Note to the reader: This blog post assumes some understanding of venture finance. If terms like “preferred stock”, “convertible instruments” and “SAFEs” are new to you, we’d suggest reading a few primers first. For the definitive work on how VCs structure investments, we recommend Venture Deals by Brad Feld and Jason Mendelson. Y Combinator also has an easy-to-digest guide on raising a Seed Round. For a primer on how post-money SAFEs work, see Y Combinator’s Quick Start Guide.
Founders, who put it all on the line, deserve investors they can trust — and we believe transparency creates fertile soil for trust. It’s why we put our operating manual online, and it’s also why we’ve decided to publish the documents we use as templates for our Series Seed investments, as well as our side letter for Simple Agreements for Future Equity (SAFEs).
Transparency shows up in every aspect of how we operate, including how we think about our focus on the future of work, what we look for in a startup, and how we make decisions.
We see publishing templates for our investment documents as a natural extension of this transparency. We hope they will give you a better sense of how we structure deals, which terms we care about, and a true-to-life taste of what it's like working with us. We want negotiation to be quick so founders can get back to building a company. We want to avoid wasting time negotiating points that are irrelevant in success and useless in failure. We also believe founders must understand every word of the contracts on which they build their business. We hope our explanations help — and that these templates snap us all to a useful grid.
In this post, we’ll share our thoughts on:
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Industry standard templates;
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How to decide which type of investment to take; and
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Rights we ask for (and why we want them).
We stand on the shoulders of giants. We want to thank the organizations which have done our industry a service by creating (and publishing) the starting versions of these legal documents:
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Our equity templates are based on Fenwick’s Series Seed documents which have been openly distributed for years. (Cooley has also contributed their own version.)
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Our SAFE side letter accompanies Y Combinator’s updated SAFE documents. YC’s investment documents have continued to evolve, and we share their commitment to explain the structure behind our investments.
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The National Venture Capital Association (NVCA) has published its forms for more than 20 years. These documents are a great reference, and many of them serve as a useful standard in negotiations. However for the seed-stage deals where we invest, we find that a lighter-weight template is more appropriate.
It’s worth noting that many investment firms and law firms prefer to use their own versions of these documents. This can make closing a deal faster for investors (since they are already familiar with the terms), though diligent founders should ask what special terms a VC wants and why.
In almost every deal, founders face the choice of which investment instrument to use. Others have written at length on the differences between equity and SAFEs; we believe it’s ultimately up to the company to decide what works best. The rights we want are the same for all of our documents, so we keep their terms as similar to each other as possible. We’re happy to use whichever investment type the founders prefer.
That said, all things being equal we prefer equity because:
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Founders and investors know how much of the company they own. We like the transparency and security of both parties knowing their respective ownership at the time of investment, without the “surprise” dilution that often comes when SAFEs convert.
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Both sides agree on the valuation. These days, raising a SAFE with a post-money cap is essentially the same as raising a priced equity round (since the cap is almost always the same as the valuation the company would use if issuing equity, aka “the cap is the price”).
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The company will end up issuing equity later anyway. It’s no longer the case that an equity financing is much slower (or more expensive) than issuing a SAFE. By issuing equity immediately, founders avoid kicking the legal can down the road and having a greater total cost of investment from a two-step deal.
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Equity offers tax advantages through the Qualified Small Business Stock (QSBS) gain exclusion. Section 1202 of the Internal Revenue Code provides investors an opportunity to avoid tax on some or all of the gain realized from the sale of some startup equity held for more than five years. To qualify for this exclusion, an “interest” in a C corporation must be “stock” — many lawyers believe SAFEs don't qualify. (And while this tax advantage benefits us as investors, it has no direct benefit to founders — and also no cost.)
Nevertheless, there are some benefits to SAFEs and convertible notes:
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The founders maintain more control (until the SAFE converts). We're fans of founder control. We generally avoid taking board seats, and prefer to be the folks founders have on speed dial if they ever need to talk through a problem. SAFEs come with fewer strings attached, though when they convert into equity later then they can come with whatever governance provisions (rights of approval, etc.) that equity includes.
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Increased flexibility in raising more before an initial equity offering. High resolution fundraising means that companies can raise smaller sums of money at various points along the way. It’s often easier to add another SAFE to the cap table than to issue another round of priced equity.
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In general, SAFEs require less paperwork, faster time to close, and (sometimes much) lower legal fees. Since SAFEs have fewer terms and typically follow YC’s template, the only document to review is typically the investor’s side letter.
We have based our Series Seed templates on Fenwick’s documents, with the following changes:
Many VCs ask startups to pay the legal costs incurred by the investors (in addition to the company’s own legal costs) when closing a round of financing. We believe legal fees are a cost of doing business and we pay our own attorneys.
In an acquisition, agreements that a startup has with Bloomberg LP (beyond Bloomberg Beta, unrelated to our investment in the startup) will remain intact after the acquisition.
Issuances of cryptocurrencies can extend a startup’s runway without diluting shareholder ownership. However, if the founders personally hold tokens in the startup (other than through their ownership of their startup, which may also own tokens), then it’s easier for interests to become misaligned: the founders’ financial gains are now tied to the price of the token. Our Series Seed documents therefore contain a protective clause which requires founders to ask for investor approval if their company issues a token (or the right to a future token) after we’ve invested.
We’ve included a side letter with the SAFEs we’ve signed, which these days are generally in the form of post-money SAFEs. That said, when we're a small minority investor, especially what we'd consider when we're writing a "flag check", we sometimes skip the side letter altogether to keep things simple.
If a founder asks to use a pre-money SAFE, we will generally add language to our side letter giving us pro-rata rights in interim SAFEs.
Our fund is set up so that any one of us can take risks fast and early. As a result, we are often the first institutional money invested in a company. To keep a level playing field for anyone investing at the same stage as us, our side letter gives us the right to any more favorable terms offered to a later investor.
When we invest in a company, we care about how the company is doing. However, SAFE holders are not entitled to receive any financial statements (balance sheets, income statements, cash flows, etc.). To formalize the open relationships we aim to foster with our founders, we ask our portfolio companies to provide us with basic financial information on a regular basis. This includes the right to unaudited quarterly and annual financial statements. We also include a right to be notified of any legal proceedings that could materially and adversely affect the company.
YC’s SAFE does not include a minimum amount the company must raise in order to trigger the SAFE’s conversion into equity — a “Qualified Financing Threshold.” The threshold is designed to protect the investor against an insignificant equity round raised at an artificially high valuation. Although this kind of insignificant raise is rare (we’ve only seen a handful of examples), we include a minimum financing threshold (our default is $3M) as protection to cover all SAFEs we buy.
While many companies elect not to implement a major investor clause, we add language to ensure we maintain majority investor rights in the next equity financing in the instances they do.
As with our Series Seed documents, we ask for a protective clause requiring founders to ask for investor approval if their company issues any token (or the rights to a future token) after we’ve invested.
The point of having standard documents is to keep them standard except when it is truly essential to make a change. We’ve often seen lawyers who, thinking they’re doing the founders a favor, insert lots of “founder friendly” provisions that end up costing the company in legal fees and time spent negotiating. In our experience, founders don’t keep those lawyers around for long. We try to start with documents that are fair to founders and investors, and we only ask founders to do things that we would be happy to do in their shoes.
Ultimately these agreements revolve around trust, and we hope that in sharing them we are taking a step towards earning more of yours. As with everything we publish, these templates are living documents, so if there’s a way you think we could be doing things better, submit a pull request!
We highly recommend reading our detailed breakdown (above) of these documents before diving in, which outlines how the terms in these documents came about, and why we think they help align the interest of entrepreneurs and investors.
As with all content we publish, this repository is a living document, so please feel free to suggest any changes via a pull request!