Let’s Have A RAFFLE

Updated 2026-03-11 at REBUS

Posted 2026-01-31

This essay is a bit of a departure from others on this site. First, it’s directed more at Investors than Founders. Second – and more importantly – it’s meant as a discussion starter. Like an LLM, I present with confidence but don’t mistake that for conclusiveness!

Motivation

I have discussed this with several experienced investors[1] and there is strong agreement that defaulting to venture – and therefore trying to be a rocket - drives bad decisions which can kill companies that would otherwise be great (albeit less high-flying). There is nothing wrong with being a great company that creates value and jobs. It’s only derisively called a “Lifestyle Company” because, for venture, it’s essentially a zero. But it’s not a zero.

Simple Agreements for Future Equity (SAFEs) are the instrument of choice for many – probably most – pre-seed and seed deals today. SAFEs reflect this venture-default view of startup financing, and they work great if the company successfully goes the venture route. But as pointed out here and here and here, they have some significant downsides. The reason is that the “simplification” is to assume the SAFE is the one-time step to a venture round. In those (few) cases, a SAFE is a great innovation. In the vast majority of cases – not one-stop a/o not venture-ready -- it’s not, leading to poor outcomes for the investors, the founders, or both. The reason for these poor outcomes is a lack of consideration of how to handle times that venture funding is unavailable or inappropriate for the company.

There has got to be a better way, one that enables early investors to invest in companies with a broader set of probable outcomes and one that enables founders to do what’s right to build their companies instead of what they think venture wants to see. That’s what this essay explores.

Real Agreements For Financing Like Equity

As noted above, SAFEs break down because they don’t consider all of the outcomes of a pre-seed or seed company. I will therefore structure this discussion to cover a MECE set of outcomes, revealing the terms needed to create a Real Agreement for Financing Like Equity (RAFFLE). The outcomes are:

The Good: the company lines up to go into orbit, and venture comes knocking
The Bad: the company “fails fast”, heading to a liquidation or subpar acquisition
The Ugly: the company manages to get to roughly breakeven with little momentum – a “zombie”
The Lifestyle: the company grows into a profitable, self-sustaining business

Let’s explore.

The Good

This is what SAFEs are optimized for and, unsurprisingly, the terms work very well in this scenario. The only comment I would make is that it would be nice if Information Rights were a standard part of the template.

The Bad

SAFEs really struggle here. A SAFE is not equity and has no vote (and often no Board observability). Investors cannot influence things by right and therefore end up receiving nothing even if the founders can salvage some assets. Preventing bad behavior is dependent almost entirely on the ethics of the founders. Note also: essentially, the pre-seed and seed investors are paying for an option on behalf of the VCs.

The inability to mitigate the downside risk is a serious issue with SAFEs for investors. The best mitigation is a Liquidation Preference. A lot of bad outcomes and bad behavior are averted with this simple term.

The Ugly

Ask any investor and they will tell you that a zombie is the worst case. The company is never going to grow enough to return capital, much less a return, but it also won’t die and leave a tax write-off behind. For SAFE investors, it’s even worse: given that the SAFE has no governing rights, the investors just have to sit idly by as their capital is tied up forever.

One idea I’ve seen to handle this is to include a “convert to Common upon maturity” option. That gives the investors the right to convert into true equity, after a certain date, if they choose. There are two issues with this. First, the term is almost always written with conversion at the cap… a cap that presumed success and now dilutes the investors to a tiny minority holding. Second, the company has no way to distribute returns (because there aren’t any returns). So, this term is lazy, uncreative, and moot.

Instead of looking at income, think about what the company does have: revenue. A small tax on revenue can give the investors a return… albeit a slow trickle. This is the heart of Revenue-Based Finance (RBF) and funds like RevUp[2] invest in just this sort of structure.

Perhaps the best we can do for The Ugly is to include a term that creates a revenue-based obligation, starting with Maturity… perhaps 5% of revenue until 2X is returned. (Any payments would reduce the obligation under the Liquidation Preference. Also, Information Rights are a must.) Having this Revenue Preference in the original document would enable a much higher risk tolerance for investors, and open a lot more companies up to seed investment.

One consideration is how to handle “stacking RAFFLEs”. That is, if a company has several tranches of RAFFLEs, does each get 5% of revenue? It would seem unfair to earlier investors if this were not so, but N*5% can rapidly drive the business into bankruptcy. (Maybe that’s OK - see Liquidation Preference!) Is there a preference… with older tranches dipping their beaks first? (That also applies to Liquidation Preference.) This requires a bit more thought.

The Lifestyle

This is where things get interesting, and handling this case is the most important theme of this paper. Originally, I thought this case was best handled with a “convert to Common” clause. Who would not want stock in a profitable company? But it occurred to me that investors might not want the politics and governance of getting returns through dividends… and that the Founders might want to buy out the investors so they can proceed with their lifestyle unencumbered.

Which gets me back to the Revenue Preference above. Note that that term works just as well in this case… better even because it explicitly handles the founder’s goal of buying out the investors. The only thing I might add is to make the payment “a minimum of 5% of revenue”. The founder can then pay more to reduce the obligation faster. Perhaps there should be an incentive to do so, counting amounts above the minimum double against the obligation.

Summary

A lot of the issues with SAFEs can be solved, or at least mitigated, through the inclusion of several terms:

Information Rights
Liquidation Preference
Revenue Preference

Only the last is a new concept,[3] but it’s easily derived from the agreements RBF companies already use. This new instrument – a Real Agreement For Financing Like Equity – not only solves problems, but also opens the aperture for early investors into companies which won’t need… or want… venture. And that’s good for all of us!

Additional Thoughts

Since publishing the original, I have had a few additional thoughts that I’d like to add.

First - the above does not indicate what type of instrument should be used. Should it be preferred equity, a contract (like a SAFE), a convertible? I think Brian Dirkmaat has a solution: Series First. He proposes a simplified preferred equity from looking at the issues with SAFEs from a different lens than mine including, importantly, 1202 tax treatment. I see our approaches as entire complementary.

One resolution to the stacked Revenue Preference issue I mentioned is not to use Revenue directly as the base for the payment calculation. Instead, we can build the Preferred to have interest - paid in cash - after maturity.

And - related to that - how do we handle the ability for the founder to buy out the Preferred? Suppose a 3-year maturity. Before maturity, the investors are clearly betting on the rocket and therefore buyback is not allowed. However, if the founder has not raised a venture round in that time, investors should be comfortable transitioning to a state where a buyback - or a buyout from a different investor - is the preferred outcome. So I think that after maturity, a reasonable multiple - even as low as 1X - is appropriate as long as accrued interest is paid.

Also I realized that I did not properly discuss exits by acquisition for zombies. To handle this case, the Liquidation Preference must include change of control provisions and may need to be participating.

[1] Shout out to Melissa Withers and Serhat Pala.

[2] I am an investor in one RevUp fund.

[3] Apparently not so new (which is good)! See https://playbook.innovative.finance/chapters/redeemable-equity/ for revenue-based dividends and redemption… which nicely covers what I was talking about.