SAFEs are not bad for entrepreneurs(blog.ycombinator.com)
blog.ycombinator.com
SAFEs are not bad for entrepreneurs
https://blog.ycombinator.com/safes-are-not-bad-for-entrepreneurs/
113 comments
Doing a seed round now.
Ultimately the terms are going to depend on investor consensus, but my strong preference is to go uncapped w/ discount.
Having a cap is an incentive for me to "grow until I'm 6 months away from X, then focus on raising instead". For some seed investors an early valuation & equity conversion may be desirable, but I'd rather "grow until I'm 6 months away from needing funds to (grow faster|survive)".
Having no cap, on the other hand, encourages me to stay lean, grow quickly & ask for money only when it has the greatest value. That's behaviour which may not be friendly to opportunistic short-term VCs looking to get a quick valuation bump, but which is strongly correlated with long-term success and eventual home-runs.
I want to give a discount because seed investors are taking a big risk on me, they deserve it.
Ultimately the terms are going to depend on investor consensus, but my strong preference is to go uncapped w/ discount.
Having a cap is an incentive for me to "grow until I'm 6 months away from X, then focus on raising instead". For some seed investors an early valuation & equity conversion may be desirable, but I'd rather "grow until I'm 6 months away from needing funds to (grow faster|survive)".
Having no cap, on the other hand, encourages me to stay lean, grow quickly & ask for money only when it has the greatest value. That's behaviour which may not be friendly to opportunistic short-term VCs looking to get a quick valuation bump, but which is strongly correlated with long-term success and eventual home-runs.
I want to give a discount because seed investors are taking a big risk on me, they deserve it.
(I'm a VC)
Uncapped notes are generally a bad idea for everyone involved because they misalign incentives. If you raise a seed at a $6m cap, both your goal and your investors' goal is to help you make as much progress as possible for a Series A. For instance, investors will do whatever they can to help you get to a $30m valuation instead of a $20m valuation. An uncapped note means that investors invest at your next round's price. That means they benefit most of the price of your next round is low. I.e. they'll do as little as possible so that your Series A is at a $20m pre instead of a $30m pre. The misalignment creates perverse incentives. For example, if you ask an investor on an uncapped note to make a key customer intro, if they say yes then their reward if you land the customer is that they'll have even less ownership at the Series A. That's not a good incentive structure :)
Uncapped notes are generally a bad idea for everyone involved because they misalign incentives. If you raise a seed at a $6m cap, both your goal and your investors' goal is to help you make as much progress as possible for a Series A. For instance, investors will do whatever they can to help you get to a $30m valuation instead of a $20m valuation. An uncapped note means that investors invest at your next round's price. That means they benefit most of the price of your next round is low. I.e. they'll do as little as possible so that your Series A is at a $20m pre instead of a $30m pre. The misalignment creates perverse incentives. For example, if you ask an investor on an uncapped note to make a key customer intro, if they say yes then their reward if you land the customer is that they'll have even less ownership at the Series A. That's not a good incentive structure :)
If an investor would rather own 5% of a $20m company than 3.3% of a $30m company, and specifically limits a company's growth to achieve that end, then it's likely someone no founder would want to work with. Make the pie bigger, no?
The real problem with capped notes is that they serve as a proxy for price. If you're going to price it, just price it. But if a note had a floor + cap that served as a min/max range for what everyone felt comfortable with, and then utilize a discount to do the actual work of allowing for uncertainty in the valuation, that would be the setup that best encapsulates the spirit of convertible notes (of course, the devil is always in the details).
The real problem with capped notes is that they serve as a proxy for price. If you're going to price it, just price it. But if a note had a floor + cap that served as a min/max range for what everyone felt comfortable with, and then utilize a discount to do the actual work of allowing for uncertainty in the valuation, that would be the setup that best encapsulates the spirit of convertible notes (of course, the devil is always in the details).
> If an investor would rather own 5% of a $20m company than 3.3% of a $30m company
It's not that simple because you're not factoring for time. Yes, both of those stakes are worth $1m, but the risk levels taken by an investor are different. For example, would you rather own 5% of Amazon when it was worth $20m, or 0.01% when it's worth $10b? Those are both $1m stakes if you ignore time, but the latter would've been worth much less than the former.
Here's a concrete example using https://angelcalc.com/model
Priced round
I invest $1m at a $10m post, owning 10%.
- If your next round is $5m at $20m pre, I'll own 8% (post-dilution) which will be worth $2m.
- If your next round is $10m at $40m pre, I'll own 8% which will be worth $4m.
If your valuation doubles, so does the value of my investment, and I keep an 8% take in either case.
Uncapped note
I invest $1m on an uncapped note, 20% discount.
- If your next round is $5m at a $20m pre, I own $1.25m (5%).
- If your next round is $10m at a $40m pre, I own $1.25m (2.5%).
Note that 1) my upside is capped to $1.25m (that's the 20% discount I got) and 2) the better your next round, the lower my ownership.
Closing thoughts
The reason the uncapped note is even more unattractive is that most companies have some perceived ideal outcome. Let's say it's a max $2b exit for this specific company. For a priced round, I own 8% of a company that could go up to $2b in value. For an uncapped note, I own 5% if you raise at a $20m pre, or 2.5% if you raise at a $40m pre. Note that the better you do, the lower my percentage, and hence the lower my potential upside. If you raise at a $20m pre my stake might be worth $2b x 5% = $100m someday. If you raise at $40m pre my stake might be worth $2b x 2.5% = $50m someday. If you really knock it out of the ball park and raise $20m on an $80m pre for your Series A, my max upside is $25m. Again, this makes no sense because I invested $1m at the exact same time in both the priced round and the uncapped note round, but in the priced round instance I own 8%, while in the uncapped round I probably own much less, and the better you do on your way to a $2b exit, the worse I do. That's a strong misalignment and there's no way for me to make that pie bigger.
It's not that simple because you're not factoring for time. Yes, both of those stakes are worth $1m, but the risk levels taken by an investor are different. For example, would you rather own 5% of Amazon when it was worth $20m, or 0.01% when it's worth $10b? Those are both $1m stakes if you ignore time, but the latter would've been worth much less than the former.
Here's a concrete example using https://angelcalc.com/model
Priced round
I invest $1m at a $10m post, owning 10%.
- If your next round is $5m at $20m pre, I'll own 8% (post-dilution) which will be worth $2m.
- If your next round is $10m at $40m pre, I'll own 8% which will be worth $4m.
If your valuation doubles, so does the value of my investment, and I keep an 8% take in either case.
Uncapped note
I invest $1m on an uncapped note, 20% discount.
- If your next round is $5m at a $20m pre, I own $1.25m (5%).
- If your next round is $10m at a $40m pre, I own $1.25m (2.5%).
Note that 1) my upside is capped to $1.25m (that's the 20% discount I got) and 2) the better your next round, the lower my ownership.
Closing thoughts
The reason the uncapped note is even more unattractive is that most companies have some perceived ideal outcome. Let's say it's a max $2b exit for this specific company. For a priced round, I own 8% of a company that could go up to $2b in value. For an uncapped note, I own 5% if you raise at a $20m pre, or 2.5% if you raise at a $40m pre. Note that the better you do, the lower my percentage, and hence the lower my potential upside. If you raise at a $20m pre my stake might be worth $2b x 5% = $100m someday. If you raise at $40m pre my stake might be worth $2b x 2.5% = $50m someday. If you really knock it out of the ball park and raise $20m on an $80m pre for your Series A, my max upside is $25m. Again, this makes no sense because I invested $1m at the exact same time in both the priced round and the uncapped note round, but in the priced round instance I own 8%, while in the uncapped round I probably own much less, and the better you do on your way to a $2b exit, the worse I do. That's a strong misalignment and there's no way for me to make that pie bigger.
I said this in another comment but it seems like these cases are assuming a long time passing between the SAFE and the priced round. Not sure if DelaneyM and pmcaffey are referring to that.
If SAFE is a way to start what would be a priced round (a few months), then your numbers would tell a different story. You getting to invest $1M and $10M cap, and then the company raising at $20M valuation later, means that you got an unfairly low priced deal (assuming company's valuation wouldn't naturally double in those couple of months).
In short timeframes (SAFE -> Priced rounds), its hard to imagine something other than discounts being fairer to all parties concerned.
In longer timeframes where the next priced round is a Series A, an year later, your point stands and is well taken.
If SAFE is a way to start what would be a priced round (a few months), then your numbers would tell a different story. You getting to invest $1M and $10M cap, and then the company raising at $20M valuation later, means that you got an unfairly low priced deal (assuming company's valuation wouldn't naturally double in those couple of months).
In short timeframes (SAFE -> Priced rounds), its hard to imagine something other than discounts being fairer to all parties concerned.
In longer timeframes where the next priced round is a Series A, an year later, your point stands and is well taken.
Thanks Leo for the detail response. The problem with this analysis is that you're comparing a priced round to an uncapped note, but using totally different and arbitrary parameters (ie. 20% discount).
I agree 20% discount is not an accurate assessment of the risk and potential increase in value from seed to A, which is usually 3x. Also, the original purpose of a note is to solve the problem of inaccurately pricing an early stage company. If that's not a problem then there's no point in not pricing. But if there's great variation in the potential of a company, then it makes sense to use a variable pricing model, which a significant discount (30-60%) better accounts for. Add in a cap and a floor (something like $4m - $40m) to protect founder & investor in extreme situations like you described.
Obviously a fixed price is better for you, the investor. But is it better for the company? Is it the best way to model the uncertainty of valuation? You argue for not dissentivizing the investor. What about the founder who raises $1m seed at $5m valuation, then raises Series A at $30m? They mispriced their seed round, and the likelihood of the A investors finding a way to diminish the value of the seed investors greatly increases.
Just an alternative view of things from an outside.
I agree 20% discount is not an accurate assessment of the risk and potential increase in value from seed to A, which is usually 3x. Also, the original purpose of a note is to solve the problem of inaccurately pricing an early stage company. If that's not a problem then there's no point in not pricing. But if there's great variation in the potential of a company, then it makes sense to use a variable pricing model, which a significant discount (30-60%) better accounts for. Add in a cap and a floor (something like $4m - $40m) to protect founder & investor in extreme situations like you described.
Obviously a fixed price is better for you, the investor. But is it better for the company? Is it the best way to model the uncertainty of valuation? You argue for not dissentivizing the investor. What about the founder who raises $1m seed at $5m valuation, then raises Series A at $30m? They mispriced their seed round, and the likelihood of the A investors finding a way to diminish the value of the seed investors greatly increases.
Just an alternative view of things from an outside.
I appreciate the follow up. I think where we disagree is that a priced round is a disincentive to the founder. Instead of a disincentive, I think a priced round is "fair." A few quick comments:
- are there any other areas where, as a buyer/investor, you buy at a discount to a future price instead of an estimated current price? For example in places where houses appreciate quickly, people still buy houses at a fixed price. No seller ever says "this house might be worth $2m-5m in 10 years, so instead of buying it for $1m today, which don't you buy it for a 20% discount to when you sell it 10 years from now?" Same thing with paintings, stocks, etc.
- the $5m -> $30m mark-up is not a mispricing. For public stocks, pricing is based is based on expected cash flows. For example, if a company is expected to make $10m/year for 30 years, it might be worth $300m today, minus an adjustment for inflation (so maybe it's only worth $200m today). For startups, the valuation is based on "% chance of a huge outcome." So when a company goes from $5m to $30m in valuation, that doesn't mean its revenues jumped 6x. What it really means is investors think the company made enough progress so that instead of a 1% chance at a $1b exit, there's now a 6% chance at a $1b exit. In that regard, the company is worth $30m today, but it was also not worth that at the seed round.
- are there any other areas where, as a buyer/investor, you buy at a discount to a future price instead of an estimated current price? For example in places where houses appreciate quickly, people still buy houses at a fixed price. No seller ever says "this house might be worth $2m-5m in 10 years, so instead of buying it for $1m today, which don't you buy it for a 20% discount to when you sell it 10 years from now?" Same thing with paintings, stocks, etc.
- the $5m -> $30m mark-up is not a mispricing. For public stocks, pricing is based is based on expected cash flows. For example, if a company is expected to make $10m/year for 30 years, it might be worth $300m today, minus an adjustment for inflation (so maybe it's only worth $200m today). For startups, the valuation is based on "% chance of a huge outcome." So when a company goes from $5m to $30m in valuation, that doesn't mean its revenues jumped 6x. What it really means is investors think the company made enough progress so that instead of a 1% chance at a $1b exit, there's now a 6% chance at a $1b exit. In that regard, the company is worth $30m today, but it was also not worth that at the seed round.
There is no way to know at the beginning if you'll be a $0M or $30M company and to make their portfolio math work they need as much upside as possible if you get to a higher valuation. The pie is fixed at 100% and everyone is fighting for more of it.
The real problem with capped notes isn't the proxy for price, it's that the cap table is impossible to discern. Capped notes actually do have an advantage in that you can do a rolling close of your round, so you don't have to have everyone invest at the same time on the same day. The downside is that it is hard to explain to your employees exactly how much they own since it depends on how the notes convert.
The real problem with capped notes isn't the proxy for price, it's that the cap table is impossible to discern. Capped notes actually do have an advantage in that you can do a rolling close of your round, so you don't have to have everyone invest at the same time on the same day. The downside is that it is hard to explain to your employees exactly how much they own since it depends on how the notes convert.
can't price it without it being a real equity round in which case closing costs are the real issue (the other reason why converts work well at early stages)
How about splitting the difference? One could issue a note that prices at the geometric mean of an agreed-on number (what would have been the "cap", but it's obviously not a cap anymore) and the Series A valuation. So if the agreed number is $6M and the round is priced at $20M, the note would convert at sqrt(6 * 20)M = $10.95M, but if the round prices at $30M, the note would convert at $13.41M. Seems like this would still leave the investor with plenty of incentive to help the business grow, without giving them what can seem an outsized share of that growth.
1) I think that's an interesting idea.
2) Complex pricing is hard to implement well (both for valuations and for product prices). It's friction for what could be a straightforward transaction.
3) It's not clear to me why the investor would want their upside capped. E.g. if I buy stock in your company and the company becomes more 3x more valuable, then why would I be okay with my stock being 2x more valuable? Why not 3x just like you? (And likewise, the founder wouldn't want my stock to be 4x more valuable if the company is 3x more valuable).
2) Complex pricing is hard to implement well (both for valuations and for product prices). It's friction for what could be a straightforward transaction.
3) It's not clear to me why the investor would want their upside capped. E.g. if I buy stock in your company and the company becomes more 3x more valuable, then why would I be okay with my stock being 2x more valuable? Why not 3x just like you? (And likewise, the founder wouldn't want my stock to be 4x more valuable if the company is 3x more valuable).
Just throwing out an idea. I think I'll have to play with the dilution calculator for a while before I even form an opinion as to whether there's a good answer to your question. I was just going off the observation that uncapped notes are apparently not completely unheard of, for whatever reason, and so maybe there's some room for compromise.
Does your assessment change at all if your horizon extends beyond the next round?
Not really. If a fair price for your company is $10m today or $40m in a year if you do well, there isn't a good reason to invest at $40m today (or even a discount like 20% off $40m).
An analogy: Amazon is $1k/share today. Let's say you think there's a 30% chance it will 3x in the next year. Would you like to invest at $2.5k/share today? The answer is No because that has negative expected value, and you'd rather just wait a year and invest at $3k/share than investing at a small discount to $3k/share today when the stock is worth much less than that.
Also, the time horizon doesn't change the misaligned incentives here. Because I get in at next round's price, I would prefer for that price to be lower.
An analogy: Amazon is $1k/share today. Let's say you think there's a 30% chance it will 3x in the next year. Would you like to invest at $2.5k/share today? The answer is No because that has negative expected value, and you'd rather just wait a year and invest at $3k/share than investing at a small discount to $3k/share today when the stock is worth much less than that.
Also, the time horizon doesn't change the misaligned incentives here. Because I get in at next round's price, I would prefer for that price to be lower.
It seems like a hidden element that we aren't talking about which really might affect everyone's reference points is the time duration between SAFE and priced rounds.
For a lot of people, I see the difference being the start of the process, and the end of process which can be a few months - in which case, an uncapped with discount seems entirely reasonable.
It seems like you are referring to a case where a substantial time has passed to materially affect the valuation in a substantive way?
For a lot of people, I see the difference being the start of the process, and the end of process which can be a few months - in which case, an uncapped with discount seems entirely reasonable.
It seems like you are referring to a case where a substantial time has passed to materially affect the valuation in a substantive way?
Isn't the whole point of notes to address the uncertainty of valuation? In your example, what happens when there's no 'fair price today'? If you think there's a 30% chance Amazon will be worth 3k in a year, what price would you pay now?
Usually fair price is based on some combination of 1) market price and 2) the investment's expected value, adjusted by some return hurdle rate. For example, if I'm looking for a 25% annual return, and next year I think Amazon is 70% likely to be $1000/share and 30% likely to be $3000/share (weighted avg = $1600/share), then a fair price might be $1280.
the point of notes is to be able to raise without expensive legal fees and be reasonable on valuation (i've done a lot of angel investing and when i invest i want a "starting point" - doesn't have to be crazy low but has to "make sense" - at least to me; 20% discount on next round isn't appealing enough {why would an angel putting money super early with the greatest chance of losing it all only get a relatively small discount})
Ease and simplicity is definitely the biggest reason notes have continued to be used. But their original purpose was to solve the problem of setting a price on early stage companies.
I agree that 20% discount by itself is not appealing enough incentive for the risk of early stage investment. But what about 40%? ...50%? A discount is just the mechanism that most accurately captures the variable nature of valuation. Finding the right number is where the modeling happens.
I agree that 20% discount by itself is not appealing enough incentive for the risk of early stage investment. But what about 40%? ...50%? A discount is just the mechanism that most accurately captures the variable nature of valuation. Finding the right number is where the modeling happens.
I believe 25% is the smallest discount I've seen thrown around, 40%-50% is rather common.
As was mentioned elsewhere, smaller discounts tend to apply to shorter horizons, such as when bridging immediately into a round. In those cases, they can be a good way for VCs to get on the cap table with prorata rights without having to muck around in series-A drama.
As was mentioned elsewhere, smaller discounts tend to apply to shorter horizons, such as when bridging immediately into a round. In those cases, they can be a good way for VCs to get on the cap table with prorata rights without having to muck around in series-A drama.
I'm unclear on how the cap would be a starting point? To DelaneyM & pcmaffey's point, it then becomes a proxy for price, so you've effectively set a valuation.
Would it be more appealing if you the round was closed in the next few months, so you investing early would be well rewarded with the discount?
Would it be more appealing if you the round was closed in the next few months, so you investing early would be well rewarded with the discount?
No investor will do an uncapped note (unless it's a bridge round) because it's a very bad deal for them. A fixed discount on the round is not enough upside to account for their risk, especially when there are plenty of investments available whether they can get a cap which gives them much more upside.
Investors will do uncapped notes for bridges because there is usually a very short time period between the note and the next round, so they actually make a better return due to the discount than they would in equity appreciation over that short time.
Investors will do uncapped notes for bridges because there is usually a very short time period between the note and the next round, so they actually make a better return due to the discount than they would in equity appreciation over that short time.
> Having a cap is an incentive for me to "grow until I'm 6 months away from X, then focus on raising instead".
This was my impression as well. I do understand that the deal has to be equitable for both sides. It also has to align interests and as your example shows, the cap doesn't.
The discount obviously makes sense since the seed funder is taking more risk.
This was my impression as well. I do understand that the deal has to be equitable for both sides. It also has to align interests and as your example shows, the cap doesn't.
The discount obviously makes sense since the seed funder is taking more risk.
This makes a lot of sense, and is also my preferred route. Have you had any feedback or pushback on this route yet?
I am also curious how the reactions differ from Angels to MicroVCs to Seed Funds.
I am also curious how the reactions differ from Angels to MicroVCs to Seed Funds.
So far everyone's been happy with an MFN, so it hasn't been much of an issue. (They seem happy to let someone else be "the bad guy" who forces terms.)
If I secure enough commitment on MFN agreements alone, I plan to default them all into a fairly generous discount.
If I secure enough commitment on MFN agreements alone, I plan to default them all into a fairly generous discount.
If you don't have concrete plans for a Series A in the 18 month timespan does a SAFE still make sense?
That's one place where the SAFE is better than a convertible note - a note will have to have a specific term for maturity, usually 18 or 12 months, but a SAFE can just sit there outstanding indefinitely until an event causes it to convert.
This could get tricky. I imagine, at some point when you feel the round is closing, you'd want to set some terms/valuation and ensure that the biggest investor (or most/all of the investors) feel good about that.
Very interested in this as well.
> and the industry standard is that companies pay for BOTH their own legal counsel and the investor’s legal fees.
Serious question - how is this still the case, or make any sense? Wouldn't it be in the investor's interest that the company doesn't spend $60K out of their raise on this, and instead on hires, product, etc?
And given how standard a process this must be for every VC firm, I imagine they would have a well-negotiated rate, which for them is an incremental cost of investing?
I'd like to believe that there are firms out there that don't do this, and that this is turns out to be some sort of advantage for them (a form of founder-friendly/company-friendly, if you will).
Serious question - how is this still the case, or make any sense? Wouldn't it be in the investor's interest that the company doesn't spend $60K out of their raise on this, and instead on hires, product, etc?
And given how standard a process this must be for every VC firm, I imagine they would have a well-negotiated rate, which for them is an incremental cost of investing?
I'd like to believe that there are firms out there that don't do this, and that this is turns out to be some sort of advantage for them (a form of founder-friendly/company-friendly, if you will).
VC's typically get to charge fees on capital they deploy, not just what their institutional investors have committed to their fund. So in theory, while they could be more transparent by reducing the amount of their investment by the amount of their legal fees and then paying them out of pocket, they prefer to instead deploy that money to the portfolio company and let them spend it. Not saying it's good for founders, but that's why they do it.
This should be coming out of the investors' management fee (the 2% of the "2 and 20") but by making "the company" pay they shift the cost onto their LPs.
The best you can do is limit the legal fees in the TS.
The best you can do is limit the legal fees in the TS.
Bingo. This is an important detail that's easy to miss; but a VC has a huge incentive to lower its own costs while increasing capital committed. Any expenses come straight from the GPs' pockets. Capital invested is paid for by LPs and the VC even earns management fees on it.
It'd be in a VC's best interest to invest $60k more for the same equity, and make the startup pay that expense, vs. paying for it directly. It's a win-win for startups and VCs. LPs get a bit screwed, however.
It'd be in a VC's best interest to invest $60k more for the same equity, and make the startup pay that expense, vs. paying for it directly. It's a win-win for startups and VCs. LPs get a bit screwed, however.
The most charitable explanation I can think of is that this is a relic of old times, and that is changing. I know of founders who have insisted on this being paid by the VC, and successfully gotten so.
But I'd also like to know how standard/non-standard this is.. and why is it even the case in the first place?
Given how Fred Wilson (and others) talk about not liking SAFE, they really should then make it easier to do priced rounds without putting the burden on founders.
But I'd also like to know how standard/non-standard this is.. and why is it even the case in the first place?
Given how Fred Wilson (and others) talk about not liking SAFE, they really should then make it easier to do priced rounds without putting the burden on founders.
> why is it even the case in the first place?
1) Because VCs were working on 'fixed income' 2) because they could. The standard deal historically is "2 and 20", i.e. the VCs get paid 2% of the fund raised per year, and the first 20% of the profit. That 2% is used to pay for salary and office space, and doesn't increase until you raise a new fund, and the 20% isn't realized until the fund ends in 10 years. So pushing the cost onto the startup saves them a decent amount of money when you're doing dozens of deals a year.
1) Because VCs were working on 'fixed income' 2) because they could. The standard deal historically is "2 and 20", i.e. the VCs get paid 2% of the fund raised per year, and the first 20% of the profit. That 2% is used to pay for salary and office space, and doesn't increase until you raise a new fund, and the 20% isn't realized until the fund ends in 10 years. So pushing the cost onto the startup saves them a decent amount of money when you're doing dozens of deals a year.
By pushing it out on startups that are supposed to be conservative with spending, and investing only on the product? Seems extremely short-sighted.
At the end of the day, this is all the LP's money, and this comes down to how much the LPs pay the VCs for their service.
Leaving aside bloat in lawyer rates because the VC doesn't care about price, the total cost to do the deal is basically unchanged though.
Leaving aside bloat in lawyer rates because the VC doesn't care about price, the total cost to do the deal is basically unchanged though.
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Serious question - how is this still the case, or make any sense? Wouldn't it be in the investor's interest that the company doesn't spend $60K out of their raise on this, and instead on hires, product, etc?
No, it would not be in the investors best interest to make that change. Under the current system all of the money spent is used to buy shares in the company. Under a system where the VC firm was responsible for their own legal fees then $25k (or whatever) would go directly to the lawyers instead of buying shares so they would end up with a bit less ownership.
EDIT: To be clear I'm not saying that I am in favor of the status quo. I am not. I'm just saying that it is understandable given the incentives of VC firms.
No, it would not be in the investors best interest to make that change. Under the current system all of the money spent is used to buy shares in the company. Under a system where the VC firm was responsible for their own legal fees then $25k (or whatever) would go directly to the lawyers instead of buying shares so they would end up with a bit less ownership.
EDIT: To be clear I'm not saying that I am in favor of the status quo. I am not. I'm just saying that it is understandable given the incentives of VC firms.
The VCs aren't the investors here.
There are 3 parties, the startup, the VCs and the LPs. The LPs are generally pension funds, college endowments, and sovereign wealth funds, i.e. institutions who can write $10M-$100M checks. The VCs are their agent, like a real estate agent helping you buying a house.
While VCs put their own money into the fund, generally the vast majority of the fund money comes from the LPs. The VCs get paid 2 and 20, 2% of the fund per year for things like salary and rent, and the first 20% of profits from the fund when it ends, in 10 years. Because of this structure, they don't get to treat the fund money as their own personal piggybank.
No matter who pays, the cost of a deal is going to be <money startup receives> + <startup legal costs> + <VC legal costs>.
Raising the cost for the VCs, without changing 2 and 20 just results in increased costs for the VC. Paying their own legal costs means they'll do fewer deals, with larger check sizes.
There are 3 parties, the startup, the VCs and the LPs. The LPs are generally pension funds, college endowments, and sovereign wealth funds, i.e. institutions who can write $10M-$100M checks. The VCs are their agent, like a real estate agent helping you buying a house.
While VCs put their own money into the fund, generally the vast majority of the fund money comes from the LPs. The VCs get paid 2 and 20, 2% of the fund per year for things like salary and rent, and the first 20% of profits from the fund when it ends, in 10 years. Because of this structure, they don't get to treat the fund money as their own personal piggybank.
No matter who pays, the cost of a deal is going to be <money startup receives> + <startup legal costs> + <VC legal costs>.
Raising the cost for the VCs, without changing 2 and 20 just results in increased costs for the VC. Paying their own legal costs means they'll do fewer deals, with larger check sizes.
you missed the parent's point.
if it paid its own legal fees it would get that much less equity.
imagine I said "I'll invest 1M at a 2M valuation but you have to burn 800K of it in a bonfire." vs if I said "I'll invest 200K at 2M valuation but I'll celebrate by burning 800K in a bonfire."
The same thing happens to the money (it burns in a bonfire / goes to the lawyers) but in the first one I have 50% of your company and in the second one I have 10% of it.
Because in the first one I added it to the equity investment before making you pay it.
if it paid its own legal fees it would get that much less equity.
imagine I said "I'll invest 1M at a 2M valuation but you have to burn 800K of it in a bonfire." vs if I said "I'll invest 200K at 2M valuation but I'll celebrate by burning 800K in a bonfire."
The same thing happens to the money (it burns in a bonfire / goes to the lawyers) but in the first one I have 50% of your company and in the second one I have 10% of it.
Because in the first one I added it to the equity investment before making you pay it.
Also, then the $25k would come out of the management fee rather than the LP's capital. Even less incentive for the fund manager to go this route!
Yup, that too.
...of a financially healthier company!
But I suppose it's really kind of a matter of accounting. As long as the outlay of the investors is equal in both scenarios, the post-money situation should be approximately the same.
That said, in reality, the VCs probably have a better understanding of the real costs of the fundraise, so I can see the argument that they'd be best served in the long-run by minimizing surprises for their portfolio companies.
But I suppose it's really kind of a matter of accounting. As long as the outlay of the investors is equal in both scenarios, the post-money situation should be approximately the same.
That said, in reality, the VCs probably have a better understanding of the real costs of the fundraise, so I can see the argument that they'd be best served in the long-run by minimizing surprises for their portfolio companies.
It really seems short-sighted, since the focus should be on making sure companies have enough runway, comfortable and focused on product. For an early stage startup, $25K- $60K can be an extra part-time/full-time (depending on location/function) employee.
That goal is not in conflict with what I said.
Say that a company needs $X to have "enough runway." The VC firm can either invest $X and pay for the firms legal fees themselves or invest $X+legal_cost and have the company pay the fees. In the latter scenario the VC firm will probably end up with a greater ownership percentage.
It is worth noting, however, that it might not really make any difference. Much like tax incidence who directly pays for the lawyer really might not matter much in terms of where things end up in the end. The cost will always, to some degree, be shared by the firm and the company.
Say that a company needs $X to have "enough runway." The VC firm can either invest $X and pay for the firms legal fees themselves or invest $X+legal_cost and have the company pay the fees. In the latter scenario the VC firm will probably end up with a greater ownership percentage.
It is worth noting, however, that it might not really make any difference. Much like tax incidence who directly pays for the lawyer really might not matter much in terms of where things end up in the end. The cost will always, to some degree, be shared by the firm and the company.
I see. So, the choice is essentially :
A: <Capital> from which the startup can pay legal fees OR
B: <Capital> + <Legal Fees> where the Capital is probably less as VC firm is probably accounting for Legal fees separately.
Even then, it is interesting that the optics of this doesn't bother investors.
Even then, it is interesting that the optics of this doesn't bother investors.
For everyone who had no idea what a safe is (beyond the big metal thing you put valuables in), I eventually found this with some digging:
https://www.ycombinator.com/documents/#safe
https://www.ycombinator.com/documents/#safe
Curious that it appears to be a non-capitalized acronym. That could definitely cause some confusion.
Apparently YC thought that capitalizing "SAFE" was inconvenient: http://blog.ycombinator.com/announcing-the-safe-a-replacemen...
For what it's worth, I think this causes more confusion than it's worth.
For what it's worth, I think this causes more confusion than it's worth.
The article is written from a place (what Eric Evans calls a 'bounded context') where the term is so well known that people just use it as a common noun. But crossing into the HN context that's no longer true, so we've uppercased it for you above.
(I almost said improper noun but apparently that's like land seahorse.)
(I almost said improper noun but apparently that's like land seahorse.)
Thanks for sharing this. I had forgotten what it was.
> The safe (simple agreement for future equity) is intended to replace convertible notes in most cases, and we think it addresses many of the problems with convertible notes while preserving their flexibility.
> The safe (simple agreement for future equity) is intended to replace convertible notes in most cases, and we think it addresses many of the problems with convertible notes while preserving their flexibility.
The article this is responding to is extremely misleading and is pure clickbait.
Safes are great. They're easy to understand, and any semi quantitative founders should be able to build dilution spreadsheets without the help of a lawyer.
Safes are great. They're easy to understand, and any semi quantitative founders should be able to build dilution spreadsheets without the help of a lawyer.
what is a SAFE? How is it different from standard equity/debt?
We did a Safe in our first VC round (and then converted it in a priced round later), and it was an easy, fast way to close. I had to convince our investor to do one because it was their first, and they also had a very positive reaction to it. Deals die because of time and we were able to get the deal done and get back to work. I would definitely do one again and I think the downsides are overblown.
Was the priced one a priced Seed or priced A? And how much later? What had changed by then?
Second one was a priced seed but honestly it was more like a classic Series A. One after that was a larger priced Series A. Second round we put together a board, didn't do that for the Safe round which was intentional on my end (instead we had a great informal meeting cadence)
This is a good post, but the one thing that stuck out at me is the $60k Series A figure. I have no doubt it's true, but comparing priced Series A legal costs to seed stage SAFE legal costs is apples to oranges. No one is debating using SAFEs for Series A's, as those are already priced rounds ~100% of the time. For a priced seed round, I've heard legal costs can vary from $5k to $20k or so. That's not insignificant, but it's way lower than $60k.
IMO the largest costs aren't the dollar costs, in fact those barely matter. The large cost to me as a founder are the weeks/months it takes to negotiate a priced round when there's so little data is borderline exercise in futility and so much work that needs to be done by exactly the person that would need to handle those negotiations. But that's more abstract than putting a solid "$60k" number on something.
And why is that cost on the founders? Is that true for your investments as well?
I've been a VC for about 5 years and tbh I don't know why this industry standard exists. It's not something that makes sense to me. I think it would be a good change for the industry to get rid of this practice, and I think the change should come from the top (e.g. the National VC Association or from a group of leading VCs).
Similarly, why do sellers pay closing costs for houses? Makes zero sense. The money is flowing from the buyer to the seller. It also inflates the price of the house since the buyer has to pay the seller to pay the closing costs. Then you have to pay mortgage interest and property tax on that inflated value.
I paid closing costs when I bought, and as my realtor said, it's like free cable. It's not a massive savings but it's free cable every month.
I paid closing costs when I bought, and as my realtor said, it's like free cable. It's not a massive savings but it's free cable every month.
Having the seller pay closing costs essentially allows the buyer (the buyer always pays transaction costs from an economic perspective) to pay the closing costs through the mortgage. I.e. the house costs 10% more, but you can mortgage it, instead of an extra 10% out of pocket.
The rationale, from the VC's perspective for the company paying for a priced transaction is the same. Really this is a way of making the LPs of the fund pay for the transaction (i.e. their money given to the company to pay the transaction) rather than the VC having to pay transaction expenses out of their fees.
The rationale, from the VC's perspective for the company paying for a priced transaction is the same. Really this is a way of making the LPs of the fund pay for the transaction (i.e. their money given to the company to pay the transaction) rather than the VC having to pay transaction expenses out of their fees.
Appreciate the reply, thanks! Any thoughts on my other question at the top of the thread - https://news.ycombinator.com/item?id=14746570
Usually valuations are determined more by the investors rather than the founder. That might sound unfair, but investors have much better market comps. (Kind of like how you might think your house should be worth $X, but a real estate agent will tell you it's worth $Y, and their guess is usually better than yours.) If there are lots of investors vying to get into a round, then the founder has a lot more pricing power.
Market terms for a seed round are either 1) a priced round, or 2) a SAFE or note with a cap and a discount. 20% is a typical discount. A typical cap, in Silicon Valley, would be $4m-$5m on the lower end (idea or prototype phase, little or no market validation) up to $8m-$10m on the higher end (product is live in the market, has decent usage, and perhaps $25k-$75k MRR if you're b2b). There are also outliers that are >$10m cap -- usually those companies have exceptionally strong growth or founders.
In practice, SAFE/note discounts don't come into play that often but caps do. That is, next rounds are usually significantly higher than the cap (and the discount doesn't apply).
Market terms for a seed round are either 1) a priced round, or 2) a SAFE or note with a cap and a discount. 20% is a typical discount. A typical cap, in Silicon Valley, would be $4m-$5m on the lower end (idea or prototype phase, little or no market validation) up to $8m-$10m on the higher end (product is live in the market, has decent usage, and perhaps $25k-$75k MRR if you're b2b). There are also outliers that are >$10m cap -- usually those companies have exceptionally strong growth or founders.
In practice, SAFE/note discounts don't come into play that often but caps do. That is, next rounds are usually significantly higher than the cap (and the discount doesn't apply).
Jon's post notes that this is the industry standard. Anecdotal, but my experience matches that claim (last data point being end of 2016).
I've never encountered any compelling rationale as to why/how that standard emerged.
I've never encountered any compelling rationale as to why/how that standard emerged.
While you can argue that SAFEs are roughly equivalent to equity (with the advantage of allowing rolling closes) they are very bad for startup employees. Many startup employees have no idea how much they really own of a company because their equity disclosures do not include the conversion of the SAFEs upon future equity rounds.
I have met many companies where the first few employees think they own 1% of the company, and after a Series A where 25% is sold they find out they only own 0.5% because the SAFE conversions took up another 25%.
In some cases founders don't understand what is happening or how to include SAFEs in their cap table, in other cases they are purposefully obscuring the cap table. Whatever the reason it's very bad.
I have met many companies where the first few employees think they own 1% of the company, and after a Series A where 25% is sold they find out they only own 0.5% because the SAFE conversions took up another 25%.
In some cases founders don't understand what is happening or how to include SAFEs in their cap table, in other cases they are purposefully obscuring the cap table. Whatever the reason it's very bad.
SAFEs (and convertible notes) are also good for pre-equity round employees because companies can grant them shares instead of options. People who own shares outright are much better off tax-wise than people with options.
You are right, though, employees are better off when they understand conversion mechanics. And when they don't work for dillholes that mislead them with complexity.
You are right, though, employees are better off when they understand conversion mechanics. And when they don't work for dillholes that mislead them with complexity.
You can grant employees shares regardless of how you raise outside capital. Whether or not you do so is a decision of the company leadership, not a result of how you raise money.
I'm not a fan of YC (I find it elitist, and imo they crowd out the 99.5% of startups that get rejected), but I can't find fault with the SAFE as an instrument.
To the extent that founders suffer too much dilution while raising via a SAFE, it's more likely the case that there was something not working with the business.
Sure, if the founders could have raised a priced equity round from the get-go, they probably should have done that over a SAFE, but more likely the legal expenses would have been too onerous for that to have been an option...
To the extent that founders suffer too much dilution while raising via a SAFE, it's more likely the case that there was something not working with the business.
Sure, if the founders could have raised a priced equity round from the get-go, they probably should have done that over a SAFE, but more likely the legal expenses would have been too onerous for that to have been an option...
SAFEs are not bad for entrepreneurs, they're bad for investors.
I won't make one anymore.
I've done two deals that involved a SAFE, and it's been almost 2 years and the companies are still looking to raise a round. If they do, I'm looking at a 10-20% return.
It's not worth it for the risk.
Indeed, at least convertible notes are debt and can be seen you're in a liquidation. A SAFE doesn't even give you that.
I won't make one anymore.
I've done two deals that involved a SAFE, and it's been almost 2 years and the companies are still looking to raise a round. If they do, I'm looking at a 10-20% return.
It's not worth it for the risk.
Indeed, at least convertible notes are debt and can be seen you're in a liquidation. A SAFE doesn't even give you that.
It seems like in cases where the companies aren't able to raise a round, they are probably not going to work out. At that stage, the point seems moot given the SV mantra of this being a 'a game of outliers'.
Also, if there is a liquidation event, then the SAFE should convert, right? And not sure if you act as an angel or represent a fund, would you rather use convertible notes or price?
Also, if there is a liquidation event, then the SAFE should convert, right? And not sure if you act as an angel or represent a fund, would you rather use convertible notes or price?
They convert to shares, which are junior to debt.
The SAFE by design contains a full ratchet anti-dilution protection for the investor, if you have raised a loot of money normally by stacking some SAFES on different dates and then raise the next converting round at a low valuation you can find yourself completely diluted.
For those of you who are running Aussie startups we don't have any equivalent of the YC SAFE. We are stuck with pricing rounds even at the seed stage which wastes a huge amount of everyone's time.
I actually tried to get some lawyers here in Australia to convert over the YC SAFE agreements to Australian law and I could not find one. Apparently the big blocking point is none of the law firms wanted to take responsibility for the legal liability. This is one area where our "innovation" government could get involved to sort out.
I actually tried to get some lawyers here in Australia to convert over the YC SAFE agreements to Australian law and I could not find one. Apparently the big blocking point is none of the law firms wanted to take responsibility for the legal liability. This is one area where our "innovation" government could get involved to sort out.
Muru-D does SAFE now and we are raising in Australia only with it. Reach out if need Australia specific templates.
+1. I've participated as an angel in a few AU rounds with SAFEs and SAFE-like instruments rather than priced rounds.
Hugh where did these docs come from?
Have these been released publically? You don't have a contact in your profile. Could you get in contact with me?
Is there a good resource (short of getting a finance degree) that would permit me to fully understand this instrument, the problems it solves, and its caveats? (heck, even a youtube video)
What's news to me out of all of that is that the transaction cost of series A averages 60k. Seems that the market for series A is a highly inefficient market as I know quite a few series A companies who would love to secure an added 60k a year customer in year one after series A, and would probably pay more for a sales person who could find that customer. Quite a gamble doing a transaction whose cost averages the annual contract value of one prized customer for most companies.
The cost of priced rounds is often brought up as a reason to choose a SAFE. Why are priced rounds so expensive in the first place?
People seem to forget that you can "price the round" without selling priced shares and incurring all the associated headache/expense if you just treat your convertible note like the warrant that it is and have it convert at a predetermined price. I've done it several times myself.
Priced equity means you're actually transferring ownership of shares. It's going to involve a lot of diligence and negotiation around rights, etc.
The short answer: lawyer time.
The short answer: lawyer time.
Short answer: attorneys.
When you do a priced round, you have to go in and change many aspects of a company's legal structure. For example, the documents drafted in a priced round may include amendments to the charter, a voting agreement, a stock purchase agreement, a right of first refusal agreement, a shareholder agreement. Drafting the legal docs for a convertible note or SAFE is less intensive and time consuming.
When you do a priced round, you have to go in and change many aspects of a company's legal structure. For example, the documents drafted in a priced round may include amendments to the charter, a voting agreement, a stock purchase agreement, a right of first refusal agreement, a shareholder agreement. Drafting the legal docs for a convertible note or SAFE is less intensive and time consuming.
Amendments, right of refusal, etc do not happen in SAFE rounds. Why do we assume they should happen in a priced round? Seems like all these documents have been generally standardized so the cost should be the same barring investors asking for extra rights in a Series A.
A couple other things: the level of due diligence is typically higher in a priced round, which eats up lawyer time. Also it's customary (for reasons no one can clearly articulate) that the investor(s) legal fees are paid by the startup in addition to its own.
As somebody who has been on both sides of the investment table, I can confirm that very few founders understand the complexities of convertible notes (SAFE or otherwise). But I think the authors of both the pro and con argument are covering only one of the points. Yes, first time founders often don't intuitively understand the impact of convertible notes on their cap table. But that's not that hard to model. Much harder to understand are the secondary impacts of convertible notes. I have raised, led and participated in dozens of rounds and, frankly, still get caught out by those.
In general, the problem is that most benefits that investors enjoy are properties of their shares rather than the money that they invested. For an equity round this is one and the same. Not so much for convertible notes. A simple example:
An entrepreneur raised a $1M convertible note with a $5M cap. Ignore discount, interest and other factors for now. She then raises a $5M round at a valuation of $20M. That yields a dilution of 20% for the round plus a "hidden" dilution of ~17% for the note conversion (1/6). That's the blurry issue that both authors discuss. But if anything the share rights are even blurrier. Let's say that the equity round came with what is commonly referred to as a 1x liquidation preference (non-participating). So they would get $5M back before other shareholders get anything. Even though I just worded that as matching the money that they put in, it is generally a property of the share class that the investors hold. For example, their $5M might have bought 5M shares at $1/share that each says "redeemable for $1 or convertible to common shares". Our note investors also hold those shares now. But instead holding one per dollar, they now hold four per dollar (since they pay 1/4 the price for such a share). Suddenly, they have effectively a 4x liquidation preference benefit and the company has to return a full $9M before common shareholders/founders see a penny of payout (despite only having $6M in the bank).
Interest rates, pre-round ESOP increases, and many other factors in convertible notes make this problem worse. And it affects just about all aspects of the cap table including voting rights, protective provisions, redemption rights, etc.. Basically, the bigger the gap between the cap and the eventual round, the bigger the privilege the note investors pick up. Not just in economic benefit where you would expect it, but also in power/insurance/protections/etc. where it isn't obvious at all. Nowhere in your term sheet for the note or equity round will it mention 4x liquidation preference. Doing so would cause instant rejection of the deal by even the most inexperienced founder! But that's exactly would is going to happen once all the conversion mechanics are executed. And that can catch even seasoned entrepreneurs off guard (and seasoned investors, including plenty of note holders who never understood that they would get these benefits).
Convertible notes - SAFE or otherwise - have a role to play in venture financing. But they are complex instruments and should be use carefully. Anything else is just a recipe for pain in the long run.
In general, the problem is that most benefits that investors enjoy are properties of their shares rather than the money that they invested. For an equity round this is one and the same. Not so much for convertible notes. A simple example:
An entrepreneur raised a $1M convertible note with a $5M cap. Ignore discount, interest and other factors for now. She then raises a $5M round at a valuation of $20M. That yields a dilution of 20% for the round plus a "hidden" dilution of ~17% for the note conversion (1/6). That's the blurry issue that both authors discuss. But if anything the share rights are even blurrier. Let's say that the equity round came with what is commonly referred to as a 1x liquidation preference (non-participating). So they would get $5M back before other shareholders get anything. Even though I just worded that as matching the money that they put in, it is generally a property of the share class that the investors hold. For example, their $5M might have bought 5M shares at $1/share that each says "redeemable for $1 or convertible to common shares". Our note investors also hold those shares now. But instead holding one per dollar, they now hold four per dollar (since they pay 1/4 the price for such a share). Suddenly, they have effectively a 4x liquidation preference benefit and the company has to return a full $9M before common shareholders/founders see a penny of payout (despite only having $6M in the bank).
Interest rates, pre-round ESOP increases, and many other factors in convertible notes make this problem worse. And it affects just about all aspects of the cap table including voting rights, protective provisions, redemption rights, etc.. Basically, the bigger the gap between the cap and the eventual round, the bigger the privilege the note investors pick up. Not just in economic benefit where you would expect it, but also in power/insurance/protections/etc. where it isn't obvious at all. Nowhere in your term sheet for the note or equity round will it mention 4x liquidation preference. Doing so would cause instant rejection of the deal by even the most inexperienced founder! But that's exactly would is going to happen once all the conversion mechanics are executed. And that can catch even seasoned entrepreneurs off guard (and seasoned investors, including plenty of note holders who never understood that they would get these benefits).
Convertible notes - SAFE or otherwise - have a role to play in venture financing. But they are complex instruments and should be use carefully. Anything else is just a recipe for pain in the long run.
Safes (and other convertible securities) convert at the cap, assuming the round valuation is higher than the cap. Where there are safes with multiple caps there are a number of methods that the lawyers use so that investors receive the correct number of shares, while solving for your point about the excess liquidation preferences.
The simplest one is that there are multiple sub classes of preferred stock ("shadow series") - eg for a Series A, there are Series A-1, Series A-2 shares that represent each cap. These classes each have their own liquidation preferences matched to the dollars put in originally. The YC-standard safe also contemplates this by referring to "safe preferred shares".
Another option is that the "extra" shares that the converting safeholders receive as a result of the difference between the conversion price and round price are given as common shares (which have no liquidation preference).
The simplest one is that there are multiple sub classes of preferred stock ("shadow series") - eg for a Series A, there are Series A-1, Series A-2 shares that represent each cap. These classes each have their own liquidation preferences matched to the dollars put in originally. The YC-standard safe also contemplates this by referring to "safe preferred shares".
Another option is that the "extra" shares that the converting safeholders receive as a result of the difference between the conversion price and round price are given as common shares (which have no liquidation preference).
Thanks for the response Kristy. You are absolutely correct that there are ways to fix these problems if you have good lawyers (and leverage). But in my experience this rarely happens. Conversely, I see the default conversion into the same new share class all the time (as a result of negotiation leverage or just because nobody involved knows any better). How does that compare to your observations with your obviously much larger portfolio? For example, what percentage of yc companies using SAFE did the pref+common conversion that you described?
Of course the other concern is that you actually have to be cognisant of this issue - or have a lawyer who is - to catch it. Maybe the SAFE could just mandate the pref+common conversion?
Of course the other concern is that you actually have to be cognisant of this issue - or have a lawyer who is - to catch it. Maybe the SAFE could just mandate the pref+common conversion?
Do you foresee YC Safe equivalent of Series A docs? One that standardizes the terms, and reduces the time/price in the process?
At Series A, you are talking about a lot more money and a lot more company history. So VCs have an incentive and the information to price and negotiate terms. And at that point, it's best to have a good startup lawyer on your side of the table because the terms will be many. A Safe is like training wheels for the complexities Series A will bring.
Really, no one has said it, but one of the few remaining competitive advantages of Silicon Valley is the legal talent available here. While I read Venture Hacks and Brad Feld as much as anyone, I'll get a good lawyer when/before I get to A.
Similarly, LLC's can be a simple stepping stone to Delaware C. Also, provisional patents are a stepping stone to a full application. Along with Safes, these allow people to move forward without the complexity and cost of completeness.
Really, no one has said it, but one of the few remaining competitive advantages of Silicon Valley is the legal talent available here. While I read Venture Hacks and Brad Feld as much as anyone, I'll get a good lawyer when/before I get to A.
Similarly, LLC's can be a simple stepping stone to Delaware C. Also, provisional patents are a stepping stone to a full application. Along with Safes, these allow people to move forward without the complexity and cost of completeness.
>one of the few remaining competitive advantages of Silicon Valley
few->many
few->many
What normally happens in a situation like in your example is that the SAFE or note investors would convert their principal into Series A preferred shares and the remainder would be issued as common stock.
So, in your example, for each dollar invested, seed investors would have 1 preferred share with 1x liquidation preference and a price of $1, and 3 shares of common stock.
So, in your example, for each dollar invested, seed investors would have 1 preferred share with 1x liquidation preference and a price of $1, and 3 shares of common stock.
If you go with SAFEs for a early Angel round (< $1M), how do you distribute equity for the founders, early (first 3-5) employees, advisors?
For advisors, there's FAST: https://fi.co/FAST
Are these supposed founders that haven't done the basic dilution math on the funds they're raising fit to be raising funds at all?
If you are not brought up in the tradition of SV startups, it is far harder than one can imagine. I've worked here and still get confused with the variation in terminology, requirements and preferences. I've a lot of empathy for anyone struggling with figuring this out - this information should be simpler and more accessible.
> The safe and its predecessor, the convertible note, have almost identical conversion features
A SAFE _is_ a convertible note, with standardized language.
A SAFE _is_ a convertible note, with standardized language.
Safes and convertible note are both types of Convertible Securities. Ie they each convert into shares at a future date, usually at a priced round.
A convertible note is structured as debt - there is interest earned until it converts and a maturity date. There are also terms about repaying the debt.
A safe is not debt - it does not have a maturity date and interest does not accrue.
So referring to a "Safe Note" is non-sensical because there is no such thing.
A convertible note is structured as debt - there is interest earned until it converts and a maturity date. There are also terms about repaying the debt.
A safe is not debt - it does not have a maturity date and interest does not accrue.
So referring to a "Safe Note" is non-sensical because there is no such thing.
> The safe is just a convertible note with the "event of default," interest, and maturity date provisions stripped out.
> - Carolynn Levy (inventor of the SAFE)
edit ... You could argue it's no longer a convertible note with those provisions taken out, but I'm not sure how much mileage you'd get with that argument.
> - Carolynn Levy (inventor of the SAFE)
edit ... You could argue it's no longer a convertible note with those provisions taken out, but I'm not sure how much mileage you'd get with that argument.
It's no longer a "note" when it loses the debt provisions.
> It's no longer a "note" when it loses the debt provisions.
You may be right, but what makes you think that?
The common law and some statutory definitions require only that promissory note be, upon breach, reducible to what are called "liquid damages" i.e. "a sum certain in money". This does not mean monetary debt or future payment of money with or without interest. It just means reducible to a certain amount.
The purpose of having a promise with "a sum certain in money" is on the enforcement end. The monetary compensation upon breach (damages) of a promissory note can be unambiguously calculated by a registrar (as opposed to assessment open to interpretation by a judge). This expedites processes such as obtaining summary or default judgment.
However, the promise needn't be in money itself, as long as there is an unambiguous objective calculation of the amount of damages.
I'm not sure how it would be calculable in the case of a note without debt or interest; I'd need to read the note language. If there was nothing specific, one could argue it is portion of the pre-money to the the valuation cap, but that'd be a very loose guess.
You may be right, but what makes you think that?
The common law and some statutory definitions require only that promissory note be, upon breach, reducible to what are called "liquid damages" i.e. "a sum certain in money". This does not mean monetary debt or future payment of money with or without interest. It just means reducible to a certain amount.
The purpose of having a promise with "a sum certain in money" is on the enforcement end. The monetary compensation upon breach (damages) of a promissory note can be unambiguously calculated by a registrar (as opposed to assessment open to interpretation by a judge). This expedites processes such as obtaining summary or default judgment.
However, the promise needn't be in money itself, as long as there is an unambiguous objective calculation of the amount of damages.
I'm not sure how it would be calculable in the case of a note without debt or interest; I'd need to read the note language. If there was nothing specific, one could argue it is portion of the pre-money to the the valuation cap, but that'd be a very loose guess.
For those interested in reading further, here is an on-point interview with Carolynn Levy:
http://abovethelaw.com/2015/01/innovation-more-than-another-...
http://abovethelaw.com/2015/01/innovation-more-than-another-...
I believe they are different in that a SAFE does have interest.
The SAFE doesn't have interest and no maturity date.
It would be useful for the founder community (especially outside YC network) to have examples of how different recent startups have done it - offered discount or cap or both, how they determined the cap, the experience at A, experience with SAFE when dealing with angels/micro VCs, etc.
Any founder willing to share that here?