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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

#81

Post by amirhirsch »

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.

My company is in one of these corner cases where we haven't converted our debts but still operate with a small, but growing revenue stream. It's possible that I will be able to repay the debts with interest in 2-5 years depending on how well we invest revenues in growth and part-time development. I wonder if it isn't more beneficial for me to have the option of paying back debts from revenues and then use revenues to pay out dividends to shareholders and more beneficial for investors to be able to call on the debt when it comes due if the company has accumulated enough revenues. With a safe, both parties seem to lose leverage over the other. I realize that startups in my situation are probably already a write-off from the investors' perspective, so perhaps it's just cheaper to ignore them, but I could imagine a number of people raising $100K safes ending up with an app that makes $30K per year and investors just get screwed.

Re: Announcing the Safe, a Replacement for Convertible Notes

#82

Post by rexreed »

grellas wrote: post #74

A few thoughts (apologies up front for the somewhat longish technical aspects of the discussion): 1. YC has once again managed to innovate in fascinating ways that help promote startups. And, it should be said, the legal work behind formulating this instrument called a "safe" is both sophisticated and commendable. It is at once simple and subtle and it covers a lot of nuanced legal technicalities that must have requi…

This is a great summary and outline of the evolution and differences of different investment structures.

One of the concerns I've heard from many founders and funders is that convertible notes or securities can place the founders at odds with the early investors when it comes to company valuation. In this case, the concern still remains whether the conversion is a note or a security.

The founders would want the company to have as large a valuation as possible at the conversion event so that the equity ownership for the amount raised is at a maximum for the founders. But the early investors (holders of the convertible note or security) would want the company to be valued lower so that their investment is converted to give themselves and not the founders greater equity, or at least up to the cap amount, if one exists.

And with regards to the cap, there's the issue that the investors are converted at a potentially much higher total equity stake than they would get if the cap didn't exist. This is because every dollar of valuation above the cap goes to increase the early investor's stake in the company at the expense of the founder who must convert them at the cap level. So the founders are thus disincented to increase the value of the company to any amount greater than the cap so as to have a conversion at a favorable level.

As such, this means that in practice the cap becomes a defacto valuation for the company at its next funding round, which is at odds with the concept that a convertible note / security allows the founders to defer the determination of the value of the company. The reason for this is that if a cap exists, the founders would not want a valuation greater than the cap as they would be rewarding the early investors at their own loss. It would not be less than the cap because then they are negotiating for a lower valuation, which is against their interests. And so, it would be precisely at the cap amount, which thus becomes the valuation.

To me, this still represents an issue with convertible notes or securities -- the placement of founders at odds with early investors with regards to valuation of the company at the conversion event.

Re: Announcing the Safe, a Replacement for Convertible Notes

#83

Post by FridayWithJohn »

grellas wrote: post #74

A few thoughts (apologies up front for the somewhat longish technical aspects of the discussion): 1. YC has once again managed to innovate in fascinating ways that help promote startups. And, it should be said, the legal work behind formulating this instrument called a "safe" is both sophisticated and commendable. It is at once simple and subtle and it covers a lot of nuanced legal technicalities that must have requi…

Sorry but tl;dr

Re: Announcing the Safe, a Replacement for Convertible Notes

#84

Post by crassus »

It's incredible how much of the law is just codifying standard practice. It's when you try to do something new that you run into trouble.

Regulation is so thick on the ground that operating in an unregulated industry is considered a business risk, because you know the regulation is coming, but you don't know what it will be. There are rules for everything.

Re: Announcing the Safe, a Replacement for Convertible Notes

#85

Post by jwb119 »

sokoloff wrote: post #62
jwb119 wrote: post #16

Earlier quoted context omitted.

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'l…

The subtlety is the Safe converts into a shadow class of securities with rights similar to the next round of preferred stock that the company issues. So those securities are not yet issued, their terms will be negotiated when the company raises that round.

In that case of your ISOs, those would be tied to the existing common stock of the company. While the actual shares that you might exercise on aren't yet issued, the class of stock itself exists and the terms are set.

Re: Announcing the Safe, a Replacement for Convertible Notes

#86

Post by jwb119 »

ChuckMcM wrote: post #79
clevy wrote: post #76

Earlier quoted context omitted.

I think with this idea you end up back at the note concept; what you are proposing sounds more like a loan / debt to me (if I understand you correctly?). The purpose of the safe, anyway, is to turn investors into stockholders at some point.

Well a debt/loan without a term, more like an uncallable zero coupon bond without a maturity date, rather it has a maturity 'condition'. As you have clearly pointed out, one of the bigger issues with convertibles is that they change over time in terms of their impact on the company. The SAFE fixes that by getting rid of the debt/loan aspect, and this would do the same but bake in a fixed redemption price. An example,…

So the Series A investors would essentially be cashing out the BOOST investors? I don't think any Series A investor would go for this. They want to see all the money go into company growth at that stage.

Re: Announcing the Safe, a Replacement for Convertible Notes

#87

Post by djabatt »

ksar wrote: post #28
ajju wrote: post #4

This is an example of one of the key things that sets YC apart from every other early stage investor. Like the startups they fund, they constantly improve their "product" to make something entrepreneurs want.

YC, with its clout, is probably the only entity that could push something like this through.

Agreed. YC is disruptive at it's core.

Re: Announcing the Safe, a Replacement for Convertible Notes

#88

Post by lanstein »

FridayWithJohn wrote: post #83
grellas wrote: post #74

A few thoughts (apologies up front for the somewhat longish technical aspects of the discussion): 1. YC has once again managed to innovate in fascinating ways that help promote startups. And, it should be said, the legal work behind formulating this instrument called a "safe" is both sophisticated and commendable. It is at once simple and subtle and it covers a lot of nuanced legal technicalities that must have requi…

Sorry but tl;dr

tl;dr? 'grellas is my attorney.

Re: Announcing the Safe, a Replacement for Convertible Notes

#90

Post by amattn »

rexreed wrote: post #82
grellas wrote: post #74

A few thoughts (apologies up front for the somewhat longish technical aspects of the discussion): 1. YC has once again managed to innovate in fascinating ways that help promote startups. And, it should be said, the legal work behind formulating this instrument called a "safe" is both sophisticated and commendable. It is at once simple and subtle and it covers a lot of nuanced legal technicalities that must have requi…

This is a great summary and outline of the evolution and differences of different investment structures. One of the concerns I've heard from many founders and funders is that convertible notes or securities can place the founders at odds with the early investors when it comes to company valuation. In this case, the concern still remains whether the conversion is a note or a security. The founders would want the compa…

Doesn't a discount align the incentives better? Is there active resistance to discounts in the investor community? Among angels at least, I personally haven't seen it...
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