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Capital raising is different in practice than on paper. Of course, if you’re a startup superstar with a huge exit under your belt, raising a first round for your second startup is going to be potentially much easier than the first-time round. Most founders are not in that position. So how does raising a round actually work?

Structure of the Round

There are three possible structures for an equity capital raise:

  • equity round (either ordinary or preference shares)
  • convertible notes
  • simple agreement for future equity (SAFE)

Each have their benefits and drawbacks, as explained below.

Equity Round

An equity round involves founders issuing investors shares in the startup in exchange for cash.

With an equity round, the key areas of negotiation will be:

  1. the company’s pre-money valuation, and
  2. investor protections such as the type of shares they are entitled to receive and their voting rights.

The company’s pre-money valuation will determine how many shares the investor will receive in exchange for its cash and what percentage shareholding each shareholder will end up with after the raise.

Certain protections can minimise the risk of investors losing their money, for example:

  • issuing investors with preference shares
  • the right to appoint a board member, and
  • veto rights regarding critical business decisions.

Understandably, investors will want to protect their investment. But it’s unwise to give away too much control over your startup, particularly in its early stages. You want to maintain running your day-to-day as you are in the best position to make decisions regarding the direction you want to take your startup.

Convertible Notes

A convertible note is a hybrid of debt and equity. It involves an investor making a loan to the startup which converts to equity on a predetermined trigger event (generally the raising of a priced round or a liquidity event). The conversion rate is usually calculated by reference to the share price of the priced round or the liquidity event.

A loan will have a term (i.e. an expiry date). It is important to determine what will happen if the loan does not automatically convert before the term expires. Will the startup repay the loan? Will it automatically convert to equity? Who decides – the lender or the company? If it is to convert, at what conversion rate?

Interest may accrue on the loan amount, and all accrued interest will convert into equity (along with the loan amount) upon the trigger event. Interest, however, isn’t a prerequisite.

The loan (and accrued interest if relevant) will usually convert to equity at a discount to reward your investor for backing your startup early on.

While using a convertible note means you can technically delay valuing your business, some notes will have a ‘valuation cap’ (i.e. a maximum price on the note that will convert into equity). Parties negotiate this valuation cap when raising the round, so you are effectively negotiating a valuation when raising under a note.

Startups typically use convertible notes at the seed round stage, although they can be useful when raising bridging finance between rounds. A convertible note should specify:

  • how much is being invested
  • what interest is payable
  • when the loan will convert
  • what discount rate will apply, and
  • the valuation cap.

Tip: Importantly, as debt is regulated, you should ensure you comply with any applicable regulations when dealing with convertible notes.


The Simple Agreement for Future Equity (also known as the SAFE) is a relatively new way of raising capital. Y Combinator, a leading US seed accelerator, introduced SAFEs in the United States, and it’s becoming increasingly popular in other countries with a strong startup culture.

The SAFE is similar to a convertible note minus the debt element. In consideration for paying a cash amount to your startup, an investor receives a contractual right to receive equity in your startup when a predetermined trigger event occurs. The trigger events are generally the same as those found in a convertible note (i.e. a priced round and a liquidation event).

The number of shares the investor receives on conversion is linked to the upfront cash injection they make and the share price of the priced round or the liquidation event (as applicable). As with convertible notes, startups may issue equity at a discount, and there may be a valuation cap.

As the SAFE is not debt, if the startup enters insolvency before the cash converts, then the startup agrees to pay the investor an amount equal to its cash injection before making any payments to its shareholders.

The advantages of raising capital using SAFEs, as opposed to convertible notes, are as follows:

  1. SAFEs do not have a term (which means that if a trigger event never occurs, then the investor will never receive shares)
  2. interest is not payable on SAFEs and so the complexities involved in converting interest into equity does not apply
  3. SAFEs are not debt and therefore are not regulated

Case Study: Samantha Wong, Head of Operations at Blackbird

Preference Share Round using AVCAL Docs – Blackbird and Baraja

Blackbird Ventures mainly invests in Seed or Series A rounds. We invest in founders who have the ambition to build a global business from day one. As Head of Operations, I spend considerable time working through the deal structure with our investee companies. Below, I’ve discussed the process which led to us investing in Baraja Pty Ltd, a startup developing 3D LIDAR technology. I’ll also explain the main terms we usually invest under.

Blackbird Ventures had been involved in the autonomous driving space for several years and knew the cost and reliability of existing LIDAR technology was a key problem these companies faced.

Once we’d decided we wanted to invest in Baraja, the next step was to provide its founders, Federico and Cibby, with a draft term sheet (usually a one pager).

Term Explanation
Round terms How much we will invest, and what the minimum and maximum round size can be. Maximum round sizes are important to VCs because we invest at the early stage, we want to ensure that neither Blackbird nor the founders are too diluted. Conversely, the minimum round size is important to ensure that you raise enough money to achieve the business milestones.
Pre-money valuation The valuation at which we will invest in the company.
Board Whether Blackbird will get a seat on the board or not.
Voting rights The key business decisions which we want to have a say in, such as materially changing the nature of the business and selling a majority of the assets of the company.
Employee Share Option Plan (ESOP) How much of an ownership stake in the company will be set aside for future employees? At Blackbird, we encourage founders to set aside 15-20%. Attracting good employees can be difficult for startups. The ability to offer sizeable amounts of equity can make a difference.
Founder vesting The terms on which the founders’ shares vest, we usually insist on four-year vesting with a one-year cliff.
Liquidation preferences When we invest, we do so through preference shares with a 1X non-participating liquidation preference. This means we get our cash back before ordinary shareholders in the event of an exit or insolvency. However, ‘non-participating’ means we don’t also get to receive cash according to our pro rata in the company. We have to choose either to just get our cash back or convert our preference shares to ordinary shares and participate in splitting the exit proceeds pro rata with other shareholders.
Preferential dividend rights We often ask for non-cumulative preferential dividend rights, which means that if a dividend is declared, then we are paid before ordinary shareholders.
Anti-dilution rights As with other early stage VCs, we generally require standard, broad-based weighted average anti-dilution rights. This means that if the startup issues shares at a lower share price than the share price the VC pays in the future, the VC will receive additional shares reflecting an adjusted share price (of all their preference shares). The adjusted share price will be calculated by the average of the price they paid and the lower price paid by the later investors.
Pro rata, Right of First Refusal & Co sale rights Rights to invest pro rata in future capital raisings, and to have a first right to buy any shares from other selling shareholders in the future. For VCs, this is probably the second most important term.


This article was an extract from LegalVision’s Startup Manual. Download the free 60-page manual featuring 10 case studies from Australia’s leading VCs and startups.


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