12/4/2023 0 Comments Convertible notes venture capitalWe look at a few of the common negotiated points here, but if this topic is new to you, we encourage you to also look at some of the “further resources” included at the end. Both have significant optionality in the terms, which are typically negotiated between the company and the investor(s) depending on mostly on leverage and bargaining skills. Modern SAFES and convertible notes have some variance to them, but generally follow a similar structure. As a general rule, though, SAFES are more commonly used for financing very early-stage companies, while convertible notes are more commonly used by slightly more mature companies, either as the last financing round before a Seed round or as a “bridge” round between equity financings (for example, a bridge financing between a company’s Series A and Series B round). Which instrument is used will largely depend on the preference of your lead investor and both have some advantages and disadvantages. These days, both convertible notes and SAFES are widely used in venture finance. SAFES are just a contract that does away with the standard characteristics of a debt instrument, but keeps the right to convert into shares at some point in time. With the goal of simplifying early-stage financing for startups and eliminating some of these company concerns, Y Combinator, a startup accelerator out of Silicon Valley, came up with a new form of convertible instrument called a simple agreement for future equity or a SAFE. From a company’s perspective, traditional debt features were also undesirable, since debt features like interest and maturity dates could sometimes create unrealistic deadlines for developing the business or raising the next round. Over time, it became apparent that the conversion factor was the primary source of value for convertible note investors and that features of debt such as an interest rate and maturity date were not always necessary to achieve investment goals. Convertible notes have many of the common features of debt: an interest rate, maturity date, events of default, even security provisions in some cases, but the key difference is that the convertible note would convert into shares upon the occurrence of certain events or at the discretion of the holder of the note. ![]() They were used as a bridge between rounds of financing (or before the first equity financing), especially where the current valuation of the company was not easy to discern or the investor had reservations about owning shares outright in an early stage or financially unstable company. ![]() Backgroundįor many years, convertible notes were the main (and arguably only) instrument you would use if you didn’t want to issue shares to an investor but they weren’t willing to take straight debt in your company. In the venture world, the two most prevalent of these instruments are convertibles notes (sometimes called convertible debentures or convertible debt) and simple agreements for future equity (known more commonly as SAFES). However, venture-backed companies are likely to encounter a hybrid form of financing that exists somewhere in between those two concepts and relies on “convertible instruments” that have some of the elements of debt but will convert at some point into shares. Companies have two basic options available when raising money from outside investors: (a) issuing shares (or an equity financing) or (b) issuing debt.
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