This is a contrarian view, but I think the startup ecosystem routinely overvalues SAFEs and convertibles. Here's why, plus what I tell founders about the issue. 1. Benefit to founders People often say they're raising via a SAFE or convertible "because it's less paperwork". Having a short form is great, but that's just the start. These instruments often don't include standard shareholder rights, like: (a) information rights - on how the business is doing (b) consent rights - to protect them against crazy founder actions (c) board representation - influence over decisions For founders, that's great: all the money, none of the hassle. 2. Benefit to investors If the company does a super-hot Series A, the early investors have got a bargain. Eg: with a convertible capped at $10m before a 20% discount, if the company then raises three months later at $20m, the convertible holders have got in at a 60% lower price than the next round. 3. Rare outcome Outside the Bay area, it's more common that the company raises at or below the cap, and the only compensation to the early investor is the discount plus any coupon. The question is: is that enough to outweigh the risk that the company dies before its next round? Or is it SAFEr, to coin a phrase, to wait for the priced round? Conclusion for founders When founders come to me raising a SAFE or convertible, I politely explain that we stopped doing these deals after our analysis showed returns that were way lower than our returns on priced rounds. Then I encourage them to go and raise a SAFE or convertible that's as big as possible. From other people. These instruments are super-cheap equity, zero strings, and super-attractive for founders. They deserve to be popular among founders. It's only for investors that they suck. Lots of people have experience of achieving amazing returns from individual SAFEs or convertibles. But what about at the portfolio level: can anyone report aggregate returns across a whole portfolio of such investments. or across the ecosystem as a whole? Glossary and links in comments.
The reality is that SAFEs are here to stay. The ASA is no better and in some cases worse than a SAFE and there is no global standard. Think you can fix some of the issues you mention through side letters which many people use.
Agree. I sell SAFEs but don't buy them. SAFEs are great for founders, and push a number of risks to the investors, including the risk that it just won't convert. I have a theory that a SAFE can be rebalanced for investors if they get low caps. Investors care about the cap because they make all of their money from hot deals that blow past the cap. A cap at half the price doubles the return. Founders, on the other hand, are stuck with a distribution where most of their deals will not hit a cap. So, a lower cap will not on average cost the founder much, but will improve returns in an investor portfolio.
But risk these days is no longer about the idea, but about the cash flow. the need to see a plan that gives return within the short term is the killer. investment for a startup shouldnt be like chemical fertilizer for the plant ( fast reach ang growth but tasteless fruit),instead maybe for soil/ maintenance, environmental support systems...
Thanks for this Tim. I think SAFEs could be used more widely where a first big potential customer is involved. For example, they could be used to help narrow the gap between government procurement (often high bar / tends to favour incumbents) and start-ups (who haven't been procured at scale by government before). This can help distribute the upside and act as a pull mechanism for innovation into government services. The weaker investor terms can be accepted as the SAFE is partially in place instead of procurement.
I agree 💯 and appreciate the fresh take on this age-old issue. I detailed the misalignments of interest here. tl;dr: SAFE used right are ok—but they rarely are. https://thevcfactory.com/safes/
Agree. Total lack of investor protections and the SAFE document is weakly written, especially in the event of non conversion. We avoid SAFEs as well. Should we do one going forward, it will be heavily augmented by side documents that go beyond our standard information rights.
SAFEs only provide a format for investing. They don’t dictate terms. In addition, you can get most of the additional terms you mentioned through side letters. YC even provides a few of them. Almost every VC I know, and there are a lot, require at least the pro-rata side letter. I’m on the Board of one of the companies I invested in on a SAFE, though that’s less important at seed, when a company is still figuring a lot of things out. It’s far more important for you to have a good relationship with the founder that enables you to help where you can. Your argument is a great example of circular and, potentially, spurious reasoning. Sounds to me like you just invested in inflated deals. And since most deals prior to Series A are done on SAFEs these days, and you did your deals at inflated valuations, of course they’re going to look bad overall. In fact, contrary to your claim, even in SV and NYC far more companies that raised a seed fail to raise again. This was the case when most initial institutional rounds were priced as well. Rather than blaming the deal format, perhaps you need to look at why you did so many inflated deals into bad companies.
Good insight! Having seen my share of deals, "Information Rights" is bare minimum an investor should always secure. For the rest, no one likes to leave money on the table.
Death of SAFEs?
General Partner and CEO Coach at Walking Ventures
8moSAFE: Simple Agreement for Future Equity YC documents: https://www.ycombinator.com/documents Invented by Carolynn Levy: https://meridian.mercury.com/carolynn-levy Fred Wilson, vintage 2017, on convertibles and SAFEs: https://avc.com/2017/03/convertible-and-safe-notes/ PS: I realise the strongest argument for participating in a SAFE or convertible is access -- the seed investor might not be able to get into the hot priced round. But if so, it's valuable to recognise the premium being paid.