And just like that the standard seed termsheet is born.
Announcing the Safe, a Replacement for Convertible Notes
41–50 of 118 posts
Re: Announcing the Safe, a Replacement for Convertible Notes
#42This is a great option. It's about time!
agreed
Re: Announcing the Safe, a Replacement for Convertible Notes
#43I like this. Instruments that look like debt (terms and interest rates) generally are the instruments of lower risk investors. Linking them to equity is the game of wall street arb desks. Turning the instrument into a warrant is more in lines with high stage early equity investing - giving folks an option on a potentially large upside.
How do wall street arbitrage desks link equity and debt? While I'm sure there's some degree of correlation, it appears that debt securities tend to be much more longer viewed than equity.
Re: Announcing the Safe, a Replacement for Convertible Notes
#44"the preferred stock that a SAFE holder is issued will have a liquidation preference that is equal to the original SAFE investment amount, rather than based on the price of the shares issued to the investors of new money in the financing. " This point is incredibly important and one of the key downsides of debt from the company perspective, as convertible notes create outsized liquidation preference upon conversion.…
Note that this isn't unique to SAFE. If you're using a standard Clerky / YC note, the debt will convert into a mix of preferred and common to ensure there's no extra liquidation preference.
Re: Announcing the Safe, a Replacement for Convertible Notes
#45What does this imply about the valuation of the company from an employee stock plan perspective? One of the nice things about convertible debt is that the investment is offset by an equal liability, providing a reasonable justification for continuing to issue stock to employees very cheaply. Does unencumbered cash (ie enterprise value) increase the risk of things like cheap stock charges? Can you use restricted stock…
Great question. Re: the implied valuation of the company, I don't believe it will be different from the notes. The safe will convert to preferred stock, and while the price of the preferred stock certainly affects the price of the common, I think it would be hard to say that a prospective valuation for an event in the future increases immediately increases the value of the common stock.
Re: Announcing the Safe, a Replacement for Convertible Notes
#46"the preferred stock that a SAFE holder is issued will have a liquidation preference that is equal to the original SAFE investment amount, rather than based on the price of the shares issued to the investors of new money in the financing. " This point is incredibly important and one of the key downsides of debt from the company perspective, as convertible notes create outsized liquidation preference upon conversion.…
Note that this isn't unique to SAFE. If you're using a standard Clerky / YC note, the debt will convert into a mix of preferred and common to ensure there's no extra liquidation preference.
Correct - the notes had this feature too, except that rather than shadow preferred, it was the preferred / common "unit" concept. The net result was the same.
Re: Announcing the Safe, a Replacement for Convertible Notes
#47Earlier quoted context omitted.
Convertible notes convert into equity (either at the holder's or issuer's option) on the QFE - a Qualifying Financing Event. Often that also includes certain revenue threshholds and/or time limits. Does the "safe" have provisions for this?
but in the worst case with the convertible note, the investor gets their money back. and often but not always, the note will also provide that if the note matures hasn't been a QFE, then the note can convert into common stock.
EDIT: Below, I mean from the point of view of subjective valuation by investors of the different possible outcomes.
Nobody wants to have debt repaid when a company takes off that you could have had early stock in. (And normally I think that convertible debt doesn't allow such provisions.)
Losing the amount invested (investment going to zero) is really, subjectively, not the "worst case" - because it's money the investors could stand to lose.
Instead, subjectively, the worst case (and related to a common investor fear, FOMO, fear of missing out), is making the original and only seed investment that launches the next Snapchat (or whatever), and then getting failing to own any of it due to something like the company not raising another formal round or otherwise repaying the debt instead. That's subjectively a much worse case, then having an investment go to zero, which is rather expected.
Losing 100% of the investment is the "default" case, not at all worst or unexpected, getting converted into equity at a very small and unsure company is the "good" case, getting converted into the next snapchat or whatever is the amazing lottery-winning case, and losing out on the next snapchat or whatever despite ponying up the cash is the worst possible case that you would kick yourself for forever, subjectively speaking. IMHO.
If people here make lots of seed-stage convertible investments they can say whether this matches their valuations, this is just my opinion.
Re: Announcing the Safe, a Replacement for Convertible Notes
#48Earlier quoted context omitted.
So, since there is no qualifying event, investors could get stuck without any ownership for a while. for YC this is most likely a non-issue, but most other investors won't be able to, thus providing YC with a bit of extra edge in attracting great entrepreneurs. Fair assessment ?
Not necessarily. The 'caps' on these warrants are likely to be lower to compensate investors.
A company that never has one of the qualifying events is likely to be an extreme corner case. So an investor could end up holding a safe for a while, but for the vast majority of companies, there will be a financing or a merger / acquisition at some (or an IPO).
Re: Announcing the Safe, a Replacement for Convertible Notes
#49This appears to be in direct response to grellas comments a few days ago[0], but I find it hard to believe that even YC could operate so quickly so I guess it is just coincidence.
Re: Announcing the Safe, a Replacement for Convertible Notes
#50Q: What happens if the startup does well after the safe and doesn't need to raise any money and doesn't have a liquidity event? Are the safe investors stuck with a security which does not derive any economic (e.g., dividends) value and they don't have any control?
This is a high class problem to have! As mentioned above, this seemed to us to be an extreme corner case. To remain simple, we tried not to draft for every scenario (which was hard, believe me - lawyers do this by nature). It may require some patience on the part of the safe holder, but odds are that eventually a company will have a liquidity event.