I borrowed $40k from a friend to bootstrap Stormpulse (a profitable SaaS business with 2,000 subscribers and 6 million visitors) from 2006–2012 and then raised $3.3m through convertible notes and priced rounds of venture capital to pivot to enterprise SaaS with Riskpulse, where I served as CEO from 2013–2018. The following is my review of the first version of the Shared Earnings Agreement (or SEAL), a new structure for startup financing authored by Earnest Capital.
Earnest Capital, a source of “early-stage funding for bootstrappers, makers, and indiehackers,” has released the first version of their term sheet, affectionately coined the SEAL. You can read the latest version online. Since the latest version is likely to change, I’ve made a copy to capture the version I’m reviewing today. You can find it here.
While there has been a small flurry of coverage and conversation about Earnest Capital to accompany the document, there hasn’t yet been a deep critique or comparison between the SEAL and other forms of capital. I’d like to offer this as my own critique by looking at this financial instrument in terms of its cost to the entrepreneur in two ways: dollars, and equity.
This approach — of separately examining dollar cost, and then equity cost, is a tightrope because of the SEAL’s hybrid debt/equity nature. But if we’re going to understand the whole of this instrument, we need to make sure we thoroughly understand its parts. Once we do, we can reconstruct the whole and understand how it works.
One final note: Earnest Capital has authored the SEAL structure, but they have also open-sourced it, such that other investors can adopt it if they wish, for their own investments. This pattern of open-sourcing an investment structure is similar to what YCombinator did with the SAFE. What does that mean for this review? Throughout this article, I will refer heavily to Earnest, but that does not mean they intend SEAL’s to be exclusive to their firm. My own intent is that this analysis is helpful to any founder that sits at a negotiating table with a SEAL on top, independent of the investor on the other side.
Before we dive into the terms and costs, an overview of the structure:
- Investors don’t initially take equity through a Shared Earnings Agreement (or SEAL), but it does have equity clauses, so it can create ownership for the investor later.
- A SEAL isn’t a loan: it does not have an explicit interest rate or payback timeline, but it is a liability in the sense of stipulating an obligatory payback.
- The payback occurs as a minimum percentage rate of “Founder Earnings”, which, assuming the founder’s salaries are below a threshold, are equal to Net Income. The boilerplate of the term sheet states 30%.
- SEAL’s do not require personal guarantees and carry no foreclosure clauses — if you fail to pay it back, there is no recourse for the investor.
- The payback amount is set upon signing the agreement and is based on a multiple (generally 3x, 4x, or 5x) of the original investment. The product of the original investment multiplied by this 3x-5x is called the Return Cap.
- Similar to a Convertible Note, SEAL’s define a Valuation Cap, effectively setting the highest price per share that an investor will be exposed to in any future financings.
- SEAL’s are a seed instrument, aimed at serving founders that are post-revenue but still early-stage.
- As a hybrid structure for lending and investment, SEAL’s fall in the same general category as Convertible Notes and SAFE’s.
“The whole point of all of this structure is to re-align us with founders.” — Tyler Tringas, Earnest Capital
On the surface, this sounds interesting. So how should founders decide whether a SEAL can work for them? Let’s think about the cost of accepting capital through a SEAL through the lenses of dollars (cash) and equity (ownership).