In a blog post this morning startup incubator program Y Combinator introduced a new investment instrument as an alternative to convertible notes. They are calling it SAFE or “simple agreement for future equity”, which was created by YC partner and lawyer Carolyn Levy and all four version can be downloaded here 1) cap with no discount 2) discount, no cap 3) cap and discount and 4) MFN, no cap, no discount (similar to the “StartFund” or YCVC terms) along with a primer.
Y Combinator partner and cofounder Paul Graham confirmed YCVC investments in the current batch will be on safe instead of notes in the Hacker News thread discussing the announcement.
The post explains the goal of this new instrument and how it overcomes the downsides of convertible notes:
The disadvantage of convertible debt is that although it’s only nominally debt, the law cares what things are nominally, and there are all sorts of regulations about debt. There has to be a term, which in California can’t be too long, and there has to be an interest rate not too far from market rates. The interest on convertible notes makes conversion complicated, and the fact that the debt has a fixed term causes extra work for both parties when it has to be extended.
A safe is like a convertible note in that the investor buys not stock itself but the right to buy stock in an equity round when it occurs. A safe can have a valuation cap, or be uncapped, just like a note. But what the investor buys is not debt, but something more like a warrant. So there is no need to fix a term or decide on an interest rate.
As a founder who has raised on convertible notes myself for Mattermark, I find this promising because updating maturity dates certainly is a hassle. Additionally, with platforms like AngelList enabling more “party” rounds where a large number of small investors participate it can become quite logistically challenging to make sure everything gets signed when an update needs to take place.
As with any change to a well-worn pattern, it might take some time for investors to adopt this new approach… as well as a bit of legal review. It will be interesting to see how things play out at Demo Day for the current batch of startups.