There are numerous options available for seed funding rounds in today's landscape. Currently, the most widely used methods include convertible notes and preferred stocks, both of which have been in existence for a considerable period. To simplify matters for entrepreneurs, two relatively newer approaches, known as SAFE (Simple Agreement for Future Equity) and KISS (Keep It Simple Securities), are gaining increased attention. However, it's important to understand how these four investment types differ and what advantages and disadvantages each of them carries. Let's delve into each one:
1. SAFE (Simple Agreement for Future Equity):
SAFEs were introduced in 2013 by Y Combinator, a startup accelerator that also makes small investments in the companies it accepts. The goal was to create a standardized, easily understood document for entrepreneurs to secure funding quickly and with less hassle and cost.
In simple terms, a SAFE is a funding contract granting investors the right to purchase stocks in a future financing round, deferring the valuation of a startup company to a later date. However, SAFEs lack a maturity date and do not accrue interest. While SAFEs can include a valuation cap and a conversion discount, they offer flexibility that entrepreneurs appreciate, though investors are often more cautious due to the reduced rights and protections.
2. KISS (Keep It Simple Securities):
Developed by 500 Startups, another accelerator, KISS was introduced a year after Y Combinator introduced the SAFE. Similar to SAFEs, the Keep-It-Simple-Securities agreement aims to simplify matters for entrepreneurs and investors while deferring the valuation question.
A KISS accrues interest at a defined rate (typically 5%) and includes a maturity date (usually 18 months), making it somewhat similar to a convertible note. This similarity may make KISS more appealing to investors than a traditional SAFE.
3. Straight Equity (Also known as Priced Equity Round or Preferred Stock):
It's evident that investors favor this financing instrument because it precisely defines all funding terms. An equity round entails negotiations regarding the company's value, the number of shares, and the share price. Right from the start, it's clear how ownership of the organization is split between the founders and investors. Since angel investors have partial ownership of the company from the outset, they often secure seats on the startup's board. From an angel investor's perspective, this is the safest way to participate in a funding round, offering comprehensive investor rights and protections, such as liquidation preferences.
However, a straight equity deal, due to its detailed outlining of future event outcomes (e.g., IPO, M&A, liquidation), demands time and resources for negotiation and agreement, resulting in relatively high costs, including legal fees.
4. Convertible Note (Also known as Convertible Debt):
For startups embarking on their first financing round (seed round), a convertible note can be an excellent alternative to preferred stocks, especially in the early stages when assessing the company's value is challenging. The valuation of the company is postponed to a later date, typically 12 to 18 months after the financing, at which point angel investors have the option to convert their investment, including accrued interest, into company equity. A convertible note facilitates faster funding for founders with fewer complexities and lower legal fees compared to preferred stock financing.
Founders and angel investors must still agree on terms for the convertible note, including the maturity date, interest rate, valuation cap, and/or discount rate. The discount rate is a critical factor, as it rewards angel investors with a lower stock price in exchange for providing early funding to entrepreneurs.
TLDR; Each Case Is Unique
There's no one-size-fits-all solution. It's advisable to seek advice from legal and financial experts before committing to a binding financing agreement. As the CEO of your new company, you want to offer angel investors an appealing opportunity to support your venture. On the other hand, as an angel investor, you aim to protect your investment while making it as easy as possible for entrepreneurs to start and succeed without getting bogged down in lengthy funding negotiations. Achieving the right financing vehicle and terms requires careful consideration of the needs of both parties and often involves a delicate balancing act.
*The information contained in this article is provided for informational purposes only, and should not be construed as legal advice on any subject matter.
Begin investing in high-potential startups or submit a pitch here: