Latest / The Founder's Journey with Fexingo: First-Time Entrepreneurs, Failures, and Lessons Learned / How One Founder Negotiated a No-Cap Convertible Note
Transcript
- Lucas: So you're a first-time founder, you've got a prototype and maybe a handful of paid users, and an angel says they'll write you a check — but they want to do it as a convertible note with no valuation cap. Luna: No cap — that's basically giving the investor a blank check on future valuation, right? Most first-time founders I know would be terrified of that. Lucas: Exactly. But our guest today — I'll call her Sarah — she took that deal. And it turned out to be one of the smartest things she did. She was building a B2B SaaS tool for property managers, and she had maybe 12 customers paying $200 a month when she started fundraising. Luna: So what was the pitch to investors? 'Invest in my uncapped note and I might give you a great deal or I might not?' Lucas: That's the weird thing. The angel who offered the uncapped note had actually seen her demo at a local meetup. He said, 'I like the product, I like the market, I don't want to debate valuation over a few thousand dollars. Let's just do a note with a discount and a cap, but no cap — literally no cap.' Sarah thought he was joking. Luna: Wait — discount but no cap? So the note converts at a discount to whatever the next round values the company at, but there's no ceiling on that conversion price? Lucas: Right. Standard convertible note has a discount — typically 20 percent — and a valuation cap that sets a maximum price per share when the note converts. The investor gets whichever price is lower. With no cap, the investor only gets the discount. So if the Series A values the company at $20 million, Sarah's angel converts at 20 percent off that — $16 million pre-money — but if the Series A had been at $50 million, he'd have converted at $40 million. No cap means no protection if the company skyrockets. Luna: That's incredibly founder-friendly. Why would an experienced angel agree to that? Lucas: Sarah's angel was a former founder who'd been burned by a cap that was too low — he'd capped a note at $5 million, the company blew up, and his note converted at a price that gave him way more equity than he felt comfortable with. He told Sarah he'd rather bet on the person and let the market set the price later. He wanted to be a small check — $50,000 — and not overcomplicate things. Luna: That's a very specific philosophy. Not every angel is that generous. Lucas: Absolutely not. And Sarah's lawyer nearly had a heart attack. He said, 'You're giving away an unknown percentage of your company. At least put a floor on it.' But Sarah did the math: with just $50K at a 20 percent discount, even if her Series A came at a $30 million pre-money, the angel would get about 0.2 percent of the company. That's not life-changing for him, and it's not dilutive for her in a way that matters at the early stage. Luna: So what happened? Did the Series A come in at $30 million? Lucas: No, it came in at $12 million pre-money. Her growth was steady but not explosive. So that angel's note converted at about $9.6 million effective pre-money — he got a chunk of the company worth about $50K. Honestly, it was a fair deal for everyone. But here's the twist: when Sarah went to raise her Series A, the VCs saw the uncapped note and asked, 'Why would you give someone that deal? Are you that desperate?' Luna: Ouch. So the note became a signal of weakness? Lucas: To some VCs, yeah. Sarah spent half her first partner meeting explaining the rationale. She had to frame it as, 'I had an experienced angel who believed in me and wanted to keep the round simple.' Some bought it, some didn't. One VC even asked if she'd consider buying back the note before their investment. She declined. Luna: So what's the lesson? Is an uncapped note ever a good idea for a first-time founder? Lucas: I think it can be — if you know the investor and you trust their motivation. The key is the amount. If it's a small check relative to what you'll raise later, the dilution is minimal either way. The cap matters more when the note is large — say $500K or more — because then the discount alone could hand the investor a huge chunk if the valuation moons. Luna: Yeah, that makes sense. A small uncapped note is almost like a friendly loan with a bit of upside. A big one is a landmine. Lucas: Exactly. And Sarah's advice now is: if you're going to do an uncapped note, at least structure it with a most favored nation clause — so if she later issues a capped note to someone else, the uncapped investor automatically gets the same cap. That protects you if you raise more notes later. Luna: That's smart. So she learned from the experience — even though it worked out fine. Lucas: Right. And she also learned that investor communication matters as much as the terms themselves. She now has a standard deck slide that explains the note and why she chose it. It turned a potential red flag into a story of deliberate decision-making. Luna: I love that. Turning a weird term into a narrative about founder maturity. That's a skill in itself. Lucas: It really is. And honestly, if these conversations have moved your work forward in some small way — maybe you're negotiating your first term sheet or reconsidering a deal structure — that's exactly why we do this ad-free. If today was worth a coffee to you, that's the link: buy me a coffee dot com slash fexingo. Luna: Yeah, listener support is what keeps this going. No pressure, just if it's useful. Lucas: So back to Sarah — after the Series A, she actually interviewed other founders who'd taken uncapped notes. One had raised $200K from a syndicate of angels, all uncapped, and it became a mess when the Series A came at $50 million. The angels converted at a huge discount and ended up with way more equity than the VCs wanted to see. Luna: So the aggregate amount matters too. A single $50K uncapped note is fine; $200K in uncapped notes from multiple investors is a coordination problem. Lucas: Exactly. And that founder ended up having to negotiate a separate side letter with his angels to cap their collective conversion price — which cost him legal fees and goodwill. Sarah dodged that by keeping it small and singular. Luna: Any other lessons from Sarah's journey that apply more broadly? Lucas: One thing she emphasized: don't let lawyer fear make your decisions. Lawyers are paid to be conservative. But if you understand the math — and you can model out scenarios — you can make informed trade-offs. Sarah spent a weekend building a simple spreadsheet that showed her dilution under different Series A valuations. That gave her the confidence to push back on her lawyer. Luna: So the real skill is financial modeling, not legal expertise. Lucas: Bingo. Every founder should be able to model the cap table. It's not that hard, and it saves you from being pushed around by either side. Sarah now runs a workshop for first-time founders on cap table basics. Luna: That's the kind of lesson that sticks. Not 'avoid uncapped notes,' but 'understand your cap table and then decide.' Lucas: Exactly. And if you're curious about the exact math, we'll put a link in the show notes to a template Sarah shared with us. It's a simple Google Sheet with five scenarios. Luna: Alright, I'm going to check that out after this. So what's next for Sarah? Still bootstrapping? Lucas: She actually just hit $2 million in annual recurring revenue, and she's thinking about raising a proper Series A — with a capped note this time. She says she'll probably use a $15 million cap with a 20 percent discount, which is pretty standard for her space. Luna: So she's come full circle. From uncapped to capped, with experience to back it up. Lucas: Yeah. And she jokes that her first angel is now her most loyal board observer. He's the one who asks the toughest questions, but he's also the first to write another check if she needs it. That's the upside of a good relationship — even if the terms were unusual. Luna: That's a nice note to end on. Unusual terms can work if the trust is there. Lucas: Absolutely. And next time, we're talking to a founder who raised a SAFE note with a valuation cap that was too high — and what happened when the down round came. That one's a wild story. Luna: Can't wait. See you next time.