I recently published a long essay covering the things we’ve learned from five years of investing in calm companies. In it, I shared the realization that the Shared Earnings Agreement investment structure is likely too complex for many cases and that we had moved most of our recent investments to a SAFE + Shared Earnings Side Letter structure. I’d like to explain that decision more and share templates of the terms we’re now primarily using.
I was and still am incredibly proud of the Shared Earnings Agreement (SEAL). One of the first things we did at the launch of Calm Company Fund (then called “Earnest Capital”) was to effectively crowdsource the creation of a new investment structure that was more aligned with the kind of companies we wanted to fund than the typical tools of a venture capitalist (read the original post here). We pointed out the major areas of misalignment—in particular that convertible notes and traditional SAFEs don’t even contemplate a future where the business is cashflowing and profitable—and put an initial draft in a public Google Doc. We got 100s of comments on Twitter, Hacker News, IndieHackers, and inline in the doc itself. The results was a well thought out structure that aligned investors with many more of the outcomes that founders want.
The vast majority of our investments from our first two funds were done using a SEAL and in practice the new structure worked pretty much according to plan.
- At least a dozen companies are profitable enough to be making quarterly Shared Earnings payments
- Two companies, including our first ever investment Hostifi, fully repaid up to a Shared Earnings cap (Reilly from Hostifi has done a great job sharing the journey on Twitter)
- Several companies have gone on to raise seed or Series A rounds where the SEAL has converted to equity (posing absolutely no obstacle to closing a venture round)
- Multiple companies have exited with SEAL investors sharing in the exit proceeds
But other subtler things didn’t go quite right:
- Some investors, especially angels, simply don’t want to do any kind of diligence on a new investment structure and strongly prefer to only use industry standard structures. I don’t this ever was an irresolvable sticking point for any founders we backed, but it certainly created a lot of extra discussion with some investors a few instances.
- The same goes for some large LPs, who simply weren’t interested in doing the diligence to understand a portfolio comprised of investment agreements they weren’t familiar with.
- Variables like the Shared Earnings Cap and Equity Basis in the original SEAL meant investors’ ownership % was a dynamic number that could change over time. While some founders really appreciated the option to “buy back” some of their equity, others found the dynamic figure confusing, especially over time and as new investors also joined the cap table.
- There’s strength in numbers when it comes to issue like legal and tax guidance. Legal precedents and IRS rulings are more likely come over time for SAFEs, which are widely used, that might not apply to a SEAL. For example, “does the 5-year QSBS clock start at the time a SAFE is signed or when it converts?” is a question that might be definitively answered some day that for sure would not be answered for a SEAL for another 10+ years if ever.
Finally, I personally felt like there was just too much emphasis on the SEAL in how both founders and investors positioned us in the market. I was constantly explaining that we were not a debt fund, or a revenue-based financing fund, or “alternative financing” (whatever that means I don’t want to be it). I would say: we are a fund designed to take a equity upside in companies building calm sustainable profitable businesses and the SEAL is just a tool to create alignment. But, I’m sure that for every person I got the opportunity to explain this to, 100 others probably put us in the wrong bucket and never reached out.
I identified these issues fairly early and starting in Fund III and into our current Fund IV, we started using a standard SAFE and a custom Shared Earnings side letter in addition to SEALs depending on the context.
We recently consolidated all this into the Shared Earnings SAFE. View the templates in Google Drive here. The docs merge the best ideas of the SEAL, like profit-sharing/Shared Earnings, with the well-known foundation of the SAFE.
In the past five years we’ve also identified some edge cases the neither our original SEAL nor a traditional SAFE handle well that we have addressed directly in our newest draft docs. Specifically:
- In some cases even if the company doesn’t raise another round of capital, it may make way more sense for investors to convert their interest into equity in the company rather than have a SAFE sit unconverted indefinitely. Our terms give investors the option to convert to equity after 18 months.
- As investors we like to be comfortable with founders making the choice to sell their company for (to them still life-changing) 7-to-low-8-figure exits, but the traditional SAFE might only offer investors to get 1x their money back in many of these scenarios (depending on the Valuation Cap). Our terms define a “Liquidity Amount” schedule that outlines certain minimum returns to the investors at certain lower exit outcomes, meaning if the founder is stoked to sell, we’re happy to help them and high-fiving when it closes.
- Shared Earnings and Investor Ownership are now simplified to a straightforward percentage. Shared Earnings are uncapped and persist until the SAFE converts, and Investor Ownership is a static number defined by the Valuation Cap.
- Founders of calm companies are way more likely to operate multiple products/businesses. Our side letter now makes it explicit which of these should be owned by the same company that investors invest in.
PS - it's also interesting to see that our friends at Indie.vc, having previously created their own redeemable equity structure, came to a similar conclusion with their recent fund.
