A company raises $100k in convertible debt and 9 months later raises $1 million of Series
A Preferred Stock at a $3 million pre-money valuation. If the Series A investors get 1
million shares in the company at $1 a share, the convertible debt holders convert their
$100k at 80 cents a share, giving them 125,000 shares of Series A Preferred Stock.
A SAFE approach to raising a friends and family round
Convertible debt solves the valuation issue, but it is not a perfect fix. Terms can still get
complicated, and though typically cheaper to issue than equity, it is still cost prohibitive for a
small friends and family round.
Two leading accelerator programs have developed agreement templates that offer three
advantages to hiring a lawyer to draft convertible note documents:
1. Simplified terms make them easier for the parties to understand
2. They are recognizable to (and sometimes used by) angel groups and VCs1
3. They are free
Y Combinator has developed a series of documents called SAFEs (Simple Agreement for
Future Equity). There are few different flavors of SAFEs but all work similar to convertible
notes, though they are not technically debt instruments.
Not to be outdone, 500 startups developed KISS docs, which come in 2 flavors; equity and
debt, the latter of which is comparable to SAFEs.
There are differences between the debt KISS and SAFEs. A significant one is that KISSes
provide rights to investors to participate in future financings.2
Since participants in a friends
and family round do not need that right, I would lean toward the SAFEs for a friends and
family financing (the document is also shorter – only 5 pages). The version that provides
for a discount, but no cap is good balance between investors and the entrepreneur (for
more information on caps, discounts, and the myriad of other deal terms see the page 4
sidebar on the book Venture Deals).
Any of these templates can of course be modified to accommodate your company’s unique
needs. You should have an attorney review any documents you plan on using to make
sure you have all of your bases covered.
While VCs and angels may be familiar with SAFEs and KISSes, they all do not necessarily like them. There is some advantage to using
a form document in a friends and family in that VCs do not have to spend time familiarizing themselves with the deal terms. That said,
VCs and angels are like snowflakes, and they each have their own view as to what they prefer to see in previous financings.
While SAFEs do not explicitly stipulate that investors can participate in subsequent rounds, they anticipate that a separate such
agreement will be included as part of the financing. This is referred to in the document as the “Pro Rata Rights Agreement.” If one will
not be used, it is best to remove this defined term, found on page 3 of the document, from your agreement, as well as paragraph 1(a)(ii),
found on page 1 of the document that says such an agreement will be executed.