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Announcing the Safe, a Replacement for Convertible Notes

blog.ycombinator.com

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Re: Announcing the Safe, a Replacement for Convertible Notes

#51

Post by 001sky »

logicallee wrote: post #47
james_alonso wrote: post #15

Earlier quoted context omitted.

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 inves…

getting x>0 is now worse than getting x=0? No.

When they repay the debt, you're not "stuck with none of it" you're stuck with indeed a x>0 portion of the company's value. Strictly speaking, you are just stuck. What escapes you is the upside of an investment that you .

The right (but not the obligation) to make that investment on pre-defined terms is the defintion of an "option".

Re: Announcing the Safe, a Replacement for Convertible Notes

#53

Post by wtvanhest »

clevy wrote: post #50
labaraka wrote: post #7

Q: 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.

What about the case where the business becomes a low growth, life style business. Is there any way to force a liquidity event?

Re: Announcing the Safe, a Replacement for Convertible Notes

#54

Post by logicallee »

001sky wrote: post #51
logicallee wrote: post #47

Earlier quoted context omitted.

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 inves…

getting x>0 is now worse than getting x=0? No. When they repay the debt, you're not "stuck with none of it" you're stuck with indeed a x>0 portion of the company's value. Strictly speaking, you are just stuck. What escapes you is the upside of an investment that you . The right (but not the obligation) to make that investment on pre-defined terms is the defintion of an "option".

Clearly I meant from the point of view of a seed-stage investor's subjective valuation of alternatives. Nobody wants to have debt repaid when a company takes off that you could have had early stock in.

Re: Announcing the Safe, a Replacement for Convertible Notes

#55

Post by thatthatis »

I'm glad YC is leading the charge to standardize and make sane very early stage funding terms. They've got market, brand, and brain power that is impossible for individual companies to match.

The next thing I'd like to see out of YC legal is some sort of over-subscription pre-sale. Something like a combined participation right/"first right of refusal"/put option that companies can sell to investors when they are hot to guarantee their future access to funds.

Re: Announcing the Safe, a Replacement for Convertible Notes

#56

Post by not_that_noob »

wtvanhest wrote: post #53
clevy wrote: post #50

Earlier quoted context omitted.

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.

What about the case where the business becomes a low growth, life style business. Is there any way to force a liquidity event?

Not that I can see. So the it's up to the parties in that eventuality to work things out.

Re: Announcing the Safe, a Replacement for Convertible Notes

#57

Post by mathattack »

oijaf888 wrote: post #43
mathattack wrote: post #22

I 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.

You can think of a convertible bond as a bond, with an option on the stock. So the bond may be worth $100, and the option to buy the stock might be worth $20. Since convertible bonds aren't liquid, and the implied option may be hard to short, the $120 combined price is really just theoretical. If the convert trades at $110, then the buyer will buy the convert, and then try to short the debt (either shorting another bond from the same company, or with CDS), shorting some amount of stock (Perhaps a half share per option calculated with Black-Sholes or another option pricing method, or perhaps going short a similar option).

Does this make sense? If not, I can try to write it in more clear English.

Re: Announcing the Safe, a Replacement for Convertible Notes

#58

Post by not_that_noob »

kg4lod wrote: post #27

I'm an entrepreneur, so it all sounds great for me, but why would investors go for this? It seems like they give up a lot of down-side protection: (1) No ability to convert or abort in the absence of a QFE, (2) no more first creditor protection -- if the company goes under, but also has outstanding loans, investors don't participate in a share of the liquidation proceeds as they would as debt holders (3) no interest…

With the progressive reduction in the cost of creating a startup, there is a shift in the leverage fulcrum toward the entrepreneur away from investors. This is a milestone that marks this progression. Yes it's marginally worse for investors, but honestly the investors who would care about such minimal edge-case benefits typically don't understand how startups work, and are thus not the ones you want anyway.

Re: Announcing the Safe, a Replacement for Convertible Notes

#59

Post by 001sky »

logicallee wrote: post #54
001sky wrote: post #51

Earlier quoted context omitted.

getting x>0 is now worse than getting x=0? No. When they repay the debt, you're not "stuck with none of it" you're stuck with indeed a x>0 portion of the company's value. Strictly speaking, you are just stuck. What escapes you is the upside of an investment that you . The right (but not the obligation) to make that investment on pre-defined terms is the defintion of an "option".

Clearly I meant from the point of view of a seed-stage investor's subjective valuation of alternatives. Nobody wants to have debt repaid when a company takes off that you could have had early stock in.

The one (only?) thing worse than debt in this case is an option that has CP's for exercise that aren't met. Then, you are truly fucked. I'm not trying to be pedantic, but its the nature of the topic at hand that to make any sense, some precision is required.

Re: Announcing the Safe, a Replacement for Convertible Notes

#60

Post by ChuckMcM »

This is the coolest financial instrument I've seen in a long time, ok ever.

It makes me wonder if there is a way to craft something so that a WeFunder or some other crowd sourced funding group could build one with multiple people participating that would have a slightly higher liquidation cash preference and no stock.

Basically it would work like this:

A group of people pool funds to fund a SAFE note with a 2x cash liquidation preference. So the next time the company raises money, they set aside 2x (or 1.5x or what ever the note says) in equivalent cash to return to the SAFE investors.

The SAFE contributors get a simple return (liquidation preference / time before liquidated), the startup gets lift off and a simple cap table (the SAFE vanishes after liquidation). It puts a cap on the return the SAFE investor gets in exchange for a somewhat lower risk (the company gets to its series A).

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