Carolynn Levy and Kirsty Nathoo - Startup Investor School Day 1

All right, this next session is actually one of my very favorites because there's so much mystery in the fundamentals of how you actually do a startup investment, what it really means, and how it works. There are no two people who are greater experts in that on the planet than my colleagues Carolyn Levy and Christina, who have dealt with these issues with, I guess, thousands of companies now. It's certainly all sixteen or seventeen hundred—why should—what is the actual number? Probably no, nobody knows it anyway—hundreds of companies. They know this stuff better than anyone.

Carolyn is the person who actually invented the SAFE. She used to be an attorney before coming here, and Kirsty is the CFO of YC. They two have a couple of pithy quotes; you can guess who said what because I don't know. One said, "All investors who can help should do so; asking for additional shares is just asking for a freebie." I'm guessing that's Kirsty but I'm not sure. "Having money is very valuable, but someone who helps with strategy and direction is priceless, so choose wisely."

So with that, I will give you Carolyn.

Is this working? Okay, yeah. I have no idea which quote is mine and which one is Kirsty's, and we were going to introduce ourselves but since Jeff just did it, we will move right along. Like Jeff said, this is the mechanical part. Okay, this presentation is about how to invest using Y Combinator's SAFE. Is my mic not on? Do people—nine lights on? Is it just on low? Better, better, better, better. Okay, I think we're good.

So, as I was saying, this presentation is about how to invest using Y Combinator's SAFE, which is the first thing I'm going to talk about. Then Kirsty is gonna describe how the SAFE converts in an equity financing. I'm going to talk about how the SAFE converts in other events, a quick word about process, and then we had some advice that Sam kind of covered, but we'll just reiterate it because it's important.

Okay, so a lot of you raised your hand when Jeff asked, or Sam asked, how many people have already angel invested, so I'm wondering how many of you have already used the SAFE? Oh, that's a lot. Okay, okay.

So, I'm gonna talk about the basics. For some of you, that's gonna be stuff you already know, but for those of you who've never used it, hopefully that will be helpful. It will be helpful. Okay, um, we drafted the SAFE for very early-stage startups, so that means that the company maybe hasn't raised or definitely hasn't raised a priced round, doesn't have any preferred stock outstanding.

You absolutely can use the SAFE for companies that are later stage that have already raised a priced round and issued preferred stock. In fact, some of you may have already done that, but we intended it for very early-stage startups.

A time when you may not want to use the SAFE is if you are looking at a company that has already issued convertible promissory notes to earlier investors. And if that's the case, you're gonna want to go ahead and just use that same note, not use the SAFE, and that's because it's a lot less complicated for a company to have all of its investors on the same document, and it's also more fair to have all the investors on the same footing.

So, obviously, if you find a company you want to invest in and they are actually doing a priced round, you're going to invest in that priced round and buy preferred stock. But for the vast majority of early-stage startups, they don't have a lead investor. They don't have a person setting the terms, setting the price of the round, and most times for very early-stage startups don't even know what they're doing yet.

And that's where the SAFE comes in, because for these very, very early-stage companies, they just want to raise a little bit of money from their friends, and from family, and from angels. And with the SAFE, they can do that very efficiently, very quickly, and very cheaply, because neither the investors nor the company need to get legal counsel.

Okay, the SAFE is an acronym that stands for Simple Agreement for Future Equity. As I said before, it is a convertible security; it converts into shares of the company's stock. The premise is very simple: you, the investor, give money to the startup right now, and at some point in the future, you're going to get your stock.

One of the most important things—I say this a lot—the SAFE is not a loan. It is not debt. It does not accrue interest. There is no right to be repaid at some point in the future at some maturity date. So please don't call it a SAFE note; that makes me really crabby.

Okay, what does it look like? I brought one; it's five pages long. Compare that to a set of financing documents, which is about five documents, and none of them are five pages long—they're all much longer. There are only two key terms I'm going to show you. This is what the intro paragraph of the SAFE looks like. You can see that there are two blank spaces there.

The first one is the amount of money that you're going to invest in the startup, and the second one is the valuation cap. Kirsty is going to get into detail about what the valuation cap is when she speaks next, but those are the only two things that you negotiate with the company. It is just that simple.

After the intro paragraph, there is a whole section that describes the conversion events, which we will get into in a minute. There is a section of definitions because it’s a legal document; we always have to have definitions.

And then the rest of it is boilerplate. An example: a boilerplate company makes reps and warranties to you about the status of the company. You make some representations to the company about being an accredited... and then there's a really skinny miscellaneous section at the end.

I want to point out what is not in the SAFE. For those of you who own preferred stock, have made an investment in a company, and gotten preferred stock, you will know about voting rights and information rights and liquidation rights. Those are not in the SAFE because the SAFE is not yet stock.

When your SAFE converts and you get preferred stock, you will be piggybacking on all those same rights that the lead investor in the round has negotiated for the preferred stock. So, you won't find those things in the SAFE.

So, um, what you will find in the SAFE is pro rata, and Sam conveniently defined that for some of you who don't know, who didn't know what it was before. It's the right to buy more stock in future rounds so that you maintain your percentage ownership of the company. The SAFE has a section that says that you will get those pro-rata rights in the next round—not the conversion round, but the next round.

So if your SAFE converts in a Series A preferred stock financing, that document will bake in the right for you to buy shares of this Series B financing so that you can maintain your pro rata percentage.

Okay, so, um, what I've been talking about is what we call the capped SAFE. It's the one that has the target valuation. Kirsty's gonna describe that in a lot more detail; it's the most commonly used SAFE that we have. But there are a couple of other versions of the SAFE that I'll go over briefly.

There is something called a discount SAFE. Instead of negotiating that valuation cap in the intro paragraph, you and a company will negotiate a discount rate, and the discount rate will then apply to the shares when you convert the SAFE. Typical discount rates range between ten and twenty percent.

So for example, if this Series A round that your SAFE is converting in—the lead investor has priced it at a dollar per share, and you've negotiated a 20 percent discount—your effective price is 80 cents a share. It's pretty simple.

There's also an uncapped SAFE, which—not—that's not very common to use; this has neither a target valuation nor a discount. So really, you're just converting your SAFE into the same price that the Series A is paying. There's no reward for being the early money; that's why it's a pretty unusual SAFE to have, but occasionally a company has such great demand that they can get away with serving up an uncapped SAFE.

So just be on the lookout for that. And then a third version is what we call the MFN SAFE. MFN stands for Most Favored Nation. It's a concept we borrowed from contract law, and there is no target valuation in this SAFE, but there's this MFN paragraph that says that if a subsequent investor negotiates a target valuation or a discount, you get to amend your SAFE to take the terms that that investor got.

So then your SAFE is no longer uncapped. Now, Kristin, all right, so now we're going to talk about how the SAFE converts, and we'll cover how the valuation cap works, the math behind the SAFE converting, and also how to understand your ownership.

So first of all, the valuation cap—this is one of the things that, as Caroline mentioned, is one of the things that you will negotiate with the founders, and you'll also hear it referred to not only as a valuation cap but a target valuation or just simply a cap.

The cap’s the highest valuation that your SAFE will convert at. So if the priced round is lower than the valuation cap in the SAFE, your SAFE will convert into shares at that priced round valuation.

And it's important to note that people get really confused with the cap; they think it's the current valuation of the company; that's really not what it is. All it is is a way for you to be rewarded for coming in at the earlier stage when, in theory, you're investing at a riskier stage.

It's the way to for you to get your rewards and your bonus. And so ideally what you really should be thinking is, if I'm putting money in at this cap, then what do I think the Series A price—how much higher do I think the next round price is going to be? And ideally, you want that high because then your reward is better.

Okay, so your SAFE will convert into shares when the company completes an equity financing—a priced round. And different companies—depending on the stage of the company, that priced round might be called the Series Seed, it might be a Series A, or there might be some situations where they've already raised the Series A, and there's some SAFEs bridging them to the Series B.

So it's just whatever the next priced round is, and we'll try to refer to it just as a priced round here, but sometimes it just slips in that it's a Series A, but it can be any priced round.

And in that equity financing, the company, the founders, will negotiate with a lead investor in that round and will create a term sheet that sets out their terms of that round, and those terms don't impact how your SAFE converts because that's set out in the SAFE itself.

But what it does impact is how many shares the SAFE converts into, as we'll go over in a moment. And so when the priced round closes, three things happen. And in the documents, they're all happening at the same time, but in the calculations, they actually go in order, and you'll see why in a moment.

So, first of all, an options pool is created or increased if the company already has one. And usually, the closing option pool is negotiated as part of the term sheet's negotiations. It usually is around 10% of the post-round shares, and that's kind of what makes this calculation a little bit complicated, as we'll see in a moment.

The next thing is that the SAFEs convert into shares, and although the SAFEs themselves don't state this, the term sheet will usually specify that the SAFEs convert in the pre-money. And what that basically means is that the shares that the SAFEs have converted into are considered when the price per share for the lead investor is being calculated, and again, you'll see that in an example in a moment.

And then thirdly, the new money comes, so the lead investor and anybody else who's investing in the round at that time will invest their money and buy their shares.

Okay, here comes the math. So, it's a very high level—for any investor, the number of shares that an investor will receive is the investment amount divided by a price per share. And the price per share is calculated by dividing the valuation by the shares issued by the company.

And the shares issued by the company is otherwise often or always referred to in the documents as the capitalization of the company. And so for a SAFE holder, the valuation is usually the cap, and the capitalization is usually the issued shares plus the increased options pool.

For the new investor, the valuation is the priced round valuation, and the capitalization is the issued shares, the increase in the options pool, and the shares that the SAFEs have converted into.

All right, here's an example. So, on the left over here, we have an example situation. So we have founders who have 9 million shares issued, and there's three founders in this example, and they're all sharing the shares equally. And at demo day in March, the company raises $800,000 on SAFEs, and they all have the same valuation cap—they all have an eight million dollar cap.

Then fast forward to November 2019—it can take that long, maybe even longer before a priced round happens, and they raise a priced round, which is where they raise four million dollars at a 16 million dollar pre-money valuation.

And the terms that are negotiated in the term sheet also are that the options pool will be increased to ten percent of the post-money, and the SAFEs convert in the pre-money. And I'm not going to get into the calculation of how the options pool increase number works because it gets very circular, as I'll show you in a moment, but just trust me that it's going to increase to this very not-round number of just over 1.4 million shares.

Okay, those are the details. So the first thing that happens is we've increased our options pool. The next thing that happens is that our SAFEs convert.

So the SAFE capitalization, as defined in the SAFE, is the issued shares plus the increase in the options pool. So 10.4, 10.4 three million shares—the SAFE conversion price is the valuation cap, because the cap is less than the priced round, divided by that capitalization to give a conversion price of seventy-seven cents.

So the shares that the SAFE investor buys are the $800,000 investments divided by this conversion price to give us just over 1 million shares. Everybody with me still? Okay, good.

So then the next thing that happens is our new money calculation happens. So this is the lead investor in the priced round. So this time, the capitalization doesn't include just the issued shares and the increase in the options pool; it also includes the shares that the SAFEs have converted into.

So this time we have a capitalization of eleven point four million shares, and then the price per share is calculated again using the price per share—sorry, their valuation from the term sheet—the 16 million divided by the eleven point four seven million shares to give a price per share of 139.

And so those that four million dollars from the new money investors will buy two point eight seven million shares. Okay, so bringing this all together, this is a very simple cap table—it's much prettier than cap tables normally look.

So for those of you that are not familiar with cap tables, how this works is it's just a way of explaining the ownership of the company and who owns what and in what proportions. So here you can see that we have our three founders—they own common shares; their numbers haven't changed.

The number of shares that they have stays the same. We have our increased options pool; this is where the employees will be issued shares from in the future. And then we have our SAFE investor who has their 1 million approx shares, and you have the priced round investor who has the 2.8 million shares.

And these SAFE investor and priced investor have preferred shares; founders and employees have common shares. So what you can see from here is that even though the SAFE investor has put in $800,000 of the total 4.8 million that the company raised, proportionality between these two investors, they actually have a much higher number of shares.

And that's the cap coming into play, and that's how the SAFE investor gets the reward for their early investing. So that's how that works. It also shows percentage ownership, and you can see that my math did work; our options pool is 10% of the total post-post money shares, which is the total of these two numbers.

Now, SAFE investors have quite a hard time of it because at the time that you actually sign your SAFE, you don't really know how much ownership you're going to wind up with after the priced round. And the reason for that is that even though the SAFE says how the SAFEs going to convert, it doesn't specify how many shares it's going to convert into, because that is dependent on the terms of the priced round.

And so in this example, the SAFE investor has just over 7 percent of the shares. And the way you can think about it, when you're signing your SAFE, if you're thinking about owners, it's kind of a rule of thumb of $800,000 invested at an 8 million cap gives an 8.8 million post-money valuation of the company.

So the SAFE investor would own approximately 9% of that—but that assumes that the SAFEs convert immediately on signing, and there's no new money, and that's actually never happened.

So the reason why this 7% is not 9%—is why it's less—is because the SAFEs have been diluted by the new money coming in. And just as an example, to just explain a little bit more, if the terms of the priced rounds had all been exactly the same except that the investor had only put in $2 million instead of $4 million, then the ownership here would be just over 8%.

So that just tells you exactly, you know, you really can't tell how much you're going to get until the priced round, because that's quite difficult. It's important to do your own modeling and to think about how you, you know, what scenarios could happen.

To explain your ownership going forward, there are a couple of things that we can share with you to help with that. Jeff, wherever he's gone, has written some software called AngelCalc, and that is modeling software that allows you to see various different scenarios.

And there's also going to be a spreadsheet that I'm going to put on the resources page at the investor school website so that you can see—you can play around with the calculations and you can see how SAFEs might convert in the future.

Okay, okay, so suppose you've invested in a company and before it raises a priced round, something else happens. Examples of what else could happen are that it could get acquired, it could fail, or nothing could happen. So I'm going to talk about those.

Okay, um, I think it's easiest to understand what happens in the SAFE in a merger-acquisition situation if you look at both extreme ends of the spectrum. The first one extreme end would be, you know, a home run situation. And by home run, actually, I think Sam mentioned this as well, this term—this is where an acquiring company is coming in and paying a lot of money for the startup you invested in.

So what happens to the SAFE? Well, you are going to convert it into shares of common stock. You're gonna do that by using the target valuation to determine the number of shares of common stock you get, and then you are gonna participate in the proceeds of that merger along with the founders and the other common stockholders.

In that case, you can expect a return that is well in excess of what you paid for your SAFE. This is also what would happen in an IPO, by the way; so same, same situation, same result, rather.

Okay, the other end of the spectrum is the aqua hire, and I don't know if this is a term that all of you in the room are familiar with, but this is a situation where an acquiring company is coming in and just taking the talent out of the startup that you invested in.

So, you know, founders and key employees, they are not paying money for the intellectual property or any other assets, and these are deals where there is usually very little money. In that situation, you are going to elect to have your SAFE paid off. So the SAFE gives you the option, and because, you know, most deals aren't at these two extremes of the spectrum, they're somewhere in the middle.

What you need to do when you're confronted with this situation is actually do the math and figure out how you get the best result, whether it's converting into shares of common stock and taking in merger proceeds or just getting paid back.

Okay, so sometimes a company raises money from you and other angel investors and just can't make it work. Hopefully, they try really hard, but sometimes it just doesn't happen, and they fail.

And when failure happens, companies need to go through an actual dissolution process, and part of the process requires that creditors be repaid. In a dissolution situation, they need to pay off their trade debt, which is vendors and landlords, and they obviously have to pay their salaries if there is any money left over.

The SAFE says that you are next in line, so if there's money, the SAFE holders and any other investors will get paid back. Often it's pennies on the dollar, but they get something before stockholders get anything.

And honestly, in a dissolution situation, not only is there never any money for stockholders, but there's rarely enough to pay back investors either. This is usually just a total failure, and you know you can expect this to happen some of the time.

What happens if nothing happens? This would be a situation where the company has raised angel and, you know, raised from angels and actually become self-sustaining, you know, profitable, and they just putter along, and suddenly they have no desire to raise a priced round, and nobody's knocking at their door to require them.

So what happens? Well, the SAFE doesn't address this, and there's a reason why the SAFE doesn't address this situation. Number one, when you try to draft for all these corner cases, it stops being a simple document; it becomes a very complicated document and a very long document.

And number two, this just doesn't happen very often. In high-growth world, this is extremely rare. But if you want to fund lifestyle companies, you definitely do not want to use the SAFE because then you're going to have this problem all the time.

If you have accidentally funded a lifestyle company, I think our advice would be to go talk to the founders about it because hopefully you invested in really good people, and they would want to do right by you and figure out how to make you whole.

That kind of goes back to Sam's point about being really careful about the founders you choose to put your money into. Oh, Curtis is going to talk about process.

Okay, so we've talked about what SAFEs are and how they convert, but now let's talk about the process for actually signing the SAFE and then also for converting it into the shares.

The first thing in this process is the handshake protocol, and the reason why we created this is to help to avoid misunderstandings. Founders are, by nature, very optimistic, and we've seen many situations where the investors said something like, "Yeah, I'm interested," meaning I'm interested in finding out more about the company, and the founder hears this as, "I'm going to invest in your company."

Q: Lots of misunderstandings and confusion.

So the handshake protocol is just simply a set of emails that sets out in writing the key terms and makes sure that everybody is in agreement. So the founder sends an email to the investor and says, "Just confirming that you're in for X dollars at Y cap," and then you reply to the email to confirm.

At this point, there's a handshake deal, and it's considered bad practice at this point to back out, and again, reputation is everything in this world, so you know you don't want to be doing things like backing out because it can harm your reputation, and on the flip side, the founders are under no obligation to take your money until that handshake deal is completed.

So especially in a hot deal where there are loads of people trying to get in, you want to run through the handshake deal process so that you know that you're actually going to be able to get into the round. You can read more on this on our website as well; there are slightly more detailed blog posts about it, but those are the key points.

Most YC founders will use Clerke to send and sign SAFEs, and this is an online platform that uses the standard YC SAFE in a template form, and then the founders add the specific details for your investment into that template.

You'll receive a signature request through Clerke where you can review the details either in summary form or the full SAFE itself, and you can sign the documents, so you don't need to do it all in person.

The founders will also include wire details at that point so you have those handy. As soon as you've signed, sometimes the founders might use other platforms, and especially non-YC founders, there's lots of options out there—HelloSign is another signing platform similar to DocuSign—or simply they might just download them from our website, which is this link, and send them to you in an email to sign and send that way.

All of those work; it's just preference. So when you receive a signature request through Clerke or whatever other means, you should check that the details in there are what you previously agreed to.

In addition, you should check that the name and signature block on the SAFE is correct, particularly if you're investing through a trust or through a fund or you've created an LLC. The founders won't always know the legal name if you haven't set that out specifically for them.

So you should make sure that those details are correct before you sign the SAFE. Don't sign the SAFE and then tell the founders it needs changing. And you should be ready to wire the money as soon as you sign the SAFE; the SAFE isn't valid until the money is wired.

And one of the things that when we ask founders what makes a good investor, one of the things that comes up a lot is that the investors sign and wire the money quickly. You know, it's important to the founders that they raise their money and get back to work, and so investors that delay the process or that say that they want to invest and then say to the founders, "Oh, but hang on because I just need to close my fund," or "I'm just...this company is nearly exited, and I'm just waiting for the transaction to happen so I can get some money."

Really, if those—if that's the situation, you should probably not be talking to founders about investing in their company until you actually have that money available.

Now when your SAFEs convert in the priced round, you'll be asked to sign more documents, and these documents will be the same documents that the lead investor has signed and will have been negotiated by the lead investors and their legal team and the company's legal team, and you'll receive an email from either the founders or their lawyers asking you to sign some documents.

You may at this point need to ask them to send you the conversion calculations, otherwise known as a pro forma cap table, so that you can actually confirm how many shares your SAFEs are converting into and see your post-money ownership.

You should definitely make sure to review the cap tables; we see—and we've now seen thousands of cap tables—it's surprising how many times the lawyers actually get the conversions wrong. So I really strongly recommend that you do review those cap tables and you make sure that you are happy with the calculations for how your SAFEs convert.

And now, sadly, you might not actually have much time to review these documents and to review the cap table. You know that the founders will be focusing on the lead investor; they'll be negotiating with the lead investor, and they'll have set a closing date, and then they'll suddenly send you an email out of the blue saying, "We need to close tomorrow. Here are the documents you have to sign."

And yes, you want to be a good citizen and you don't want to hold up the closing, but also, you know, this is your investment, and you need to make sure that you're happy and that you reviewed the documents and that you, you know, accept the terms in there. So don't sign until you are happy with those documents.

All right, okay. So as I mentioned, Sam kind of already said some of this stuff, but I'll just reiterate because these are really important points.

The first piece of advice—and this is what we meant about thinking about the upside—is this is just Sam's power-law point. If you believe in the power law and you invest that way, you mean then what you're not gonna do is waste time negotiating downside protection, because what you've realized is that eking out a one and a half x return on all these little investments is not worth it when you have the mindset that you're funding the next Google, and that's going to be your, you know, 100x return.

The next point you wanted to make is be helpful. And Sam also touched on this a lot. Be helpful when the founders ask. Sometimes angels write checks and they completely disappear, and sometimes angels write really, really small checks and then they pester the heck out of founders forever.

Don't do that. Figure out—be the kind of angel that just gives the right amount of help. Sometimes angels think that they need to ask to be on the board of directors in order to be officially helpful, and you don't.

And please don't, because it's actually not something the founders probably want. Sometimes—I mean, there's exceptions—but usually, they don't want early investors on their board of directors. And lastly, tolerate failure.

I think that all the other speakers in this course are going to talk about this a lot. I think it's really easy to get buyer's remorse when a company really starts to struggle, and I think that gets even worse when the founders decide to pivot.

But you should expect and prepare for pivots and remember the SAFE is not a loan. You can't go running in there and ask for your money back just because the founders start doing something different. You need to tolerate that, and you need to be supportive, and you need to give the founder a chance.

Okay, so in conclusion, we have covered quite a lot here, and SAFEs—although on first glance look simple—can get quite complex. So if there's anything to take away from this, these are the key points:

Use the SAFE to invest; it's the fastest and easiest method. Understand your rights as a SAFE holder at the point of conversion—I cannot stress this enough—but understand your ownership and understand where that comes from.

And finally, be patient. You know, this is a long game; you're going to be with the company through highs and lows, and you need to see it out. So good luck to you all! I hope you all make lots of great investments, and I think we have some time for some questions.

You want to take questions?

So the question is, how do you make sure that you are fully rewarded? Is that what you were saying? Okay, so...and the vulnerability of the cap to the subsequent money.

So, you know, the numbers we're talking about here are an eight million dollar cap and a 60 million dollar Series A pre-money valuation. If you're invested in the next Google, you're going to exit at thirty billion dollars or whatever the number is. So whether your cap is eight million and the Series A is 16 million, or whether your cap is 10 million and the Series A is 14 million, there is still a huge amount of upside there.

So, and that's—and that's where you need to think; you're still going to get that upside because you still have that ownership from having that early valuation investment. And also, you need to remember, you do have pro-rata rights, and remember Sam made the point that you need to exercise those because yes, you are gonna get really, really, really diluted because you're the early money.

But if you can't afford it and you can keep putting more money in, then when you have that liquidity event, you should recognize all that upside.

I think the question was directed towards the SAFE itself as potentially vulnerable, and I don't see that, I think that that's a misunderstanding of the way convertibles—convertible debt or a SAFE—actually converted to shares of stock.

And again, as they said, I will hearken back to Sam's idea that it won't matter in the end whether you invest in a SAFE, a convertible note, or equity. If you invested in Airbnb at ten, fifteen, twenty, or thirty million dollars, you'll still have the sort of returns that the Daurio saw with, if you invest seventy million dollars—you can do the math—do the math of investing seventy thousand dollars in a company that becomes worth ten, twenty, or thirty billion dollars at a valuation of ten or twenty million, and it will be stunning.

So the question was, who controls how much money the founders raised on SAFEs, and what do you do as an investor if you sign a SAFE with, let's say, an eight million dollar cap today, and then the founder comes and raises and signs another SAFE with another investor tomorrow at a five million dollar cap?

So the first part of the question—the founders decide how much they're going to raise on the SAFEs, and you know the advice that we give to the founders is to be very thoughtful about how much you actually raise on the SAFE because you are selling the company—you know, you're selling part of the company.

And so we counsel them to be very careful about dilution and to really think about that. So whilst the investor doesn't have a huge amount to say in that, the founders are thinking about how to make that work for them.

The second part of the question is about the cap, and it's pretty unlikely that you will sign a SAFE with a valuation cap of 8 million let's say, and then the next day they'll sign a cap with 5 million. Usually, like Sam and Jeff have mentioned, there is some element of herd mentality going on in investing. So, if an 8 million cap works for other investors, then the next investor is likely to take that as well.

Maybe the situations where sometime further down the road, they might raise money with a slightly lower cap, and it’s really circumstance dependent at that point. You know, there's nothing written into the documents to protect you from that unless you have the MFN provision in there.

But you know, again, we advise founders to treat people fairly, and you know, if things have changed or something's happened, then see what they can do to help their investors. We see this happen all the time.

Oh, did everyone hear that question? Ooh. Oh, for the low, right? Okay, so what happens when the lead investor in the state—let's say you have a SAFE and it's converting into a Series A round, and the lead investor is not respecting the rights in the SAFE—for example, the pro-rata right?

You need to fight back on this. We see this happen all the time. We advocate—we tell our founders all the time—you do not get to ignore the rights in the SAFE; this is a contractual right. You're breaching the contract if you do not give the SAFE holders their pro-rata right.

This goes back to something [unclear] said—it kind of sucks when they only give you 24 hours to read these documents because you should immediately be going through and making sure that they did give you these rights right.

And you should also be checking the cap table to make sure that they converted your SAFE correctly. But so the answer to the question in short is: find it, notice it, tell them that's not okay, push back on it, make them honor their contract.

And oftentimes, it's actually the lawyers who are trying to make this more streamlined, and the founders either don't know it's happening or they haven't really registered. And so if you go and say to the founders, "Hey look, I have pro-rata rights here," then they'll be pretty willing to make that change in the documents.

Their reputation matters too, by the way—not just yours. So if they screw you over and don't give you the right that you had, that reflects poorly on them as well.

So the question was, should we consider investing as an LLC or as an individual for tax considerations and various other things? Well, if you're immersed in an LLC, they're pass-through entities anyway, so the taxes would still roll up into your personal tax returns, and usually it just depends on circumstances.

You know, if you're investing your own money, it usually makes sense to just invest directly, or if you have a trust, to be able to do it through that. If you start to be pooling money together, either amongst a number of investors or using other people's money to invest, then it makes more sense to create an LLC or some kind of fund structure.

Okay, so the question is why is there no pro-rata in the conversion round, and is there a way to get it if you want it? So the reason that we didn't put pro-rata in the conversion round is because back at the time that we drafted the SAFE—this goes back to about 2013—seed rounds looked a little different.

There was usually a shorter time in between the seed and the Series A. Things have changed a lot in the last couple of years, and so we are actually thinking about, well, maybe we need to rejigger things; maybe it should look different.

Because the timing is now very different. But in the interim, what a lot of angel investors do is they do just like you said—they sign a side letter, and they say that they give themselves—negotiate with the company for a side letter to give themselves a pro-rata right, to not only have their SAFE convert into series A, but then to purchase more shares on top of the conversion shares at the lead investor price.

So that does happen. Well, you got it. I mean, if that works better for you, then you should continue to use it because it's just all about your investment strategy and sort of your approach to it.

I think in this class you're going to hear a lot about the approach that Sam described, and for those kinds of investments, we think the SAFE works really well. But obviously, you're all going to have different strategies, and you need to use whatever instrument works best with your strategy.

So the question was, do you need a PPM, a private placement memorandum, to do a SAFE? And the answer is emphatically no; you don't even need a term sheet to do the SAFE. You don't even need a PPM these days to do priced rounds; nobody really does those anymore.

A SAFE is just one document; that's all you need. For priced rounds, it's usually just a term sheet; that's all you need. So I don't—I haven't seen a PPM in years; that's the answer to that.

And then the second question was, do SAFEs work around the world? And in general, the answer is yes. But there are some situations where they don't necessarily work. I know that we've heard some companies in India aren't able to use SAFEs, so I think it depends on who the investor is—they have to be on a certain list—and also I think in the UK they've sort of rejiggered the SAFE a little bit to make it so that it works better for the Enterprise Investment Scheme relief that's available over there.

But it's—you know, if you are investing in other countries and you're investing in companies in other countries, then you should do your homework to make sure that it actually is a valid document in that country.

So the question is, sometimes this question has had SAFEs that don't converse in the pre-money. How common is that? Well, so first of all, it's getting less and less common that the SAFEs convert at the same time as the round.

Series A lead investors are getting more clever about this and realizing that if the SAFEs convert in the pre-money, then the lead investors are getting less dilution. And really all that's happening is, if the SAFEs do convert in the round, they'll just massage the valuations to still get to the same place, which is usually around 20% of the company post-Series A.

There was a second part to that question—I will say that that exact point is exactly what this gentleman was saying about pro-rata, because that is more of a trend that we're seeing that sort of argues for going ahead and having the SAFEs also have a pro-rata in the conversion round.

So these things are all tied together, and again I'll just go back—you said the primer doesn't do the math that way. Again, 2013, when it was tough—things looked a little different and they've evolved. And so we are definitely talking about evolving the SAFE in certain ways.

And just to reiterate, the SAFE itself doesn't mention this. It doesn't mention that it will be in the pre-money or it will be in the round. All the SAFE says is how do you define the capitalization to work out your conversion price for the SAFE itself.

Yeah, yeah. So the point there was that founders don't understand this either, and that's absolutely right. And you know, again, one of the things that I spend hours and hours with founders as they're raising money at Demo Day and beyond is explaining to them how this works and how to think about dilution and how to understand what converting in the pre-money means and all these different terms.

And you know, at the end of the day, it's one of those things that there's only so much we can do, and if the founders don't want to understand it, then you know, there isn't a lot there that we can do for them.

There are so many resources, though. So maybe, you know, maybe everybody just needs to go to these resources. If you do the math and you do the pro-rata and start out the provider—the pro forma cap table—and everyone agrees on what that looks like, it is so much better.

It just—everyone just needs to take the time to model it out; it eliminates so much confusion if you take the time to do that.

Okay, the question is, is there case law around investor liability when you're investing as an individual rather than through a legal entity? There is tons of case law regarding stockholder non-liability for poor, bad things that the corporation does. If the stockholders aren't liable, then certainly if you go even further out the circle, and you just have people have put money in for exchange for a convertible security, there's not—it's not a problem. So you're fine, if I understand your question correctly.

Okay, so the question is, what's the optimal legal structure for the startup? So for YC, we invest in mainly Delaware C corps. For you signing SAFEs, you'll probably want to make sure that the companies are C corps.

It doesn't matter if they're in Delaware or if they've incorporated in California or wherever else it might be. Obviously, if you're investing in foreign companies, then you'll need to do a little bit more homework because we don't necessarily know what the—how all the structures work in all the different countries.

We have seen some investments where people have invested into LLCs, but we don't really understand how that happens, so I would recommend that you stick with C corps. High-growth companies are not LLCs.

Our MFN standard and SAFE? No, they are in the SAFE; the Most Favored Nation that I discussed sort of in the middle of the presentation—those are not standard; those go along with the—those are part of the SAFE that doesn't have a cap.

So what this person maybe asked me is can I get—can I negotiate a target valuation or a discount rate with a company and also have an MFN so that if someone gets something better I can amend my SAFE after the fact and get that better term?

It's kind of like what your question was; what happens if I do eight million and next another angel does five million? Can I get the benefit? We don't have that flavor of SAFE because I kind of feel like you make a bargain; you live with it, right?

You get the best bargain you can get, the two of you, and then that's what you live with. So we don't—we don't have that flavor of SAFE up on our website. You can drop an MFN into the SAFE if that's what you and the company agree is fair, so it's possible you could just cut and paste that paragraph right into a capped or a discount SAFE if you want to.

I wouldn't—I would counsel founders that it's probably not the right way to go, but you could try it. Just a couple of quick things and then we're done for today.

So SAFEs are weird and convertibles are weird. I have done over a hundred investments, and I decided—not all SAFEs, but mostly in convertibles—and I decided I better figure out what happens when they convert. I realized I had very little ideas.

Someone back there pointed out that both investors and founders get really confused—as Carolyn said, there's a lot of tools now. I actually built a tool called AngelCalc that's open and available. It lets you very simply and quickly model what a SAFE conversion looks like.

Because it's worse than just the fact of weather. And by the way, Angel always assumes it's in the pre-money because it's always in the pre-money now—almost always.

And if it's not, I can't remember; I may have built something in to allow you to do it if it's not in the pre-money, but it almost always is. And they're pre-money, but it's much worse if there's multiple SAFEs with multiple valuations, multiple different discounts—which is often not uncommon now.

So as Carolyn said, the best thing to do is to model this—to see what it really looks like to work with the founders. Remember that the question is to, you know, what do you do if later investors try to screw you?

I actually wrote a post about this called "Transparency in Startup Investing" and I think what you ought to do is you ought to ask for anything that you should actually provide a form that you can send to the founder and say, or to the entire team sending you the update that says, "Hey, are any of my rights changed from my document?"

And if they are, then you should have a conversation—not with the lawyer—not with the VC, with the founder who you know. Remember, has a relationship with you I hope you are the first best investor—the person who believed in them before the rest.

It's going to be hard for them to look you in the eye and say "screw you" I took away your pro-rata. Again, I think you need to be careful with these; you don't want to screw up their deal.

And you want to be a great investor, but it is fair, and they have the power in almost every case—almost every case—to go back to their investors and to the lawyers and say, "Why are you doing this? You know, Kirsti is the best investor I've had. How are you taking away from my pro-rata?"

The other thing I'll say about lifestyle companies and why I think the SAFE is preferred in general to debt is because we've seen too many times where the fact that there's debt there is used to kill a company that didn't have to die.

And it's too easy for investors to call that debt when it's not payable, and we tend to be on founder sides—that might sound weird as investors—but it turns out that if you end up on the founder's side more often than not, then your probability of getting in the one company that will make all those other investments irrelevant is much higher.

We're done today. Tomorrow, we are going to be kicked off by Dalton Caldwell talking a lot about founder meetings, which is going to be a great session I think. And then after that, we have two amazing presenters—Paul Buchheit is going to talk about in his sort of epic investing career what he's learned, and I'm gonna have a brief conversation with Michael Seibel, the CEO of Y Combinator.

Thank you all very much for coming or live-streaming, and we'll see you tomorrow!