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From an entrepreneur’s perspective, a convertible note can be a scary and costly financing arrangement. Convertible notes are debt instruments. They can bring headaches and uncertainty because they create risk of negative consequences stemming from maturity dates, potential insolvency, and–among other things–falling under unintended regulatory control. They can also be quite complex, and may even have to include subordination agreements. For some startups, it is exactly what is needed. For others, the paperwork and legal fees are a constriction on the future of the company.
Enter Y Combinator. Since 2008 they have been actively involved in helping startups streamline their legal process for accessing capital. Recently, Carolynn Levy (formerly of Wilson Sonsini) has spearheaded the development of a new initiative building on her previous work–she contributed to the convertible note structure Y Combinator previously recommended. Along with the Y Combinator backed startup, Clerkly, they have developed and disseminated an alternative to the convertible note called SAFE, a “Simple Agreement for Future Equity”.
SAFE is meant to simplify the process by being a short, often one page, document that significantly lowers transaction costs for the company and its new investors. Under SAFE, the agreement is not a debt instrument, but instead it is basically a standardized convertible equity arrangement. There are a few different options for alterations, but it really is intended to help streamline the entire startup and investment community through standardization. Consequently, the only term that is really negotiable is the valuation cap. SAFE is offered as a starting point for negotiation and is available on the Y Combinator website, along with a plethora of great information for startups, investors, and even their lawyers. If a startup wants to avoid the traditional lawyer route altogether, Clerkly is now equipped to handle SAFE agreements.
Take a look at the Simple Agreement for Future Equity. Let us know if you think this is the end of Convertible Notes.
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