Part I: Raising without romance: A matter-of-fact guide to equity capital

We’ve blogged on various occasions in the past about VC.

In June 2021, we wrote an ode and epitaph to VC, and more recently, in March 2024, we posted a brief review of “founder vs. investor”, a brutally candid book about how the relationship between Founder and investor is inherently fraught with friction.

Today’s post is less subjective and takes a matter-of-fact approach to equity capital, starting with an overview of recent trends, followed by a brief explanation of a standard Simple Agreement for Future Equity (SAFE), and closing with a discussion of a typical VC term sheet.

§ 2A. How to safely use a SAFE

SAFEs are a widely-used fundraising instrument for pre-seed, seed and even A round equity capital.

Carta’s 2024 State of Pre-Seed report indicates that most pre-priced rounds used SAFEs across industries, with crypto leading with 98%.

On average, projects use 4 convertible instruments (mostly SAFEs) before doing a priced round, with SAFEs raises starting at $250k to around $5MM.

What this means is that if you are looking to attract equity investors for your project, you will most likely be using a SAFE, possibly combined with a Token Warrant if at some point in the future your project will be issuing a native token.

In essence, a SAFE gives your investor the right to click into shares at a point in the future where the valuation of your company is established in what is called a “priced round”.

Key is that investors have visibility as to how many shares they will get, given that at the moment they invest, the company hasn’t priced its shares yet i.e. no valuation has to be agreed at the moment SAFEs are used.

This is a key attraction of using SAFEs, as agreeing on valuation with a cartel of investors can lead to prolonged back and forth, so SAFEs shortcut this process by creating a mechanism in which your investors are essentially given a formula by which they can calculate their future stake.

2.1The visibility of post-money SAFEs comes at the price of more Founder dilution

The easiest way to give your SAFE investors visibility on what % of the company they will eventually own is by using what is called a “post-money” SAFE.

No surprise perhaps that, according to Carta’s research, in 2024 over 80% of pre-priced rounds use post-money price caps:

Perplexity does a good job explaining the post-money price cap SAFE:

A post-money price cap in a SAFE is a predetermined maximum valuation at which an investor's investment will convert into equity. This cap takes into account the total amount of SAFE investments when calculating the company's valuation.

Key features of a post-money price cap in a SAFE include:

• Fixed ownership percentage: It allows investors to lock in a specific percentage of equity in relation to other shareholders, including other SAFE investors.
• Clarity and certainty: Both investors and founders can know the ownership percentages in relation to other stakeholders before the new financing round that triggers the conversion.
• Calculation method: The post-money cap considers the pre-money number of shares plus investment shares of all SAFE holders.
• Conversion mechanics: The SAFE converts into equity at the valuation of the next priced equity financing round or at the predetermined valuation cap, whichever is lower.
• Dilution effect: With post-money SAFEs, founders are at greater risk of having their ownership percentage diluted in future priced rounds, as SAFE investors' percentages remain fixed.

Quoted from the entry

“For example, if an investor provides $1 million with a post-money valuation cap of $10 million, they effectively lock in a 10% ownership stake in the company upon conversion, even if the company is priced at say $12MM at the time of the priced round, since SAFE holders will opt to use the lower cap rather the higher valuation for their conversion.”

— Otonomos, 28 February 2025

By contrast, a pre-money SAFE means valuation is effectively deferred until later financing rounds, creating uncertainty about an investor’s final ownership stake, as the amount of equity an investor receives is not fixed at the time of investment, making it harder to predict future ownership percentages. This becomes particularly problematic with multiple pre-money SAFE rounds, which will make it more challenging to track and calculate ownership stakes.

2.2Other SAFE terms

Other SAFE terms are pretty standardized and the number of key areas for Founders to be aware of are well documented. We list them here in summary:

• Conversion Triggers: the SAFE will define the specific event(s) that cause the SAFE to convert into equity, such as a priced equity round or a liquidity event. This begs the question what happens if the company never reaches such “Financing Event”. Founders should be cautious of refund clauses that require returning invested funds to SAFE investors, as these funds are likely to be spent by the time a priced round occurs.
• When determining the deadline of the Financing Event, it is important to find a realistic balance. While SAFE investors assume a significant portion of the early risk and shouldn't be kept waiting too long to acquire stock, ideally, you will secure enough funding to last 6-18 months and avoid reentering the market for additional capital too soon.
• The threshold amount that defines a Financing Event should also be realistic. The company's funding requirements should determine when it's appropriate to move to a priced round, and it's perfectly reasonable to stack SAFEs until that point.
• Participation Rights: These may allow investors to participate in future funding rounds to maintain their ownership percentage.
• Lock-up Periods: These may restrict founders from selling their shares for a certain period.
• Non-disclosure Terms: Provisions to protect the company's confidential information.
• Representations and Warranties: The company must represent that the SAFE is authorized under its governing documents and doesn't conflict with existing obligations.
• Statements by the company about its formation and authorization to issue SAFEs.
• Governing Law and Dispute Resolution Clause: Specifies how conflicts between parties will be resolved.
• Restriction on Investor Assignment: Limits on how investors can transfer their SAFE rights to others.

§ 3B. A warrant for tokens

When Web3 projects raise funds through a SAFE, investors typically anticipate receiving a token allocation that corresponds to their investment amount if the project intends to launch a token in the future.

The legal structure of this allocation is a Token Warrant, which is separate from the SAFE. This is distinct from a SAFT/E (Simple Agreement for Tokens and Equity), which presents legal challenges, at least within the U.S. The Warrant's purpose is to incentivize investors to participate in the SAFE, and therefore it must be legally separate from it.

The Token Warrant does however cross-reference the SAFE by giving the holder the right, but not the obligation, to receive or purchase a specific number of tokens at a predetermined price or under specific conditions, typically within a set timeframe.

The conversion mechanism into tokens under a Token Warrant outlines how this right is exercised and how the tokens are issued or delivered to the holder.

While such conversion varies depending on the terms set by the issuing entity (which is typically outside of the U.S., e.g. in the British Virgin Islands), here’s a general explanation of how it typically works:

• Issuance of the Warrant: When a Token Warrant is created, it specifies key details such as the number of tokens it entitles the holder to, the exercise price (if applicable), the expiration date, and any conditions for conversion. These terms are often tied to the project's tokenomics or fundraising goals
• Triggering Event or Exercise: The conversion mechanism is activated when the warrant holder decides to exercise their right or when a predefined condition is met. This could be:
• Manual Exercise: The holder actively chooses to convert the warrant into tokens, often by paying the exercise price (if any) in fiat, cryptocurrency, or another agreed-upon asset.
• Automatic Conversion: Some warrants convert automatically upon a specific event, such as the launch of the token on a blockchain network, a vesting milestone, or the project reaching a certain stage of development.
• Determination of Token Amount: The number of tokens received depends on the warrant's terms. For example: A fixed ratio (e.g., 1 warrant = 10 tokens).
• A formula based on the exercise price and the token’s market value at the time of conversion.
• Most often a “1 for 1” allocation in which the % equity SAFE holders receive is matched 1 for 1 with an equal % of the project’s token for a symbolic payment under the warrant (say $100), effectively allowing SAFE investors to double dip without having to pay for the tokens.

As we’ve seen above, given that most SAFEs are issued with post-money cap, investors can easily calculate what % of tokens they are set to receive.

Key here is to define over what amount of tokens this % allocation will apply. We have seen terms where this calculation applies on all present and future tokens, which seems excessive, as this means SAFE investors would have to be continually topped up as more tokens get minted over the lifetime of the project.

A more restrictive approach is to only apply the conversion to the amount of tokens in “free float” at the moment of conversion, e.g. using the number of tokens offered for sale to the wide community, excluding any pre-mints and tokens held in reserve.

If the warrant isn’t exercised by the expiration date or if conditions aren’t met, it may expire worthless, meaning no tokens are issued. Some warrants might also include provisions for extension or alternative outcomes (e.g., a refund).

For a real-world analogy, think of a Token Warrant like a stock warrant in traditional finance, but adapted for digital assets. The conversion mechanism is essentially the "how and when" of turning that promise into actual tokens you can hold, trade, or use in a decentralized ecosystem.

3.1The split personality of projects with both equity and tokens

In Web3 projects that involve both stockholders (traditional equity holders) and token holders (participants in the decentralized ecosystem), revenue flow is a bit of a hybrid beast, blending centralized corporate structures with decentralized tokenomics.

The exact path depends heavily on the project's design—its legal setup, governance model, and how it defines the roles of stocks and tokens.

Here’s a breakdown of how it generally works:

1. Revenue Generation

Web3 projects typically generate revenue through activities like transaction fees (e.g., on a blockchain protocol), service fees (e.g., DeFi platforms or NFT marketplaces), subscriptions, or partnerships. This revenue usually flows into the project’s treasury or operational entity, which could be a traditional company (like a Delaware C-Corp) or a decentralized autonomous organization (DAO), depending on how it’s structured.

2. Stockholders’ Share

Stockholders are tied to the centralized, legal entity behind the project—think of it as the "Web2" side. Revenue allocated to them follows traditional corporate finance principles:

• Profits: After operating costs, a portion of the revenue might be recognized as profit by the company. Stockholders could receive this as dividends, stock buybacks, or reinvestment into the business, depending on the company’s strategy and bylaws.
• Equity Value: Revenue growth often boosts the company’s valuation, benefiting stockholders through higher share prices if the company goes public or gets acquired.
• Control: Stockholders typically have voting rights over high-level decisions (e.g., appointing executives or approving mergers), which indirectly influences how revenue is managed.

For example, if a Web3 project like a blockchain gaming company generates $10 million from in-game NFT sales, the parent company might take a cut (say, $3 million) to cover costs and distribute profits to stockholders.

3. Token Holders’ Share

Token holders participate in the decentralized, "Web3" side of the project, and their revenue flow is tied to the token’s utility and governance design:

• Direct Rewards: Some projects distribute revenue to token holders via mechanisms like staking rewards, profit-sharing pools, or buy-and-burn programs (where revenue is used to buy back and destroy tokens, increasing scarcity and value). For instance, a DeFi protocol might share 20% of its swap fees with token stakers.
• Ecosystem Incentives: Revenue might be reinvested into the ecosystem—e.g., funding liquidity pools, developer grants, or community initiatives—which indirectly benefits token holders by driving demand and token value.
• Governance Power: Token holders often vote on how treasury funds (which include revenue) are spent, giving them influence over whether it’s distributed, reinvested, or held.

Using the same gaming example, the remaining $7 million might flow into a DAO treasury, where token holders vote to allocate it—say, 50% to staking rewards and 50% to game development, by way of grants out of the project’s decentralized Foundation.

4. The Split: Tension and Balance

The tricky part is how revenue gets divided between stockholders and token holders, which isn’t always clear-cut:

• Legal Structure: If the project has a centralized company, it might prioritize stockholders first (e.g., covering costs and dividends) before sending excess to the token ecosystem.
• A DAO-heavy project might flip this, prioritizing token holders.
• Tokenomics Design: The whitepaper or smart contracts often define what percentage of revenue (if any) goes to token holders. Some projects earmark a fixed share (e.g., 30% of fees), while others leave it vague or discretionary, or subject to a token holder vote.
• Regulatory Pressure: In jurisdictions like the U.S., regulators might view token distributions as dividends, forcing projects to treat them like securities and align them closer to stockholder rules, complicating the flow.

5. Practical Examples

• Uniswap: A DeFi protocol with no stockholders (fully DAO-driven). Revenue from fees goes to liquidity providers and governance token holders who vote on treasury use.
• Axie Infinity (Sky Mavis): The company behind it has stockholders who benefit from its centralized revenue (e.g., marketplace fees), while token holders (AXS) earn staking rewards and influence ecosystem decisions.
• Layer 1 Blockchains (e.g., Ethereum): No stockholders, but early backers (VCs) might hold tokens, blurring the line—revenue (gas fees) mostly benefits validators and stakers.

Learning to live with schizophrenia

We blogged a while back (February 2022) about the schizophrenia at the heart of projects that issue equity and tokens.

Revenue in these hybrid Web3 projects flows like a river with two tributaries—one feeding the traditional stockholder bucket (profit, equity growth) and the other the token holder bucket (rewards, ecosystem value).

The split depends on how the project balances centralized control with decentralized participation. If the company prioritizes shareholders, token holders might get less direct revenue but benefit from ecosystem growth. If it leans Web3-native, token holders might see more immediate returns, while stockholders rely on long-term equity gains.

§ 4C. Ready for a priced round

As discussed above, at the moment of a priced round, all your SAFE investors will convert into stock of your company using the conversion formula of the SAFE (typically on post-money terms).

If the company’s valuation is lower than the SAFE cap, the amounts under the post-money SAFE will be used as the nominator over the post-money valuation in the denominator to calculate the stake SAFE holders will have in the company once everything is said and done. Employee Share Options Plans too will come into the picture here and whilst Founders prefer to add them so everybody dilutes , investors often like to see the ESOP priced in before they calculate how much ownership of the company their investment will secure.

In summary, much will be open for negotiation, typically with a lead investor who agrees the terms and invests the bulk of the money, with other investors following on the same terms.

4.1Economic and control rights

Much has been written and is researchable when it comes to termsheets and pitfalls for Founders.

A helpful heuristic is to divide the terms of a VC termsheet into clauses that deal with the economics of the investment and those that secure governance control.

We all read the horror stories of founders who, after years of eating glass, have no upside left when the project they built exits, or who get booted out by investors in mid-flight.

Typically, such unhappy outcomes are the result of the interplay of economic and governance clauses of the Term Sheet which then find their way into the long-form Stockholder Agreement.

As a founder, navigating this Term Sheet can feel like deciphering a foreign language—except the stakes are your company’s future!

The terms dictate how much control, equity, and economic upside you’ll retain, so it’s worth understanding the key ones that could trip you up or protect you.

4.2Cutting through the jargon

Here’s a rundown of the typical terms you should zero in on, explained in a way that cuts through the jargon:

• Valuation (Pre-Money and Post-Money)

As with the SAFE, here too pre- vs post-money is the starting point: how much your company is worth before (pre-money) and after (post-money) the VC’s investment. A higher valuation sounds great—it means less equity given up—but watch out for inflated numbers that set unrealistic expectations for future rounds. If the VC pushes for a $10M pre-money valuation on a $2M investment, your post-money is $12M, and they own ~16.7% (2MM over 12MM). Negotiate hard here, but know it’s a balance—too high, and you risk a down round later.

• Liquidation Preference

This decides who gets paid first if the company is sold or shuts down. A “1x liquidation preference” means VCs get their investment back before anyone else sees a dime. Watch for “participating” preferences (e.g., 1x plus a share of the leftovers)—it’s a double-dip that can leave founders with crumbs in a modest exit. Push for non-participating if you can; it’s fairer.

• Board Composition

VC often want a board seat to influence decisions. A typical setup might be 3 seats: one for the founder, one for the VC, and one “independent.” Be cautious if they push for control, and be wary of agreeing to too many matters which will always need the VC Board Member to agree on, irrespective of the Board composition. You want a Board that advises, not dictates. Retaining a founder-friendly majority or at least a tiebreaker is key early on.

• Vesting Schedule

With vesting, even your own equity isn’t safe. VCs might insist on a 4-year vesting schedule with a 1-year cliff for founders, meaning you earn your shares over time. Yes you read that right: Even though you started out with 100% of Stock when you formed your C-Corp, you’re not building down from your equity but instead have to earn ownership of your own company. So if you’ve already been grinding for years, argue for “credit for time served” to accelerate this. Otherwise, leaving early - especially if VCs find Cause, which they can by fabricating allegations of misconduct - could cost you big: You will likely forfeit even the equity that vested in the past, meaning VCs can grab all your Founder shares and dole it out to anybody they think is better placed to run the business.

• Anti-Dilution Protection

If your next round is at a lower valuation (a “down round”), this protects VCs by giving them more shares to offset the hit. “Full ratchet” is brutal—it adjusts their price to the new low, massively diluting you. “Weighted average” is gentler and more common. Fight for the latter; full ratchet is a red flag.

• Option Pool

VC often require a chunk of equity (e.g., 10-20%) to be set aside for future hires before their investment. If it’s carved out of your pre-money valuation, it dilutes you, not them. Push for it to come post-money or be smaller—every percent matters.

• Control Rights (Protective Provisions)

These are veto powers VCs get over big moves—think selling the company, raising more money, or changing the charter. It’s reasonable for them to protect their investment, but if the list is too long (e.g., approving every hire), it handcuffs you. Negotiate to keep operational freedom.

• Drag-Along Rights

This lets VCs force all shareholders to sell if they approve a deal. It’s meant to avoid holdouts, but if the threshold is too low (say, 50% of Preferred Stockholders, which is the class of Stock VC typically gets whilst you’ll hold Common Stock), you could be dragged into a sale you hate. Aim for a higher bar, like 75%, and ensure Founders have a say.

• Pro-Rata Rights

VCs might secure the right to invest in future rounds to maintain their ownership percentage. Fine in theory, but if they’re the only ones with cash at the table later, it can squeeze out new investors. Consider capping this or making it optional.

• No-Shop Clause

Once you sign a Term Sheet, this locks you into exclusive talks with the VC for 30-60 days. It’s standard, but a long window (90 days) or vague terms can trap you if they drag their feet. Keep it short and tight—30 days max.

These terms aren’t just legalese—they shape your leverage, payout, and autonomy. The VC’s goal is to de-risk their bet; yours is to keep enough skin in the game to make it worth the grind. Get a good lawyer who’s seen these deals before - ideally one who is not in the pocket of VC - and don’t be afraid to push back, especially on valuation, liquidation, and control. It’s your company, at least for now. Be strategic about the terms that matter for the stage you’re at.

Go to Part II: How to raise from the community in an unscammy way

Quoted from the entry

“Schedule a call with Otonomos before you raise.”

— Otonomos, 28 February 2025

Schedule today