People used the old SAFE as a bridge to priced preferred stock rounds. Similarities Between Convertible Notes and SAFE notes. At its core, a SAFE is basically a warrant to purchase stock in a future priced round. So why the change? There are two main changes I will touch on. I would love to hear from you. Essentially, a SAFE is a warrant to purchase stock in a future priced round. SAFE notes were introduced to simplify the working of Convertible notes. A Convertible Note has a ‘best before date’ of say a year. This only matters when the term is longer than a year, but otherwise doesn’t matter for a short‐term investment. Confused. I promise you the math to calculate SAFE are not simple. Let’s do some math to show how this happens. You don’t have to have a discount on either, but they are pretty normal. Read more here: Convertible note terms that you don’t understand. As I said before, if you do it wrong you really, really messed up! A SAFE with no maturity date lets you the founder keep raising SAFE notes and indefinitely delay the conversion. The basic advice will be: SAFEs and convertible debt are cheaper / faster to do than equity. Let’s face reality. You have to deal with Convertible Notes at some point. Hang on, taxable income if the company fails? This doesn’t make sense. However, SAFE is converted in the next round of financing. Because the effective discount at which the amount of the SAFE investment or the interest under the convertible note (and accrued interest, in the case of a note) gives the investor more of your company than you would have sold in an equity round based on a valuation equal to the valuation cap. To understand Safe vs convertible note let’s discuss the basic concept. That rarely makes sense and only if you intend writing more SAFEs before you do the series-A. Feel free to contact us, and we’ll be more than happy to assist you! If you don’t know what you are doing you can use a SAFE and not have to deal with a lot of technical stuff that investors might know more than you about. In particular, there is no interest paid and no maturity date, and therefore SAFEs are not subject to the regulations that debt may be in many jurisdictions. It was created by the Silicon Valley accelerator Y-Combinator as a new financial instrument to simplify seed investment in 2013. This includes a lot of clauses included in a very detailed and lengthy document. Interest accrual is beneficial for investors for the obvious economic incentives, but it creates an incentive for the founder to get an equity round done sooner rather than later. I definitely see and agree with your logic, but reality of pre-revenue startup is that these partnerships will expose them to clients and potential revenue generating capital. SAFE was created as a simple tool for seed investment that is purposefully designed to be easy to understand. The difference here is that whilst a convertible note can allow for the conversion into the current round of stock or a future financing event, a SAFE only allows for conversion into the next round of financing when preference shares are issued. However, in the case of SAFE, the need for a 409A valuation may arise. So if you have a 20% discount to what the investors pay: Series-A price x (1-20%). That means they do not carry an interest rate. Thank you for the detailed analysis above! I’ve not posted a third party blog to date. SAFEs are more like equity instruments than debt, so they rank after convertible notes in a liquidation. A SAFE is simpler and shorter than most convertible notes. How observative 😉 Crap, I didn’t write about this, clearly? Convertible notes and SAFE notes are used as funding instruments in the initial stages of the business. With convertible notes and the old SAFE you don’t really know, though you can sort of guess a bit in a range. SAFE documents function similarly to convertible notes, but they are not debt vehicles – meaning that the investment amount is set up to convert into equity at a predefined point, and there is no expectation that the startup will repay the amount of the investment. Convertible notes include a clause for maturity date, which is not present in the SAFE notes. Helping Founders take their Dream Company to the Next Level. As the post SAFE is on post-money, investors have (fairly) defined ownership. Founders use the SAFE to get rounds done quickly in the seed phase. It just depends on the terms either way right? No (You can do a friends and family round if you are running out of cash), Yes, if exceed investment threshold (Can depend), Possible to include a payout in case of change of control: 1x payout or conversion into shares, Possible to include a payout in case of change of control  (Sometimes 2x payout, e.g. SAFE is not a debt instrument and, therefore, it doesn’t have a maturity date. And when an equity round is inevitably priced, entrepreneurs don’t like the founder dilution numbers at all.”. They also can have the same types of terms such as a discount, cap, MFN (most favored nation), convert predominantly into the same class of share as the next round as well as pro-rata rights (as agreed. Yes, convertible notes may involve a $5k legal fee, but what’s $5k if you don’t get screwed by the SAFEs in future? If convertible terms are set out with the conversion and pro-rata terms you suggest are founder-bad at the end of the article, i’m lost as to how we reach the conclusion that convertibles are founder better? Here is how they introduce their full-ratchet: In this scenario, Investor B’s safe converted into 10.3% ownership versus the 10% implied by its $8m post-money valuation cap because the Series Seed price per share is less than this safe’s Safe Price. That’s what the marketing says. They thought it applied when the SAFE converted (the Series A), rather than the round after conversion (the Series B). Convertible notes may be stand-alone or structured as a “series” of identical convertible notes, as SAFEs typically are, but the better and more typical structure is a singular parent “Note Purchase Agreement” (NPA) that contains most of the substantive terms of the financing and short “Demand Promissory Notes” issued to each investor as evidence of the date and amount of that investor’s investment. The SAFE is effectively a standalone round. These notes are issued in the initial stages of a company. Both SAFE and Convertible notes provide the option of converting the investment into, For example, if during the seed round you chose SAFE, you would be able to convert into equity in the next financing round which is the, Usually neither Convertible notes nor SAFE require any kind of administrative fees and services. However, among the two, Convertible Notes is the more complex one. The phrase “SAFE note” is a misnomer. Rode – Yes. We mainly help experienced founders who have had exits raise again. Standard pro rata rights don’t make sense for both angels and institutional investors. Companies often prefer convertible debt to equity financings because convertible debt can essentially delay the question of the company’s valuation until later in the company’s lifecycle. This is achieved by incorporating in the agreement either a (1) discount, (2) a valuation cap, or (3) a combination of the two. This doesn’t really matter to founders, but it does to investors. Convertible Notes have a maturity date which is typically a year. The investor then gets shares in the future when they convert at your series-a. SAFEs and convertible debt help you maintain control, for longer. As pointed out in the definition, convertible notes can be intricate and lengthy. SAFEs are not a debt instrument. It’s called an uncapped note. There's no big difference in this case. Since then, these both have become highly popular among companies and investors. This investment is later turns into equity in the company. If you want to understand how all the math works, you can download a SAFE calculator I made here: SAFE Calculator for the Y-Combinator Post Money SAFE. It aims to be a short and simple document. If each SAFE is a round then why do they not get diluted by new SAFE rounds? This problem really boils down to who gets diluted and how much the company is worth. The SAFE note is seen as more straightforward and does not include a lot of burdens. You need to know what you are doing though. It’s structured similarly to an unsecured loan. Safe: Pros: Straightforward and short document: expense-wise and constraint-wise. This means that ownership of a SAFE investor will be measured after (post) all funds raised from SAFE notes (whether in one or multiple  signed over a period of time) but before (pre) new capital raised from equity investors (and increase in ESOP) in a priced round in which the SAFEs are converted into equity. This can cause some issues when the maturity date comes a knocking. Either the startup or the service provider is getting a bad deal. Depending on your negotiating skills and your company’s traction, you can get a SAFE or convertible note without a valuation cap. Convertible notes are debt, whereas SAFE notes are warrants. This is nice for simplicity, but it doesn’t give control to you. Although SAFE notes and convertible notes are somehow similar, they have some notable differences. Its name is an abbreviation for, Simple Agreement for Future Equity. Well, when Y-com introduced the note, startups and investors were primarily using convertible notes for early stage fundraising. Convertible notes, although heavier in implementation, are safer, thus preferred by most start-ups. The reality is more nuanced. If you have an early exit, convertible notes and SAFE have similar payout mechanisms in the event of a change in control (acquisition/IPO). Both SAFE and convertible notes allow for a conversion into equity. This means if there is any money left it first goes to convertible note investors and then to the SAFE holders. SAFE notes gone awry create undue negotiating tension between CEOs/founders and new investors, especially if this interaction occurs during the first priced equity round, because it … If you know nothing but want to get the best average terms, do a pre money SAFE. However, considering elements like maturity date, interest rate, conversion terms will help you decide which of the two is more suitable for your specific needs.Â. Similarities and differences: Convertible Note vs SAFE? Sometimes true. The world changed so seed is a phase. There are only a few things to agree. It’s that simple. The SAFE is written to give the investor the choice of a 1x payout or conversion into equity on an “as converted basis”. The SAFE or convertible note can “crowd out” new investors in the next round and make it very hard to find a lead investor or any high quality investors. There is no interest accumulation on the SAFE as there is no interest rate. At the start these things are the same except for interest, maturity and event of default. The reality is investors aren’t idiots. I had a call with a founder at Y-Combinator a while back and his plan was to raise one round (tell whatever about future raise plans to investors) and never raise again since the note would not convert. Pre-money vs post-money conversion is a detail not always included in the terms of a note agreement, yet it can make a massive difference to the outcome of a new round of financing. In both cases, the SAFE and note will convert into equity. I don’t F about with “in-kind” as it never works out. More than that, it’s also dilutive in ways you don’t get told. The convertible note may vary, but will typically be similar. It is a short-term debt financing instrument. In a future funding round, a SAFE would be converted into equity, when you go through a funding round whereby equity is issued. Comparing SAFE Convertible Instrument and KISS Convertible Notes. I’m being a little sarcastic here. There are a few differences between convertible notes and SAFEs. So if you know basic law stuff you don’t even need a lawyer. We’re going to go through the differences in a minute. A startup raising $500k from 10 angels ($50k each) has different considerations than raising $2m from a single institutional investor. It’s not as clear for convertible notes which dilute one another (Post SAFE don’t dilute one another). I do say don’t do SAFE notes…. If not, we are going to break down the key things you need to know so you won’t be taken advantage of. SAFE seem like they are a great concept. As we discussed, they are very similar to a SAFE. Since SAFE has no interest rate, you save a little dilution. Safe: MFN, no Valuation Cap, no Discount, SAFE Calculator for the Y-Combinator Post Money SAFE, Convertible note terms that you don’t understand, Investors pays money  to have the right to get equity at a conversion event, Investor loans money which can convert to equity at a qualifying fundraising round, Higher (Can get complicated if you understand CNs), As agreed as a side letter (Template only for cap version). Assuming both converts at a ‘normal’ round where preference shares are being issued, then both SAFE and the Convertible Note get preference shares (normally) and the same terms as the investors. For every procedure from conversion to the maturity date, you can have detailed terms and conditions. Who gets diluted? Founders have zero idea how long the seed phase will last and they reach series-A. The discount is simple. Both investors don’t know what the exact terms of the shares will be. We can ignore interest, which economically makes the SAFE and Note scenario exactly the same. SAFE doesn’t have this issue as it is built in. The 1- % is termed as the Discount Rate in the SAFE docs (The “Discount Rate” is [100 minus the discount]%.). Maturity Date – Convertible notes include a clause for maturity date, which is not present in … SAFE is considered to be the simpler version of the convertible note. The thing with convertible notes is that the more you know, the more you realize that they are complex and have the potential to be misunderstood. Convertible debt, however, can carry an interest rate ranging from a 2% – 8% (most falling around 5%). So all the while they are going to raise multiple ‘seed rounds’. I know a founder that did this on purpose. Andrew Krowne of Dolby Family Ventures wrote in TechCrunch: “We have observed that many founders don’t do the basic dilution math associated with what happens to their cap table (specifically their personal ownership stakes) when these notes actually convert into equity. They are both viewed as being faster and cheaper to execute than a full priced round by most people. While convertible note is a debt, a SAFE note is not debt: a convertible note includes an interest rate and maturity rate, a SAFE note doesn’t. Obviously who the acquiring company is and the state of their stock will decide which route the investor takes. Once you reach the date of maturity, you have two choices: Paying back your principal is rationally not going to happen if you aren’t doing well (and even if you are doing well! If you have a low cap, then you can get diluted more than you probably thought you would be under a convertible note and the old SAFE. A cap sets the max price that investors pay. With the new SAFE, investors know almost exactly how much they own (There is dilution when you increase the option pool prior to the S-A round). They used to be founder friendly, now they are investor friendly. Developed by Y Combinator in the year 2013, SAFEs work as convertible security. This might make the founders lean towards the SAFE notes since there is no additional liability of paying interest to the investors. Both SAFE and Convertible notes work on the same underlying principle of converting the investment (received in the initial stages) into equity at a future date. A well-drafted convertible note can give you flexibility on how your investment will be treated when the trigger event occurs. Oh well. The founders and staff take all the dilution on multiple rounds of SAFEs. With the help of 7 Venture capitalist’s and their decade long investing experience, we have compiled a list 10 of blunders founders make in their startup journey. Yup, things are going to get a little complicated for those who haven’t been paying attention. Alex, what if the startup became profitable and did not seek further funding after the first SAFE? While the SAFE is not actually a convertible note (as previously observed), Kiss comes very close to the classical model of convertible note: it accrues interest at … That pro rata right in the old SAFE applied to the financing after the round in which the original safe converted (e.g. The SAFE can convert when you raise any amount of preference shares. Hence, this will ensure you are in control of how things pan out in the future. for 500 Startups). For example, if during the seed round you chose SAFE, you would be able to convert into equity in the next financing round which is the series A. Life’s too short. It is a winner for entrepreneurs. Tl;dr: Do you understand the difference between a SAFE and convertible note? Instead, they are more like a warrant. But reality has a habit of getting in the way of theory. Both SAFE and Convertible Notes aim to get the company investment in its initial stages. Learn how your comment data is processed. SAFEs. The detailed nature of Convertible notes works as a benefit point by providing the company with a larger degree of control. Well, we’re going to get into the differences to a relatively technical level (but not too nerdy). The SAFE has fewer terms than a convertible note, and the convertible note is normally longer (and there are two documents). 409A is a valuation of the common stocks of your company by a third party.  So, it helps to determine the fair market value of common stocks. Under most analyses, the distinction between SAFEs and convertible notes is more one of form than one of substance. In short, SAFE is not as great as you think. The maturity date puts the founders under a schedule. App social fundraising financial model in excel, Enterprise, consumer and SME SaaS financial fundraising model, Ecommerce business plan fundraising financial model for physical inventory, Marketplace financial fundraising model in excel, SaaS Financial Model Template for Startups, Subscription ecommerce fundraising financial model, 50Folds Excel Productivity Addin For Modeling. It is a convertible security with a creative acronym.”. Both SAFE and convertible notes allow for conversion into equity. The Post SAFE treat each note as a round, but each SAFE does not get diluted by the next round?! It would effectively involve shutting down the company and declaring bankruptcy. It’s still a low-cost loan, so again who cares- you need the money. SAFEs, in particular, … I don’t know why angels sometimes ask for a board seat when they, for example, do a SEIS round in the UK. SAFEs convert into stock in a future priced round. Well-suited for companies that need a short-term, lesser amount of funding to carry them to the next larger round of investment. The new SAFE only has pro-rata as a side letter. What do you mean by partnership – it’s investing for equity? The startup can just pay the investor the principal + interest just like in a convertible note. So let’s get into them in a little detail. Due to the interest being accrued, all other terms and initial investment being the same between a SAFE and convertible note, once the conversion happens, the investor with the convertible will generally have more purchasing power due to the interest accrued. You can download this for your nerdy pleasure in the download box at the top. You can literally download the SAFE from the Y-Com website and use it as it is. Convertible notes dilute one another, so dilution is shared. SAFEs, or simple agreements for future equity, were introduced by Y Combinator in late 2013 as a replacement for convertible debt. This is an important consideration, since the downside case is quite common. In fact, the SAFE is worse than a full ratchet. SAFE get fully protected from convertible dilution when the valuation cap is higher. It is not the floor! They are mentioned in the SAFE documents with a cap (obviously). One improvement would be to fix the capitalization (denominator) in SAFE rounds. The world has changed though. This is a joke. Now multiple seed rounds can provide multi-year runways with no conversion to shares. You wouldn’t even notice if you didn’t pay attention to the point of building a template (Like I have…). In a priced round, anti-dilution would only trigger if the valuation is lower than the price. A thorough understanding is required to decide which option (Safe vs convertible note) would be more suitable to the needs of the company. SAFE come with their own share of baggage now. The alternative is a document with an MFN or Most Favoured Nation clause, which means investors get the same terms as new convertible note holders. It’s just a number less than what the price the series-A investor pays. There is an old and new SAFE structure. This effectively prevents a liquidation overhang. The name is quite self-explanatory for the function it performs. SAFEs are treated as equity during a liquidity event. This later stage is usually the next fundraising round. If you are raising for your startup and need expert help writing it, head over to Perfect Pitch Deck. But watch out. There are four versions of the new post-money safe, plus an optional side letter. if the safe converts in the Series A, the pro rata right applies to the Series A). With the SAFE Note, investors can buy equity in the company at a later stage. But for Convertible notes along with conversion at maturity in the future round, it could also be done in the current round.Â. There is now an optional and standard side letter with pro-rata rights that apply to the round in which the safe converts (e.g. This debt automatically converts into shares of preferred stock upon the closing of a qualified financing round, such as a normal priced seed or Series A round of financing. That’s fab in theory. There is no math reason Y-Com could not allow prior SAFEs to get diluted by subsequent ’rounds’ of SAFE. This simplicity is the primary motivation of a SAFE. They are not simple and can create a huge mess. The preferred stock issued to SAFE investors at conversion has a liquidation preference equal to the amount the investor paid for the SAFE. Otherwise, the investor should have just invested at the round in which they convert. Unless you explicitly add in a clause into your Convertible Note, the investors may get a liquidation preference overhang, meaning they have more liquidation preference than they paid for. Now let’s replay the above steps, except instead of doing an equity round for the seed, let’s do a convertible note or SAFE round. So yes, this is a real risk. In a Liquidity Event, the safe is junior to creditors and outstanding indebtedness (including outstanding convertible notes) and has the same priority as standard non-participating Preferred Stock. They are used to bridge to a real funding milestone like a seed round (before seed became a phase) or a Series A. Press to. You sign them with investors when you are raising and the investor gives you money. SAFE is an acronym that stands for “simple agreement for future equity”. When you write your docs it’s 80 NOT 20! Convertible Note is a debt instrument that the investors can use later on to buy the equity of the company. If you don’t know who is whom, it is you…. Convertible notes typically have a 2x payout. A disadvantage of convertible notes is that if the note can’t be repaid it triggers “cancellation of debt income.” Depending on the structure of the firm (e.g., an LLC), this can create taxable income back to the founders. They expect you to get big and earn them bank when you exit. This creates a lot of uncertainty for investors (less with the post note), but that’s not your problem. That’s both good and bad depending on your level of competence. To make it easier to compare the SAFE (New one) and convertible notes, I’ve put together a matrix. They removed the pro rata right as a default, which was a default in the original safe. One little difference is the SAFE may convert (depends on which SAFE document you use) into a class of stock called SAFE Preferred Stock. SAFE gives the investor the choice of a 1x payout or conversion into equity at the cap amount to participate in the buyout. You need to get shite done and product shipped, and frankly you’re not really worth enough for anyone to really care about information rights and the like. You can download the docs from each of these links: If you want the plain English guide to the notes, I’ve done a line by line of each of the documents here so you understand everything that is in them: A convertible note is a type of debt that has the right to convert into equity when you hit an agreed upon milestone. Anything you don’t understand or want to add? People give reasons for why terms aren’t set when people do notes, but my no-BS logic for why you don’t set terms, is who cares? However, in the case of SAFE, the need for a 409A. which is sort of ironic. Both SAFEs and convertible notes can have valuation caps, discounts, and “most-favored-nations” clauses (an agreement to offer the SAFE note investor the same terms as future investors on subsequent investment rounds and/or the opportunity to pull their proceeds out first in the event of a sale or winding-up of the company).
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