
Announcing the Safe, a Replacement for Convertible Notes - katm
http://blog.ycombinator.com/announcing-the-safe-a-replacement-for-convertible-notes
======
grellas
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 required some pretty careful thought to get right. The result
should be extremely helpful to startups and their founders and gives founders
one more powerful tool to use for their most important funding needs.

2\. The safe enables founders to raise early-stage funds without having to do
a premature equity round. The tax laws create problems for startups and their
founders if they raise money from outside investors too early in exchange for
stock grants. This typically winds up putting an unacceptably high price on
the common stock, creating tax risks for all concerned and also lessening the
value of incentives that can be offered to key people going forward (fuller
thoughts here:
[https://news.ycombinator.com/item?id=6849648](https://news.ycombinator.com/item?id=6849648)).
If first outside funding is to be deferred, though, the perennial challenge
becomes how to fund the interim process.

3\. The convertible note meets this need by combining the attributes of debt
and equity instruments. The investor loans funds to the company and the
company signs a note promising to repay the principal with interest. If,
however, the company can do a qualified funding before the note matures, the
debt converts into preferred-stock equity on the terms struck with the equity
investors at first funding, usually with a price discount, sometimes with a
price cap, and typically with merger-premium protection for the converting
noteholders for the added risk they take in being early in the game when risks
are at their highest. In that case, the debt vanishes and the noteholder
becomes an equity holder and everybody wins in terms of optimal positioning of
their respective stakes in the venture: founders have gotten their cheap stock
that they can hold until a liquidity event, at which time they can sell
typically for long-term capital gains and with no intervening taxes to pay;
noteholders have gotten their equity stakes with all protections and with no-
less-favorable pricing than that offered to the preferred stock investors who
presumably have negotiated a good, arms-length deal for themselves; the
company avoids a too-early high repricing of its stock so it can continue to
offer good incentives to new team members as they join; and the company does
not usually have to fool with 409A valuations or with other strings and
formalities attending the bringing in of investors via equity rounds. All of
which is great. But debt is debt. And, unless and until a first funding
occurs, it must be carried on the balance sheet as debt. Debt also carries
interest. And when it comes due, the noteholder has a legal right to sue for
its repayment if it is not paid. If the noteholder wants to extend the term, a
series of formalities are required to do so and, in their absence, the parties
stand at legal risk.

4\. The convertible note supplanted an earlier form of convertible note used
many years back by which individual investors would see startups as being much
akin to small businesses and would loan the money to the venture with the
primary aim of making a good interest return on their investment. This might
be called an "optional convertible" note and I remember doing many of these
back in the day as a lawyer. That sort of note saw the conversion right as a
privilege belonging strictly to the noteholder. In the normal course, the debt
was expected to be repaid with interest. It might even be secured with the
company's assets as collateral. It might be personally guaranteed by the
founders. These were all the normal lender protections expected by those who
had the investment mindset of that day. The conversion was there as an added
perk only: if the company happened to do very well, then the investor could
forget about the debt as such and could instead elect to convert it into
equity (very typically common stock and at a price set up front, at the time
the note was signed). So, for instance, an investor would loan $50K at 10%
interest at a time when the company had little value but could elect to
convert at, say, $.50/sh at any time in the sole discretion of the investor.
The mindset in this era, then, was primarily upon the debt as debt but with an
equity kicker to cover long-shot cases.

5\. This mindset all changed during the bubble era, when convertible notes
came in to help solve the early-stage funding problem. With its "forced
conversion" element, it not only combined the elements of debt and equity but
did so with equity being the main focus of the investor. Few if any investors
by that time were primarily interested in being repaid the debt owed by the
company. The equity upside motivated the investment and the debt came to be
seen as added insurance just in case the venture did not pan out as hoped.
Because of its force-conversion attribute, it was regarded under law as a
"security," which basically means that the investor casts his lot primarily
with the managerial efforts of company management while forgoing legal rights
intended to protect a debt-type investment.

6\. The safe seeks to confer the benefits of a convertible instrument without
carrying with it the baggage of debt. It would thus be regarded under law as a
"convertible security." That means the debt protections largely go away for
the investor and the investor places his bet almost entirely on the efforts of
company management. Thus, if this instrument achieves widespread adoption, the
investor mindset will have evolved over the years from "loan with equity
kicker" (old form of optional convertible note) to a convertible-note-style
security instrument with true loan features (today’s conventional convertible
note) to a pure convertible security (the safe).

7\. I think it should work beautifully in the YC context. Whether it will
achieve widespread acceptance or not will depend on investor expectations. I
am not so sure. After all, the earliest investors do take the biggest risks.
Is it enough to compensate them with a discounted price or price cap at
conversion? If I were to guess, I would say that it is enough in the YC
context. But it will be interesting to see if investors generally come to feel
this way. In effect, the safe does leave founders saying to early investors,
"Give us your money and but wait on getting your equity: if it goes well, you
get equity; if it does not, you get nothing and you have almost no rights."
Apart from a very vibrant context such as YC, where investor demand is already
high, I am not sure how well that will sell when all the investor needs to say
in response is, "how about us just doing a convertible note instead." I
personally believe that for the general range of cases the pull toward a
conventional convertible note will be _very_ strong, and founders will have
real difficulty convincing investors why they should forego the benefits of a
convertible note in favor of a convertible security where the only advantages
to the latter lie strictly with the company. But who knows? The YC magic has
worked before to transform investor mindsets (I vividly remember how horribly
out of favor convertible notes were just a short while back) and it may work
this time too. Whether it does or not, we can all be thankful that YC is doing
great and innovative things to add to the vibrancy of the startup world, and
the safe is one more thing to add to the list (kudos to their excellent
lawyers as well).

~~~
FridayWithJohn
Sorry but tl;dr

~~~
mediaman
If you can't appreciate George Grellas's contributions, then please refrain
from giving us yours.

George's writings on HN, from a seasoned startup lawyer who's been around the
block many times and has much to offer, are incredibly valuable, and all of us
owe him some gratitude for it as it is high quality and he is not paid for it.
And I'm sure he has plenty of business to handle without doing it for leads.

------
frisco
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 with a safe or would you want to
stick to ISOs and the 409(a) rules?

~~~
clevy
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.

~~~
frisco
I guess I'm not asking about the implied cap from the future conversion into
preferred, but the EV stemming from the mere ownership of, say, a million
dollars by the company. We use restricted stock that vests by lapsing a right
to repurchase, since it's cheaper for the employee (no cost associated with
the option itself) and it starts the long term cap gains clock right away.
This makes them a direct shareholder, though, and if the only stock
outstanding in the early days is common, it seems like the cash-related EV
would have to be attributed to it, right?

------
ajju
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.

~~~
jedberg
And share it with everyone.

~~~
EGreg
Is it open source?

~~~
jedberg
Yes. Last line of the post.

------
MediaSquirrel
"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. And when things don't go as well as you hoped,
liquidation preference matters a ton.

Kudos PG et al. EXCELLENT work.

See:
[http://ycombinator.com/safe/SAFE_Primer.docx](http://ycombinator.com/safe/SAFE_Primer.docx)

~~~
andrewfong
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.

~~~
clevy
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.

------
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).

~~~
clevy
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.

~~~
ChuckMcM
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, you get this thing (lets call it a BOOST), which is $100K with a
redemption price of $125K. Now you startup goes 18 months, then does a series
A raise for 1.125M$. They redeem the BOOST for 125K, pocket the $1M, and their
series A investor gets their chunk of preferred. The 'rate' on our BOOST then
is 25%/1.5years or 16.6% APR.

Example 2. Same deal except the series A comes 6 months later. Now the
redemption in only 1/2 year gives an effect return of 50% APR.

Example 3. Company starts, grows to a going concern, runs for 5 years and then
gets bought by BigCorp, and the BOOST is redeemed. Now its effective APR is 5%
(actually less than that if you're not doing simple interest etc but it
illustrates the point doesn't it?)

Example 6. Startup goes poof and dissolves. BOOST is effectively at the head
of the line on distribution of the asset value.

Take $100K, divide it into $10K chunks, spread it across 10 different BOOSTS
with other investors in them and spread the risk still further.

~~~
jwb119
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.

~~~
ChuckMcM
"So the Series A investors would essentially be cashing out the BOOST
investors?"

Yes. But lets look at it from a couple of different perspectives before we
conclude they won't like that.

First we'll assume that the Series A is much larger than the BOOST redemption
cost, anywhere from about 10x to 20x. We make that assumption because it the
BOOST aka "seed" round is much bigger than that the Series A looks more like a
Series B than a Series A, which is to say the company valuation isn't really
in a place where VCs would jump in ok?

Lets put some numbers down which makes talking about it easier.

Lets say the Series A really is 9X the BOOST so in a post money valuation with
60 percent for the company founders/employees we're looking at a cap table
that is

    
    
                      versus
        60% employee          60% Employee
        36% VC                40% VC
         4% BOOST              0% BOOST
    

So in the left scenario everyone stays in, and in the right hand scenario the
Series A investor has effectively "bought out" the BOOST investor. (the money
flow is different but the effect is the same). Lets assume that value post
money was $5M.

Company value increases 5x and the company is sold for $25M.

Series A guy in the left scenario gets their liquidation preference + 36% of
the remains (with participation) whereas in the right scenario they get their
liquidation preference + 40% of the remains (again with participation) in the
second scenario.

If the company is going to do well (and they assume it will) they do better by
_not_ having the BOOST guys in the cap table then they do with them there
taking a percentage. If the company does poorly they still lose their same
investment they would have lost anyway.

Things are simpler for the BOOST guy too, instead of managing dozens of small
share holdings in small companies they get a smaller but faster return. This
creates a reliable source of seed money for the ideas, which creates a larger
pool of potential Series A investments for VC companies.

------
kg4lod
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 = less equity at conversion? Am I
wrong here? What am I missing? Thanks YC for your ongoing efforts!

~~~
tptacek
I'm assuming that the theory here is that the good investors are more
concerned about being in on the next Snapchat or Airbnb, and a lot less
interested in bolstering downside protections that only apply if an investment
is going to be one of the unproductive ones anyways.

Meanwhile, the good companies aren't going to be likely to entertain financing
on anything but terms like these, so fighting them just incurs an adverse
selection penalty.

The same thing seems to have happened with convertible debt, which was
preceded by financing mechanisms that were way, way more onerous for
entrepreneurs.

~~~
kg4lod
Completely agree with you. The article seems to make the point that investors
would welcome these changes, when in reality, we will be forcing these changes
on investors. That was precisely my experience with the series AA.

------
labaraka
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?

~~~
clevy
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.

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

~~~
jedberg
> 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.

------
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? <snip> 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?

~~~
clevy
Re question 1: you read correctly. An investor just get its money back in a
change of control. An investor using this form of safe would have to be very
confident that the safe would be amended to match a later safe with better
terms. To be perfectly honest, this form of safe may not be very popular for
this reason, but uncapped notes with an MFN clause have been popular, so we
decided to have a safe like that too. Re question 2: if the company has
drafted its IRA to exclude the safe holders from pro rata rights, then the
company must give those rights via side letter instead. Many investors feel
very strongly about pro rata rights, so we drafted the safe to ensure that the
company had to give them, but with some flexibility as to where (e.g., in a
side letter rather than in an IRA).

~~~
danshapiro
Aha. It seems odd then to say that there are two choices in the case of MFN
conversion, when they amount to the same thing.

I know YC has seen MFN usage in the "everyone gets $100k" scenario, but I also
could see them useful for family and friends rounds where an unsophisticated
investor with a conflict of interest wants to put in the first $10k but not
set a price. In that case, a default conversion might make sense as an option.

------
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?

~~~
clevy
The notes have proliferated because they are quick and easy (no transaction
costs, etc.) so it's the way many startups like to raise money. Priced rounds
are fine too - they just tend to take more time and involve costs. YC and
others have open-sourced streamlined equity financing documents, but so far,
nothing has been as easy as raising on a convertible note.

~~~
DenisM
clevy, I literally said in my comment _I understand the advantages of notes_.
I don't need to be convinced. Notes are great.

My question is different - to what extent investors find note financing
acceptable/appealing? Is it only YC companies that get the privilege? Is it a
Silicon Valley thing, not used much elsewhere (like Seattle)? Is it used
everywhere, and I just happened to be unlucky with it?

~~~
clevy
Sorry, DenisM. Investors in the Silicon Valley find notes very acceptable. It
is not only YC companies that raise early money on notes, many other companies
do too. Notes may be the most popular in SV, but I am sure that investors in
other places use them as well. I think maybe you just got unlucky.

------
w4
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?

~~~
jwb119
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.

~~~
w4
Well, sort of. In a broad sense an option is simply an irrevocable right to
acquire or do something, without an obligation to actually acquire or do it.
You can write options for whatever you'd like, despite securities being the
most common use.

You're right about securities; the security usually exists prior to offering a
contract on it. But even then it gets a little more complicated. For instance,
I can write a naked option (an option to buy a security I don't even own).
They're pretty flexible instruments, and I'm not sure how Safes are
substantially different. That having been said, it sounds great for founders
and funders, since it's far simpler than the alternatives, and I'm shocked no
one has thought to do this before. Kudos to the YC folks for having the
insight to set it up.

~~~
jwb119
Right, but I wasn't speaking in the broad sense. In the legal sense, an option
has to have a very specific underlying security. That's the case with even a
naked option - you know exactly what the underlying security is. The Safe is
substantively different because the underlying security isn't defined at that
specific level.

But agreed, kudos to YC :)

~~~
w4
Ah, I see what you're saying.

Is there indeed a statutory or regulatory requirement to that effect? I'm not
an attorney and you are, so you'd know better than me, but it's my
understanding that "option" applies broadly to contractual obligations and
rights to sell/purchase property or rights at some sort of preordained terms,
conditions, price, or whatever.

------
pg
Incidentally, the clevy whose responses you see on this thread is safe author
Carolynn Levy.

------
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.

------
acjohnson55
Anybody know how this compares to convertible equity schemes, like [1], which
made front page last summer in a few stories?

[1] [http://techcrunch.com/2012/08/31/thefunded-founder-
institute...](http://techcrunch.com/2012/08/31/thefunded-founder-institute-
and-wilson-sonsini-debut-startup-friendly-seed-financing-vehicle-convertible-
equity/)

~~~
ed
Safe is probably favored to become the standard vehicle for seed rounds, a
benefit of being sponsored by YC. Investors will require less convincing and
at first glance Safe seems to be at least as good as convertible debt (as fast
and cheap as convertible debt, with no promise of repayment).

~~~
acjohnson55
That's certainly valid from a marketing standpoint. Although, convertible
equity was published WSGR, which may not be a household name, is still an
entity that anyone in the funding game should be familiar with.

I'm really more interested in whether there are significant structural
differences between the two schemes.

------
CyrusL
Will YC VC use these in the upcoming batch?

~~~
pg
Yes, the YCVC investments this batch are going to be on safes instead of
notes.

~~~
vasilipupkin
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 ?

~~~
ksar
Not necessarily. The 'caps' on these warrants are likely to be lower to
compensate investors.

~~~
clevy
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).

------
bananacurve
This 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.

[0]
[https://news.ycombinator.com/item?id=6849648](https://news.ycombinator.com/item?id=6849648)

------
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.

------
beachstartup
> Safes should work just like convertible notes, but with fewer complications.

it's not an option because the purchase price of an option is lost to the
seller no matter what.

it's not a loan because it doesn't have to be paid back on a schedule.

so basically it's more like a _convertible security deposit_.

------
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?

------
tslathrow
Not a big fan of capital structure above common for early-stage investing. Too
much possibility of fucking over the common. Why not bundle a non-expiring
warrant with convertible preferreds?

Consider also how much harder this will make private placements.

------
cominatchu
I have a question about using this. In the SAFE Primer it states:

"The table below sets forth a comparison between the Standard Preferred and
the SAFE Preferred, as each would be described in the company’s certificate of
incorporation:"

Reading the SAFE it mentions "SAFE Preferred Stock" and seems to partially
define it. Does this mean you must have "SAFE Preferred stock" defined in your
articles of incorporation to use a SAFE, or can the SAFE stand alone?

~~~
clevy
The SAFE Preferred Stock would be whatever you end up calling it in the
charter - for example, Series AA (just something to differentiate it from the
preferred stock being issued to the new money investors). So no, you would not
actually call it "SAFE Preferred Stock" in your COI. Does that make sense?

~~~
cominatchu
Yes thanks, so if the articles just authorize the issuance of common stock one
needs to amend them before using a SAFE?

------
JackFr
So as I understand it, investors want priority over equity holders in the
event of a liquidation, but without the regulation and potential tax headaches
of debt.

Since [convert] = [bond] + [option] what we do is make [bond] pay no coupon,
and strike the option weirdly and make it look like it is a new (disruptive?)
form of investment, when really it's tax/regulatory arb.

Caveat: I am not a lawyer or banker, nor have actually read the documents,
though I did read the OP.

~~~
syedkarim
I don't think anyone is claiming it to be truly innovative and disruptive, as
it's basically a warrant. But that doesn't take away from the value that the
Safe creates, which is a standardized and well-thought out legal instrument
that is freely available and modifiable.

------
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.

------
adventured
I really appreciate what YC does in this regard. I raised venture capital from
a large angel investor, and his team relied heavily on the YC documents (
[http://ycombinator.com/documents/](http://ycombinator.com/documents/) ). I
feel like it made the process a lot easier overall.

------
eigenrick
So did YC just invent private equity options?

------
mathattack
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.

~~~
oijaf888
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.

~~~
mathattack
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.

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marrington
This looks good to me, as long as it's enforceable (as in the state sees it as
a valid, binding contract). It's still debt until it converts as far as I can
tell, which is the only way I know of to give the company money today for
securities that don't exist yet.

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rhc2104
The SAFE looks great. But one question is, shouldn't SAFE holders have the
right to veto a dividend?

While this would be sociopathic behavior, what would stop this from happening?

1) Start company 2) Raise 1 million dollars on SAFEs 3) Distribute 1 million
dollar dividend 4) Dissolve company

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steven2012
Very interesting! Sounds like a really good thing for YC members.

So if a company manages to get to a pre-IPO stage, will the accounting for
these warrants be more complex? It sounds like trying to value one of these
warrants might add some/a lot of extra work.

~~~
jwb119
Just like a convertible note, as soon as there is an equity financing the Safe
would just "convert" into a class of preferred stock. So you wouldn't have the
valuation problem after you do a first financing, if I understand correctly.

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malandrew

        "has the advantages of convertible debt without some of 
        the disadvantages."
    

For which counter-party? The startups or the investors?

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sethbannon
And just like that the standard seed termsheet is born.

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SilasX
Can someone give the short version?

1) What is the current problem with convertible notes?

2) How does this solve that?

~~~
balls187
Depending on whom you ask (Investors or Founders), Capped notes have a
different set of negatives.

From the article, this new financial instrument is attempting to solve the
problem that Convertible Debt has a set of restrictions: term limits and
interest rates close to market rates. This causes lead to complications, when
the note converts, or when the term expires.

This solves it by no longer issuing "debt", but instead the right to buy stock
at an agreed price. This is similar to a Warrant, which is typically used for
advisor compensation.

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not_that_noob
Nice work, pg and gang, and keep things sane and simple for everyone.

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beautybasics
Finally something sane

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dennisgorelik
Is buying SAFE similar to buying CALL option?

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ATLmediaguy
This is a great option. It's about time!

~~~
jlevy
agreed

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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_.

