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The keyword future rounds and valuation cap has 142 sections. Narrow your search by selecting any of the keywords below:
- discount rate (51)
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1.A summary of the advantages and disadvantages of using SAFE or convertible notes for both founders and investors[Original Blog]
SAFE and convertible notes are two popular forms of financing for startups that do not involve selling equity upfront. Instead, they allow investors to provide capital in exchange for the right to convert their investment into equity at a later stage, usually when the startup raises a priced round of funding. Both SAFE and convertible notes have their own advantages and disadvantages for both founders and investors, depending on various factors such as the valuation cap, the discount rate, the interest rate, the maturity date, and the pro rata rights. In this section, we will compare and contrast the pros and cons of using SAFE or convertible notes from different perspectives, and provide some examples to illustrate the impact of these financing instruments on the equity dilution of the startup.
Some of the pros and cons of using SAFE or convertible notes are:
1. Valuation cap: The valuation cap is the maximum valuation at which the investor can convert their investment into equity. It is meant to protect the investor from paying too much for the equity in the future, and to reward them for taking the risk of investing early. A lower valuation cap means a higher conversion price for the investor, and vice versa.
- Pros: For founders, using a SAFE or convertible note with a high valuation cap can help them avoid giving up too much equity in the future, and preserve their ownership and control of the startup. For investors, using a SAFE or convertible note with a low valuation cap can help them secure a larger share of the equity at a lower price, and increase their return on investment.
- Cons: For founders, using a SAFE or convertible note with a low valuation cap can result in a significant equity dilution in the future, and reduce their ownership and control of the startup. For investors, using a SAFE or convertible note with a high valuation cap can result in a smaller share of the equity at a higher price, and decrease their return on investment.
- Example: Suppose a startup raises $1 million from an investor using a SAFE with a $10 million valuation cap. If the startup later raises a Series A round at a $20 million pre-money valuation, the investor will convert their SAFE into equity at a $10 million valuation, and receive 10% of the equity. However, if the startup raises a Series A round at a $40 million pre-money valuation, the investor will still convert their SAFE into equity at a $10 million valuation, but receive only 5% of the equity. In this case, the investor would have been better off using a lower valuation cap, or negotiating for a discount rate.
2. discount rate: The discount rate is the percentage by which the investor can buy the equity at a lower price than the other investors in the future round. It is meant to compensate the investor for the time value of money, and to incentivize them to invest early. A higher discount rate means a lower conversion price for the investor, and vice versa.
- Pros: For founders, using a SAFE or convertible note with a low or no discount rate can help them minimize the equity dilution in the future, and maintain a higher valuation for the startup. For investors, using a SAFE or convertible note with a high discount rate can help them obtain a larger share of the equity at a lower price, and enhance their return on investment.
- Cons: For founders, using a SAFE or convertible note with a high discount rate can result in a significant equity dilution in the future, and lower the valuation of the startup. For investors, using a SAFE or convertible note with a low or no discount rate can result in a smaller share of the equity at a higher price, and diminish their return on investment.
- Example: Suppose a startup raises $1 million from an investor using a convertible note with a 20% discount rate and no valuation cap. If the startup later raises a Series A round at a $20 million pre-money valuation, the investor will convert their convertible note into equity at a $16 million valuation, and receive 6.25% of the equity. However, if the startup raises a Series A round at a $40 million pre-money valuation, the investor will still convert their convertible note into equity at a $32 million valuation, but receive only 3.125% of the equity. In this case, the investor would have been better off using a valuation cap, or negotiating for a higher discount rate.
3. interest rate: The interest rate is the annual percentage that the investor earns on their investment until it is converted into equity. It is meant to reflect the opportunity cost of the investor, and to account for the inflation and risk of the investment. A higher interest rate means a higher conversion price for the investor, and vice versa.
- Pros: For founders, using a SAFE or convertible note with a low or no interest rate can help them reduce the amount of debt they owe to the investor, and avoid paying interest on the investment. For investors, using a SAFE or convertible note with a high interest rate can help them increase the amount of equity they receive upon conversion, and earn interest on the investment.
- Cons: For founders, using a SAFE or convertible note with a high interest rate can result in a higher amount of debt they owe to the investor, and increase the interest payments on the investment. For investors, using a SAFE or convertible note with a low or no interest rate can result in a lower amount of equity they receive upon conversion, and forego interest on the investment.
- Example: Suppose a startup raises $1 million from an investor using a convertible note with a 10% interest rate and a $10 million valuation cap. If the startup later raises a Series A round at a $20 million pre-money valuation after one year, the investor will convert their convertible note into equity at a $10 million valuation, and receive 11% of the equity. However, if the startup raises a Series A round at a $20 million pre-money valuation after two years, the investor will still convert their convertible note into equity at a $10 million valuation, but receive 12.1% of the equity. In this case, the investor would benefit from a longer time to conversion, while the founder would suffer from a higher debt burden.
4. maturity date: The maturity date is the deadline by which the investor can convert their investment into equity or demand repayment. It is meant to protect the investor from being locked in an indefinite investment, and to create a sense of urgency for the founder to raise a future round. A shorter maturity date means a sooner conversion or repayment for the investor, and vice versa.
- Pros: For founders, using a SAFE or convertible note with a long or no maturity date can help them avoid the pressure of raising a future round within a certain timeframe, and give them more flexibility and control over the timing of the conversion or repayment. For investors, using a SAFE or convertible note with a short maturity date can help them secure a faster conversion or repayment of their investment, and reduce the uncertainty and risk of the investment.
- Cons: For founders, using a SAFE or convertible note with a short maturity date can result in the pressure of raising a future round within a certain timeframe, and limit their flexibility and control over the timing of the conversion or repayment. For investors, using a SAFE or convertible note with a long or no maturity date can result in a slower conversion or repayment of their investment, and increase the uncertainty and risk of the investment.
- Example: Suppose a startup raises $1 million from an investor using a convertible note with a 2-year maturity date and a 10% interest rate. If the startup fails to raise a future round within 2 years, the investor can either convert their convertible note into equity at the current valuation of the startup, or demand repayment of their investment plus interest. If the startup's valuation is $15 million, the investor will convert their convertible note into equity and receive 7.41% of the equity. If the startup's valuation is $5 million, the investor will demand repayment of their investment plus interest, which amounts to $1.21 million. In this case, the investor would have a choice between equity or cash, while the founder would have to face the consequences of not raising a future round.
5. pro rata rights: The pro rata rights are the rights of the investor to maintain their percentage ownership of the startup in future rounds by investing more money. They are meant to protect the investor from being diluted by new investors, and to allow them to increase their stake in the startup. A stronger pro rata right means a higher priority for the investor to participate in future rounds, and vice versa.
- Pros: For founders, using a SAFE or convertible note with a weak or no pro rata right can help them attract more investors in future rounds, and have more freedom and leverage in negotiating the terms of the future rounds. For investors, using a SAFE or convertible note with a strong pro rata right can help them retain their percentage ownership of the startup in future rounds, and have more influence and involvement in the startup.
- Cons: For founders, using a SAFE or convertible note with a strong pro rata right can result in a lower availability of capital in future rounds, and have less freedom and leverage in negotiating the terms of the future rounds. For investors, using a SAFE or convertible note with a weak or no pro rata right can result in a lower percentage ownership of the startup in future rounds, and have less influence and involvement in the startup.
- Example: Suppose a startup raises $1 million from an investor using a SAFE with a 10% equity ownership and a strong pro rata right.
A summary of the advantages and disadvantages of using SAFE or convertible notes for both founders and investors - SAFE: SAFE vs convertible notes: which one causes more equity dilution
2.How they benefit or harm investors and founders?[Original Blog]
One of the most important terms to negotiate in a pre-money valuation deal is the valuation cap. A valuation cap is a limit on the valuation of the company at which the investor's money will convert into equity in a future financing round. A valuation cap can have significant implications for both the founders and the investors, depending on how it is set and how the company performs. In this section, we will discuss the pros and cons of valuation caps from different perspectives, and provide some examples to illustrate their effects.
Some of the pros and cons of valuation caps are:
1. For founders, a valuation cap can be a way to attract investors by offering them a lower price per share than the current valuation of the company. This can help the founders raise more money and retain more control over their company. However, a valuation cap can also dilute the founders' ownership in future rounds if the company's valuation exceeds the cap. For example, if a founder raises $1 million at a $5 million valuation cap, and then raises another $10 million at a $20 million pre-money valuation, the founder will own 40% of the company after the first round, but only 25% after the second round.
2. For early-stage investors, a valuation cap can be a way to secure a higher return on their investment by getting more shares for their money in future rounds. This can also protect them from overpaying for their shares if the company's valuation drops in subsequent rounds. However, a valuation cap can also reduce the investor's upside potential if the company's valuation skyrockets in future rounds. For example, if an investor invests $1 million at a $5 million valuation cap, and then the company raises another $10 million at a $100 million pre-money valuation, the investor will own 16.67% of the company after the first round, but only 4.76% after the second round.
3. For later-stage investors, a valuation cap can be a way to avoid paying too much for their shares by using the lower price per share set by the cap. This can also align their interests with the early-stage investors and create a more harmonious relationship among shareholders. However, a valuation cap can also create a misalignment of incentives between the later-stage investors and the founders, as the later-stage investors may have less motivation to increase the value of the company. For example, if an investor invests $10 million at a $100 million pre-money valuation, and there is an existing investor who invested $1 million at a $5 million valuation cap, the later-stage investor will own 9.09% of the company, while the early-stage investor will own 4.76%. The later-stage investor may not want to see the company's valuation increase too much, as that would dilute their ownership and benefit the early-stage investor more.
As we can see, valuation caps have both advantages and disadvantages for different parties involved in a pre-money valuation deal. Therefore, it is important to carefully consider how to set and negotiate them, and to understand their implications for future rounds of financing.
3.What to look for in term sheets and cap tables?[Original Blog]
One of the most important aspects of raising capital for your startup is negotiating the terms of dilution. Dilution refers to the reduction in your ownership percentage of the company as a result of issuing new shares to investors or employees. While dilution is inevitable when you raise funds, you can minimize its impact by understanding what to look for in term sheets and cap tables. Term sheets are the documents that outline the key terms and conditions of the investment deal, such as valuation, amount, equity type, and rights. Cap tables are the spreadsheets that show the ownership structure of the company, including the number and percentage of shares held by founders, investors, and employees. In this section, we will discuss some of the best practices and tips for negotiating dilution from different perspectives: founders, investors, and employees.
- Founders: As a founder, your main goal is to retain as much control and ownership of your company as possible, while still raising enough capital to grow your business. To do this, you need to pay attention to the following factors in term sheets and cap tables:
1. Valuation: This is the most obvious and crucial factor that determines how much dilution you will face. Valuation is the estimated worth of your company based on various factors, such as market size, traction, revenue, and growth potential. The higher the valuation, the less dilution you will experience, as you will be able to sell fewer shares for more money. However, valuation is not a fixed number, but a range that can be negotiated with investors. You should do your research and benchmark your company against similar startups in your industry and stage, and be prepared to justify your valuation with data and evidence. You should also avoid overvaluing your company, as this can lead to unrealistic expectations and difficulties in raising future rounds.
2. Equity type: This refers to the kind of shares you are issuing to investors, such as common stock, preferred stock, convertible notes, or SAFE (Simple Agreement for Future Equity). Each equity type has different implications for dilution, as they have different rights and preferences attached to them. For example, preferred stock usually gives investors certain privileges over common stock, such as liquidation preference, anti-dilution protection, and voting rights. Convertible notes and safe are debt instruments that convert into equity at a later date, usually at a discount or a valuation cap. These instruments can reduce your dilution in the short term, but increase it in the long term, depending on the conversion terms. You should understand the pros and cons of each equity type and choose the one that best suits your needs and goals.
3. Rights: These are the additional terms and conditions that investors may request or offer in exchange for their investment, such as board seats, veto power, information rights, pro rata rights, drag-along rights, and co-sale rights. These rights can affect your dilution in various ways, as they can limit your decision-making authority, influence your exit strategy, and entitle investors to participate in future rounds. You should carefully review and negotiate these rights, and balance them with the value and expertise that investors bring to the table. You should also avoid giving away too many rights to too many investors, as this can create conflicts and complications down the road.
- Investors: As an investor, your main goal is to maximize your return on investment and protect your downside risk, while still supporting the growth and success of the startup. To do this, you need to pay attention to the following factors in term sheets and cap tables:
1. Valuation: This is the most obvious and crucial factor that determines how much equity you will receive for your investment. Valuation is the estimated worth of the company based on various factors, such as market size, traction, revenue, and growth potential. The lower the valuation, the more equity you will get, as you will be able to buy more shares for less money. However, valuation is not a fixed number, but a range that can be negotiated with founders. You should do your due diligence and evaluate the company's potential and risks, and be prepared to offer a fair and realistic valuation that reflects the market conditions and the stage of the company. You should also avoid undervaluing the company, as this can demotivate the founders and harm the relationship.
2. Equity type: This refers to the kind of shares you are buying from the founders, such as common stock, preferred stock, convertible notes, or SAFE (Simple Agreement for Future Equity). Each equity type has different implications for your return and risk, as they have different rights and preferences attached to them. For example, preferred stock usually gives you certain privileges over common stock, such as liquidation preference, anti-dilution protection, and voting rights. Convertible notes and SAFE are debt instruments that convert into equity at a later date, usually at a discount or a valuation cap. These instruments can increase your return in the short term, but decrease it in the long term, depending on the conversion terms. You should understand the pros and cons of each equity type and choose the one that best suits your risk appetite and investment strategy.
3. Rights: These are the additional terms and conditions that you may request or offer in exchange for your investment, such as board seats, veto power, information rights, pro rata rights, drag-along rights, and co-sale rights. These rights can affect your return and risk in various ways, as they can give you more control and influence over the company, protect your interests in case of adverse events, and enable you to participate in future rounds. You should carefully review and negotiate these rights, and balance them with the value and expertise that you bring to the table. You should also avoid asking for too many rights or imposing too many restrictions on the founders, as this can stifle their creativity and flexibility.
- Employees: As an employee, your main goal is to align your incentives and rewards with the growth and success of the company, while still having a fair and transparent compensation package. To do this, you need to pay attention to the following factors in term sheets and cap tables:
1. Equity amount: This is the number of shares or options that you are granted as part of your compensation package. Equity amount is usually determined by your role, seniority, experience, and performance, as well as the company's stage, valuation, and culture. The more equity you have, the more you will benefit from the company's growth and exit, but also the more you will be diluted by future rounds. You should negotiate your equity amount based on your market value and your expectations, and compare it with the industry standards and benchmarks. You should also understand the vesting schedule and the exercise price of your options, as these affect your ownership and taxation.
2. Equity type: This refers to the kind of shares or options that you are granted as part of your compensation package, such as common stock, restricted stock, incentive stock options, or non-qualified stock options. Each equity type has different implications for your ownership and taxation, as they have different rules and regulations attached to them. For example, common stock gives you the same rights and preferences as the founders, but also exposes you to the same risks and liabilities. Restricted stock gives you the full ownership of the shares, but also subjects you to the vesting schedule and the taxation at the grant date. Incentive stock options give you the option to buy the shares at a fixed price, but also limit your eligibility and the amount you can exercise. Non-qualified stock options give you more flexibility and freedom, but also impose higher taxes and fees. You should understand the pros and cons of each equity type and choose the one that best suits your personal and financial situation.
3. Equity dilution: This is the reduction in your ownership percentage of the company as a result of issuing new shares to investors or employees. Equity dilution is inevitable when the company raises funds, but it can also affect your potential payout and motivation. You should be aware of the current and projected dilution of your equity, and how it affects your valuation and return. You should also look for the terms and conditions that can protect your equity from excessive dilution, such as anti-dilution clauses, participation rights, and acceleration clauses. You should also consider the trade-offs between dilution and growth, and whether the company is raising capital for the right reasons and at the right terms.
What to look for in term sheets and cap tables - Dilution: What it is and how to avoid it
4.How_to_use_a_SAFE__What_are_the_key_terms_and_conditions_of_a?[Original Blog]
A SAFE, or a Simple Agreement for Future Equity, is a popular way for startups to raise money from investors without having to set a valuation or issue shares. Instead, the investor agrees to provide funding in exchange for the right to receive equity in the future, usually at a discount to the valuation of the next round of funding. A SAFE is not a debt instrument, so there is no interest or maturity date. It is also not a convertible note, which is a debt that can be converted into equity at a later date.
A SAFE can be an attractive option for both founders and investors, as it simplifies the fundraising process and reduces the legal costs and complexities. However, a SAFE also comes with some key terms and conditions that need to be understood and negotiated carefully. In this section, we will discuss some of the most important aspects of a SAFE, such as:
- The valuation cap
- The discount rate
- The pro rata rights
- The most favored nation clause
- The post-money vs. Pre-money SAFE
1. The valuation cap: The valuation cap is the maximum valuation at which the SAFE investor can convert their investment into equity. For example, if the valuation cap is $10 million, and the startup raises a Series A round at $20 million, the SAFE investor will get equity at $10 million, effectively doubling their stake. The valuation cap protects the SAFE investor from being diluted too much in the future rounds, as they get to buy shares at a lower price than the new investors. However, the valuation cap also limits the upside potential for the SAFE investor, as they cannot benefit from the higher valuation of the startup.
The valuation cap is one of the most contentious and negotiable terms of a SAFE. From the founder's perspective, a lower valuation cap means giving away more equity to the SAFE investor, and potentially to the future investors as well. Therefore, the founder would prefer a higher valuation cap, or no cap at all. From the investor's perspective, a higher valuation cap means getting less equity for their investment, and losing out on the growth potential of the startup. Therefore, the investor would prefer a lower valuation cap, or a cap that is close to the current market value of the startup.
The valuation cap can be influenced by several factors, such as the stage and traction of the startup, the size and terms of the SAFE investment, the availability and interest of other investors, and the market conditions and trends. A good way to negotiate the valuation cap is to do some research and benchmarking on the comparable startups and deals in the same industry and geography, and to have a realistic and data-driven valuation of the startup. Another way is to use a range or a formula for the valuation cap, rather than a fixed number, to allow for some flexibility and adjustment based on the future performance and events.
2. The discount rate: The discount rate is the percentage by which the SAFE investor can buy equity at a lower price than the new investors in the next round of funding. For example, if the discount rate is 20%, and the startup raises a Series A round at $10 per share, the SAFE investor will get to buy shares at $8 per share, effectively getting a 25% return on their investment. The discount rate rewards the SAFE investor for taking the risk and providing the capital early, before the startup has proven its viability and value.
The discount rate is another important and negotiable term of a SAFE. From the founder's perspective, a higher discount rate means giving away more equity to the SAFE investor, and diluting the existing shareholders more. Therefore, the founder would prefer a lower discount rate, or no discount at all. From the investor's perspective, a lower discount rate means getting less equity for their investment, and missing out on the opportunity cost of investing elsewhere. Therefore, the investor would prefer a higher discount rate, or a rate that reflects the risk and return of the SAFE investment.
The discount rate can be influenced by similar factors as the valuation cap, such as the stage and traction of the startup, the size and terms of the SAFE investment, the availability and interest of other investors, and the market conditions and trends. A good way to negotiate the discount rate is to balance it with the valuation cap, and to consider the trade-offs and scenarios of different outcomes. For example, if the startup raises a higher valuation in the next round, the discount rate will have more impact than the valuation cap, and vice versa. Another way is to use a variable or a sliding scale discount rate, rather than a fixed rate, to account for the time and uncertainty of the SAFE conversion.
3. The pro rata rights: The pro rata rights are the rights of the SAFE investor to participate in the future rounds of funding, and to maintain their percentage ownership of the startup. For example, if the SAFE investor owns 10% of the startup after the SAFE conversion, and the startup raises a Series B round, the SAFE investor will have the right to invest in the Series B round to keep their 10% stake. The pro rata rights protect the SAFE investor from being diluted too much in the future rounds, as they get to buy more shares at the same price as the new investors.
The pro rata rights are a common and desirable term of a SAFE. From the founder's perspective, granting pro rata rights to the SAFE investor means having a committed and supportive investor for the long term, and potentially reducing the need and cost of raising more capital in the future. Therefore, the founder would generally be willing to offer pro rata rights to the SAFE investor, unless they have a strong reason or preference to exclude them. From the investor's perspective, having pro rata rights means having the option and opportunity to increase their investment and ownership in the startup, and to benefit from the future growth and valuation. Therefore, the investor would generally seek and expect pro rata rights from the SAFE investment, unless they have a limited budget or interest to follow on.
The pro rata rights can be influenced by the availability and allocation of the shares in the future rounds, and the terms and conditions of the new investors. A good way to negotiate the pro rata rights is to specify the scope and extent of the rights, such as whether they apply to all future rounds or only to certain rounds, and whether they are based on the pre-money or post-money ownership. Another way is to include some clauses or mechanisms to waive or modify the pro rata rights, such as a pay-to-play provision, a drag-along right, or a right of first refusal.
4. The most favored nation clause: The most favored nation clause is a clause that allows the SAFE investor to amend their SAFE agreement to match the terms and conditions of any other SAFE agreements that the startup may enter into with other investors. For example, if the startup issues another SAFE with a lower valuation cap or a higher discount rate than the existing SAFE, the most favored nation clause will enable the existing SAFE investor to adjust their SAFE accordingly, and to get the same or better deal as the new SAFE investor. The most favored nation clause ensures that the SAFE investor is not disadvantaged or discriminated by the startup, and that they get the best possible terms for their investment.
The most favored nation clause is a fairly standard and reasonable term of a SAFE. From the founder's perspective, agreeing to the most favored nation clause means having to treat all SAFE investors equally and fairly, and to avoid issuing any unfavorable or inconsistent SAFE agreements in the future. Therefore, the founder would generally have no problem with the most favored nation clause, unless they have a specific or strategic reason to offer different terms to different SAFE investors. From the investor's perspective, having the most favored nation clause means having the assurance and flexibility to modify their SAFE agreement in the future, and to avoid being locked into a suboptimal or outdated deal. Therefore, the investor would generally want and appreciate the most favored nation clause, unless they have a special or exclusive relationship with the startup.
The most favored nation clause can be influenced by the number and timing of the SAFE agreements that the startup may issue, and the variations and differences of the terms and conditions among them. A good way to negotiate the most favored nation clause is to define the scope and extent of the clause, such as whether it applies to all terms and conditions or only to certain ones, and whether it applies to all SAFE agreements or only to certain ones. Another way is to include some exceptions or limitations to the clause, such as a minimum or maximum amount of the SAFE investment, a time period or expiration date of the clause, or a mutual consent or notification requirement for the amendment.
5. The post-money vs. Pre-money SAFE: The post-money vs. Pre-money SAFE is a distinction that affects how the SAFE conversion and the equity ownership are calculated. A post-money SAFE means that the SAFE investment is included in the valuation of the startup at the time of the SAFE issuance, and that the SAFE investor will get a fixed percentage of the equity based on the valuation cap and the discount rate. A pre-money SAFE means that the SAFE investment is not included in the valuation of the startup at the time of the SAFE issuance, and that the SAFE investor will get a variable percentage of the equity based on the valuation cap, the discount rate, and the amount of the new money raised in the next round. The post-money vs. Pre-money SAFE can have a significant impact on the dilution and the ownership of the startup and the SAFE investor.
The post-money vs. Pre-money SAFE is a relatively new and complex term of a SAFE. From the founder's perspective, a post-money SAFE means giving away less equity to the SAFE investor, and diluting the existing shareholders less. Therefore, the founder would prefer a post-money SAFE, or a SAFE that is clearly stated as post-money.
How_to_use_a_SAFE__What_are_the_key_terms_and_conditions_of_a - SAFE: how to raise money with a simple agreement for future equity
5.How have some successful startups and investors used KISS and SAFE in their deals?[Original Blog]
One of the most important decisions that founders and investors have to make is how to structure their financing agreements. There are different types of instruments that can be used to raise capital, such as equity, debt, convertible notes, and more recently, KISS and SAFE. KISS stands for Keep It Simple Security and SAFE stands for Simple Agreement for Future Equity. Both are designed to simplify the process of early-stage fundraising and avoid some of the complexities and costs associated with traditional term sheets. In this section, we will look at some examples of how some successful startups and investors have used KISS and SAFE in their deals, and what are the benefits and drawbacks of each option.
Some examples of KISS and SAFE deals are:
1. Airbnb. Airbnb is one of the most well-known examples of a startup that used SAFE to raise capital. In 2014, Airbnb raised $475 million in a Series D round led by TPG at a valuation of $10 billion. However, before closing the round, Airbnb also raised $150 million from existing investors using SAFE. The SAFE had a valuation cap of $10 billion and a 20% discount rate, meaning that the investors would get shares at a lower price than the Series D investors. The SAFE also had a pro rata right, which allowed the investors to participate in future rounds and maintain their ownership percentage. The SAFE gave Airbnb more flexibility and speed in raising capital, and also rewarded its loyal investors with a favorable deal.
2. Coinbase. Coinbase is another example of a startup that used SAFE to raise capital. In 2017, Coinbase raised $100 million in a Series D round led by IVP at a valuation of $1.6 billion. However, before closing the round, Coinbase also raised $15 million from existing investors using SAFE. The SAFE had a valuation cap of $1.6 billion and a 10% discount rate, similar to Airbnb's SAFE. The SAFE also had a pro rata right, which gave the investors the option to invest more in future rounds. The SAFE allowed Coinbase to secure additional funding from its existing investors without diluting its equity too much, and also gave the investors a chance to increase their stake in the company.
3. ZenPayroll. ZenPayroll, now known as Gusto, is an example of a startup that used KISS to raise capital. In 2014, ZenPayroll raised $60 million in a Series B round led by Google Capital at a valuation of $560 million. However, before closing the round, ZenPayroll also raised $15 million from existing investors using KISS. The KISS had a valuation cap of $560 million and a 15% discount rate, similar to SAFE. The KISS also had a pro rata right, which gave the investors the opportunity to invest more in future rounds. The KISS enabled ZenPayroll to raise more money from its existing investors without complicating its cap table, and also gave the investors a favorable deal.
4. Y Combinator. Y Combinator is one of the most influential and successful startup accelerators in the world. It has funded over 2,000 startups, including Airbnb, Coinbase, Dropbox, Stripe, and many more. Y Combinator is also the creator of SAFE, which it introduced in 2013 as a replacement for convertible notes. Y Combinator uses SAFE to invest in its startups, typically $125,000 for 7% of the company. The SAFE has no valuation cap and no discount rate, meaning that the investors will get shares at the same price as the next round of funding. The SAFE also has no interest rate, no maturity date, and no repayment obligation, making it very simple and founder-friendly. The SAFE allows Y Combinator to invest in a large number of startups quickly and efficiently, and also gives the startups more control over their valuation and equity.
How have some successful startups and investors used KISS and SAFE in their deals - KISS: What is a KISS and how does it compare to a SAFE
6.Investor Perspectives on Convertible Notes[Original Blog]
Convertible notes are a popular form of financing for startups, especially in the early stages. They allow investors to lend money to a company and receive equity in return, without having to agree on a valuation upfront. This can be beneficial for both parties, as it reduces the risk and complexity of the deal. However, convertible notes also have some drawbacks and challenges that investors should be aware of before investing. In this section, we will explore some of the main perspectives and considerations that investors have when using convertible notes, such as:
1. The conversion terms and triggers. One of the most important aspects of a convertible note is how and when it converts into equity. Typically, this happens at a future equity round, such as a Series A, where the note holders receive a discount or a valuation cap on the price per share. The discount is a percentage reduction on the price that new investors pay, while the valuation cap is a maximum limit on the valuation that the note holders can convert at. These terms are meant to reward the note holders for their early support and risk-taking. However, they can also create conflicts and misalignments between the note holders and the founders, especially if the valuation cap is too low or the discount is too high. For example, if the valuation cap is lower than the pre-money valuation of the next round, the note holders will effectively own more of the company than the new investors, which can dilute the founders and create resentment. Conversely, if the valuation cap is too high or the discount is too low, the note holders will not receive a fair return on their investment, which can discourage them from investing further. Therefore, investors should carefully negotiate and evaluate the conversion terms and triggers, and make sure they align with their expectations and goals.
2. The maturity date and interest rate. Another key aspect of a convertible note is the maturity date and the interest rate. The maturity date is the deadline by which the note has to be repaid or converted, while the interest rate is the annual percentage that accrues on the principal amount of the note. These terms are meant to provide some protection and incentive for the investors, in case the company fails to raise a future equity round or exits before the conversion. However, they can also create pressure and uncertainty for the company, especially if the maturity date is too short or the interest rate is too high. For example, if the maturity date is less than a year, the company may not have enough time to achieve the milestones and traction needed to raise a follow-on round, which can force them to convert at unfavorable terms or default on the note. Conversely, if the maturity date is too long or the interest rate is too low, the investors may not have enough leverage or motivation to help the company succeed, which can reduce their involvement and alignment. Therefore, investors should balance and adjust the maturity date and interest rate, and make sure they reflect the stage and potential of the company.
3. The information and participation rights. A third aspect of a convertible note is the information and participation rights. These are the rights that the note holders have to access information about the company's performance and finances, and to participate in future rounds of financing. These rights are meant to provide some transparency and continuity for the investors, as they wait for the conversion or exit of the note. However, they can also create challenges and trade-offs for the company, especially if the information and participation rights are too extensive or restrictive. For example, if the note holders have too much information rights, they may interfere with the company's decision-making or leak sensitive information to competitors or other investors. Conversely, if the note holders have too little information rights, they may lose trust and confidence in the company, or miss out on important updates and opportunities. Similarly, if the note holders have too much participation rights, they may crowd out or compete with other investors in future rounds, or impose unfavorable terms or conditions on the company. Conversely, if the note holders have too little participation rights, they may be diluted or excluded from future rounds, or lose their influence or relationship with the company. Therefore, investors should consider and negotiate the information and participation rights, and make sure they are reasonable and appropriate for the stage and situation of the company.
These are some of the main perspectives and considerations that investors have when using convertible notes. Convertible notes can be a useful and flexible tool for financing startups, but they also come with some risks and complexities that investors should be aware of and prepared for. By understanding and evaluating the pros and cons of convertible notes, investors can make informed and strategic decisions that benefit both themselves and the companies they invest in.
7.Key Terms and Conditions of a SAFE Agreement[Original Blog]
A SAFE agreement, or a Simple Agreement for Future Equity, is a contract between a startup and an investor that allows the investor to provide funding to the startup in exchange for the right to receive equity in the future. Unlike a convertible note, a SAFE does not have an interest rate, a maturity date, or a minimum valuation. This makes it simpler and more flexible for both parties, as they do not have to negotiate these terms or worry about repayment. However, a SAFE also has some key terms and conditions that both the startup and the investor should be aware of before signing the agreement. In this section, we will discuss some of these terms and conditions from different perspectives, and provide some examples to illustrate their implications.
Some of the key terms and conditions of a SAFE agreement are:
1. Valuation cap: This is the maximum valuation of the startup at which the investor can convert their SAFE into equity. For example, if the investor invests $100,000 in a SAFE with a $10 million valuation cap, and the startup raises a Series A round at a $20 million valuation, the investor can convert their SAFE into equity at a $10 million valuation, effectively getting a 50% discount on the share price. The valuation cap protects the investor from dilution in case the startup becomes very successful and raises money at a much higher valuation. However, it also limits the upside potential for the investor, as they cannot benefit from the full value of the startup. The valuation cap also affects the startup, as it reduces the amount of equity they can retain in future rounds. Therefore, both parties should carefully consider the valuation cap and how it aligns with their expectations and goals.
2. Discount rate: This is the percentage discount that the investor gets on the share price when they convert their SAFE into equity. For example, if the investor invests $100,000 in a SAFE with a 20% discount rate, and the startup raises a Series A round at a $10 per share price, the investor can convert their SAFE into equity at a $8 per share price, effectively getting a 20% discount. The discount rate rewards the investor for taking the risk of investing early in the startup, and gives them an incentive to provide more funding. However, it also reduces the amount of equity that the startup can raise in future rounds, as they have to sell their shares at a lower price. Therefore, both parties should carefully consider the discount rate and how it affects their valuation and dilution.
3. Pro rata right: This is the right of the investor to maintain their percentage ownership in the startup by participating in future rounds of funding. For example, if the investor invests $100,000 in a SAFE with a pro rata right, and the startup raises a Series A round of $1 million, the investor can invest another $100,000 in the Series A round to keep their 10% ownership in the startup. The pro rata right allows the investor to avoid dilution and increase their exposure to the startup's growth. However, it also obliges the investor to provide more funding to the startup, which may not be feasible or desirable for them. The pro rata right also affects the startup, as it limits their ability to attract new investors or raise more money from existing investors. Therefore, both parties should carefully consider the pro rata right and how it impacts their funding strategy and relationship.
4. Trigger events: These are the events that trigger the conversion of the SAFE into equity. The most common trigger events are a qualified financing, a change of control, or a dissolution of the startup. A qualified financing is a round of funding that meets a certain threshold of money raised, usually determined by the startup and the investor. A change of control is a sale, merger, or acquisition of the startup by another entity. A dissolution is a liquidation or bankruptcy of the startup. Depending on the trigger event, the investor may receive different types of equity, such as preferred shares, common shares, or cash. The trigger events also affect the timing and certainty of the conversion, as some events may happen sooner or later than expected, or may not happen at all. Therefore, both parties should carefully consider the trigger events and how they affect their rights and obligations.
Key Terms and Conditions of a SAFE Agreement - SAFE: a simple and flexible way to raise funding for your startup
8.Negotiating the Terms of a Convertible Note[Original Blog]
One of the most important aspects of using convertible notes for startups is negotiating the terms of the note with the investors. The terms of the note will determine how much equity the investors will get, how much interest the startup will pay, and what kind of rights and protections the investors will have. Negotiating the terms of a convertible note can be challenging, as both parties have different goals and expectations. In this section, we will discuss some of the key terms of a convertible note, and how to negotiate them effectively. We will also provide some insights from different perspectives, such as the startup founder, the angel investor, and the venture capitalist. Here are some of the main terms of a convertible note that you should pay attention to:
1. Valuation cap: This is the maximum valuation of the startup at which the note will convert into equity. For example, if the note has a valuation cap of $10 million, and the startup raises a Series A round at a $20 million valuation, the note will convert into equity at a $10 million valuation, giving the investors a lower price per share and a higher ownership percentage. The valuation cap is usually favorable to the investors, as it protects them from dilution in case the startup becomes more valuable. The startup founder, on the other hand, may prefer a higher valuation cap, or no cap at all, as it gives them more flexibility and control over their equity. The valuation cap is one of the most negotiated terms of a convertible note, and it depends on factors such as the stage of the startup, the market conditions, and the bargaining power of the parties. A common way to negotiate the valuation cap is to use a range, rather than a fixed number. For example, the startup founder may propose a valuation cap of $8 million to $12 million, and the investor may counter with a valuation cap of $6 million to $10 million. Then, they can try to find a middle ground that works for both sides.
2. Discount rate: This is the percentage discount that the note holders will get when the note converts into equity. For example, if the note has a 20% discount rate, and the startup raises a Series A round at a $1 per share price, the note will convert into equity at a $0.8 per share price, giving the investors a lower price per share and a higher ownership percentage. The discount rate is usually favorable to the investors, as it rewards them for taking the risk of investing early. The startup founder, on the other hand, may prefer a lower discount rate, or no discount at all, as it reduces the dilution of their equity. The discount rate is another highly negotiated term of a convertible note, and it depends on factors such as the expected valuation of the startup, the time horizon of the investment, and the opportunity cost of the capital. A common way to negotiate the discount rate is to use a sliding scale, rather than a fixed number. For example, the startup founder may propose a discount rate of 15% if the note converts within 12 months, 20% if the note converts within 18 months, and 25% if the note converts within 24 months. The investor may counter with a discount rate of 20% if the note converts within 12 months, 25% if the note converts within 18 months, and 30% if the note converts within 24 months. Then, they can try to find a middle ground that works for both sides.
3. Interest rate: This is the annual interest rate that the note will accrue until it converts into equity. For example, if the note has a 5% interest rate, and the note converts after 2 years, the note holder will get an additional 10% of the principal amount as interest. The interest rate is usually favorable to the investors, as it increases their return on investment. The startup founder, on the other hand, may prefer a lower interest rate, or no interest at all, as it reduces the amount of debt they have to repay. The interest rate is usually less negotiated than the other terms of a convertible note, as it is often set by the market and the legal regulations. However, it is still important to pay attention to the interest rate, as it can have a significant impact on the economics of the deal. A common way to negotiate the interest rate is to use a benchmark, such as the prime rate, the LIBOR, or the federal funds rate, and add a margin, such as 2% or 3%, to reflect the risk and the opportunity cost of the investment.
4. Conversion trigger: This is the event that will cause the note to convert into equity. The most common conversion trigger is a qualified financing round, which is a round of equity financing that meets certain criteria, such as the amount raised, the valuation, and the participation of institutional investors. For example, if the note has a conversion trigger of a qualified financing round of at least $1 million, the note will convert into equity when the startup raises a round of $1 million or more from venture capitalists. The conversion trigger is usually favorable to the startup founder, as it gives them the option to delay the conversion of the note until they are ready to raise a larger round of equity. The investors, on the other hand, may prefer a lower conversion trigger, or a mandatory conversion trigger, such as a maturity date, a change of control, or an IPO, as it gives them more certainty and liquidity. The conversion trigger is another negotiated term of a convertible note, and it depends on factors such as the runway of the startup, the fundraising strategy, and the exit potential. A common way to negotiate the conversion trigger is to use a combination of different events, such as a qualified financing round of at least $500,000, or a maturity date of 3 years, or a change of control, whichever occurs first. This way, both parties can have some flexibility and protection.
5. Pro rata right: This is the right of the note holders to participate in future rounds of equity financing, in proportion to their ownership percentage. For example, if the note holder owns 10% of the startup after the conversion of the note, and the startup raises a Series B round of $10 million, the note holder has the right to invest $1 million in the Series B round, to maintain their 10% ownership. The pro rata right is usually favorable to the investors, as it allows them to increase their stake in the startup, and avoid dilution from future rounds. The startup founder, on the other hand, may prefer to limit or waive the pro rata right, as it gives them more flexibility and control over their cap table, and reduces the signaling risk of having existing investors not participate in future rounds. The pro rata right is another negotiated term of a convertible note, and it depends on factors such as the valuation of the startup, the availability of capital, and the relationship between the parties. A common way to negotiate the pro rata right is to use a threshold, such as a minimum ownership percentage, or a minimum investment amount, that the note holder has to meet to exercise their pro rata right. For example, the startup founder may propose that the note holder has to own at least 5% of the startup, or invest at least $250,000, to have the pro rata right. The investor may counter with a lower threshold, such as 3% or $100,000. Then, they can try to find a middle ground that works for both sides.
These are some of the main terms of a convertible note that you should pay attention to when negotiating with investors. Of course, there are other terms that may be relevant, such as the security type, the liquidation preference, the anti-dilution protection, and the information rights. However, these terms are usually less common and less important for convertible notes, as they are more applicable to equity financing. The key to negotiating the terms of a convertible note is to understand the goals and expectations of both parties, and to find a balance that aligns the interests and incentives of both sides. By doing so, you can use convertible notes as a powerful tool to raise capital for your startup, and to build a strong relationship with your investors.
Negotiating the Terms of a Convertible Note - Convertible notes: Convertible Notes for Startups: How to Use Them and What to Avoid
9.What is a convertible note and why do startups use it?[Original Blog]
A convertible note is a type of debt instrument that can be converted into equity shares of the issuing company at a later date. It is often used by startups as a way of raising capital without having to give up too much ownership or valuation in the early stages of their business. In this section, we will explore what a convertible note is, how it works, and how to use it effectively for your startup. We will also look at the advantages and disadvantages of convertible notes from the perspectives of both the founders and the investors.
Some of the main features of a convertible note are:
1. Principal and interest: The principal is the amount of money that the investor lends to the startup, and the interest is the percentage of the principal that accrues over time. The interest rate is usually lower than a traditional loan, as the investor expects to make a higher return when the note converts into equity. The principal and interest are added together to determine the amount of equity that the investor will receive upon conversion.
2. maturity date: The maturity date is the deadline by which the startup has to repay the principal and interest to the investor, or convert the note into equity. The maturity date is usually set between 12 to 36 months from the date of issuance. If the startup fails to repay or convert the note by the maturity date, the investor may have the option to demand repayment, extend the maturity date, or convert the note at a discounted valuation.
3. conversion triggers: The conversion triggers are the events that cause the note to convert into equity. The most common conversion triggers are:
- Qualified financing: This is when the startup raises a certain amount of money from a subsequent round of funding, usually a Series A round. The note converts into the same type of equity that the new investors receive, at the same price per share. The note holders may also get a discount on the conversion price, which means they get more shares for the same amount of money. The discount rate is usually between 10% to 30%.
- Change of control: This is when the startup is acquired by another company, or undergoes a merger or an IPO. The note converts into equity at the valuation of the acquisition or the IPO, or at a predetermined valuation cap, whichever is lower. The valuation cap is the maximum valuation at which the note can convert, and it protects the note holders from dilution in case the startup becomes very successful. The valuation cap is usually set between $3 million to $20 million.
- Voluntary conversion: This is when the startup or the investor decides to convert the note into equity before any of the above triggers occur. The conversion price is usually based on the valuation cap or a mutually agreed valuation. The voluntary conversion may require the consent of both parties, or only one of them, depending on the terms of the note.
4. Equity type and ownership: The equity type is the kind of shares that the note holders receive upon conversion. The most common equity types are:
- Common stock: This is the basic type of equity that gives the note holders the same rights and privileges as the founders and employees of the startup. The note holders get to vote on major decisions, receive dividends, and participate in the upside of the startup. However, they also bear the risk of losing their investment if the startup fails or gets diluted by future rounds of funding.
- Preferred stock: This is a special type of equity that gives the note holders some advantages over the common stock holders. The note holders get to enjoy a liquidation preference, which means they get paid first in case of an exit, up to a certain multiple of their investment. They may also have anti-dilution protection, which means they get to maintain their percentage of ownership in the startup regardless of future rounds of funding. However, they may have to give up some voting rights, dividends, and upside potential in exchange for these benefits.
- SAFE (Simple Agreement for Future Equity): This is a newer and simpler alternative to a convertible note, created by Y Combinator. A SAFE is not a debt instrument, but a contract that gives the investor the right to receive equity in the future, under certain conditions. A SAFE does not have a principal, interest, maturity date, or repayment obligation. It only has a conversion trigger, a valuation cap, and a discount rate. A SAFE is designed to be more founder-friendly and investor-friendly, as it reduces the complexity and cost of the deal.
The ownership percentage that the note holders get upon conversion depends on the conversion price, the valuation of the startup, and the amount of money invested. The ownership percentage can be calculated using the following formula:
$$Ownership\ percentage = \frac{Amount\ invested}{Conversion\ price \times Post-money\ valuation} \times 100\%$$
For example, suppose an investor lends $100,000 to a startup using a convertible note with a 20% discount rate and a $5 million valuation cap. The startup then raises a Series A round of $10 million at a $20 million pre-money valuation ($30 million post-money valuation). The note converts into equity at the lower of the two prices: the Series A price ($0.5 per share) or the discounted valuation cap price ($0.4 per share). The note holder gets 250,000 shares ($100,000 / $0.4) and owns 0.83% of the startup (250,000 / 30,000,000 x 100%).
Some of the advantages and disadvantages of convertible notes from the perspectives of the founders and the investors are:
- Advantages for founders:
- Flexibility: Convertible notes allow the founders to raise money quickly and easily, without having to negotiate the valuation or the terms of the equity with the investors. The founders can defer these decisions until a later stage, when they have more traction and data to support their valuation. The founders can also adjust the terms of the note to suit different investors, such as offering a higher discount rate or a lower valuation cap to early or strategic investors.
- Cost-effectiveness: Convertible notes are cheaper and faster to execute than equity deals, as they require less legal documentation and due diligence. The founders can save time and money on lawyers, accountants, and valuation experts, and focus more on building their product and growing their business. The founders also avoid paying taxes on the money raised, as it is considered a loan rather than income.
- Control: Convertible notes allow the founders to retain more control and ownership of their startup, as they do not have to give up any equity or board seats until the note converts. The founders can also avoid some of the restrictions and obligations that come with equity financing, such as reporting requirements, veto rights, and drag-along rights. The founders can run their startup as they see fit, without having to answer to the investors or compromise on their vision.
- Disadvantages for founders:
- Debt: Convertible notes are a form of debt that has to be repaid or converted at some point. If the startup fails to raise a subsequent round of funding or achieve an exit before the maturity date, the founders may face a cash crunch and have to repay the investors with interest, or give up a large chunk of equity at a low valuation. The founders may also have to deal with the pressure and expectations of the investors, who may demand more information, involvement, or influence over the startup.
- Dilution: Convertible notes can lead to significant dilution for the founders and the early employees, as they have to share the equity with the note holders when the note converts. The dilution can be even more severe if the startup raises multiple rounds of convertible notes, or if the startup becomes very successful and exceeds the valuation cap. The founders may end up owning a smaller percentage of a larger pie, which may affect their motivation and alignment with the investors.
- Uncertainty: Convertible notes create uncertainty for the founders, as they do not know how much equity they will have to give up or what valuation they will get until the note converts. The founders may also face conflicts or disputes with the investors, who may have different opinions or expectations about the conversion triggers, the conversion price, or the equity type. The founders may have to renegotiate the terms of the note or deal with legal issues, which can be costly and time-consuming.
- Advantages for investors:
- Upside potential: Convertible notes give the investors the opportunity to participate in the future growth and success of the startup, as they get to convert their debt into equity at a favorable price. The investors can benefit from the discount rate and the valuation cap, which lower the conversion price and increase the number of shares they receive. The investors can also choose the equity type that suits their preferences and risk appetite, such as common stock, preferred stock, or SAFE.
- Downside protection: Convertible notes also protect the investors from the downside risk of the startup, as they have the option to get their money back with interest if the startup fails or underperforms. The investors can also enjoy a liquidation preference, which ensures that they get paid first in case of an exit, up to a certain multiple of their investment. The investors can also have anti-dilution protection, which prevents them from losing their percentage of ownership in the startup due to future rounds of funding.
- Access and influence: Convertible notes allow the investors to access and support promising startups at an early stage, before they raise a larger round of funding or attract more competition. The investors can also leverage their network, expertise, and reputation to help the startup grow and succeed, and build a strong relationship with the founders. The investors can also have some influence over the startup, such as providing feedback, advice, or introductions, or having some voting rights or board representation.
- Disadvantages for investors:
What is a convertible note and why do startups use it - Convertible note: Convertible Note for Startups: What It Is: How It Works: and How to Use It
10.What are some common questions and misconceptions about a SAFE and how to answer them?[Original Blog]
Some of the FAQs about a SAFE are:
1. What are the benefits of a SAFE for a startup? A SAFE can offer several benefits for a startup, such as:
- Speed: A SAFE can be signed quickly and easily, without requiring lengthy negotiations or legal fees.
- Simplicity: A SAFE is a short and simple document that avoids complicated terms and clauses that are often found in traditional equity financing agreements.
- Flexibility: A SAFE allows the startup to defer the valuation of the company until a later round of financing, when the company has more traction and data to support its valuation. A SAFE also gives the startup the option to choose from different types of SAFEs, such as capped, uncapped, or discount-only, depending on the preferences of the startup and the investor.
- Alignment: A SAFE aligns the interests of the startup and the investor, as both parties share the same goal of increasing the value of the company. A SAFE also eliminates the risk of dilution for the investor, as the investor will receive the same percentage of equity as if they had invested in the previous round.
2. What are the drawbacks of a SAFE for a startup? A SAFE can also pose some drawbacks for a startup, such as:
- Uncertainty: A SAFE creates uncertainty for the startup, as the startup does not know how much equity it will have to give up to the investor in the future, or when the conversion will happen. A SAFE also exposes the startup to the risk of having multiple SAFEs with different terms and conditions, which can create confusion and complexity for the startup and its future investors.
- Pressure: A SAFE can put pressure on the startup, as the startup has to raise a subsequent round of financing within a reasonable time frame, otherwise the SAFE investor may lose confidence and patience. A SAFE also increases the expectations of the investor, as the investor expects the startup to achieve a higher valuation in the next round, otherwise the investor may not get a good return on their investment.
- Cost: A SAFE can be costly for the startup, as the startup has to pay a premium to the investor in the form of a discount or a valuation cap. A SAFE also reduces the bargaining power of the startup in the future rounds, as the startup has to honor the terms of the SAFE and may have less room to negotiate with new investors.
3. What are the benefits of a SAFE for an investor? A SAFE can offer several benefits for an investor, such as:
- Access: A SAFE can give the investor access to early-stage startups that may not be ready or willing to raise a traditional equity round. A SAFE can also allow the investor to invest smaller amounts of money and diversify their portfolio.
- Protection: A SAFE can protect the investor from dilution, as the investor will receive the same percentage of equity as if they had invested in the previous round. A SAFE can also protect the investor from overpaying, as the investor will receive a discount or a valuation cap that ensures a lower price per share than the future investors.
- Upside: A SAFE can offer the investor a potential upside, as the investor can benefit from the growth and success of the startup. A SAFE can also offer the investor a preferential treatment, as the investor will have the right to participate in the future rounds and receive information and updates from the startup.
4. What are the drawbacks of a SAFE for an investor? A SAFE can also pose some drawbacks for an investor, such as:
- Risk: A SAFE can be risky for the investor, as the investor does not receive any ownership or control over the startup until the conversion happens. A SAFE also exposes the investor to the risk of losing their entire investment, if the startup fails or does not raise a subsequent round of financing.
- Delay: A SAFE can cause a delay for the investor, as the investor has to wait until the conversion happens to receive their equity. A SAFE also depends on the terms and conditions of the future rounds, which may not be favorable or compatible with the terms of the SAFE.
- Lack: A SAFE can lack some features and benefits that are typically available in traditional equity financing agreements, such as voting rights, board representation, dividends, liquidation preferences, anti-dilution provisions, and drag-along rights.
These are some of the common questions and misconceptions about a SAFE and how to answer them. A SAFE can be a useful and convenient tool for startups and investors to raise money and support innovation, but it also requires careful consideration and understanding of the implications and trade-offs involved. A SAFE is not a one-size-fits-all solution, and it may not be suitable for every startup or investor. Therefore, it is important to consult with a legal and financial advisor before signing or accepting a SAFE.
11.How to Structure a SAFE to Attract Investors?[Original Blog]
One of the most important aspects of raising money for your early stage startup is how to structure your SAFE (Simple Agreement for Future Equity). A safe is a contract that gives investors the right to receive equity in your company at a later date, usually when you raise a priced round of funding. A SAFE is not a debt instrument, nor does it have a maturity date or interest rate. It is a simple and flexible way to raise money without having to negotiate the valuation of your company or give up board seats.
However, not all SAFEs are created equal. There are different terms and conditions that can affect how attractive your SAFE is to potential investors. In this section, we will discuss some of the key factors that you should consider when structuring your SAFE, and how to balance the interests of both parties. We will also provide some examples of how different SAFEs can impact your future fundraising and dilution.
Here are some of the main elements that you should pay attention to when structuring your SAFE:
1. Valuation cap: This is the maximum valuation at which your SAFE will convert into equity in your future priced round. For example, if you raise a SAFE with a $10 million valuation cap, and then you raise a Series A at a $20 million pre-money valuation, your SAFE investors will get equity at a $10 million valuation, effectively getting a 50% discount. A lower valuation cap means a higher return for your SAFE investors, but also more dilution for you and your existing shareholders. A higher valuation cap means a lower return for your SAFE investors, but also less dilution for you and your existing shareholders. You should try to set a valuation cap that reflects the fair market value of your company at the time of the SAFE, and that leaves enough room for growth in your future rounds.
2. Discount rate: This is the percentage discount that your SAFE investors will get on the share price of your future priced round. For example, if you raise a SAFE with a 20% discount rate, and then you raise a Series A at a $1 per share price, your SAFE investors will get equity at $0.80 per share, effectively getting a 20% discount. A higher discount rate means a higher return for your SAFE investors, but also more dilution for you and your existing shareholders. A lower discount rate means a lower return for your SAFE investors, but also less dilution for you and your existing shareholders. You should try to set a discount rate that reflects the risk and reward of investing in your company at the time of the SAFE, and that is competitive with other investment opportunities in the market.
3. Most favored nation (MFN) clause: This is a provision that gives your SAFE investors the right to amend their SAFE terms to match any more favorable terms that you offer to other investors in the future. For example, if you raise a SAFE with a $10 million valuation cap and a 20% discount rate, and then you raise another SAFE with a $8 million valuation cap and a 25% discount rate, your first SAFE investors can choose to update their terms to match the second SAFE terms. An MFN clause protects your SAFE investors from being disadvantaged by future SAFEs that you may raise with better terms. However, it also limits your flexibility to raise money from different sources and at different stages of your company's development. You should try to avoid or limit the scope of the MFN clause, and only offer it to your early and strategic investors who are adding value to your company beyond capital.
4. Pro rata right: This is the right that gives your SAFE investors the option to participate in your future priced rounds and maintain their ownership percentage in your company. For example, if you raise a SAFE with a 10% ownership stake, and then you raise a Series A with a 20% dilution, your SAFE investors can choose to invest more money in the Series A to keep their 10% stake. A pro rata right allows your SAFE investors to benefit from your company's growth and avoid being diluted by future rounds. However, it also reduces the amount of new capital that you can raise from new investors in your future rounds. You should try to offer a pro rata right to your SAFE investors who are committed to supporting your company in the long term, and who can add value to your future rounds. You should also consider setting a minimum threshold for the pro rata right, such as a certain amount of investment or a certain ownership percentage, to avoid having too many small investors in your cap table.
These are some of the main factors that you should consider when structuring your SAFE to attract investors. Of course, there are other terms and conditions that you may want to include or exclude in your SAFE, depending on your specific situation and goals. You should always consult with a lawyer and an accountant before signing any legal documents, and make sure that you understand the implications and consequences of your SAFE terms. A well-structured safe can help you raise money quickly and efficiently, while preserving your control and ownership of your company. A poorly-structured SAFE can cause problems and conflicts in your future fundraising and governance, and potentially jeopardize your company's success. Therefore, you should be careful and thoughtful when choosing your SAFE terms, and try to align them with your investors' expectations and interests.
How to Structure a SAFE to Attract Investors - SAFE: What is a SAFE and how to use it to raise money for your early stage startup
12.Alternatives to raising capital through a seed round[Original Blog]
One of the most common questions entrepreneurs ask is how to raise capital for their startup. The answer, of course, depends on the individual business and its needs. However, one of the most common ways to raise capital for a startup is through a seed round.
A seed round is when a company raises money from investors to help finance its early stages of development. Seed rounds are typically smaller than later rounds of funding, such as Series A or B rounds. The money raised in a seed round can be used to help pay for things like product development, market research, and hiring.
There are a few different types of seed rounds, each with its own advantages and disadvantages. The most common type of seed round is a convertible note. Convertible notes are essentially loans that convert into equity in the company if it is successful. The advantage of this type of seed round is that it doesn't put a lot of pressure on the company to perform immediately. The downside is that the company may have to give up a larger percentage of equity if it is successful.
Another type of seed round is called a priced round. In a priced round, the company sells equity in the company for a set price. This type of round is more risky for the company because it has to value itself at a certain price. If the company is not successful, it may not be able to raise money in future rounds. However, if the company is successful, it will have less dilution than in a convertible note round.
There are also seed rounds that are a combination of convertible notes and priced rounds. These are called SAFE rounds or KISS rounds. SAFE rounds are less risky for the company because they have a lower valuation cap. KISS rounds are more risky because they have no valuation cap.
No matter what type of seed round you choose, there are a few things to keep in mind. First, make sure you have a good business plan. This will help you raise money and convince investors that your company is worth investing in. Second, don't take too much money. It's better to dilute your ownership by taking less money than to dilute your control by taking too much money. Finally, remember that a seed round is just the beginning. You will likely have to raise more money in future rounds to continue growing your business.
13.How to Structure a Convertible Note Offering?[Original Blog]
One of the most important decisions that fintech startups face when raising capital is how to structure their convertible note offering. A convertible note is a type of debt instrument that can be converted into equity at a later stage, usually at a discounted price. Convertible notes are popular among early-stage startups because they allow them to defer the valuation of their company until they have more traction and proof of concept. However, convertible notes also come with various terms and conditions that can affect the startup's future fundraising and dilution. Therefore, it is essential for fintech founders to understand the implications of different convertible note structures and negotiate the best deal for their startup. In this section, we will discuss some of the key aspects of convertible note structures, such as:
- The interest rate: This is the annual percentage rate that accrues on the principal amount of the convertible note until it is converted or repaid. The interest rate can vary depending on the market conditions, the risk profile of the startup, and the bargaining power of the investors. Typically, the interest rate for convertible notes ranges from 2% to 8%, with an average of 5%. The interest rate can affect the conversion price of the note, as well as the amount of debt that the startup has to repay if the note is not converted.
- The maturity date: This is the date when the convertible note becomes due and payable, unless it is converted or extended before then. The maturity date can range from 6 months to 3 years, with an average of 18 months. The maturity date can affect the startup's cash flow and liquidity, as well as the investors' rights and incentives. If the note matures before the startup raises a qualified financing round, the investors can either demand repayment of the note, convert the note into equity at a predetermined valuation, or extend the note for another period of time.
- The conversion trigger: This is the event that triggers the conversion of the convertible note into equity. The most common conversion trigger is a qualified financing round, which is a subsequent round of equity financing that meets certain criteria, such as raising a minimum amount of capital, having a minimum valuation, or having a lead investor. The conversion trigger can affect the timing and valuation of the conversion, as well as the dilution of the existing shareholders. If the startup raises a qualified financing round, the note holders can either convert their notes into equity at a discounted price, or retain their notes until a later event, such as an exit or another conversion trigger.
- The conversion price: This is the price per share at which the convertible note is converted into equity. The conversion price can be determined by various methods, such as a fixed price, a valuation cap, or a discount rate. The conversion price can affect the amount and percentage of equity that the note holders receive, as well as the dilution of the existing shareholders. For example, if the conversion price is set by a fixed price of $1 per share, the note holders will receive 1 share for every $1 of principal and accrued interest. If the conversion price is set by a valuation cap of $10 million, the note holders will receive 1 share for every $10 million divided by the pre-money valuation of the qualified financing round. If the conversion price is set by a discount rate of 20%, the note holders will receive 1 share for every 80% of the price per share of the qualified financing round.
- The pro rata right: This is the right of the note holders to participate in future rounds of equity financing on the same terms as the new investors. The pro rata right can affect the availability and allocation of capital for the startup, as well as the dilution of the existing shareholders. If the note holders have a pro rata right, they can invest additional capital in the startup and maintain their percentage ownership. If the note holders do not have a pro rata right, they can be diluted by the new investors and lose their influence and upside potential.
These are some of the main factors that fintech startups should consider when structuring their convertible note offering. However, there is no one-size-fits-all solution, and each startup should tailor their convertible note structure to their specific needs and goals. To illustrate how different convertible note structures can affect the startup's outcomes, let us look at some hypothetical examples:
- Example 1: Startup A raises $500,000 from angel investors using a convertible note with a 5% interest rate, a 2-year maturity date, a qualified financing round of $1 million as the conversion trigger, a valuation cap of $5 million as the conversion price, and a pro rata right for the note holders. After 1 year, Startup A raises a Series A round of $2 million at a pre-money valuation of $10 million. The note holders can convert their notes into equity at a conversion price of $5 million, which is lower than the pre-money valuation of the Series A round. The note holders receive 10% of the post-money valuation of the series A round, which is $1.2 million, for their $500,000 investment. The note holders also have the option to invest another $120,000 in the Series A round to maintain their 10% ownership. The founders and the existing shareholders are diluted by 10% by the note holders, and by another 16.67% by the Series A investors.
- Example 2: Startup B raises $500,000 from angel investors using a convertible note with a 5% interest rate, a 2-year maturity date, a qualified financing round of $1 million as the conversion trigger, a discount rate of 20% as the conversion price, and no pro rata right for the note holders. After 1 year, Startup B raises a Series A round of $2 million at a pre-money valuation of $10 million. The note holders can convert their notes into equity at a conversion price of 80% of the price per share of the Series A round, which is $0.8 per share. The note holders receive 6.25% of the post-money valuation of the Series A round, which is $750,000, for their $500,000 investment. The note holders do not have the option to invest more in the Series A round, and their ownership will be diluted by future rounds. The founders and the existing shareholders are diluted by 6.25% by the note holders, and by another 16.67% by the Series A investors.
- Example 3: Startup C raises $500,000 from angel investors using a convertible note with a 5% interest rate, a 1-year maturity date, no conversion trigger, a fixed price of $1 per share as the conversion price, and a pro rata right for the note holders. After 1 year, Startup C does not raise a qualified financing round, and the note matures. The note holders can either demand repayment of the note, which is $525,000, or convert the note into equity at a fixed price of $1 per share. The note holders decide to convert the note into equity, and receive 525,000 shares, which is 52.5% of the startup's equity. The note holders also have the option to invest more in the future rounds to maintain their 52.5% ownership. The founders and the existing shareholders are diluted by 52.5% by the note holders, and by any future investors.
When you dive into being an entrepreneur, you are making a commitment to yourself and to others who come to work with you and become interdependent with you that you will move mountains with every ounce of energy you have in your body.
14.Conversion Mechanics and Valuation Cap[Original Blog]
One of the most important aspects of convertible notes is how they convert into equity when the startup raises a subsequent round of funding. The conversion mechanics and the valuation cap are two key terms that determine the amount and the price of the equity that the note holders will receive. In this section, we will explain what these terms mean, how they affect the investors and the founders, and what are some of the common scenarios and challenges that arise from using convertible notes.
- Conversion mechanics: This term refers to the formula that calculates how many shares of equity the note holders will get when the note converts. The basic formula is:
$$\text{Number of shares} = \frac{\text{Principal amount} + \text{Accrued interest}}{\text{Conversion price}}$$
The principal amount is the original amount of money that the investor lent to the startup. The accrued interest is the interest that accumulates over time on the principal amount, usually at a fixed annual rate (e.g., 5%). The conversion price is the price per share that the note holders will pay for the equity, which is usually based on a discount or a cap (or both) applied to the valuation of the startup in the subsequent round.
- Valuation cap: This term refers to the maximum valuation of the startup that the note holders will use to calculate their conversion price. For example, if the note has a $10 million cap and the startup raises a Series A round at a $20 million valuation, the note holders will use the $10 million cap as their valuation, not the $20 million valuation. This means that they will get more shares for the same amount of money, and thus a higher ownership percentage in the startup. The valuation cap is a way of rewarding the early investors for taking more risk and supporting the startup when it was less valuable.
Some of the insights from different point of views are:
- From the investor's perspective, the conversion mechanics and the valuation cap are crucial for determining the return on their investment. The investor wants to get as many shares as possible for the lowest price possible, and thus prefers a lower cap and a higher discount. The investor also wants to protect their ownership percentage from being diluted by future rounds of funding, and thus may ask for anti-dilution provisions or pro-rata rights in the note agreement.
- From the founder's perspective, the conversion mechanics and the valuation cap are important for preserving their control and ownership of the startup. The founder wants to give away as few shares as possible for the highest price possible, and thus prefers a higher cap and a lower discount. The founder also wants to avoid giving too much power and influence to the early investors, and thus may resist granting them any special rights or preferences in the note agreement.
- From the startup's perspective, the conversion mechanics and the valuation cap are relevant for maintaining a healthy and balanced cap table. The startup wants to have a fair and reasonable valuation that reflects its growth and potential, and thus prefers a cap that is aligned with the market and the expectations of the future investors. The startup also wants to have a diverse and supportive group of investors that can provide value beyond money, and thus prefers a note that is flexible and simple to execute.
Some of the common scenarios and challenges that arise from using convertible notes are:
- The uncapped note: This is a note that does not have a valuation cap, and thus the conversion price is based solely on the discount. This means that the note holders will benefit from any increase in the valuation of the startup, but will also bear the risk of any decrease in the valuation. This type of note is more favorable to the founders, as they do not have to commit to a specific valuation and can raise more money without diluting their ownership. However, this type of note is less attractive to the investors, as they do not have any upside protection and may end up paying a higher price than the future investors.
- The high cap note: This is a note that has a very high valuation cap, and thus the conversion price is almost always based on the cap, not the discount. This means that the note holders will get a very low price per share, and thus a very high ownership percentage in the startup. This type of note is more favorable to the investors, as they get a significant discount and a guaranteed minimum return. However, this type of note is less favorable to the founders, as they have to give away a large portion of their equity and may face difficulties in raising future rounds of funding at a higher valuation.
- The multiple notes scenario: This is a scenario where the startup raises more than one convertible note from different investors at different times and terms. This means that the startup will have multiple note holders with different conversion prices and preferences. This type of scenario is more complex and challenging to manage, as the startup has to keep track of the different notes and their conversion conditions, and may face conflicts and disputes among the note holders when the note converts. The startup may also have to deal with the issue of the "stacked caps", where the total valuation of the startup implied by the sum of the caps of the different notes is higher than the actual valuation of the startup in the subsequent round. This may result in a significant dilution of the founders and the future investors, and may require a renegotiation of the terms of the notes.
15.Key takeaways and action steps for startup founders[Original Blog]
One of the most important decisions that startup founders have to make is how much equity to give up in exchange for funding. This decision affects not only the current value of the company, but also the future potential of the founders and investors. In this section, we will summarize the key takeaways and action steps for startup founders who want to balance dilution and premoney valuation in their fundraising rounds. Here are some of the main points to remember:
1. Dilution is the percentage of ownership that founders and existing shareholders lose when new investors buy shares in the company. Dilution can be calculated by dividing the number of new shares issued by the total number of shares after the round.
2. Premoney valuation is the value of the company before the investment, based on the price per share and the number of shares outstanding. Premoney valuation can be calculated by multiplying the price per share by the number of shares before the round.
3. Postmoney valuation is the value of the company after the investment, based on the price per share and the number of shares outstanding. Postmoney valuation can be calculated by adding the amount raised to the premoney valuation, or by multiplying the price per share by the number of shares after the round.
4. Price per share is the amount that each share of the company is worth, based on the valuation and the number of shares. Price per share can be calculated by dividing the premoney valuation by the number of shares before the round, or by dividing the postmoney valuation by the number of shares after the round.
5. Valuation cap is a term used in convertible notes and SAFE agreements, which are types of debt instruments that convert into equity at a later stage. A valuation cap sets a maximum valuation for the conversion, regardless of the actual valuation at that time. This gives an advantage to early investors, who get more shares for their money.
6. Discount rate is another term used in convertible notes and SAFE agreements, which gives a percentage discount on the price per share at conversion. This also gives an advantage to early investors, who pay less for their shares than later investors.
7. Anti-dilution provisions are clauses in term sheets that protect investors from being diluted by future rounds at lower valuations. There are different types of anti-dilution provisions, such as full ratchet, weighted average, and broad-based weighted average. These provisions adjust the price per share or the number of shares for previous investors, depending on how much lower the new valuation is.
8. Option pool is a reserve of shares that are set aside for future employees, advisors, and board members. The option pool reduces the premoney valuation and increases dilution for founders and existing shareholders, since it is usually created before a new round of funding. The size and terms of the option pool are often negotiated between founders and investors.
9. pro rata rights are rights that allow existing investors to maintain their percentage ownership in future rounds by investing more money. pro rata rights can reduce dilution for existing investors, but also increase dilution for founders and other shareholders, since they take up more space in the round. Pro rata rights are usually granted to lead investors or investors who meet a certain threshold of ownership.
10. Exit strategy is the plan for how founders and investors will realize their returns from their investment in the company. The most common exit strategies are acquisition, merger, IPO, or secondary sale. The exit strategy affects how much dilution and valuation matter, since different exit scenarios may have different outcomes for different stakeholders.
As a startup founder, you should be aware of these concepts and how they affect your company's value and your stake in it. Here are some action steps that you can take to balance dilution and premoney valuation in your fundraising rounds:
- Do your homework: Research comparable companies in your industry and stage, and understand how they are valued and funded. Use online tools and calculators to estimate your own valuation and dilution. Talk to mentors, advisors, and peers who have experience in fundraising and can give you feedback and advice.
- Know your worth: Have a clear vision and strategy for your company, and be able to articulate your value proposition, traction, growth potential, competitive advantage, and market opportunity. Be confident but realistic about your expectations and goals, and don't undersell or oversell yourself.
- Know your needs: Calculate how much money you need to raise to achieve your milestones and reach your next stage. Consider your burn rate, runway, revenue, profitability, and growth rate. Don't raise more money than you need, but also don't raise too little that you run out of cash or lose momentum.
- Know your options: Explore different sources and types of funding, such as bootstrapping, grants, crowdfunding, angel investors, venture capitalists, convertible notes, SAFE agreements, equity, debt, etc. Understand the pros and cons of each option, and how they affect your valuation and dilution. Choose the option that best suits your stage, goals, and preferences.
- Know your investors: Identify and target potential investors who are interested in your industry, stage, and vision. Do your due diligence on their background, reputation, portfolio, track record, and terms. build relationships and trust with them, and communicate your progress and challenges. Seek investors who can add value beyond money, such as expertise, network, mentorship, and support.
- Know your terms: Negotiate the terms of the deal with your investors, such as valuation, dilution, option pool, anti-dilution provisions, pro rata rights, board seats, voting rights, etc. Be prepared to make trade-offs and compromises, but also stand up for your interests and rights. Don't be afraid to walk away from a bad deal or a bad investor.
- Know your exit: Have a clear exit strategy for your company, and align it with your investors' expectations and goals. Be realistic about the likelihood and timing of your exit, and the potential returns for you and your investors. Plan ahead for the legal, financial, and operational aspects of your exit.
By following these steps, you can balance dilution and premoney valuation in your fundraising rounds, and maximize the value of your company and your stake in it. Remember that dilution and valuation are not the only factors that matter in fundraising. You should also consider the fit, alignment, and relationship with your investors, as well as the impact and vision of your company. Fundraising is a complex and challenging process, but it can also be rewarding and fulfilling if done right. Good luck!
16.Structuring a Convertible Note Offering for Your Fintech Startup[Original Blog]
One of the most important decisions you will have to make when raising capital for your fintech startup is how to structure your convertible note offering. A convertible note is a type of debt instrument that can be converted into equity at a later date, usually at a discount or a valuation cap. Convertible notes are popular among early-stage startups because they allow them to raise money quickly and easily, without having to negotiate a valuation or give up too much equity. However, convertible notes also come with some trade-offs and risks, both for the founders and the investors. In this section, we will discuss some of the key factors and best practices that you should consider when structuring a convertible note offering for your fintech startup. We will also provide some examples of how different fintech startups have used convertible notes to raise capital and minimize dilution.
Some of the factors that you should consider when structuring a convertible note offering are:
1. The amount of capital you need and the stage of your startup. The amount of capital you need will depend on your business model, your growth plans, and your runway. The stage of your startup will also affect the terms and conditions of your convertible note, such as the interest rate, the maturity date, and the conversion triggers. Generally, the earlier the stage, the more favorable the terms for the founders, as they have more leverage and less risk. However, you should also be realistic and not raise more money than you need, as this could lead to overvaluation and excessive dilution in the future.
2. The interest rate and the maturity date of your convertible note. The interest rate is the annual percentage rate that accrues on the principal amount of your convertible note until it converts or matures. The maturity date is the date when your convertible note becomes due and payable, unless it converts earlier. The interest rate and the maturity date are usually negotiated between the founders and the investors, and they reflect the risk and the opportunity cost of the investment. Typically, the interest rate ranges from 2% to 8%, and the maturity date ranges from 12 to 36 months. You should aim for a low interest rate and a long maturity date, as this will give you more time and flexibility to grow your business and increase your valuation before conversion. However, you should also be aware that a high interest rate and a short maturity date could create pressure and urgency for you to raise another round of funding or achieve a liquidity event before the note expires.
3. The discount rate and the valuation cap of your convertible note. The discount rate and the valuation cap are two mechanisms that determine the conversion price of your convertible note, i.e., the price per share at which your note converts into equity. The discount rate is the percentage discount that your note holders get when they convert their notes into equity in a future round of funding. The valuation cap is the maximum valuation at which your note holders can convert their notes into equity, regardless of the actual valuation of your startup in a future round of funding. The discount rate and the valuation cap are usually inversely related, meaning that the higher the discount rate, the lower the valuation cap, and vice versa. The discount rate and the valuation cap are also negotiated between the founders and the investors, and they reflect the expected return and the downside protection of the investment. Typically, the discount rate ranges from 10% to 30%, and the valuation cap ranges from $1 million to $20 million. You should aim for a high discount rate and a high valuation cap, as this will minimize the dilution and maximize the ownership of your existing shareholders. However, you should also be careful not to set the discount rate and the valuation cap too high, as this could deter potential investors or create misalignment of incentives between you and your note holders.
4. The conversion triggers and the pro rata rights of your convertible note. The conversion triggers and the pro rata rights are two clauses that specify when and how your convertible note converts into equity, and whether your note holders have the right to participate in future rounds of funding. The conversion triggers are the events that trigger the conversion of your convertible note, such as a qualified financing, a change of control, or an IPO. The pro rata rights are the rights that allow your note holders to maintain their percentage ownership of your startup by investing in future rounds of funding. The conversion triggers and the pro rata rights are also negotiated between the founders and the investors, and they reflect the alignment and the expectations of the parties. Generally, the conversion triggers should be clear and objective, and the pro rata rights should be fair and reasonable. You should aim for conversion triggers that are favorable to you and your existing shareholders, such as a high minimum amount of qualified financing, a high valuation threshold for change of control, or a high share price for IPO. You should also aim for pro rata rights that are balanced and mutually beneficial, such as a pro rata right based on the post-money valuation of the round, a pro rata right subject to a minimum investment amount, or a pro rata right with a limited duration.
Some examples of how different fintech startups have used convertible notes to raise capital and minimize dilution are:
- Stripe: Stripe is a leading online payment platform that enables businesses to accept and process payments from customers around the world. Stripe raised its first round of funding in 2010, using a convertible note with a $20 million valuation cap and a 10% discount rate. This allowed Stripe to raise $2 million from prominent investors such as Peter Thiel, Sequoia Capital, and Andreessen Horowitz, without having to set a valuation or give up too much equity. Stripe later raised several rounds of funding at increasing valuations, reaching a $95 billion valuation in 2021. Stripe's early convertible note holders benefited from the huge upside potential of the company, while Stripe's founders and employees retained a significant stake in the company.
- Revolut: Revolut is a global financial platform that offers banking, investing, and crypto services to millions of customers across 35 countries. Revolut raised its first round of funding in 2015, using a convertible note with a £66 million valuation cap and a 20% discount rate. This allowed Revolut to raise £1.5 million from prominent investors such as Balderton Capital, Index Ventures, and Point Nine Capital, without having to set a valuation or give up too much equity. Revolut later raised several rounds of funding at increasing valuations, reaching a $33 billion valuation in 2021. Revolut's early convertible note holders benefited from the rapid growth and expansion of the company, while Revolut's founders and employees retained a significant stake in the company.
- Plaid: Plaid is a leading data network that connects fintech applications to millions of bank accounts across the US, Canada, and Europe. Plaid raised its first round of funding in 2013, using a convertible note with a $5 million valuation cap and a 20% discount rate. This allowed Plaid to raise $2.8 million from prominent investors such as Spark Capital, Google Ventures, and New Enterprise Associates, without having to set a valuation or give up too much equity. Plaid later raised several rounds of funding at increasing valuations, reaching a $13.4 billion valuation in 2021. Plaid's early convertible note holders benefited from the high demand and adoption of the company's products, while Plaid's founders and employees retained a significant stake in the company.
As you can see, structuring a convertible note offering for your fintech startup is not a trivial task. It requires careful planning, negotiation, and execution. You should consider the pros and cons of each factor and clause, and how they affect your short-term and long-term goals. You should also consult with your legal and financial advisors, and do your market research and due diligence. By doing so, you can use convertible notes to raise capital for your fintech startup and minimize dilution, while creating value and alignment for yourself and your investors.
17.Negotiating Terms and Conditions in a SAFE Agreement[Original Blog]
One of the most important aspects of using a SAFE (Simple Agreement for Future Equity) for your startup is negotiating the terms and conditions with your investors. A SAFE is not a standard contract, but rather a customizable framework that can be adapted to suit the needs and preferences of both parties. However, this also means that there are some key issues that need to be discussed and agreed upon before signing a SAFE. In this section, we will explore some of the common terms and conditions that are involved in a SAFE agreement, and provide some tips and insights on how to negotiate them effectively. We will cover the following topics:
1. Valuation cap: This is the maximum valuation of your startup at which the SAFE investors can convert their investment into equity. A lower valuation cap means a higher percentage of ownership for the SAFE investors, and vice versa. The valuation cap is usually determined by the market conditions, the stage and traction of your startup, and the bargaining power of both parties. A common mistake that founders make is to set the valuation cap too high, which can deter potential investors or make them demand a higher discount rate. A good practice is to research the valuation ranges of comparable startups in your industry and stage, and use them as a reference point for your negotiations.
2. Discount rate: This is the percentage discount that the SAFE investors get when they convert their investment into equity. A higher discount rate means a lower price per share for the SAFE investors, and vice versa. The discount rate is usually set to incentivize the SAFE investors to invest early and take on more risk. The discount rate is often negotiated in conjunction with the valuation cap, as they both affect the ownership stake of the SAFE investors. A common strategy is to offer a lower discount rate if the valuation cap is lower, or a higher discount rate if the valuation cap is higher. For example, you could offer a 20% discount rate if the valuation cap is $10 million, or a 25% discount rate if the valuation cap is $15 million.
3. Pro rata rights: This is the right of the SAFE investors to participate in future rounds of financing and maintain their percentage of ownership. Pro rata rights can be beneficial for both parties, as they allow the SAFE investors to increase their investment and support your startup, and they allow you to raise more capital from existing investors who are already familiar with your business. However, pro rata rights can also be problematic, as they can limit your flexibility and control over your cap table, and they can create conflicts with other investors who may want to invest more or less than the SAFE investors. Therefore, pro rata rights should be carefully considered and negotiated, and they should be clearly defined in the SAFE agreement. For example, you could specify the minimum or maximum amount that the SAFE investors can invest in future rounds, or the time frame or conditions under which they can exercise their pro rata rights.
4. Most favored nation (MFN) clause: This is a clause that grants the SAFE investors the right to amend their SAFE agreement to match any more favorable terms that you offer to other investors in the same or subsequent rounds. An MFN clause can be useful for both parties, as it can simplify the negotiation process and ensure fairness and consistency among your investors. However, an MFN clause can also be risky, as it can create a downward pressure on your valuation and terms, and it can discourage other investors from investing in your startup if they know that their terms will be matched by the SAFE investors. Therefore, an MFN clause should be used sparingly and cautiously, and it should be limited in scope and duration. For example, you could limit the MFN clause to only apply to certain terms, such as the valuation cap or the discount rate, or you could limit the MFN clause to only apply to the current round or a certain period of time.
These are some of the main terms and conditions that you need to negotiate when using a SAFE for your startup. Of course, there may be other terms and conditions that are specific to your situation and your investors, and you should always consult with a lawyer before signing any legal documents. However, by following these general guidelines and tips, you can increase your chances of reaching a fair and mutually beneficial agreement with your SAFE investors. Remember, a SAFE is not a one-size-fits-all solution, but rather a flexible and adaptable tool that can help you raise capital for your startup.
Negotiating Terms and Conditions in a SAFE Agreement - SAFE: What It Is and How to Use It for Your Startup
18.A comparison of the key differences and advantages of SAFE over convertible notes[Original Blog]
safe and Convertible notes are two popular instruments for raising capital in the early stages of a startup. Both of them allow investors to provide funding to a startup in exchange for the right to convert their investment into equity at a later date, usually when the startup raises a priced round of financing. However, there are some key differences and advantages of SAFE over Convertible Notes that make it a more attractive option for both founders and investors. In this section, we will compare and contrast SAFE and Convertible Notes on the following aspects:
1. Valuation and Discount: Convertible Notes require the startup and the investor to agree on a valuation cap and a discount rate at the time of the investment. The valuation cap is the maximum valuation at which the investment can convert into equity, and the discount rate is the percentage reduction in the price per share that the investor will pay compared to the future investors. SAFE, on the other hand, does not require a valuation cap or a discount rate, but instead uses a valuation trigger mechanism. This means that the investment will convert into equity only when the startup raises a priced round of financing that meets or exceeds a certain threshold, which is determined by the SAFE agreement. This gives the startup more flexibility and avoids the need to negotiate a valuation cap or a discount rate, which can be challenging and subjective in the early stages of a startup. For example, if a startup raises $100,000 using a Convertible Note with a $5 million valuation cap and a 20% discount rate, the investor will get 2.5% of the equity ($100,000 / $4 million) if the startup raises a priced round at a $5 million valuation, or 2% of the equity ($100,000 / $5 million) if the startup raises a priced round at a $10 million valuation. However, if the startup raises $100,000 using a SAFE with a $5 million valuation trigger, the investor will get 2% of the equity ($100,000 / $5 million) regardless of the valuation of the priced round, as long as it is at least $5 million.
2. Interest and Maturity: convertible Notes are debt instruments that accrue interest over time and have a maturity date, which is the deadline by which the startup has to repay the principal and the interest to the investor, or convert the investment into equity. The interest rate and the maturity date are also negotiated at the time of the investment, and typically range from 2% to 8% and 12 to 24 months, respectively. SAFE, on the other hand, is not a debt instrument and does not accrue interest or have a maturity date. It is a simple agreement that remains in effect until the investment converts into equity or the startup is acquired or dissolved. This eliminates the risk of default or insolvency for the startup, and reduces the administrative burden and legal complexity for both parties. For example, if a startup raises $100,000 using a convertible Note with a 5% interest rate and a 18-month maturity date, the startup will owe the investor $107,500 ($100,000 + $7,500 interest) after 18 months, unless the investment converts into equity before that. However, if the startup raises $100,000 using a SAFE, the startup will not owe anything to the investor until the investment converts into equity or the startup is acquired or dissolved.
3. Pro-Rata Rights and Dividends: Convertible Notes usually grant the investor pro-rata rights, which are the rights to participate in future rounds of financing and maintain their percentage ownership of the startup. This can be beneficial for the investor, as it allows them to increase their stake in the startup and protect their investment from dilution. However, pro-rata rights can also be disadvantageous for the startup, as it can limit their ability to raise capital from new investors and create conflicts of interest among existing investors. SAFE, on the other hand, does not grant pro-rata rights to the investor, unless they are explicitly included in the SAFE agreement. This gives the startup more control and flexibility over their fundraising strategy and capital structure. Convertible Notes may also entitle the investor to receive dividends, which are payments made by the startup to the shareholders from their profits or reserves. This can be costly and burdensome for the startup, especially if they are not generating enough revenue or cash flow. SAFE, on the other hand, does not entitle the investor to receive dividends, unless they are explicitly included in the SAFE agreement. This allows the startup to reinvest their profits or reserves into their growth and development. For example, if a startup raises $100,000 using a Convertible Note with pro-rata rights and dividends, the investor will have the right to invest in future rounds of financing and receive payments from the startup's profits or reserves, in addition to their equity stake. However, if the startup raises $100,000 using a SAFE without pro-rata rights and dividends, the investor will only have the right to convert their investment into equity, and nothing else.
As you can see, SAFE offers a simple and fair alternative to Convertible Notes, as it provides more advantages and fewer disadvantages for both founders and investors. SAFE is designed to align the interests of both parties and facilitate a quick and easy fundraising process, without the need for complex and costly negotiations, valuations, interest payments, maturity dates, pro-rata rights, or dividends. SAFE is also more transparent and standardized, as it uses a simple and clear agreement that can be easily understood and executed by both parties. Therefore, SAFE is a better option for raising capital in the early stages of a startup, as it allows both founders and investors to focus on the most important thing: building a successful and sustainable business.
A comparison of the key differences and advantages of SAFE over convertible notes - SAFE: A simple and fair alternative to convertible notes
19.Tracking Investor Rights and Conversion Mechanics[Original Blog]
One of the most important aspects of a SAFE agreement is how it affects the rights and obligations of the investors and the founders when the SAFE converts into equity. Conversion mechanics determine when, how, and at what price the SAFE holders will receive shares in the company. Tracking investor rights and conversion mechanics is essential for both parties to understand their ownership and control of the company, as well as their potential returns and risks. In this section, we will discuss the following topics:
1. The trigger events for SAFE conversion. There are two main scenarios that can trigger the conversion of a SAFE into equity: a qualified financing and a liquidity event. A qualified financing is a round of equity financing that meets or exceeds a certain amount of money raised by the company, as specified in the SAFE agreement. A liquidity event is a change of control or sale of the company that results in cash or stock payouts to the shareholders. Depending on the terms of the SAFE, the investors may have different preferences and incentives for each trigger event.
2. The valuation caps and discounts for SAFE conversion. A valuation cap is a maximum valuation of the company that is used to calculate the conversion price of the SAFE. A discount is a percentage reduction of the price per share paid by other investors in the qualified financing round. Both valuation caps and discounts are designed to reward the SAFE holders for taking an early risk in investing in the company, and to protect them from dilution in future rounds. However, they can also create conflicts and complexities when multiple SAFEs with different terms are involved.
3. The pro rata rights and MFN clauses for SAFE conversion. A pro rata right is a right to participate in future rounds of financing to maintain or increase one's ownership percentage in the company. An MFN (most favored nation) clause is a clause that grants the SAFE holder the right to amend their SAFE agreement to match any more favorable terms offered to other SAFE holders in the same or subsequent rounds. Both pro rata rights and MFN clauses are optional and negotiable features of a SAFE agreement, and they can have significant implications for the fundraising strategy and valuation of the company.
4. The post-money and pre-money SAFEs. A post-money SAFE is a newer version of the SAFE that was introduced in 2018 to simplify the conversion mechanics and make them more transparent. A post-money SAFE calculates the SAFE ownership percentage based on the post-money valuation of the company, which is the sum of the pre-money valuation and the amount raised in the round. A pre-money SAFE, on the other hand, calculates the SAFE ownership percentage based on the pre-money valuation of the company, which is the valuation before the round. The choice between a post-money and a pre-money SAFE can affect the dilution and allocation of shares among the founders and the investors.
To illustrate these topics, let's look at some examples of how different SAFEs can convert into equity under different scenarios. Suppose a company has raised $100,000 from two SAFE investors, A and B, with the following terms:
- Investor A: $50,000 at a $5 million valuation cap, no discount, no pro rata right, no MFN clause.
- Investor B: $50,000 at a $10 million valuation cap, 20% discount, pro rata right, MFN clause.
Now, let's assume the company raises a Series A round of $1 million at a $20 million pre-money valuation, which is a qualified financing that triggers the conversion of the SAFEs. How will the SAFEs convert into equity?
- Investor A: The conversion price for investor A is the lower of the valuation cap divided by the pre-money valuation, or the price per share paid by the Series A investors. In this case, the valuation cap divided by the pre-money valuation is $5 million / $20 million = 0.25, which is lower than the price per share paid by the Series A investors, which is $1 million / ($20 million + $1 million) = 0.0476. Therefore, investor A will receive shares at a conversion price of 0.25, which means they will get $50,000 / 0.25 = 200,000 shares, or 0.95% of the company.
- Investor B: The conversion price for investor B is the lower of the valuation cap divided by the pre-money valuation, or the price per share paid by the Series A investors multiplied by the discount factor. In this case, the valuation cap divided by the pre-money valuation is $10 million / $20 million = 0.5, which is higher than the price per share paid by the Series A investors multiplied by the discount factor, which is 0.0476 x 0.8 = 0.0381. Therefore, investor B will receive shares at a conversion price of 0.0381, which means they will get $50,000 / 0.0381 = 1,312,336 shares, or 6.25% of the company. Additionally, investor B will have the right to invest more money in the Series A round to maintain or increase their ownership percentage, which is their pro rata right. Investor B also has an MFN clause, which means they can choose to adopt the same terms as investor A if they are more favorable, but in this case they are not.
The table below summarizes the conversion results for the two SAFE investors and the Series A investors:
| Investor | Amount invested | Conversion price | Shares received | Ownership percentage |
| A | $50,000 | 0.25 | 200,000 | 0.95% |
| B | $50,000 | 0.0381 | 1,312,336 | 6.25% |
| Series A | $1,000,000 | 0.0476 | 21,000,000 | 100% - 7.2% = 92.8% |
As you can see, the different terms of the SAFEs can have a significant impact on the conversion mechanics and the ownership distribution of the company. Therefore, it is important for both the founders and the investors to track and understand the investor rights and conversion mechanics of the SAFEs they use or accept.
Tracking Investor Rights and Conversion Mechanics - SAFE: What is a SAFE and how to use it to raise money for your early stage startup
20.The_term_sheet__What_is_it__what_are_the_key_terms__and_how_to[Original Blog]
One of the most important steps in raising pre-seed funding for your cleantech startup is to negotiate and sign a term sheet with your potential investors. A term sheet is a document that outlines the main terms and conditions of the investment deal, such as the valuation, the amount of money, the type of securities, the rights and obligations of both parties, and the timeline of the transaction. A term sheet is not a binding contract, but it serves as a basis for drafting the final legal agreements.
A term sheet can be very complex and intimidating, especially for first-time founders who may not be familiar with the jargon and the implications of each clause. However, it is crucial to understand what you are agreeing to and how it will affect your startup's future. A term sheet can have a significant impact on your ownership, control, and decision-making power in your company, as well as your ability to raise more money, exit, or pivot in the future.
Therefore, it is essential to negotiate the term sheet carefully and strategically, with the help of your lawyer, mentors, and advisors. You should not accept the first offer that you receive, nor should you sign anything that you do not fully comprehend. You should also be prepared to walk away from a deal that does not align with your vision and goals.
In this section, we will explain what are the key terms in a term sheet, why they matter, and how to negotiate them effectively. We will also provide some examples and tips from different perspectives: the founder, the investor, and the lawyer. We hope that this will help you to navigate the term sheet process with confidence and clarity.
The key terms in a term sheet can be divided into two categories: economic terms and control terms. Economic terms determine how the pie is divided among the shareholders, while control terms determine who has the power to influence the company's decisions. Here are some of the most common and important terms that you should pay attention to:
1. Valuation: This is the value of your company before and after the investment, also known as the pre-money and post-money valuation. The valuation determines how much equity you are giving up to the investors in exchange for their money. For example, if your pre-money valuation is $10 million and you raise $2 million, your post-money valuation is $12 million, and the investors own 16.67% of your company ($2 million / $12 million). The higher the valuation, the less equity you have to dilute, and the more you retain for yourself and your team. However, you should also be realistic and not overvalue your company, as this may scare away investors or create unrealistic expectations for future rounds. Valuation is often based on a combination of factors, such as the market size, the traction, the team, the technology, the competition, and the comparable deals. You should do your research and benchmark your company against similar startups in your sector and stage, and be ready to justify your valuation with data and evidence.
2. Amount: This is the amount of money that the investors are willing to invest in your company. The amount should be enough to cover your runway, which is the time until you run out of cash, for at least 12 to 18 months. This will give you enough time to achieve your milestones, grow your business, and raise your next round of funding. However, you should also not raise more money than you need, as this may increase your burn rate, lower your valuation, and reduce your flexibility. You should have a clear and detailed budget and financial plan, and know how much money you need and how you will spend it. You should also consider the terms and conditions attached to the money, such as the type of securities, the interest rate, the maturity date, and the conversion options.
3. Type of securities: This is the type of financial instrument that the investors are buying in your company. The most common types of securities for pre-seed funding are convertible notes, SAFE (Simple Agreement for Future Equity), and equity. convertible notes are debt instruments that can be converted into equity at a later date, usually at a discounted rate. SAFE are similar to convertible notes, but they are not debt and do not have an interest rate or a maturity date. Equity are shares of ownership in your company, which can be either preferred or common. preferred shares have more rights and privileges than common shares, such as liquidation preference, anti-dilution protection, and voting rights. The type of securities affects the risk and reward for both the founders and the investors, as well as the complexity and cost of the deal. You should understand the pros and cons of each type of securities, and choose the one that best suits your situation and goals.
4. Conversion terms: These are the terms that determine how and when the convertible notes or SAFE will be converted into equity. The most important conversion terms are the valuation cap and the discount rate. The valuation cap is the maximum valuation at which the notes or SAFE will be converted, regardless of the actual valuation of the company at the time of conversion. The discount rate is the percentage by which the notes or SAFE will be converted at a lower price than the actual valuation of the company at the time of conversion. For example, if the valuation cap is $15 million and the discount rate is 20%, the notes or SAFE will be converted at the lower of $15 million or 80% of the actual valuation. The conversion terms affect the amount of equity that the investors will receive in the future, and the dilution that the founders will face. The lower the valuation cap and the higher the discount rate, the more favorable it is for the investors, and vice versa. You should negotiate the conversion terms carefully, and try to balance the interests of both parties. You should also consider the trigger events that will cause the conversion, such as a qualified financing round, an acquisition, or an IPO.
5. Liquidation preference: This is the term that determines how the proceeds from a sale or liquidation of the company will be distributed among the shareholders. Liquidation preference gives the preferred shareholders the right to receive their money back before the common shareholders, and sometimes more than their money back, depending on the multiple. For example, if the liquidation preference is 1x, the preferred shareholders will receive their initial investment back before the common shareholders. If the liquidation preference is 2x, the preferred shareholders will receive twice their initial investment back before the common shareholders. Liquidation preference protects the investors from losing money in a downside scenario, but it also reduces the potential upside for the founders and the employees. You should try to negotiate a liquidation preference that is fair and reasonable, and avoid any excessive or punitive terms, such as participating or cumulative liquidation preference. You should also be aware of the impact of liquidation preference on your exit strategy, and calculate the different scenarios and outcomes based on your valuation and exit price.
6. Anti-dilution protection: This is the term that protects the investors from being diluted in future rounds of funding, if the company raises money at a lower valuation than the previous round. Anti-dilution protection adjusts the conversion price of the preferred shares, so that the investors can receive more shares to maintain their percentage of ownership. There are two main types of anti-dilution protection: full ratchet and weighted average. Full ratchet is the most aggressive and unfavorable for the founders, as it lowers the conversion price to the lowest price paid by any investor in any future round. Weighted average is more moderate and common, as it lowers the conversion price based on the average price paid by all investors in all future rounds, weighted by the amount of money raised. Anti-dilution protection can have a significant impact on the founder's dilution and control, especially in a down round, where the company raises money at a lower valuation than the previous round. You should try to avoid or limit the anti-dilution protection, or at least opt for the weighted average method, which is more fair and balanced. You should also be careful of the impact of anti-dilution protection on your cap table, and use a spreadsheet or a software to track and manage your equity and dilution.
7. Voting rights: This is the term that determines who has the power to make decisions and approve actions in the company. Voting rights are usually attached to the shares of ownership, and each share has one vote. However, some shares may have more or less voting power than others, depending on the class and the preferences. For example, preferred shares may have more voting rights than common shares, or vice versa. Some actions may also require a higher or lower threshold of votes than others, depending on the significance and the impact. For example, some actions may require a simple majority (more than 50%) of votes, while others may require a super majority (more than 75%) or a unanimous (100%) consent. Voting rights affect the founder's ability to control and influence the company's direction and strategy, as well as to protect their interests and vision. You should try to retain as much voting power as possible, and avoid any terms that may undermine or override your voting rights, such as drag-along or veto rights. You should also be aware of the voting rights of your co-founders, your team, and your other stakeholders, and try to align them with your goals and values.
8. Board composition: This is the term that determines who will sit on the board of directors of the company, and how they will be appointed and removed.
The_term_sheet__What_is_it__what_are_the_key_terms__and_how_to - Cleantech Investors: How to Find and Pitch Cleantech Investors for Pre Seed Funding for Your Startup
21.How KISS compares to other funding instruments such as SAFE, convertible notes, and equity?[Original Blog]
KISS stands for Keep It Simple Security, and it is a type of funding instrument that aims to simplify the process of raising capital for startups. KISS is similar to SAFE (Simple Agreement for Future Equity) in that it is a contract that gives investors the right to receive equity in the future, at a discount or a valuation cap, when a triggering event occurs, such as a qualified financing round, an acquisition, or an IPO. However, KISS differs from SAFE in some aspects, such as having a maturity date, an interest rate, and a pro rata right. In this section, we will compare KISS to other funding instruments, such as SAFE, convertible notes, and equity, and discuss the advantages and disadvantages of each option from the perspective of both founders and investors.
1. SAFE vs KISS: SAFE was created by Y Combinator in 2013 as a simple and standardized way to fund early-stage startups. SAFE is not a debt instrument, meaning that it does not have a maturity date, an interest rate, or a repayment obligation. SAFE also does not have a pro rata right, which is the right of an investor to participate in future rounds of financing to maintain their ownership percentage. SAFE is designed to be founder-friendly, as it gives them more flexibility and control over their company. However, SAFE can also create some challenges for investors, such as dilution risk, valuation uncertainty, and lack of alignment with the founders. KISS was created by 500 Startups in 2014 as an alternative to SAFE that addresses some of these issues. KISS is a hybrid instrument that combines some features of debt and equity. KISS has a maturity date, typically 18 to 24 months, after which the investor can ask for their money back or convert to equity at the then-current valuation. KISS also has an interest rate, typically 5% to 8%, that accrues until conversion or repayment. KISS also has a pro rata right, which gives the investor the option to invest more in future rounds to avoid dilution. KISS is designed to be more balanced and fair for both founders and investors, as it provides some protection and incentives for the investors, while still giving the founders some flexibility and simplicity.
2. Convertible notes vs KISS: convertible notes are another type of funding instrument that are widely used by startups and investors. convertible notes are debt instruments that can be converted to equity at a later date, usually at a discount or a valuation cap, when a triggering event occurs, such as a qualified financing round, an acquisition, or an IPO. Convertible notes are similar to KISS in that they have a maturity date, an interest rate, and a pro rata right. However, convertible notes also have some differences from KISS, such as having a principal amount, a minimum investment amount, and a conversion mechanism. Convertible notes have a principal amount, which is the amount of money that the investor lends to the startup, and that the startup has to repay or convert to equity. Convertible notes also have a minimum investment amount, which is the minimum amount of money that an investor has to invest to participate in the round. Convertible notes also have a conversion mechanism, which is the formula that determines how many shares of equity the investor will receive when the note converts. The conversion mechanism can be either automatic or optional, depending on the terms of the note. Convertible notes are more complex and less standardized than KISS, as they require more negotiation and documentation. Convertible notes can also create some challenges for both founders and investors, such as debt overhang, valuation misalignment, and multiple liquidation preferences.
3. Equity vs KISS: Equity is the most common and traditional way of funding startups. Equity is the ownership stake that the investor receives in exchange for their money. Equity can be either preferred or common, depending on the rights and preferences that the investor has. Preferred equity gives the investor some advantages over common equity, such as liquidation preference, dividend rights, anti-dilution protection, and board representation. Equity is the most straightforward and transparent way of funding startups, as it reflects the true value and ownership of the company. However, equity also has some drawbacks, such as being more expensive, time-consuming, and dilutive than KISS. Equity requires more due diligence, valuation, and legal work than KISS, which can increase the cost and length of the fundraising process. Equity also gives the investor more control and influence over the company, which can limit the founder's autonomy and vision. Equity also dilutes the founder's ownership and reduces their upside potential, as they have to share the profits and exit proceeds with the investor.
As you can see, KISS is a unique and innovative funding instrument that offers some benefits and trade-offs compared to other options. KISS can be a good choice for startups that are looking for a simple, fast, and flexible way to raise capital, without giving up too much equity or control. KISS can also be a good choice for investors that are looking for a balanced and fair way to invest in startups, without taking too much risk or losing too much upside. However, KISS is not a one-size-fits-all solution, and it may not be suitable for every startup or investor. Therefore, it is important to understand the pros and cons of each funding instrument, and choose the one that best fits your needs and goals.
How KISS compares to other funding instruments such as SAFE, convertible notes, and equity - KISS: how to simplify your funding process with a keep it simple security
22.How to Structure a SAFE Agreement for Your Startup?[Original Blog]
A SAFE agreement, or a Simple Agreement for Future Equity, is a contract between a startup and an investor that allows the investor to receive equity in the future at a discounted price, without specifying a valuation for the startup at the time of the investment. This way, the startup can raise money quickly and easily, without having to negotiate complex terms with multiple investors. However, structuring a SAFE agreement can be tricky, as there are several factors to consider, such as the amount of investment, the valuation cap, the discount rate, the pro rata rights, and the trigger events. In this section, we will explain how to structure a SAFE agreement for your startup, and what are the pros and cons of each option. We will also provide some examples of how different SAFE agreements can affect the outcome for both the startup and the investor.
Here are some steps to follow when structuring a SAFE agreement for your startup:
1. Decide how much money you need to raise and how many SAFE agreements you want to issue. The first step is to determine how much capital you need to grow your startup, and how many investors you want to involve in your fundraising round. You can issue multiple SAFE agreements to different investors, as long as you have enough equity to allocate in the future. However, you should also consider the dilution effect of issuing too many SAFE agreements, as this will reduce your ownership percentage and control over your startup. A good rule of thumb is to raise only as much money as you need to reach your next milestone, and to limit the number of SAFE agreements to a reasonable amount.
2. Choose a valuation cap and a discount rate for your SAFE agreement. The valuation cap and the discount rate are two key terms that determine how much equity the investor will receive in the future, when the SAFE agreement converts into shares. The valuation cap is the maximum valuation of your startup at which the investor can convert their SAFE agreement into equity. The discount rate is the percentage by which the investor can buy shares at a lower price than the current valuation of your startup. For example, if your startup is valued at $10 million, and you offer a SAFE agreement with a $8 million valuation cap and a 20% discount rate, the investor can buy shares at $6.4 million ($8 million x 80%), which is equivalent to a 36% equity stake ($6.4 million / $10 million x 100%). The valuation cap and the discount rate are usually negotiated between the startup and the investor, and they depend on factors such as the stage of the startup, the market potential, the risk profile, and the investor's preferences. Generally, the lower the valuation cap and the higher the discount rate, the more favorable the terms are for the investor, and vice versa.
3. Decide whether to include pro rata rights in your SAFE agreement. Pro rata rights are the rights of the investor to maintain their percentage ownership in the startup, by investing more money in future rounds of financing. For example, if an investor owns 10% of your startup after converting their SAFE agreement, and you raise another round of funding at a higher valuation, the investor can invest more money to keep their 10% stake, or else their ownership will be diluted by the new investors. Pro rata rights are optional, and they can be beneficial or detrimental for both the startup and the investor, depending on the situation. For the startup, pro rata rights can provide a loyal and supportive investor base, and reduce the need to find new investors for future rounds. However, pro rata rights can also limit the startup's flexibility and bargaining power, as they have to reserve a portion of their equity for the existing investors, and they may face pressure to accept unfavorable terms or valuation from them. For the investor, pro rata rights can protect their ownership and upside potential, and allow them to follow the growth of the startup. However, pro rata rights can also impose a financial burden and a commitment risk, as they have to invest more money in each round, and they may lose their rights if they fail to do so.
4. Specify the trigger events for your SAFE agreement. The trigger events are the scenarios that cause the SAFE agreement to convert into equity, or to terminate without conversion. The most common trigger events are:
- An equity financing round. This is when your startup raises money by selling shares to new investors, usually at a higher valuation than the SAFE agreement. In this case, the SAFE agreement converts into equity at the valuation cap or the discount rate, whichever is lower. For example, if your startup raises $5 million at a $20 million valuation, and you have a SAFE agreement with a $10 million valuation cap and a 20% discount rate, the SAFE agreement converts into equity at $8 million ($10 million x 80%), which is equivalent to a 10% equity stake ($8 million / $20 million x 100%).
- A change of control. This is when your startup is acquired by another company, or merges with another entity. In this case, the SAFE agreement converts into equity at the valuation cap, or the investor receives a cash payout equal to their investment amount, whichever is higher. For example, if your startup is acquired for $15 million, and you have a SAFE agreement with a $10 million valuation cap and a $1 million investment amount, the SAFE agreement converts into equity at $10 million, which is equivalent to a 6.67% equity stake ($10 million / $15 million x 100%), or the investor receives a cash payout of $1 million, whichever is higher.
- A dissolution or bankruptcy. This is when your startup ceases to operate, or files for bankruptcy protection. In this case, the SAFE agreement terminates without conversion, and the investor loses their investment amount, unless there are any remaining assets to distribute to the creditors and shareholders. For example, if your startup goes bankrupt, and you have a SAFE agreement with a $10 million valuation cap and a $1 million investment amount, the SAFE agreement terminates without conversion, and the investor loses their $1 million, unless there are any assets left to pay them back.
These are some of the main steps and considerations when structuring a SAFE agreement for your startup. However, you should always consult with a lawyer and an accountant before signing any legal documents, as there may be other implications and risks involved. A SAFE agreement can be a simple and fast way to raise money for your startup, but it can also have a significant impact on your future equity and valuation, so you should be careful and informed when choosing this option.
The art of delegation is one of the key skills any entrepreneur must master.
23.Valuation, equity, milestones, and exit strategy[Original Blog]
One of the most challenging and crucial aspects of angel investing is negotiating the terms of the deal with the founders of the crypto startup. The terms of the deal will determine how much money you will invest, how much equity you will receive, what milestones the startup needs to achieve, and what exit strategy you will pursue. Negotiating the terms of the deal is not a one-size-fits-all process, as different investors and startups may have different preferences, expectations, and goals. However, there are some general principles and best practices that can help you navigate this process and reach a mutually beneficial agreement. In this section, we will discuss the following topics:
1. How to value a crypto startup and decide how much to invest
2. How to determine the equity stake and the type of securities to use
3. How to set realistic and measurable milestones for the startup's progress
4. How to plan for an exit strategy and protect your rights as an investor
## 1. How to value a crypto startup and decide how much to invest
Valuing a crypto startup is not an exact science, as there are many factors that can affect the startup's potential and future performance. Some of these factors include:
- The quality and experience of the founding team
- The size and growth of the target market
- The uniqueness and scalability of the product or service
- The traction and revenue of the startup
- The competitive landscape and the barriers to entry
- The regulatory and legal risks and opportunities
As an angel investor, you need to do your own due diligence and research on the startup and its industry, as well as compare it with similar startups that have raised funds or exited in the past. You can use various methods and tools to estimate the startup's valuation, such as:
- The market approach: This method uses the market multiples of comparable startups to derive the valuation of the startup. For example, if the average price-to-sales ratio of similar crypto startups is 10, and the startup has annual sales of $1 million, then the valuation of the startup is $10 million.
- The income approach: This method uses the projected future cash flows of the startup to discount them to the present value. For example, if the startup expects to generate $2 million in net income in five years, and the discount rate is 20%, then the present value of the startup is $0.8 million.
- The cost approach: This method uses the cost of creating a similar startup from scratch to estimate the valuation of the startup. For example, if the startup has spent $500,000 on developing its product, hiring its team, and acquiring its customers, then the valuation of the startup is at least $500,000.
However, these methods are not definitive and may not capture the intangible value of the startup, such as its vision, innovation, and social impact. Therefore, you should also consider your own judgment and intuition, as well as the startup's willingness and ability to negotiate. You should also factor in the stage and maturity of the startup, as early-stage startups typically have lower valuations than later-stage startups.
Once you have an estimate of the startup's valuation, you need to decide how much money you want to invest in the startup. This will depend on your budget, risk appetite, and portfolio strategy. You should also consider the following questions:
- How much money does the startup need to achieve its next milestone?
- How much money are other investors willing to invest in the startup?
- How much ownership and control do you want to have in the startup?
- How much dilution are you willing to accept in future rounds of funding?
As a rule of thumb, you should aim to invest enough money to have a meaningful stake in the startup, but not so much that you overexpose yourself to the risk of failure. You should also diversify your investments across different startups, sectors, and stages, to reduce your overall risk and increase your chances of success.
## 2. How to determine the equity stake and the type of securities to use
The equity stake is the percentage of the startup's ownership that you will receive in exchange for your investment. The equity stake will determine your share of the startup's profits, losses, and decision-making power. The equity stake is usually calculated by dividing the amount of money you invest by the pre-money valuation of the startup. For example, if you invest $100,000 in a startup that has a pre-money valuation of $1 million, then your equity stake is 10%.
However, the equity stake is not fixed and can change over time, depending on the type of securities you use to invest in the startup. Securities are the legal instruments that represent your rights and obligations as an investor. There are different types of securities that you can use to invest in a crypto startup, such as:
- Common stock: This is the most basic and straightforward type of security, which gives you the same rights and obligations as the founders and employees of the startup. You will receive a proportional share of the startup's profits and losses, as well as the right to vote on major decisions affecting the startup. However, you will also bear the full risk of the startup's failure, and you will be the last in line to receive any payouts in case of liquidation or acquisition.
- Preferred stock: This is a type of security that gives you some preferential rights and benefits over the common stockholders, such as:
- Liquidation preference: This means that you will be paid before the common stockholders in case of liquidation or acquisition, up to a certain amount or multiple of your investment. For example, if you have a 1x liquidation preference, and the startup is sold for $10 million, you will receive your initial investment of $100,000 before the common stockholders receive anything. If you have a 2x liquidation preference, you will receive $200,000 before the common stockholders receive anything.
- Dividend rights: This means that you will receive a fixed or variable percentage of the startup's profits, before the common stockholders receive anything. For example, if you have a 5% dividend right, and the startup makes $1 million in net income, you will receive $50,000 before the common stockholders receive anything.
- Anti-dilution rights: This means that you will be protected from the dilution of your equity stake in case of future rounds of funding, by adjusting the conversion price or rate of your preferred stock. For example, if you have a full ratchet anti-dilution right, and the startup raises another round of funding at a lower valuation than the previous round, you will be able to convert your preferred stock into common stock at the lower valuation, thus increasing your equity stake.
- Conversion rights: This means that you will have the option to convert your preferred stock into common stock at any time, or under certain conditions, such as an IPO or a qualified acquisition. This will allow you to enjoy the upside potential of the common stock, such as capital appreciation and voting rights.
- Convertible notes: This is a type of security that is essentially a loan that you give to the startup, with the expectation that it will be converted into equity in the future, usually at a discounted rate or with a valuation cap. For example, if you invest $100,000 in a startup using a convertible note that has a 20% discount rate and a $5 million valuation cap, you will be able to convert your note into equity at the next round of funding, at a 20% lower price than the other investors, or at a maximum valuation of $5 million, whichever is lower. This will give you a higher equity stake than the other investors. Convertible notes are typically used for seed-stage or bridge financing, as they are faster and cheaper to issue than equity securities, and they defer the valuation negotiation until the next round of funding.
- simple Agreement for Future equity (SAFE): This is a type of security that is similar to a convertible note, but without the interest rate, maturity date, or repayment obligation. It is a simple and flexible contract that gives you the right to receive equity in the future, under certain conditions, such as a valuation trigger or a liquidity event. For example, if you invest $100,000 in a startup using a SAFE that has a $5 million valuation cap, you will receive equity in the future, at a valuation of $5 million or lower, depending on the terms of the SAFE. SAFE is a relatively new and popular instrument that was created by Y Combinator, a leading accelerator program for startups.
As an angel investor, you need to weigh the pros and cons of each type of security, and choose the one that best suits your risk-reward profile, preferences, and goals. You should also consider the impact of each type of security on the startup's capital structure, valuation, and incentives. You should aim to strike a balance between protecting your downside and aligning your interests with the founders and the startup's success.
## 3. How to set realistic and measurable milestones for the startup's progress
Milestones are the specific and quantifiable goals that the startup needs to achieve within a certain timeframe, to demonstrate its progress, validate its assumptions, and attract more funding. Milestones can be related to various aspects of the startup's performance, such as:
- Product development: This includes the tasks and deliverables that the startup needs to complete to build, test, and launch its product or service, such as creating a prototype, conducting a beta test, or releasing a minimum viable product (MVP).
- Customer acquisition: This includes the metrics and targets that the startup needs to reach to acquire, retain, and grow its customer base, such as generating a certain number of leads, conversions, sign-ups, or referrals.
- Revenue generation: This includes the indicators and benchmarks that the startup needs to achieve to generate and increase its revenue, such as achieving a certain
24.Key Terms and Conditions of Convertible Notes[Original Blog]
One of the most important aspects of raising money through convertible notes is to understand the key terms and conditions that affect the valuation and conversion of the notes into equity. These terms and conditions can have a significant impact on the amount of ownership and control that the founders and the investors will have in the future rounds of funding. In this section, we will discuss some of the common terms and conditions of convertible notes, such as:
1. Discount rate: This is the percentage by which the valuation of the startup is reduced when the notes convert into equity. For example, if the startup raises a Series A round at a $10 million valuation and the notes have a 20% discount rate, then the note holders will convert their notes at a $8 million valuation, which means they will get more shares for the same amount of money. The discount rate is usually negotiated between the founders and the investors, and it reflects the risk and reward of investing in the startup at an early stage.
2. Valuation cap: This is the maximum valuation at which the notes can convert into equity. For example, if the startup raises a Series A round at a $15 million valuation and the notes have a $10 million valuation cap, then the note holders will convert their notes at the lower of the two valuations, which is $10 million. The valuation cap is also a way of rewarding the early investors for taking more risk, and it protects them from being diluted too much in the future rounds. The valuation cap is usually set by the founders based on their expectations of the future valuation of the startup.
3. Interest rate: This is the annual percentage rate that accrues on the principal amount of the notes until they convert into equity. For example, if the startup raises $100,000 in convertible notes with a 5% interest rate and a 2-year maturity date, then the note holders will receive $110,250 worth of equity when the notes convert. The interest rate is usually low compared to other forms of debt, and it is often waived or deferred by the investors until the conversion. The interest rate is usually determined by the market conditions and the legal requirements of the jurisdiction where the startup is incorporated.
4. Maturity date: This is the date by which the notes must be converted into equity or repaid in cash. For example, if the startup raises $100,000 in convertible notes with a 2-year maturity date, then the note holders have the right to demand their money back or convert their notes into equity after 2 years. The maturity date is usually set by the investors based on their expectations of the time frame for the startup to raise a qualified equity financing round, which is a round that triggers the conversion of the notes. The maturity date can also be extended by mutual agreement between the founders and the investors.
5. Conversion triggers: These are the events that cause the notes to convert into equity automatically or optionally. The most common conversion trigger is a qualified equity financing round, which is a round that meets certain criteria, such as the amount raised, the valuation, and the type of investors. For example, if the startup raises $1 million in a Series A round at a $10 million valuation from a reputable venture capital firm, then this would qualify as a conversion trigger for the notes. Other conversion triggers can include a change of control, such as a merger or acquisition, or an IPO, which are events that offer liquidity to the investors. The conversion triggers are usually defined by the investors based on their preferences and goals.
These are some of the key terms and conditions of convertible notes that you should be aware of when raising money for your startup. convertible notes can be a simple and fast way to raise money, but they also come with some complexities and trade-offs that you should carefully consider and negotiate with your investors. By understanding the implications of these terms and conditions, you can make informed decisions that will benefit your startup and your investors in the long run.
Key Terms and Conditions of Convertible Notes - Convertible notes: A simple and fast way to raise money for your startup
25.What are SAFE and convertible notes, and why are they used by startups and investors?[Original Blog]
One of the most common challenges that startups and investors face is how to value the company and determine the share price in the early stages of fundraising. There are many uncertainties and risks involved in investing in a startup that has not yet proven its product-market fit, traction, or profitability. To overcome this challenge, some startups and investors use alternative financing instruments, such as safe and convertible notes, that defer the valuation and share price determination until a later round of funding. In this section, we will explain what are SAFE and convertible notes, and why are they used by startups and investors. We will also compare and contrast their advantages and disadvantages, and how they affect the equity dilution of the founders and the investors.
SAFE stands for simple Agreement for Future equity. It is a contract that allows an investor to provide capital to a startup in exchange for the right to receive equity in the future, at a discount rate, when a triggering event occurs. A triggering event is usually a qualified financing round, where the startup raises a certain amount of money from other investors at a pre-money valuation. The SAFE investor will then receive shares of the same class and series as the new investors, but at a lower price per share, reflecting the discount rate. The discount rate is typically between 10% and 30%, depending on the negotiation between the startup and the investor. For example, if a startup raises $1 million from a SAFE investor at a 20% discount rate, and then raises another $5 million from other investors at a $10 million pre-money valuation, the SAFE investor will receive $1.25 million worth of shares ($1 million / (1 - 0.2)) at a price per share of $0.8 ($10 million / 12.5 million shares), while the new investors will pay $1 per share ($10 million / 10 million shares).
Convertible notes are debt instruments that allow an investor to lend money to a startup in exchange for the right to convert the loan amount, plus accrued interest, into equity in the future, at a discount rate, when a triggering event occurs. A triggering event is usually a qualified financing round, where the startup raises a certain amount of money from other investors at a pre-money valuation. The convertible note investor will then receive shares of the same class and series as the new investors, but at a lower price per share, reflecting the discount rate and the interest rate. The discount rate is typically between 10% and 30%, and the interest rate is typically between 2% and 8%, depending on the negotiation between the startup and the investor. For example, if a startup raises $1 million from a convertible note investor at a 20% discount rate and a 5% interest rate, and then raises another $5 million from other investors at a $10 million pre-money valuation after one year, the convertible note investor will receive $1.1025 million worth of shares ($1 million x (1 + 0.05)) at a price per share of $0.784 ($10 million / 12.75 million shares), while the new investors will pay $1 per share ($10 million / 10 million shares).
Both SAFE and convertible notes are used by startups and investors for the following reasons:
1. They simplify the fundraising process by avoiding the need to negotiate the valuation and share price in the early stages, when there is not enough data or traction to support a reliable valuation. They also reduce the legal costs and paperwork involved in issuing equity.
2. They align the interests of the startups and the investors by giving the investors an incentive to help the startups succeed and increase their valuation in the future rounds, where they will receive their equity. They also protect the investors from the downside risk of losing their money if the startup fails or does not raise another round of funding.
3. They provide flexibility and optionality to the startups and the investors by allowing them to choose the best terms and conditions for their situation, such as the discount rate, the interest rate, the valuation cap, the maturity date, and the conversion mechanism. They also allow the startups to raise multiple rounds of funding using the same instrument, and the investors to participate in multiple rounds of funding using the same instrument.
However, SAFE and convertible notes also have some drawbacks and differences that affect the equity dilution of the founders and the investors. Equity dilution is the reduction in the percentage ownership of the founders and the existing investors when new shares are issued to new investors. equity dilution can affect the control, voting power, and financial returns of the founders and the existing investors. Some of the drawbacks and differences are:
- SAFE and convertible notes delay the valuation and share price determination until a later round of funding, which can create uncertainty and unpredictability for the founders and the investors. The valuation and share price in the future may be higher or lower than expected, depending on the market conditions, the performance of the startup, and the terms of the new round of funding. This can result in more or less equity dilution for the founders and the investors than anticipated.
- SAFE and convertible notes increase the complexity and uncertainty of the cap table, which is the record of the ownership and equity distribution of the startup. The cap table can become more difficult to manage and understand when there are multiple rounds of funding using different instruments with different terms and conditions. The cap table can also change significantly when the triggering events occur and the instruments are converted into equity. This can affect the decision-making and planning of the founders and the investors.
- SAFE and convertible notes differ in their legal and economic nature, which can have implications for the equity dilution of the founders and the investors. SAFE is an equity instrument, while convertible note is a debt instrument. This means that:
- SAFE does not have a maturity date, while convertible note does. A maturity date is the deadline by which the startup has to repay the loan amount, plus accrued interest, to the investor, or convert it into equity. If the startup does not raise another round of funding before the maturity date, the convertible note investor can demand repayment or conversion, which can put pressure on the startup and affect its cash flow and valuation. SAFE does not have this problem, as it does not obligate the startup to repay or convert the investment until a triggering event occurs.
- SAFE does not have an interest rate, while convertible note does. An interest rate is the percentage of the loan amount that the startup has to pay to the investor as a compensation for the time value of money. The interest rate increases the amount of money that the convertible note investor will receive in the future, and thus increases the amount of equity that they will receive when the loan is converted. SAFE does not have this feature, as it does not charge any interest to the startup.
- SAFE does not have a valuation cap, while convertible note usually does. A valuation cap is the maximum valuation at which the investment can be converted into equity. The valuation cap protects the investor from the risk of overpaying for the equity in the future, if the valuation of the startup increases significantly. The valuation cap also limits the amount of equity dilution that the investor will experience when the investment is converted. SAFE does not have this benefit, as it does not impose any limit on the valuation at which the investment can be converted. However, some SAFE investors may negotiate for a valuation cap as an additional term.
SAFE and convertible notes are alternative financing instruments that are used by startups and investors to defer the valuation and share price determination until a later round of funding. They have some advantages and disadvantages, and they affect the equity dilution of the founders and the investors in different ways. The choice between SAFE and convertible notes depends on the preferences, goals, and expectations of the startups investors, as well as the market conditions and the terms of the future rounds of funding.