I have recently been offered the opportunity to invest in a YC cleantech startup, alas via an unpriced SAFE.
Pursuant to my personal investment rules, I don’t fund uncapped SAFE or convertible notes (1), even if they are secured by Most Favoured Nation rights (2) (3).
Rationale
- Incentives are misaligned: I am against using uncapped SAFEs because it removes the incentive for the investor to invest in the company’s growth. If the company experiences significant growth and is valued much higher in the next funding round, the investor who used an uncapped SAFE will not receive the benefit of the increased valuation. It is as if you were directly investing in the next round of the company, without at the time of making your investment, knowing anything about its future valuation (4).
- The risk of dilution: As SAFE notes don’t have a maturity date, the longer a company takes to raise another round of funding, the more diluted the early investors’ equity stake becomes. If the company continues to raise funds through SAFE notes, the early investors may end up with a much smaller share of the company than they expected. This risk is mitigated by the MFN clause, but you still get diluted based on the best-negotiated terms. For an example of how dilution operates in SAFE rounds, please see this interesting discussion https://bit.ly/3OB4VFZ
Conclusion
While some investors may choose to use uncapped SAFEs or convertible notes secured by Most Favoured Nation rights, I personally choose not to fund them. The misaligned incentives and risk of dilution make these investment options less appealing to me, and I prefer to invest in other ways that align better with my personal investment rules. It’s important for each investor to carefully consider their own investment strategy and make choices that align with their goals and values.
P.S.: for further reading on the topic of investing through SAFEs, I recommend going to the source itself: YC combinator – https://bit.ly/44aBwbA
There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know.
Donald Rumsfeld
(1) An uncapped Simple Agreement for Future Equity (SAFE) is a financing option that does not have a valuation cap. This means that the investor who uses uncapped SAFEs will not receive a discount on the next round of funding and will not have a maximum valuation cap.
(2) This clause ensures that the investor will receive the best possible terms compared to any other investors in the same series of SAFE or convertible notes. The MFN clause is often used when the company and the investor want to punt on conversion terms, knowing that the terms may change in future rounds of financing.
(3) “I’m not going to agree a cap right now, but if you raise some money from some other investors who do have a cap and those terms are better than my terms, I get their terms as well as an investor.” – https://bit.ly/44aBwbA
(4) “I’m going to put money in now as an investor and when you do a priced round, I’ll get the same price as the priced round investors are going to get.” – https://bit.ly/44aBwbA