Understanding Financing Structures: SAFEs, Convertibles Notes, Priced Rounds & more with Becki DeGraw | Wilson Sonsini Startup Legal Basics

Episode Summary

Executive Summary: The episode explains startup financing basics for first-time founders, comparing convertible notes, SAFEs, and priced rounds. Becky DeGras argues that SAFEs are founder-friendly but less protective for investors, convertible notes add debt-like guardrails, and priced rounds make sense only when check sizes and company maturity justify the legal cost and complexity.

Main Topics: Convertible notes (Priority: 5/5): Debt instruments designed as a faster, cheaper alternative to equity rounds; they usually convert into preferred stock in the next financing and include interest and maturity terms. SAFEs vs. convertible notes (Priority: 5/5): SAFEs are simple contracts for future equity, not debt, with no interest or maturity date; they are easier, cheaper, and more founder-friendly, but can be less protective for investors. Investor protections and edge cases (Priority: 5/5): The discussion highlights uncertainty around SAFEs in rare cases, such as no conversion or dissolution, and how side letters can add protections like conversion deadlines and information rights. Priced rounds and legal cost (Priority: 4/5): Priced equity rounds are more expensive and administratively heavy, but become appropriate when raising larger amounts or when investors want clear ownership and valuation. Negotiation strategy and market dynamics (Priority: 4/5): The speakers emphasize trust, reputation, and timing in Silicon Valley, noting that founders should protect key points but avoid over-negotiating minor terms when capital is available. Founder leverage and control (Priority: 4/5): A strong business reduces investor attempts to replace founders or exercise control; the best protection is executing well and building leverage through growth.

Key Arguments: Convertible notes are debt while outstanding, so they do not appear as equity on the cap table until conversion. SAFEs were created by Y Combinator to simplify early fundraising and minimize legal negotiation, making them faster and cheaper than notes. SAFEs are more founder-friendly because they typically lack interest and maturity dates, reducing pressure to force repayment or conversion on a deadline. Convertible notes are generally more investor-protective because the debt structure provides a conversion deadline and interest. Side letters can be used to add investor protections to SAFEs, such as a forced conversion date and monthly information rights. Investors largely accept SAFEs now because many early checks are small and the market has become more founder-friendly. Priced rounds usually do not make economic sense for small raises because legal fees can be disproportionate to the amount raised. The size of the check and investor demand usually determine when a company should move from SAFEs/notes to a priced round. Founders can sometimes use an additional small financing or top-off to delay a priced round if they are close to a major milestone. The strongest defense against control issues is building a great business; successful founders retain leverage and reduce investor interference.

Data Points: Convertible note interest rate: 6% to 8% - Typical rate cited for convertible notes; described as a real, market-based interest rate. Convertible note maturity: 24 months - Referenced as a common conversion or repayment deadline for notes. SAFE/convertible note check size: $100K - Example of a small early investment that may not warrant heavy negotiation. SAFE rounds: $5M to $10M - Speaker noted seeing SAFE rounds at this scale without side letters or conversion deadlines. Legal fees for priced rounds: $75K to $100K - Estimated total legal cost for doing a priced round properly, including company and investor counsel. Investor counsel fee caps: $25K to $50K - Typical cap the lead investor may ask the company to cover. Founder advice threshold for priced round: Millions of dollars - Guidance that priced rounds usually make sense only once raises are in the millions. Example valuation move: $15M to $20M - Illustrative scenario where an investor offered to invest at a higher valuation as the company hit traction. Example ownership outcome: 14% - Speaker described ending up with about 14% ownership after negotiating the final terms of a follow-on investment.

Pivotal Quotes: "That will never happen. That's ridiculous because the company's going to get bought." — Becky DeGras: Referring to the assumption that a SAFE will always convert in the next round, later challenged by edge cases like TopTal. "This is a 10-year, sometimes 20-year relationship. Let's do it right." — Host: Emphasizing the importance of proper documentation and thoughtful negotiation in founder-investor relationships. "The best protection is just kick ass at the business." — Becky DeGras: Summarizing how strong execution is the most effective way for founders to preserve control and avoid investor conflict.

Implications: Founders should choose financing instruments based on stage, amount, and leverage: use SAFEs/notes for speed and small raises, priced rounds for larger/more mature financings, and add targeted protections when needed. Execution and reputation remain the real control mechanism.