Convertible and SAFE notes

"Founders should insist that their lawyers publish, to them and the angel/seed investors, a “pro-forma” cap table at the closing of the note that shows how much of the company each of them would own if the note converted immediately at different prices. This “pro-forma” cap table should be updated each and every time another note is isssued. Most importantly, we cannot and should not continue to allow founders to issue notes to investors and not understand how much dilution they are taking on each time they do it."

Requiring that a cap-table be published is somewhat different than ensuring that the founders understand their dilution. It's quite likely there is a ton of overwhelming information/events going on during a close, and it's easy (though it shouldn't be) at this stage for a founders eyes to glaze over yet another-table. But taking the extra 60 minutes to walk through the implications of dilution, and ensuring that they actually get it is something a responsible investor/VC will do.

But notes/SAFEs are great for the earliest employees since we can grant them real shares instead of options. Plus, we can do it at par value.

Shares granted before a priced round are typically identical to the shares a founder has, with all the same tax advantages.

Doing priced rounds early means having to worry about a 409a early, and probably giving employees worse quality equity (or creating income tax problems for them).

Of course it's still possible to get more dilution than expected if you raise at unrealistically high caps (or uncapped!) and convert at a lower valuation down the road, but even that is probably less painful than a conventional down round.

Priced rounds are great for VCs because they remove all their risk. But they don't remove any founder risk. Do a down-round after a priced round and you'll wish you were just taking more dilution from a SAFE.

> "1. They defer the issue of dilution until a later date".

When the company is doing well, notes allow founders get less dilution, sometimes way less. This is great for founders, and is just about the only time in the whole startup thing where things go better than expected for founders.

If the company is doing badly, I'll take a lower conversion rate over having to raise a down-round any day.

> "2. They obfuscate the amount of dilution the founder(s) is taking. I think many investors actually like this"

He sets up a moral imperative: you're an irresponsible founder if you don't know what dilution you're taking. But I know what dilution I'm taking: it's X _or less_!! (Again, in a down-round I'm fucked either way, so the downside of notes doesn't matter)

> "3. I cannot tell you how many angry pissed off angel investors [..] they own a LOT less than they thought they did."

And here we get to the crux of the issue, investors own less. If investors own less, who owns more? Founders do.

> "4. Most importantly, we cannot and should not continue to allow founders to issue notes to investors and not understand how much dilution they are taking on each time they do it. This is WRONG."

"Silly inexperienced founders accidentally give investors a bad deal. This is morally WRONG". Needless to say, I'm unsympathetic to this view.

Look I understand why VCs don't like notes. But to pretend that this is a founder-friendly thing is beyond irritating (note: he's far from the only VC to do this!). And this is one of the reasons I trust YC far more than any other investors - they're in it to help people make startups and they argue for founder-friendly terms.

(PS there is a real issue in that inexperienced founders might raise too much thinking its free money, and then they get a lower cap than expected. But my only bad experience with raising with notes is that VCs treat it as a lower implied valuation when raising the next round.)