you a typical. Example. We actually. Have. The best conversion of our customer meaning like the best way for us to sell customer is we find a customer that’s already paying a base rate. So this is my typical pitch to them is that I know you’re a fintech company, but you do know that the convertible note the combo debt that you raised your PC on seat round with, say the $5,000,000 incomparable note that you raised, it could be problematic to you when you’re when you’re selling your product to the big banks. The reason is because banks will look at your debt equity. Ratio. And in the generally accepted accounting principles. Convertible notes sit on your balance sheet as a debt. Save dozen, save says on the balance sheet as an asset, like as an equity right. Like it doesn’t say it’s not that because you don’t have to pay that amount back even though someone else never get paid back to their investors. They almost always end up getting converted into the startups equity. But the bank doesn’t care about that. They’re saying, hey, in order for me to purchase your product. I’m a big bank. I’m CBC, I’m RBC. Your debt equity ratio needs to be at this, but your combo, no. Every single dollar you ever raise was through. A comparable note. That will actually keep your start up out of the vendor list of a lot of these financial institutions because these financial institutions are looking for longevity. Of their vendors. If you’re not going to be around because you have a tight debt. Equity ratio we don’t do Business with you? So that’s the type of like knowledge that many Bay St. lawyers don’t. Is the the the type of the the basic lawyer? Would that would have that knowledge. They would be a partner working exclusively with like Super late stage companies. Right. Companies that or even growth stage companies that raise you know $100 million, they will have that knowledge, but the first year, second year, third year associate working at a fancy base. Confirm. It would never happen. Right. So I think in in terms of choosing legal counsel, it’s like the person has to. So my mentor, who’s a big tech lawyer in Waterloo, worked at Mel Thompson, worked at growing, he worked at Silicon Valley, Uh for 10 years, so he taught me a lot of those things. That I learned and. I would say to choose a legal counsel. I would go with that type of lawyer or Capita for that matter. 

Hessie Jones 

Nice Plug. OK. OK. So last question for you. What does an optimal investor founder relationship look like over the course of five, seven years if if you were to say this is the type of a relationship that I have that I want to have so that it gets me to? My growth goals, but at the same time creates creates an environment that makes me feel comfortable. With this relationship. 

Ben Su 

That’s a great question. So I actually listened to a like an interview for, I think his name is Daniel Eberhart. He’s the founder of Coho Pay. So he’s also a portfolio founder of Drive Capital Drive Capital, also investing in Capita. So he brought up this story that Chris Olsen, who’s the founder of Drive Capital, says on co-host board of directors. Right. And Daniel told the story that, you know. Chris had a huge disagreement with UH. Daniel and Chris said to Daniel that, hey, listen, ultimately you are the CEO. You are the founder of the company. I disagree with you, but when you’re wrong. I’m not going to tell you that I told you so. Right. So I I think it’s that like that’s a type of I would say personality and wisdom that founder should look for in investors that they’re onboarding. So that you know the relationship, the ongoing relationship can be built on trust and mutual respect. Right. And some of the things I some of the questions I get asked. By uh. Some. Accelerator program in downtown Toronto. The question was how culturable are you? Well, I say, hey, look, I wouldn’t be here if I didn’t listen to your advice of my mentors or my investors, right? But also, I wouldn’t be here if I listen to every single advice. From the so-called experts, the consultants, the lawyers. So. I I think. At the end of the day, the relationship needs to be like, hey, the founders in the driver’s seat, the best you can do is to make available of the insights experience that you have because you had that experience. Make that available accessible to the founder and the founder. Also, one of the things that we’re super disciplined about is every single month, capital will always write an investor update to our captive investors will tell them. The winds of this month, the losses of the month and what we learned from this month and sometimes we have ask session. Saying, hey, we’re. Looking for help on on this site. And sometimes we don’t. But we are. Super vulnerable. We’re super transparent in terms of the things that we share in our monthly investor updates with our CAP table investors. And sometimes they’re super awesome people. I have a philosophy that people become successful because they’re kind. Most people become successful because they’re kind because. Uh. Kind. People like to help kind people. You don’t become successful by becoming by being a jerk, right? So we benefit a lot from the kindness of people. Our CAP table as well as people that never made it to our CAP table. You know, one of the partners I want to mention his name because I have only good thing to say about him. His name is Kevin Madeo. He was a founding CTO, co-founder of Mile Vision and he’s a. Partner graph adventures. We often go for walks with Kevin in Ottawa. And Kevin gives us super awesome insights. About you know what you should think as a founders? Often he tells us, hey, I’m going to put my founder hat on. This is what I’m going to tell you now. I’m going to put my VC hat on. This is what I’m going to tell you. And so that’s the relationship that we have. With our CAP table investor as well as people who are not. 

Hessie Jones 

That’s great. That’s, you know, I think the one thing that I’m learning just from our conversation is that founders do have choices. They don’t have to accept what’s in front of them. And they do have negotiating power. If if they know some, some of the things that you had mentioned here. They’re going to. I guess in in a lot of cases like you, your founder, you you built a company, you have a, you have a law degree, a lot of them don’t. But I think founders have to learn how to become this Jack of. All trades, and especially when it comes to investor relationship, because this is the one that’s going to be like a crucial relationship for the growth of their company. So thank you so much Ben for for coming and giving visit insights. This is 1 episode that I think is going to be really meaningful and it’s going to help a lot about. Found this in the process, so thank you. 

Ben Su 

Thank you so much for the opportunity to tell our story. 

Hessie Jones 

No, no problem. So the audience, if you have topics you want us to explore, please e-mail us at communications at altitudeaccelerator.ca tech uncensored. It’s powered and produced by altitude accelerator. We’re hosted on Spotify and you can find us wherever you get your podcasts. So until next time. My name is Jesse Jones. Please stay curious and be inspired. 

Ben Sue 

Alright, bye bye.