Legal must-haves before raising capital with Becki DeGraw | Wilson Sonsini Startup Legal Basics

Episode Summary

Executive Summary: Becky DeGrazia explains that when a startup moves from SAFEs/notes to a priced equity round, legal cleanup becomes urgent. Founders should involve counsel early, validate cap tables, IP assignments, vesting, and employment docs, and model dilution/waterfalls with pro formas so they understand who gets what in a financing or exit.

Main Topics: Bring counsel in early (Priority: 5/5): Legal advisors should review the company before a signed term sheet to avoid delays and hidden cleanup issues that can stretch closing from weeks to months. Cap table hygiene and valid issuance (Priority: 5/5): Investors will scrutinize ownership records, board approvals, and stock purchase documents; missing issuance paperwork can force reissuance at today’s valuation and create tax problems. IP assignments and employment agreements (Priority: 5/5): Missing founder IP assignment docs or weak employment paperwork are major diligence blockers because they create ownership and enforceability risk. Understanding SAFEs, notes, and document terms (Priority: 4/5): Both founders and angels may sign standard SAFE documents without review, but edited terms can dramatically change economics and surprise investors later. Pro forma cap tables and dilution modeling (Priority: 5/5): Founders should build projected cap tables to understand how SAFEs, notes, option pools, and new financing convert and dilute ownership. Waterfalls, exits, and board dynamics (Priority: 5/5): Modeling sale scenarios, liquidation preferences, bank fees, and carve-outs helps founders know whether they will actually receive proceeds in an exit. Founder education on financing basics (Priority: 4/5): Knowing terms like pre-money, post-money, fully diluted, liquidation preference, and ESOP is framed as part of the founder job and essential for negotiation.

Key Arguments: Early legal review prevents expensive delays; once a term sheet is signed, cleanup can add weeks or months to closing. The three biggest diligence blockers are cap table integrity, IP assignment, and employment agreements. A missing or invalid stock issuance can require issuing shares at today’s higher valuation, creating tax and cash consequences. Founders should not assume a SAFE is truly standard; investors or founders can edit terms in ways that materially change outcomes. A pro forma cap table is necessary to understand dilution from option pools, SAFEs, notes, and the new preferred round. Founders should run exit-waterfall scenarios before agreeing to a sale so they know whether an exit actually benefits management and employees. Understanding financing terminology and mechanics gives founders leverage and reduces disadvantage in investor negotiations.

Data Points: Typical time to close a priced round: 4 to 6 weeks - Becky notes that once cleanup issues arise, closing can take longer than the normal timeframe. Option pool size example: 10% - Used as an example of an employee stock option pool that can materially affect dilution. Investor ownership example: 30% - Example where a lead investor buys 30% before an ESOP is created, changing dilution economics. Management carve-out example: 30% - Illustrative carve-out Becky suggests for management in a sale scenario. Sale example: $50 million - Hypothetical exit value used to explain how a carve-out would distribute proceeds. Investor portfolio economics example: 20% carry - Used to explain why an investor may prefer returning capital to LPs after crossing their hurdle. SAFE return example: 1.7 or 1.12% - Example of an investor being paid back cash on a SAFE in an up-round due to edited terms. Note liquidation preference example: 3x - Example of a note with a heavy liquidation preference affecting waterfall outcomes. Banker fee example: 5% with a minimum of $2 million - Used in an exit-waterfall example to show transaction deductions. Overhang example: $30 million - Illustrative amount of obligations/claims that can sit ahead of common in a sale waterfall.

Pivotal Quotes: "time to grow up" — JCal: Describing the moment when a startup moves from SAFEs/notes into a priced round and needs cleanup. "Cap table, IP assignment stuff, and employment agreements. Those are the ones" — Becky DeGrazia: Becky identifies the top diligence blockers that most commonly hold up closing. "The cap table has to be perfect. It has to be pristine." — JCal: Emphasizing investor expectations for exact ownership math and clean records.

Implications: Founders should treat financing hygiene as core operating work. Early diligence, documentation, and scenario modeling reduce delays, protect valuation, and prevent painful surprises at financing or exit.