SAFE and KISS Notes- Startup Fundraising
Another option to raise capital for early-stage startups, aside from issuing equity or convertible debt notes, is the utilization of SAFE (Simple Agreement for Future Equity) and KISS (Keep It Simple Securities) notes. These synthetic financial instruments combine the advantages of equity and debt instruments.
SAFE Notes, introduced by Y Combinator in 2013, aim to simplify the complexities associated with traditional convertible debt instruments in early-stage funding for startup founders and investors. It is a concise document, typically five pages long, and essentially free from complex legal jargon. It outlines the events triggering the conversion of the SAFE to equity and specifies the rights of the investor and the issuing company.
The key distinction is that, unlike convertible notes, SAFE Notes do not have a maturity period, accrue interest, or function as debt instruments. Instead, they operate as unpriced warrants.
There are two types of SAFE Notes: Pre-Money SAFE, which has been in existence, and Post-Money SAFE, introduced by Y Combinator in 2018.
The main difference is that with a Pre-Money SAFE, investors do not know the exact percentage of ownership they will have at the close of a Series A round. In a pre-money SAFE, the SAFE investment amount is added to the company’s valuation to calculate the investor’s ownership stake.
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Eg: Company A is seeking funding and has not yet determined its valuation. Investor X agrees to invest $100k in Company A through a pre-money SAFE. Later, Company A raises a funding round at a valuation of $1m. In this case, the pre-money SAFE investment of $100k would be added to the $1m valuation, resulting in a total valuation of $1.1m. Investor X’s ownership stake would be calculated based on the $1.1m valuation.
With a Post-Money SAFE, they have clarity on their ownership percentage at Series A, ie the investor’s ownership stake is calculated based on the company’s valuation at the time of investment, including the SAFE investment amount.
Eg: Company B raises a funding round at a valuation of $2m Investor Y agrees to invest $150k in Company B through a post-money SAFE. In this case, the investor’s ownership stake would be calculated based on the $2m valuation, including the $150k investment.
Since each SAFE Note’s conversion calculation is independent of the others, the Post-Money SAFE provides greater clarity regarding an investor’s ultimate ownership stake in the company.
KISS notes, although similar to SAFE notes introduced by the accelerator 500 Startups, offer more flexibility to investors in terms of conversion mechanics. KISS can take the form of either convertible debt or equity, providing investors with flexibility in structuring their investments.
You can find the ready-to-use template for SAFE notes here — https://lnkd.in/eKubK-Jm
