Founder's Guide to Notes & SAFEs: Caps, Discounts & More

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This article is a summary of a YouTube video "A Founder's Guide to Notes & SAFEs: Caps, Discounts & More | Dose 036" by Dreamit
TLDR Convertible notes and safes are financing instruments for startups that allow investors to lock in an investment at an early stage without discussing valuation, and the cap in these instruments is a mechanism that rewards early investors for their risk by placing a ceiling on the startup's value in the next round.

Key insights

  • 🤔
    It's important for founders to understand the ins and outs of setting the right terms for their fundraising rounds.
  • 💰
    Convertible notes and safes allow startups to raise their first round of funding without having to determine a valuation, making it easier for investors to lock in an investment at an earlier stage.
  • 💰
    The discount feature in convertible notes allows early investors to purchase shares at a reduced price compared to the next round's equity investors.
  • 💰
    The conversion valuation cap (cap) is a mechanism that rewards early investors for their risk and efforts in increasing the value of a startup, providing them with the opportunity to purchase at a lower price if the startup's value exceeds the cap in the next round.
  • 💰
    The price per share that early investors receive in the next round is determined by the mechanism that yields a lower price per share, either the discount or the cap.
  • 📈
    Setting a cap on the valuation to which the note or SAFE converts can align the interests of founders and seed investors, as both parties want the valuation to be as high as possible.
  • 📉
    In certain situations, such as when serial entrepreneurs with successful track records are raising funds, investors may be willing to invest without a valuation cap, but with a discount instead.
  • 💰
    Founders may choose to do an early round with no cap when dealing with unsophisticated angel investors or a friends and family round, offering a note or safe with a 15 to 20 percent discount.

Q&A

  • Why do most early investors prefer capped safes and notes?

    — Most early investors prefer capped safes and notes because if the value of a startup they invest in later increases significantly without a cap, it will dilute their investment and they won't take the risk of an uncapped investment.

  • What happens if investors wait and see before investing?

    — If investors wait and see before investing, they may end up buying in without the discount, resulting in less equity as the valuation increases.

  • In what situations can founders dictate terms without a cap?

    — Founders can dictate terms without a cap when they have already raised funds, need a bridge round, or are dealing with unsophisticated angel investors, but they should proceed cautiously in these cases.

  • Is the valuation discussion deferred when using a cap?

    — No, the valuation discussion is not deferred when using a cap. The price per share for early investors will be determined by sophisticated investors.

  • What is the purpose of the cap in convertible notes and safes?

    — The cap in convertible notes and safes is a mechanism that rewards early investors for their risk by placing a ceiling on the startup's value in the next round.

Timestamped Summary

  • 💡
    00:00
    Startups often struggle with determining the terms, including the cap, when raising funds through convertible notes and safes.
  • 💡
    00:37
    Convertible notes and safes are easy financing instruments for startups that allow investors to lock in an investment at an early stage without discussing valuation, with convertible notes being debt financing that converts into preferred stock and safes not having an interest rate or maturity date, and both can be structured with a discount for early investors.
  • 💡
    01:41
    Early investors are given a discount on their investment, allowing them to buy more shares at a reduced price, and there is also an interest rate and a maturity date on the note.
  • 📝
    02:24
    The cap in a convertible note or safe is a mechanism that rewards early investors for their risk by placing a ceiling on the startup's value in the next round, allowing initial investors to purchase at a lower price if the cap is exceeded, and it is important to understand that early investors do not receive both a discount and extra shares if the cap is exceeded.
  • 📝
    03:41
    Most early investors prefer capped safes and notes to avoid dilution of their investment if the startup's value increases significantly, while investors may buy in without a discount if the valuation makes sense.
  • 💡
    05:13
    Capping the valuation of a startup in notes and SAFEs aligns the interests of founders and investors, ensuring that both parties want the valuation to be as high as possible.
  • 💡
    06:35
    Valuation caps are determined by the negotiated estimate of a startup's value and are set at fair market value, but there are instances where uncapped notes may be used, such as when serial entrepreneurs with successful track records offer discounts to investors without a cap.
  • 📝
    07:38
    Founders can dictate terms without a cap in certain situations, but should be cautious. Valuation discussion is not deferred with a cap and early investors' share price is determined by sophisticated investors.
Play video
This article is a summary of a YouTube video "A Founder's Guide to Notes & SAFEs: Caps, Discounts & More | Dose 036" by Dreamit
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