SAFE: How Founders Should Paper Their Own Investments in Their Startups

YCombinator has made a splash over the fast few weeks regarding its new SAFE (Simple Agreement for Future Equity) security that it will be using for investments in YC startups. It accomplishes everything convertible notes do, without the nasty “hammer” of a maturity date (i.e. the money coming due if another financing never happens). It seems everyone took to their blogs to comment on SAFE’s provisions, so I’m not going to repeat that here. Instead, here are some links:

I’d like to establish a point that (I think) hasn’t been touched upon by the startup bloggerati: that SAFE appears to be the perfect way for founders to paper their own capital investments in their startups.

Background Reading: SHL – Founder Convertible Notes

  • At the inception of a startup, founder stock should generally be issued at a very low per share value: typically $0.00001 per share.
  • Issuing the stock at a higher per share price (for, say, a founder’s investment of $20,000) potentially establishes a Fair Market Value of the stock that will make it much more expensive for future employees to receive equity in the company, which negatively impacts hiring.
  • “Founder Notes” are a way to (i) issue founder stock cheaply, but (ii) still paper a founder’s investment of serious money (aside from sweat) in her/his startup. And (in my experience) later investors like to see the extra “skin in the game” from a founder.  They’re not happy about it being reflected in a debt instrument, but it’s usually a net-plus for the founder.
  • But one downside is that, in the case of multiple founders, by issuing founder notes you’ve just handed a co-founder a very sharp object to use against the Company (and other founders) if things don’t go as planned and the note never gets converted. Founders sometimes end up hating each other. Better to keep the weapons in the closet.

Solution: SAFE – The “Discount, No Cap” Version

  • 20% Discount should be fair
  • I suggest the uncapped version because founders shouldn’t be setting capped valuations at the formation/early stages of the Company.
  • SAFE is also a bit more digestible to those Angels who may have a problem with Founders having a debt claim on the Company.

Founders now have a standardized security to paper their personal investments in their startups, (A) without screwing with the Company’s FMV and, more importantly, (B) without giving co-founders a way to blow up the Company at a “maturity date.” So while Texas Angels will likely take some time to warm up to SAFE, founders putting real money in their startups have definitely benefited from YC’s new instrument.

Nutshell: Founder Notes were a way to paper a founder’s investment of personal funds without messing with a startup’s FMV, but “maturity” created a problem in a multiple founder context. SAFE resolves that problem.