It’s not uncommon for startups to crowd-fund. The founders may not have the money needed to bring into realization their business idea. So, they can legitimately acquire different amounts of money from a large number of people. The capital raised is then used to purchase equipment, subscribe to B2B services, and meet operating costs.
As an investor, one of the ways you can financially support a seed-stage company is by safe notes. Before getting into the advantages, take time to understand what these are.
What Are SAFE Notes?
Safe is the abbreviation for simple agreement for future equity. In other words, you make a cash investment with the hope that you’ll acquire shares sometime in the future.
At this juncture, the company you’re investing in hasn’t yet offered shares to the public. As you’re aware, the initial public offering comes with its fair share of legal compliance. And thus, founders may want to avoid the lengthy procedure but still have funds to kickstart their business.
Once the firm embarks on priced capital raising, your safe notes can convert to equity. The number of shares you get depends on how much cash you invested and the price per share. With this detailed background information, you can now consider the following advantages of this investment option:
1. Easy To Understand
The safe note agreement, created by Y combinator, is a brief 5-page document. This should be easy for you to read within a few minutes and fully understand the contents. Furthermore, you don’t need a lawyer to help you interpret the text written therein.
As such, it saves you the time and money you’d have to spend on lawyer fees. Also, it helps if you’re moneyed but without the capacity to comprehend tons of legal material.
2. Less Bureaucracy
When a business gets to the stage of priced capital raising, founders and investors usually need to carry out a lot of deliberations. The series of meetings can quickly tire you out.
Luckily, safe notes allow the business architects to use your cash without you signing off on every decision they make. This way, the company proceeds faster than it would have managed with dozens of shareholder meetings.
Additionally, the company doesn’t have to file safe notes with the government and other regulatory bodies. This approach saves you time as an investor. As long as your investment will finally bring returns, you can concentrate on other life matters.
3. Generous Discounts
Remember, you’re investing in a seed-stage business with no guarantee that the venture will turn out successful. That’s quite a risk. More so, you don’t have security similar to that of a shareholder. The founders understand the kind of uncertainty you’ve exposed yourself to.
And thus, as a reward for your bravery, they can decide to discount the share prices for you. While others buy one share at USD$ 500 and you’ll pay 10-30% less. That means the higher number of shares you have and subsequently, the higher dividends.
4. Valuation Caps
While making your investment, you have no idea how much the company will be worth when they undertake a priced capital raising. If the valuation is unexpectedly humongous, your investment may not be adequate to purchase a significant number of shares.
Luckily, safe notes may come with valuation caps. This provision protects you from getting fewer shares if the valuation of the company bursts through the roof. Suppose the business does a priced round at a valuation of USD$10 million. If you settle on a valuation cap of USD$4 million, your safe notes will convert based on a USD$4 million valuations rather than USD$10 million. That’s one trick of protecting your finances when investing.
5. Minimal Negotiations
Perhaps all you may have to negotiate with the founders is the discounts and valuation caps. That’s all! Who doesn’t like such a straightforward investment option?
Sometimes, business negotiations can consume a lot of time, energy, and mental resources. The fewer negotiations you have to make, the better for you. Your mind remains uncluttered and at peace.
6. Equity Conversion
When lending any company your cash, your goal is to receive dividends year after year unless you’re doing it for charity. As earlier indicated, safe notes convert to equity during priced rounds. Ideally, safe notes allow you to buy shares way before the initial public offer. And you agree that it’s the early bird that catches the worm.
In comparison to convertible notes, safes may earn you more shares.
7. Early Exit
In case you lose interest in the company, you have the option to make an early exit before your safe notes convert to shares. Generally, you’ll receive a 1x payout. This payout is understandable since the company hasn’t yet made significant profits.
Similarly, if the issuer is unsuccessful with the business and disbands it, you’re entitled to receiving the exact amount of cash you invested.
Things To Note About Safe Notes
Even though safe notes have numerous advantages as highland above, there are a few aspects you may want to put into consideration. These are:
1. No Interest
Safe notes don’t accrue interests. No matter how long your cash stays with the company, it doesn’t gain value in the form of interest. This aspect might be a turn-off, especially if you’re the kind of investor who longs for their capital to grow with time.
2. Possibility Of Non-Payment
Safe notes aren’t official debt instruments. If they eventually fail to convert to equity, the company isn’t legally obligated to repay your money. This fact may scare you away, but investors are risk-takers.
3. No Fixed Term
In the safe note agreement, there’s no stipulation regarding the maturity date. It’s left open. That means you may have to wait for one, two, or maybe even ten years before your investment converts to equity. Moreover, it’s not a guarantee that the company will have a priced capital raising. The business may dissolve if the idea is no longer feasible.
You now have enough insight into safe notes. They have several advantages over other investment options like convertible notes. But even so, they come with a few risks, as every investment does. As long as the benefits outweigh the downsides, you can confidently invest your money and hope for returns in the future.