Getting to work with founders and funds gives you a great perspective on what terms deserve some extra attention on a deal. Whether it's your first preseed round or you're looking at bridge financing, knowing how a term will impact your goals is key. Here are five founder tips for your seed round:
1. A reasonable discount. Whether it's a SAFE or a convertible note ("Notes"), there is almost always going to be talk of a discount at the conversion to equity on the next financing round. A reasonable discount could be as low as 5% and as high as 25% depending on the risk. This may seem rudimentary but I recently heard of an investor asking for a 40% discount which frankly is predatory.
2. Discount OR a valuation cap. SAFEs and Notes also can utilize a valuation cap on the conversion to equity at the next round. This effectively sets the minimum equity that the SAFE or Note holder will receive upon conversion. This is a common term, however, founders should make an effort to avoid having both a discount and a cap in the same instrument. Having both a discount and a cap can be downright burdensome for a founder.
3. Drop the trigger. Most SAFEs and Notes will have a threshold or a trigger built into them. This is an amount that the startup has to raise before the SAFE or Note will automatically convert to equity. The higher this number is, the more the founder has to raise at the next round. The lower the number, the easier it will be to hit that conversion.
4. Run the numbers. Put it in a spread sheet, run scenarios, know how much you'll be diluted. This is critical for a founder utilizing a Note or SAFE. Set out your goal for your next round, calculate the conversion to equity, and see how much you can expect to be diluted after the cap and discount.
5. Convert ASAP. Keep in mind that the longer you wait to convert a Note (or to a lesser degree a SAFE) the more expensive it is becoming for you. Most Notes for instance are accruing interest (which may also convert to equity). Layering multiple rounds of notes and SAFEs on top of each other can result in a drastic dilution of the founders.
*And of course make sure you utilize experienced counsel so that you can get proper advice for your particular circumstances. This is only meant to be for general educational purposes and does not constitute legal advice nor does it create an attorney client relationship. For more information on SAFEs and Notes check out the below journal article published in the Minnesota Law Review.
Over the past decade, there has been an explosion in seed financing for early-stage technology startups. Increasingly, this seed financing is channeled to these companies via an entirely new form of investment contract—the deferred equity agreement.2 One version of this agreement—the Simple Agreement for Future Equity (SAFE)—made its debut in 2013...While these instruments have attracted extensive attention in the startup blogosphere, there exists remarkably little information about the role they play in the real world.
http://www.minnesotalawreview.org/wp-content/uploads/2019/02/Coyle_Final.pdf
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