Episode Summary
Executive Summary: In this episode of Startup Basics, host Jason Calacanis and attorney Becky DeGraw from Wilson Sonsini discuss financing structures for startups, focusing on convertible notes, SAFEs, and priced rounds. They compare the pros and cons of each, highlighting that SAFEs are more founder-friendly but have untested legal issues, while convertible notes offer more investor protection. The conversation also covers side letters, the importance of trust in Silicon Valley, and strategic advice on when to raise capital.
Main Topics: Convertible Notes vs. SAFEs (Priority: 5/5): Comparison of convertible notes and SAFEs, including their structures, conversion terms, and implications for founders and investors. SAFE Agreement Risks (Priority: 4/5): Discussion of the risks associated with SAFEs, such as lack of maturity date and interest, and the potential for non-conversion as seen in the TopTal case. Side Letters and Investor Protections (Priority: 3/5): Explanation of side letters as a tool for investors to add protections like conversion dates and information rights to SAFE investments. Priced Rounds and Legal Costs (Priority: 4/5): Overview of priced equity rounds, typical legal fees ($75k-$100k), and when it's appropriate to pursue a priced round versus a convertible instrument. Strategic Fundraising Advice (Priority: 5/5): Practical advice on when to take money, the value of 'kicking the can down the road' with convertible notes, and the importance of business performance. Founder Control and Business Performance (Priority: 3/5): Emphasis on how strong business performance gives founders leverage and protects against investor overreach.
Key Arguments: Convertible notes are debt instruments that convert into equity, offering investors more protection with interest and maturity dates. SAFEs are not debt or equity but contracts for future equity, making them more founder-friendly but riskier for investors due to lack of conversion triggers. The TopTal case illustrates a critical flaw in SAFEs: if a company never has a qualifying equity round, investors may never convert to equity. Side letters can mitigate SAFE risks by adding conversion deadlines and information rights, but many investors forgo them for small amounts. Priced rounds are costly ($75k-$100k in legal fees) and should only be pursued for rounds of $1 million or more. Founders should 'take the money' when offered at a reasonable valuation, as capital markets can shift rapidly. Strong business performance is the best protection for founders against losing control or being replaced.
Data Points: Typical interest rate on convertible notes: 6-8% - Interest rate range for convertible notes, pegged between mortgage rates and credit card rates. Legal fees for a priced round: $75,000 - $100,000 - Total legal costs for a Series A round, including company counsel and investor counsel fees. Investor legal fee cap: $25,000 - $50,000 - Typical fee cap for investor counsel in a priced round, often paid by the company. Minimum round size for a priced round: $1 million - Becky advises founders not to consider a priced round unless raising at least $1 million. Example SAFE round size without side letters: $5-10 million - Large SAFE rounds that occur without side letters, relying on trust in Silicon Valley.
Pivotal Quotes: "The safe was named safe. It feels really safe for a founder. But having been both of these things, I have seen the safes not be completely safe for the investors." — Becky DeGraw: Discussing the perceived safety of SAFEs for founders versus the actual risks for investors. "If you're putting in a couple million, maybe you start considering doing a note instead, and you don't do the safe." — Becky DeGraw: Advice on when investors should prefer convertible notes over SAFEs based on investment size. "I think there's actually just one really simple answer, and that's just kick ass at the business. If you do that, investors are going to be happy." — Becky DeGraw: On how founders can maintain control and avoid being replaced by investors.
Implications: Founders should carefully weigh the trade-offs between SAFEs and convertible notes, considering investor protections and legal costs. The TopTal case highlights the need for clear conversion terms. Strong business performance remains the ultimate leverage for founders. Investors may increasingly demand side letters for larger SAFE investments.
About This Week in Startups
Jason Calacanis covers startups, tech, markets, media, and all the hottest topics in business and technology. He also interviews the world’s greatest founders, operators, investors, and innovators.