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andreasklinger authored Dec 23, 2024

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title: 'Uncapped notes don't work for first rounds.'
publishedAt: '2024-12-23'
summary: 'Uncapped safe notes misalign incentives in first rounds… let me explain why'
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Uncapped notes seem like the ideal to fundraise. While you talk with bigger funds you close some angels and you keep your options open to go big.

But in reality it's not aligning incentives and frequently absurdly hard to navigate

Let me explain…

### Example: You raise a bit of money from angels

Let's say I invest at uncapped SAFE with 15% discount in your company

Uncapped means the valuation will be the valuation of the next priced round.
In this example minus 15% to give a bit of a bonus to the angel.

But this also means the more i help you making a successful round, the more expensive my own investment will be.
The more i get you other angels involved on the uncapped note, the longer you got runway to increase valuation until i have a final price.

This means the incentives of myself (and all other the angels) will be to not help you making a big next round.

And now we got an issue. It's already hard enough to raise money, hard enough to find angels who want to put work in.
But now misaligning incentives creates a whole new set of friction. Because frequently those angels should be the ones making the next round happen…

### But…

Obvious some will help a bit just out of principle. But all would help a LOT more if incentives would be well-aligned.

Because of this, I always stay away from them out of principle.
I am either in fully and help to make it big, or not at all.

### What works better:

a) Either don't close the investments until you have terms (decided by you or by a lead) - and just communicate a range until then to collect soft-commitments.

b) Or just pick a valuation and close a smaller amount quickly to gain momentum.

Sometimes this leads to multiple tranches – eg a very small round quickly at lower valuation, then a mid-sized one a month later – some people call this staged fundraising rounds.
Sometimes this can also lead to larger funds waking up. Because now the power dynamic changed.
A company needing to raise 2-3M will need a lead. And most good VCs know which deals their competitors are looking at.
And they know they usually got a bit of time to gauge market interest.

If all of a sudden an angel round happens the startup might not need to raise for at least 8 months, 8 months in which other VCs might pre-empt the next round.
This changes the dynamic. It's no longer an "if the company raises" but a "when the company raises" their next round – and who will lead it.

### Uncapped notes can work if:

1) The angel check is super small in comparison to your next round (eg someone investing small amount between rounds) or…
2) The round is almost around the corner (like next weeks) and you want to give some early believers a slightly better deal.

Written, because for some reason, i had three different founders the last week trying to raise a first-round on uncapped notes and struggling to do so…

hope that helps
✌️

Andreas

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