Convertible and SAFE Notes

Angel/seed rounds used to be done via priced equity securities, either common or preferred. Then, starting about ten years ago, we started to see convertible debt being used in the angel and seed rounds. By 2010 this was the norm and Paul Graham tweeted this in Aug 2010:

Which led me to write this blog post here on AVC. I was not a fan of convertible notes then and I am not a fan of them now. USV has done a number of convertible and SAFE notes since then. I would guess that we have done a dozen or more of them in seed and angel rounds we have participated in. We are not opposed to convertible and SAFE notes and will not let the form of security the founder wants to use get between us and investing in a company that we like.

But I continue to think that convertible and SAFE notes are not in the best interests of the founder(s).

Here is why:

  1. They defer the issue of valuation and, more importantly, dilution, until a later date. I think dilution is way too important of an issue to defer, for even a second.
  2. They obfuscate the amount of dilution the founder(s) is taking. I think many investors actually like this. I do not. I believe a founding team should know exactly how much of the company they own at every second of the journey. Notes hide this from them, particularly the less sophisticated founders.
  3. They can build up, like a house of cards, on top of each other and then come crashing down on the founder(s) at some point when a priced round actually happens. This is the worst thing about notes and doing more than one is almost always a problem in the making.
  4. They put the founder in the difficult position of promising an amount of ownership to an angel/seed investor that they cannot actually deliver down the round when the notes convert. I cannot tell you how many angry pissed off angel investors I have had to talk off the ledge when we are leading a priced round and they see the cap table and they own a LOT less than they thought they did. And they blame the founder(s) or us for it and it is honestly not anyone’s fault other than the harebrained structure (notes) they used to finance their company.

The Series A focused VC firms that often lead the first priced rounds get to see this nightmare fold out all the time. The company has been around for a few years and has financed itself along the way with all sorts of various notes at various caps (or no cap) and finally the whole fucking mess is resolved and nobody owns anywhere near as much as they had thought. Sometimes we get blamed for leading such a dilutive round, but I don’t care so much about that, I care about the fact that we are allowing these young companies to finance themselves in a way that allows such a thing to happen.

Here are some suggestions for the entire angel/seed sector (founders, angel investors, seed investors, lawyers):

  1. Do priced equity rounds instead of notes. As I wrote seven years ago, the cost of doing a simple seed equity deal has come way down. It can easily be done for less than $5k in a few days and we do that quite often.
  2. The first convertible or SAFE note issued in a company should have a cap on the total amount of notes than can be issued. A number like $1mm or max $2mm sounds right to me.
  3. Don’t do multiple rounds of notes with multiple caps. It always ends badly for everyone, including the founder.
  4. Founders should insist that their lawyers publish, to them and the angel/seed investors, a “pro-forma” cap table at the closing of the note that shows how much of the company each of them would own if the note converted immediately at different prices. This “pro-forma” cap table should be updated each and every time another note is isssued. Most importantly, we cannot and should not continue to allow founders to issue notes to investors and not understand how much dilution they are taking on each time they do it. This is WRONG.

Honestly, I wish the whole scourge of notes would go away and we could go back to the way things were done for the first twenty years I was in the venture capital business. I think it would be a better thing for everyone. But if we can’t put the genie back in the bottle, we can at least bottle it up a bit better. Because it is causing a lot of problems for everyone.

#VC & Technology

Comments (Archived):

  1. JimHirshfield

    Was the cost of an equity round the main driver of this trend to convertibles 10 years ago? Or was it that convertibles kicked the can down the road on the hard negotiation of valuation?

    1. fredwilson

      I think it was YC deciding that notes were better and pushing for them

      1. LE

        So the obvious question then is why did YC ‘decide’ and advocate for that.

        1. MacLane Wilkison

          Because of the rolling close and avoiding long negotiations over anything other than cap/discount.

          1. LE

            and avoiding long negotiationsOk. But playing advocate on behalf of the other point of view is it possible that that is the case simply because of the number of deals that YC is handling at any given time? Which is vastly more than a VC like USV. So while it may be couched as ‘better for the entrepreneur to avoid long negotations’ I read it as ‘better for YC and suits their particular purpose’. [1] I am not even saying that to imply there is something wrong that they are doing it (more power to them). Just that what is bothersome to YC is not necessarily better for the entrepreneur (although it could be).[1] For example what is time effective and makes sense for a parent with 10 children is not the same as a parent with 2 children all else equal.

          2. MacLane Wilkison

            There’s no cost to an investor who spends endless time negotiating terms. There is a massive cost to the founders and the company.

          3. LE

            An investors time has value. What you are saying is the same as someone who thinks that an attorney who files a lawsuit on his own behalf has no costs because he is not paying for his own time. There is to mention, as only one variable, the concept of opportunity cost. As someone who gets paid to negotiate on others behalf I can assure you that negotiating takes up valuable time that could be spent on other things. It is most definitely not ‘no cost’ or even close. I can back that up with proof of deals that have stretched to over 300 emails back and forth not to mention texts and phone conversations.

        2. Jan Sessenhausen

          Always thought the simple reality of players like YC (or other players with early equity in companies) was the simple reduction of legal work and thus costs shortly after own invest, fast path to close financings where an investor might do something out of emotion (e.g. after a demo day) and especially the postponing of an own decision whether to pick up pro-rata ….

          1. LE

            fast path to close financings where an investor might do something out of emotion (e.g. after a demo day)Key and good point. Time kills all deals. Don’t give anyone time to think.

        3. Antone Johnson

          Paul Graham’s vintage post on “high-resolution financing” gives one answer. It’s certainly not unique to YC. As an early stage startup lawyer I’ve lost count of the number of times a founder has come to me (e.g., after a demo day) and said something along the lines of “I met with X and they’re ready to write a check NOW for $50K. What paperwork do I need to take it?”What are the options? It would be nuts to try to use that as the basis to value a priced equity round (even Series Seed). It would be reckless to tell the entrepreneur to hang tight, try to get a few more committed and then seek a fair valuation based on what a lead investor dictates or consensus among the group (aka “herding cats”). As we all know, that initial offer could evaporate tomorrow unless the wire has already hit the startup’s bank account. The founder has a business to build, has to keep the lights on, and turning down investment capital in hand TODAY is simply not an option.Until another option exists to take investment capital immediately, ad hoc, on multiple occasions within a period of a few weeks or months, often on slightly varying terms (“high-resolution”), with minimal legal expense and complexity, it’s hard to imagine living without convertible notes or similar instruments like SAFEs.

  2. Eric Friedman

    I think eShares has done a great job of solving the founder view problem through transparent and easy to read cap tables and vesting. I am more cautious of lawyer cap table views as they are accurate but harder to read.

    1. David Haber

      <3 eShares.


    We use notes where I work and I am usually (99% of the time) not a fan of them for these very reasons. Without advance explanation they can often be confusing. I’ve seen entrepreneurs “sweeten” the notes by attaching warrants, but that can often confuse investors even more.

  4. Charlie Locke

    The concept that these instruments are not in best interest of the founder(s) is the foundation of the article. The problem is, all the points don’t actually support that argument.If this is just a whine fest for VC’s and angels, then fine. In the meantime, founders will always seek the path of least resistance to capital. But don’t call a negotiation with a VC (that does them all day) on valuation with a possibly pre-revenue company, something that’s in the best interest of the founder. Founders feel like they will always lose that battle – which is why convertibles are a great alternative.

    1. fredwilson

      Did you read #1 through #4 in my post? All of those points support the argument that notes are not in the best interests of the founder.And this is not a VC whine fest. We are happy to buy notesWhat we are not happy doing is fucking over founders and that is what is happening way too often with notes

      1. Keith Teare

        Fred, I think there is a more interesting post in this. What has led to it being normal that startups do several pre-institutional rounds (I see 1,2, even 4 rounds done before an A). A lot has to do with the almost 10x growth in number of funded startups per year between 2005 and 2016, and the channels they come through (Accelerators, Incubators, Angel Groups, Micro-Funds). More. has to do with the wholesale abandonment of true Venture investing (Series A and B) and its replacement by post-traction growth investing (hence seed has to last longer). The move away from risk on Sandhill Road and its replacement by multiple seed stage providers who give more companies less each means we have moved to a short-term traction based investing paradigm. Long term thinking and funding are scarce. The instruments used for multiple seed rounds are one thing. The very existence of these is another, connected, variable. I’m with you on transparency and clarity. But I think there is a bigger problem here that impacts innovation itself.

        1. ShanaC

          why is that happening

  5. Guy Friedman

    Has there been a large difference in returns between priced vs convertible seed rounds in your fund? I always find it odd when the argument is “founders/investors don’t understand the dilution.” I think most actually do the math and make a conscious choice.

    1. fredwilson

      No. The economics to us are similar. It’s the founders who are getting screwed by then

  6. David Haber

    Agree with all of this. To me, pricing our seed round for Bond Street was particularly important as we had a few friends and family involved, in addition to institutional investors. It felt important to be able to say that you’re going to be investing X and owning Y of the company. Same goes with building your early team. These are critical hires who should fully understand their economic interest and upside potential in the company.Another thing that was out of favor with founders for a while was the idea of not having an outside board member in the seed. I’ve had the opposite experience. Having someone lead the seed (vs. a party round) who has a real economic interest in seeing the company be successful, and who gives their guidance and counsel on a consistent basis, has been a huge benefit to the trajectory of our company. It also created a sense of discipline and a good cadence to track progress for my co-founder and I as first time founders..02 from the other side of the table :).

    1. fredwilson

      You bring up the employees which I left out of this post and should not have. They are such an important part of the equation. Thanks for bringing them up

  7. Owen

    What do you think about very early funding, say the first $100k, $200k, or $500k. Where a rolling close is desired? Should you price for every $25k? Or should the founder stop working on the product until they raise their angel round of $XXX in order to get going?

  8. Jeff Hohner

    Founders who eventually become indentured servants through dilution will most certainly never be happy – let alone early investors. Knowing where one stands wrt to their ownership stake at all times – from the beginning and all through the journey to exit (and being able to properly track implications at each funding round) seems so fundamental and obviously so important for both founder and investor, but it seems to have gone by the wayside. As easy as convertible debt seems to be to move things faster along (add in any cap or extra term you want), I totally agree with you that priced equity is the way to go, and everyone should try to work their way back home.

  9. Richard

    Motivation – make the conversion rate a function of the conversion prices

  10. LE

    And they blame the founder(s) or us for it and it is honestly not anyone’s fault other than the hairbrained structure (notes) they used to finance their company.Well no it’s their fault for not having enough experience to understand that this can and does happen. The only question is whether it’s anyone else’s responsibility or moral obligation to point it out to them. If you want a guarantee, buy a toaster.

  11. Frank W. Miller

    You’ll have to let me rant here. I have a thing about convertible debt, having been on the receiving side of it a couple of times. I really can’t think of anything that demonstrates how VCs are trying to stick it to entrepreneurs.If the company fails, it doesn’t matter, equity or debt isnt going to matter. But if the company succeeds, the VCs just take that little extra slice of the profit away by taking the interest while it was debt, then converting to equity when it becomes apparent that the company is going to increase in value. Ballless. Gutless. If you want to make an investment, either given em a loan if you’re not sure whats going to happen or just make an equity investment and skip the pickpocket thing.What really kills me is that this dynamic is well known by everybody. Yet the entrepreneurs continue to take them, because they have no choice. What greater proof do you need of silly lopsided power relationship between VCs and entrepreneurs.So Paul Graham has stuck it to every one of the companys in his current class. What that tells me is his class isn’t very good because he doesn’t have the chutzpah to make simple equity investments in them. I’d look doubly close before piling on any of these companies.

    1. LE

      Ballless. Gutless. If you want to make and investment, either given em a loan if you’re not sure whats going to happen or just make an equity investment and skip the pickpocket thing.Not a VC or investor myself. But don’t agree with the constant attitude of how awful behavior like this is at all. Nobody is forcing any startup to accept any terms. It’s a negotiation. This isn’t big steel meeting in the Poconos to set price and terms of sales illegally.As Iococca used to say ‘if you can find a better car, buy it’….

      1. Frank W. Miller

        Of course they are. The company has no leverage when this occurs. Even if the company is doing alright, the VCs will come in and seize on the slightest little potential for badness and valuations drop and the entrepreneur that probably has a payroll to meet has no choice. The VCs recognize this and pounce with their little uppers that won’t show up until later on. This is exactly the problem I’m pointing out. VC is not a marketplace, its a oligarchy. Wake up.

        1. LE

          Wake up.Actually, as you describe it, exactly the work I’d like to do for a living. But in all seriousness coming from a business where I’ve had to collect bad debts from deadbeat accounts (where the money mattered to me personally….including having a gun pointed at me one time) I simply don’t have much sympathy at all. It’s business and one of the risks of doing anything that you don’t fully understand where the other party has more knowledge or power is exactly this type of thing happening.

  12. Arik R

    Future founder here. Can you give an hypothetical example with numbers? Your post makes me cautious, and so I’d love to get an example that allows me to contextualize it and really see/feel what the problem would look like.

    1. kevando

      I always asked for these kind of scenarios and never got them. I always thought I just didn’t know something, but I guess there’s possibly more to it.PS, I love your disqus photo. It’s from that LSD experiment right?

      1. fredwilson

        It’s work to produce examples. That’s why I didn’t do it.

        1. kevando

          Thanks for sharing Mark’s post. Sorry if I came across talking about your blog. In my previous startup, I always asked my co-founder and our investors to describe our funding in terms of scenarios and they never did.

        1. Ryan Lackey

          This was solved in the SAFE by the shadow preferred stock to eliminate liquidity preference overhang. The downside is it creates a new class of preferred stock. If the economics are “normal” such that there isn’t much overhang it may be worth converting to the regular preferred stock.As a founder I solidly prefer SAFE for early round. Being able to issue regular founder shares the the earliest employees makes up for all the rest of these issues. (I’m not 100% convinced on the high resolution financing idea with a rolling close.)The other big benefit — most of the bad economics from SAFEs in multiple non-increasing-cap raises come from what would have been equity down rounds or the company just not raising money and thus dying otherwise. Some unforeseen dilution is better than some unforeseen death.

  13. Tommy

    One thing to always remember when reading advice like this (which is excellent advice of course): “don’t do multiple notes with multiple caps” – unless you have to.Sometimes you have to. Rule #1 is always “do what you have to do unless it’s unethical”.

  14. Richard Gray

    I am a Founder of a start-up just emerging from stealth. We are issuing SAFEs to F&F plus the odd Angel with a $1.7m ceiling on the valuation at completion of a Preferred round. We are pre-data so off the radar of most VC. Given that, we are a high risk investment. I want our first investors to be the right side of the next round. I think the valuation ceiling achieves that. I took the valuation by taking an average of what a number of incubators//accelerators would give to their incumbents. This felt right as we have MVP, small Team and are ready for pilot program.Given our particular circumstances, Where have we made an error, for us Founders or our new investors? What am I missing? Thanks for candid advice.

    1. Frank W. Miller

      Please try to say no when they offer this to you. It will be hard cuz they’ll probably hold the company over your head to get what they want. Try to be strong.

    2. Ugo

      Long time reader, first time commenter. Love this blog!Richard, thanks for taking the time to describe your situation. I’m in a very similar situation myself and I too would like to hear thoughts as to why the ‘SAFE note to F/F with a valuation cap’ might be problematic in the future. Thanks!

      1. ShanaC


  15. Jeff Gray

    I agree with your position in general, and with your specific recommendations if these instruments are going to be used. That said, there are some very good business reasons to use a notes vs. a priced equity round, most notably speed. Good thoughts and comments all around though.

  16. Rob Underwood

    Founders should insist that their lawyers publish, to them and the angel/seed investors, a “pro-forma” cap table at the closing of the note that shows how much of the company each of them would own if the note converted immediately at different pricesWhat’s noteworthy is that this is really a very basic task that should not take much time and effort. I have done this for clients using our host’s basic Google sheets model referenced here,…, in a matter of a couple hours. Maintaining good cap table hygiene from day 1 pays lots of good dividends down the road.The post also for some reason brought to mind my idea for a Kickstarter to produce t-shirts that say “I gave money on Kickstarter to help fund some guy’s startup and all I got was this lousy t-shirt.”

  17. Ryan Feit

    I agree that convertible notes can be problematic depending on how they are structured. The biggest issue with convertible notes by far is driven by the emergence of uncapped SAFE Notes over the past few years. These uncapped notes (especially when coupled with no maturity date and/or no discount or interest) simply do not reward early-stage investors for the large investment risk they are taking. Why are these dangerous for investors? Simple example below:Uncapped Convertible Note Example:Joe and 20 other people collectively invest $1 million into Rick’s startup Placebook.Instead of negotiating the valuation (which would be somewhere between a $3-5 million valuation) they invest in an uncapped convertible note with a 20% discount to the valuation at the next round of financing.18 months later, after significant growth, Placebook raises a small round from venture capitalists at a $100 million pre-money valuation.Outcome: Joe and the other 20 investors’ convertible note will convert at a 20% discount to the $100 million valuation (i.e. at an $80 million valuation). As a result, they will own just 1.25% of Placebook.Capped Convertible Note Example:Joe and 20 other people collectively invest the same $1 million into Rick’s startup Placebook.But this time, they invest in a note with a $5 million valuation cap which dictates the maximum valuation they will receive when the note converts. The cap is critical in an upside case as you will see below.Placebook once again raises a small round from venture capitalists at a $100 million pre-money valuation 18 months down the line.Outcome: Joe and the other 20 investors’ convertible note will convert at the maximum valuation of $5 million. As a result, they will own 20% of Placebook instead of 1.25%!Although this is purposely an extreme example, it illustrates the danger of investing in an uncapped SAFE Note. Furthermore, when there is no maturity, discount and interest, this same thing could actually occur years after the initial investment and the angel investors get no additional compensation for taking substantially more risk.

    1. jason wright

      SAFE = simple agreement (for) future equitySounds so benign, so simple, so…’safe’.SHARKS.

    2. Rob Hunter

      Is anyone actually raising money on an uncapped SAFE? I know 200+ founders who have raised on the SAFE and every single one of them had a cap.

      1. Ryan Feit

        Unfortunately yes. We have around 500 startups apply to raise capital on SeedInvest each month and have had to reject or restructure our fair share of deals with uncapped SAFE notes.

        1. Rob Hunter

          Yeah, now that’s just stupid. I’m surprised to hear it! Uncapped anything is definitely a problem.

          1. Ryan Feit

            Yep same page Rob

    3. Leroy BigFish Yue

      Hi Ryan, a very clear illustration. But if they can agree on a cap of 5m, why wouldn’t they just do an equity deal at 5m to save all the mathematical confusion? In the beginning, the Note was invented to avoid the valuation argument. It seems to me that now we change the argument to the (valuation) Cap. The discount will only be meaningful when the priced round is lower than the Cap, which in essence means a down round – a big failure on the part of the founder, in which case everyone will be unhappy anyways. I am having difficulty explaining SAFE to individual investors. They usually do not have the time or patience to listen to the math so if we had to agree on a cap, I am thinking we just might as well do an equity deal.

      1. Ryan Feit

        Leroy, agree with your points above. If you have have agreed to $5 million valuation I would just do a priced round and go with a $5 million pre-money valuation. That is better for you anyways.In practice most startups we see which are raising on a note with a $5 million cap would probably get a $3-$4 million pre-money if they priced it. Otherwise I agree, if the cap is the same as what you get with preferred stock just price it.

  18. Mac

    AVC often does priced equity rounds of $5k or less? Where did I miss that?

    1. kenberger

      The ~5k = cost of *doing the deal*, eg: legal fees.

      1. Mac

        Many thanks. I see that now. AADD is a challenge.

  19. DT

    From the entreprenuer’s point of view, what is the effective difference between a priced round with liquidation preferences and a convertible note?

  20. Daniel Myers

    I have heard some ‘house of cards’ warnings but no one has ever brandished a good example to convince me of these. Most successful founders I know haven’t had very negative experiences with SAFEs/Notes and it typically seems like VCs are the ones objecting…

  21. William Mougayar

    I agree. It’s like kicking the can down the road further.

  22. Alex Dunsdon

    Yesssssss. Thank you for writing this.

  23. andrewparker

    When founders (both spark portfolio and not) tell me they are debating between a note or a priced round for the capital they are raising, I simply reframe the question to them. I tell them, would you rather raise equity with a full ratchet anti-dilution or with a broad-based weighted-average anti-dilution? I quickly explain what the two different terms mean if the founder is unsure. All the founders pick broad-based weighted-average. So, then I say, “Great! So, do a priced round now instead of a note.”The only time I don’t take this approach is if the note is uncapped (and, instead, has a discount into the next round as incentive to the investor), but I’m finding uncapped notes to be increasingly uncommon. They are only used for bridges, which is the only good purpose of a note in the first place.If you’re doing a capped note, always do it in equity instead. Pretty simple.

    1. David Semeria

      I agree that priced rounds make more sense all round. In five years we’ve only taken money using notes on two occasions, and both were for small amounts and for the same reason: short term funding to get us to the next round, without wanting to condition the price of the round.I assume this would meet your definition of ‘bridge’.

    2. fredwilson

      Well said Andrew

    3. Antone Johnson

      Fair point, but not quite *that* simple. It depends on how high a cap founders can negotiate. High enough and the full ratchet never kicks in. Alternatively, if stuck with a low valuation cap, how much money the company takes at that cap makes all the difference.My broken-record soapbox speech to entrepreneurs is to focus on dilution, dilution, dilution. When that first F&F money comes in $10K at a time, it’s virtually irrelevant what form of anti-dilution it gets; $100K at a low cap simply won’t move the needle on the cap table as a whole down the road. (F&F also tend to be the least aggressive in negotiating low caps, if any at all.) On the other hand, taking a large convertible debt investment at a low cap can be catastrophic to founders when they find all those extra conversion shares issued to noteholders dilute the hell out of them. (At least SAFEs avoid the extra burdens of accrued interest, liquidation preference overhang and “ticking time bomb” maturity dates.)Doing rolling closes in a “lots-of-little-guys” F&F-to-angel round, in a rapidly developing early stage business over the course of several months, I’ve seen the cap creep upward during the round (e.g. $4 to 5 to 6 million). If you take more money later in the progression, it mitigates the full ratchet effect.

      1. andrewparker

        I don’t follow your logic in the first paragraph. You say that if founders can negotiate a high enough cap, then the full ratchet never kicks in. I would say the opposite of that is true. The higher the cap, the more likelihood the full ratchet anti-dilution will kick in. Founders only avoid the full ratchet anti-dilution if the next equity round, which converts the debt note into equity, is done at a higher price than the cap. So, the higher the cap, the higher the hurdle for the next round to clear.

        1. Antone Johnson

          That’s backwards. The “ratchet” terminology is a bit misleading when applied to convertible notes; it’s analogous but not really “anti-dilution” protection in the same way those provisions operate in Series A and later preferred stock deals, where they’re triggered by down rounds.The cap operates mathematically to ensure the note investor doesn’t end up with a tiny number or % of shares if the equity round (call it Series A) is priced *too high*. (Cynics might call that “anti-accretion protection” or a form of insurance against a Series A investor coming along as the “greater fool”.) Entrepreneurs question why they should be “penalized for success” (assuming valuation is a proxy) with greater dilution by the way caps operate.When speaking to entrepreneurs, the “full ratchet” comparison is appropriate in that *if* the cap kicks in, the formula is draconian in terms of issuing additional investor shares (and therefore diluting *founders*) on a 1-for-1 basis.

          1. Leroy BigFish Yue

            “Entrepreneurs question why they should be penalized for success” — I think this is the key point in which the arrangement doesn’t make complete sense. Also, if a reasonable cap can be agreed, why not do an equity deal? I am facing exactly the situation you described: “a lots-of-little-guys F&F-to-angel round, in a rapidly developing early stage business over the course of several months”, and in addition, each one has his/her own preference and understanding on how SAFE works.

    4. ShanaC

      why are uncapped note becoming increasingly uncommon?

      1. Matt A. Myers

        Likely because in more cases than not – perhaps because founders who want them understand the value – the VCs will overall get less equity than if it’s done for straight-up cash? Or rather, the investments that do the best – where they’d make 100x+ return, that is where getting lower % equity is a big problem on fund ROI.How I wish convertible notes were structured is the cap is a set minimum % of equity and not based the value – unless I am still confused about notes and that’s how they work. E.g. If value is set at $20mm when someone’s investing $2mm more into business, then the $1mm that was invested through a capped note at 10% minimum equity, with a discount, would receive at minimum 10%. So in this case, $1mm would be worth 5% of $20mm, however because there’s that min cap, they would get 10% (and I presume + their discount). Worse case scenario, if that $1mm investment only gets a startup to a place where the next money coming in only values the company at $2mm, then that $1mm capped 10% minimum note would convert to 50% equity for those investors. Therefore, the founder must really be sure what they can do with that convertible note money. This isn’t how convertible notes or SAFEs perform, right?Why isn’t that a thing – or is it a thing? Or am I confusing?

  24. myprasanna

    I do not understand how this can be a source of surprise, to founders, unless there is a down-round. I do understand why investors might complain though. Since the more the notes issued, the less the ownership they get to keep.

    1. Jay Levy

      I believe the surprise in terms of dilution occurs for a few reasons:1) Founders typically wind up doing more convertible debt / SAFE’s than they originally anticipated. Starts to pile up like credit card debt.2) While it can be minor the combination of the extra money taken in along with the extra time, creates an impact of the interest.3) Many founders don’t model out the future and only model out today.

      1. myprasanna

        Would have happened in case of a normal priced round as well? Except the interest. Unclear if interest really kills startups, I suspect not.If you’re talking about cons of a rolling close, because it’s easy to take in more. Well that’s the pro. Can move fast.

  25. Larry Putterman

    As always timing is everything.

  26. Jay Levy

    Thanks for sharing this. Hopefully founders will take note and push their counsel to do equity rounds. We’ve found the many of the big law firms tend to push the convertible note / SAFE on since they can be filled out in minutes and it allows the law firm to befriend the founders by doing these for free.

  27. David Waxman

    Convertible notes seem easier because they kick lots of cans down the road, valuation is just one of them, pro-rata rights–and the major investor threshold–are another The way that these various issues get settled can cut either way: for or against the investors or founders. Personally, I’d prefer to know what I’m getting/selling, no matter which seat I’m sitting in (and I’ve sat in both).

  28. Steve Orell

    Excellent post! How can you make an investment without quantifying a valuation? You create a financial instrument which shifts the downside risk to the other party.

  29. Jon Callaghan

    Great explanation, Fred, of what we see all the time. I completely agree. More often than not, the seemingly “simple” convert winds up hurting Founders. We don’t like them for this reason. Thank you for such a clear articulation of what we view as a fundamental misunderstanding (and misalignment) in the marketplace.

  30. Nikhil Kapur

    Coincidently I wrote a post at the exact same time on what we are seeing with notes in Asia.…. They are not cheaper to execute (not really), not faster (unless it’s a rolling close), and not at better terms (full ratchet). But there are usually two reasons because of which we see this happen here. Some founders just want to close a round as it comes and are more than happy to do a rolling close with angels. I am not sure how else can you do the rolling round without a note. At other times, founders are trying to be in control, and have a special problem with forming a board and giving out board seats. They feel it’s the easiest way to not form a board at an early stage.Also, Fred is right, it has been promoted more and more by YC and the whole word just follows these guys. 500 Startups is quite active here as well and they have done a fair share of promotion of KISS. At least both the docs are cleaner than the off-the-shelf convertible notes docs an angel might propose.

  31. OurielOhayon

    what if you price too low? you actually build something highly valuable but downpriced yourself?

  32. Sean OSullivan

    @fredwilson:disqus is entirely right on this. SOSV is the #2 seed investor in the world (according to CrunchBase) and we see this ALL THE TIME.The worst of this is “stacked notes”, when you have two or more rounds of capital, all using convertible notes, and the founder imagines things are going OK because the one round of notes is at a higher valuation than the next. It’s not. Do the spreadsheet. It ends up in tears.The second worst situation is when a bunch of capital is raised, say $3-$4m, and the founders still leave it as a note structure. The people who get hurt the most by these notes are the founders (because they are getting dilution but no-one else is, and effectively they get doubly diluted because the incoming lead investor often has a equity target of 20% or something, and the notes don’t dilute until after the founders dilute). Not smart. And frankly the founders don’t know what they are doing because they haven’t been through it before.At SOSV, we advise founders to just sell equity at a fixed price, if possible. (Understood if the total raised is <$500k, it’s OK to stay as notes). We’ve also devised an “Trigger” CLN, which we are testing out, whereby if the notes raised hit a target, it triggers an automatic priced round (and thus, the founder can get and close individual notes all day long to keep the business alive, but when they hit the target the round is done and priced, subject to standard terms).If anyone wants to work on this with SOSV, just e-mail stephen.mccann (at) and we’ll be happy to share what our legal team is developing.You’re absolutely right Fred, it’s a mess and a ticking time bomb for founders who start to succeed. For everyone else, it doesn’t really matter.

    1. Leroy BigFish Yue

      “incoming lead investor often has a equity target of 20%” — a good point to keep in mind. Thanks.”<$500k, it’s OK to stay as notes” — So for a small initial round, SAFE/Equity makes little difference if the cap/valuation can be agreed. Great to have cleared my mind after reading this post and the comments. Thanks guys!

  33. Guy Lepage

    Great post and I agree with 90% of it. Taking the convertible debt route can also lead to massive problems if the company runs into trouble as well.One thing I would like to point out is luxury. As in, not all companies have the luxury of, nor should they, spending $5k on a round of investment. $5k is one months salary for a founder in the earliest stage. That’s a big bet. I personally believe that this should be picked up by the lead investor. You want it. You buy it. Don’t put the burden on the company. If the team is right, foot the bill. IMHO.

  34. Charlie Federman

    Amen! Well said and really so important for culture and alignment

  35. Jordan Selleck

    KISS note < $500K F&F round < 5 HNW investors. Opinion?Context: NYC, FinTech, beta launched, strong customer f/b, CEO and CTO, sub-$5M cap@fredwilson:disqus @ryanfeit:disqus @andrewparker:disqus @sean_osullivan:disqusI’m seriously exhausted from this whole research over the past month. Just want to do what’s both fair and market, wrap up the discussion and get back to business.

  36. Fabio Povoa

    In Brazil, convertible notes are done for a totally different reason: tax and legal (work) liability.Doing an equity round on a small company leaves the angel(s) totally exposed (solidarity) to any / all tax and work (salaries, etc) liabilities incurred by the company. No angel investor in their sane mind would ever put their personal savings – house, car, retirement ! – on the line by being a equity owner in a small company.

  37. Artificial Intelligence

    We agree to disagree. CNs have a well established pricing advantage .

  38. sethlevine

    Such an interesting topic Fred. Made me re-read the post I wrote in response to that same tweet from Paul:

  39. Antone Johnson

    One size never fits all. There was a great Twitter debate on this subject back in 2012 among Fred, Dave McClure, Chris Dixon, Adam Nash, Scott Belsky, Ted Rheingold, Jonathan George, Marcus Ogawa and others. I Storified it here:…The conversation hasn’t changed much except (1) SAFEs have eclipsed “convertible equity” (Adeo Ressi’s contribution) as the most common convertible note variant, and (2) with a couple more years experience seeing startups pile up and [re-]extend convertible debt seed rounds, the consequences are becoming increasingly problematic in many cases as Fred writes in this post.

  40. Gonçalo Amorim

    Paul, I see your point. Using convertibles as if they were multiple credit cards is obviously not a good idea. Having said that, for a first injection of cash in a new venture, I actually am supportive of convertibles especially when you do not have reasonable fundamentals or traction to vie for (usually the case for 1st time founders)

  41. ShanaC

    1) Maybe you should bring back pieces of MBA monday2) Ok, just for the sake of argument, when do you think it is a good idea to use SAFE notes?

  42. Niko Hrdy

    Another reason for investors to not like notes is that they do not qualify for QSBS until they convert into equity.

  43. Jim Gibbs

    I am a prime example of why we need notes.I’m a Black American, and I work in GovTech. Getting your 8a is a golden ticket, for minority owned companies. If I were to raise a priced round, I wouldn’t be majority owner, and would lose my 8a certification eligibility.We’re growing our revenue over 30% MoM, in a $50B market, and financing would let us expand exponentially faster. Needless to say, it would only make sense to raise money now. That’s why raising capital using SAFEs are important to my business.

  44. Matthew Green

    Not just early companies have been stung here. I have seen listed public companies get stung with convertible notes, especially if the share price isn’t where we expected it to be (same issue really).

  45. Paul Azous

    Totally an issue if structured ‘unnaturally’. We see them all time and are asked to write convertible notes and bonds many times weekly.Paul AzousCEO,

  46. Stephen Mangano

    As a young start-up but an experienced entreprenuer, I recently executed SAFE agreements with my investors and while time will tell, they seem to work well. The cautions laid out are good ones and we followed all of these. Pricing the round so valuation was known but protecting investors downside dilution in an appropriate way. I feel it enabled me to pontentially get a stronger valuation off the early raise, while at the same time avoiding a drawn out valuation discussion and legal fees that come with more complex documents. I do agree with the uncapped comments as that would make no sense. I also do see the risk of future rounds or too large an amount raised this way. Like any early financing vehicles, there is no perfect scenerio, but I was glad I discovered the SAFE structure and I believe it enabled me to get through my first round with relative ease.

  47. LE

    And maybe it’s your writing style–you like to say things as either/or, as though all situations call for this approach.Sure but as Fred says ‘strong beliefs, loosely held’. Besides when writing or blogging it’s best to be more polarized than it is circumspect. Brings out the comments and opinions and gets more attention. Such as yours (which is really good).It would be nice if every startup could raise what they need in the time they need it, but that’s often not the caseExactly. Just like most companies can’t retain the control that Zuckerberg did and some aren’t even able to raise any money at all.

  48. awaldstein

    Well said.Truth be told of course is that what I call cash flow, what you better call operating businesses are not really served by the traditional tech VC ecosystem that well.Whether it be your biz, a restaurant or consumer hard goods business–they all fall into a different realm that traditional ‘go big or home’ types of models.Not a criticism of that structure, just a different animal in my experienced and underserved.