As a start-up founder, you are most probably looking to raise fund for your company and you can have a number of potential equity deals to consider when you’re negotiating with investors, so you end up confused. Convertible, SAFE and KISS notes are one of the best deals that can definitely help you raise money to kick start your business.
SAFE and KISS notes were created by Y Combinator and 500 Startups, a startup money accelerator, the first created what is so called SAFE notes which means Simple Agreement for Future Equity and the second created the KISS notes which means Keep It Simple Security. These notes have so much in common, but they also have their specific aspects.
The main purpose of those agreements is converting debt into equity. More specifically speaking, Convertible, SAFE and KISS notes are a form of short-term debt that converts debts into equity, typically during a future financing round. As a result, the investor would be loaning money to a startup and instead of returning that same amount of money plus its interest, the investor would receive equity in the company.
The creators of the Convertible, SAFE and KISS documents had the same ambition: to simplify the seed financing process by creating a simple standard document to adopt whenever startup founders are looking for outsiders to invest in their company. Having a standard form documents means there are less points to negotiate between founders and investors, therefore, the document can be put in place and the startup receives the funds faster.
- When is needed:
If you’re an early-stage startup looking to raise fund and grow quickly, then Convertible, KISS and SAFE notes are the perfect options for you. You’re probably wondering why not try and seek venture capitalists’ investors? Well, if you are seeking venture funding, then one of the challenging questions you’ll face is: What’s your company’s valuation? This is a hard question to answer when it comes to early-stage startups, a question that you can skip it in case you’re executing a Convertible, KISS or SAFE note, by skip it I mean skip the real current valuation of the company.
- Typical clause:
The most typical clauses to be included whether in a Convertible, SAFE or KISS notes are the following:
A Valuation Cap, which is a clause that stipulates the price at which your debt will convert into equity, it sets the highest price that can be used to set the conversion price. This is kind of a reward for investors bearing the risk of investing in a very early stage startup.
A Discount Rate, which is a clause that represents the discount the investor will get when converting the debt into equity. This also another compensation clause for the investor considering the risk he’s taking by investing early.
An Interest Rate, since the investor is loaning money to the company so including a clause that specify the interest rate could is necessary. However, such interest will not be paid back in cash but instead it will be paid back with additional shares in the company.
A maturity date, which is the date when the company needs to repay the loans by giving shares to the investors.
Having all of these clauses in one agreement together is not mandatory considering that there are various types of Convertible, SAFE or KISS notes. For example, here are the main types of SAFE notes: (i) a Valuation Cap with no Discount Rate, (ii) a Discount Rate with no Valuation Cap, (iii) a Valuation Cap and a Discount Rate, and (iv), a no Valuation Cap with no Discount Rate.
- Why is this important? How can a lawyer help?
As previously mentioned, those agreements are super important and beneficial for early stage startups looking for extra funds to run their businesses. It’s also the fastest, simplest and cheapest way to raise funds. There is also no need to create a specific class of shares or issue common stock. This avoids a number of complications, including those arising from company valuations, stock option grants, and related tax implications. Eventually, this allows startup founders to focus more of their time and energy on their company and on generating potential returns for their investors.
Finally, always keep in mind to have the right legal counsel when it comes to executing such agreements. A lawyer can help you identify which type of Convertible, SAFE or KISS notes is right for your specific case.