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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

#61

Post by EGreg »

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".

That depends, if you have a portfolio of many companies and you expect that most of them will fail but one will bring huge returns -- and then the one that should bring huge returns turns out to merely repay you 10%, then yes, it's worse.

Re: Announcing the Safe, a Replacement for Convertible Notes

#62

Post by sokoloff »

jwb119 wrote: post #16
w4 wrote: post #9

So, based on the writeup, it's just an option? And this didn't exist already? It seems so obvious in retrospect it's surprising no one had thought to do this. Is there anything special that makes this substantially different from a vanilla option, or is it just that a Safe is standardized in an easy to use way?

An option, strictly speaking, has an underlying security that already exists. The Safe, like a convertible note, doesn't have an underlying security yet, since the company hasn't created the preferred stock that it would convert into yet.

But the security does exist I think; they're just not yet traded on a public/liquid market. I've received ISOs in two different companies that were privately held. Those were definitely options, definitely on securities that existed, and those became publicly valued and liquid only after a purchase by a public company (in one case) and an IPO (in the other).

It's entirely possible that I'm missing a subtlety, and I'll follow the discussion to learn what that is.

Re: Announcing the Safe, a Replacement for Convertible Notes

#63

Post by rabbitonrails »

frisco wrote: post #33

What 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…

Strictly speaking this should increase the common value relative to common under the equivalent convertible note because, as designed, the terms of the Safe are more favorable to common than a convertible note.

However, like a convertible note, the Safe does not place a valuation on the company at the time of its issuance, merely a cap; and almost always it will be used only when no prior preferred round has established such.

So for 409a appraisals, which, for seed-stage companies, rely heavily upon expectations about a future round, there will be relatively little impact. Namely the preference of the projected future financing will be slightly smaller relative to the note scenario, for the reasons detailed in this thread. This will increase the common value a bit, but not much.

An exception might be if the appraiser bases his conclusions on a balance sheet metric that comes out differently without the liability you mention, which is not as common.

Re: Announcing the Safe, a Replacement for Convertible Notes

#64

Post by jedberg »

not_that_noob wrote: post #56
wtvanhest wrote: post #53

Earlier quoted context omitted.

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.

> So the it's up to the parties in that eventuality to work things out.

That's usually a bad way to make a legal contract. As an investor I'd want something a little more definitive.

Re: Announcing the Safe, a Replacement for Convertible Notes

#65

Post by danshapiro »

Two questions:

- in the acquisition of a company with an MFN SAFE, it says that the instrument can convert in to common at the fair market value of the stock. Isn't that the FMV the purchase price? So isn't that the same as getting your original money back (no matter how successful the company may become)?

Regarding pro rata rights it says:

Do SAFE holders get pro rata rights? This pro rata right must be in either the Equity Financing documents or a side letter.

Is this saying investors need to add pro rata rights to your SAFE, or that they only get them if the subsequent preferred financing has them?

Re: Announcing the Safe, a Replacement for Convertible Notes

#66

Post by DenisM »

This might be a good time to ask - are investors in general comfortables with notes vs. doing a priced round?

I understand the advantages of notes, but I found that many investors don't like it. We had many who agreed to a modest priced round, but absolutely wouldn't do a convertible note, and yet Paul says most YC startups make do with the notes. There is a disconnect somewhere here.

So am I the exception from the norm, or is YC the exception?

Re: Announcing the Safe, a Replacement for Convertible Notes

#68

Post by joshpadnick »

Another significant benefit to not having actual debt is what happens if the company has been operating at a loss at the time the debt is converted. The IRS treats debt that is converted as "debt relief" which is equivalent to income, which is taxable. In the case of my company, when we raised our Series A, I converted from a single-member LLC to a C-corp, and wound up getting a tax bill for around $50,000(!) for the "debt relief", which was ultimately paid out of the proceeds of the money we raised, which in turn came out of the company's pocket.

So, in the end, we wound up paying a "convertible debt tax" to the government. I'm actually surprised this comment hasn't come up yet; I would have thought the convertible debt tax would be somewhat common.

Re: Announcing the Safe, a Replacement for Convertible Notes

#69

Post by kylered »

Few questions...

Does this give YC an ability to set a lower cap because it has reduced the investor upside in a forced conversion?

If I were an entrepreneur, would I continue to raise multiple safe rounds and keep pushing the cap on the safe up? That would make the most financial sense to me as an entrepreneur. I'm not sure investors would want that, but it creates a large incentive for the entrepreneur.

Why is a forced conversion bad? I always thought a timeline was a good incentive to create value for investors, and to optimize around timing your fundraise with your cap amount.

How do you compensate investors for time value money if the deal takes a long time to get to the next round when there is no forced conversion or accrued component?

Re: Announcing the Safe, a Replacement for Convertible Notes

#70

Post by mikeg8 »

This sounds awesome. As a first time founder who was just about to close a small round on convertible notes, I realized what a pain some of the nuances with convertible debt were. Interest and maturity never really made sense to me from an investor perspective. I love that YC keeps raising the bar and works so hard to simplify life for both founder and angel.
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