SAFE Convertible Note Template, Y-Combinator, and Kindrik Partner

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https://www.ycombinator.com/documents/

Y Combinator introduced the safe (simple agreement for future equity) in late 2013, and since then, it has been used by almost all YC startups and countless non-YC startups as the main instrument for early-stage fundraising.

Our first safe was a ‚Äúpre-money‚ÄĚ safe, because at the time of its introduction, startups were raising smaller amounts of money in advance of raising a priced round of financing (typically, a Series A Preferred Stock round). The safe was a simple and fast way to get that first money into the company, and the concept was that holders of safes were merely early investors in that future priced round. But early stage fundraising evolved in the years following the introduction of the original safe, and now startups are raising much larger amounts of money as a first ‚Äúseed‚ÄĚ round of financing. While safes are being used for these seed rounds, these rounds are really better considered as wholly separate financings, rather than ‚Äúbridges‚ÄĚ into later priced rounds.

In 2018 we released the ‚Äúpost-money‚ÄĚ safe. By ‚Äúpost-money,‚ÄĚ we mean that safe holder ownership is measured after (post) all the safe money is accounted for - which is its own round now - but still before (pre) the new money in the priced round that converts and dilutes the safes (usually the Series A, but sometimes Series Seed). The post-money safe has what we think is a huge advantage for both founders and investors - the ability to calculate immediately and precisely how much ownership of the company has been sold. It‚Äôs critically important for founders to understand how much dilution is caused by each safe they sell, just as it is fair for investors to know how much ownership of the company they have purchased.

Pro Rata Side Letter (Singapore).docx22.6KB
Postmoney Safe - MFN Only - FINAL.docx48.2KB

https://kindrik.sg/templates/se-asia-safe-convertible-note/

what this is

This note is a convertible instrument that is intended to be used to document a seed investment from a third-party investor or a bridge financing from existing shareholders.

The terms of the note are substantially based on the simple agreement for future equity created by the US accelerator, Y-Combinator.

how it works

This agreement anticipates that the investment amount is drawn down in a lump sum on one date and is unsecured. The amount of the investment is not a loan, has no set maturity or repayment date and does not accrue interest. The investment amount remains outstanding until:

  • it is automatically converted to equity on the date of a qualifying equity financing
  • it is repaid or converted (at the election of the investor) on the occurrence of a liquidity event.

you might also like

We also have another popular variation of the convertible note ‚Äď our¬†KISS convertible note template.

The terms of the note are substantially based on the keep-it-simple-security created by 500 Startups.

using our templates

Use of a template by business users is free of charge and is subject to you agreeing to our template terms of use.

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Raising capital for your startup: convertible notes vs equity

If you are considering raising money for your startup in Southeast Asia, there are two main ways you can do it: either by giving away equity in exchange for money, or by using convertible notes. In this guide we explain how each approach works and the pros & cons of the different methods.

what is a convertible note?

In simple terms, a convertible note is a loan that converts to equity when you do your next fundraising round ‚Äď a¬†qualifying capital raise.¬†In other words, investors will loan money to a startup, and then rather than get their money back with interest, the investors will receive shares in the next round. Originally used more for bridging rounds, where money was given to make it to the next funding round, convertible notes are now very common in seed rounds.

There are two key features of a convertible note. One is that a convertible note will usually convert¬†at a discounted price to the next round price. In other words, founders are trying to incentivise investors by saying, ‚Äúif you invest in us today [when we‚Äôre a riskier bet], we‚Äôll give you 20% off when it comes time to our Series A round‚ÄĚ.

The second key feature is its valuation cap, which protects investors by putting a ceiling on the conversion price of the note and lets the investors share in any significant increase in valuation (that might have come as a result of their investment of money and resources).

types of convertible note

There are two main forms of note used in Southeast Asia: the KISS-style note used by 500 Startups, and the SAFE note based on the note developed by Y Combinator.

Under the KISS convertible note, the note is repayable on the maturity date (typically 18-24 months from the date of the convertible note) if it has not already converted to shares. The investor can also choose to be repaid the investment amount (or a multiple of the investment amount) on a liquidity event.

A SAFE note, on the other hand, is not repayable at the end of a fixed period, and the company must only repay the note if an insolvency event occurs, or if the investor chooses to be repaid on a liquidity event rather than convert their note. A SAFE is essentially a quasi-equity instrument, whereas as KISS is quasi-debt, because there is a contingent repayment obligation.

The KISS and the SAFE notes also differ in the ways that they can convert.

A KISS note converts:

  1. automatically when the company raises its next round (the qualifying capital raise);
  2. at the investor’s election when a liquidity event occurs (like the sale of the company); or
  3. at the investor’s election at the maturity date.

On the other hand, a SAFE note converts automatically when the company raises a qualifying capital raise, or if the investor so chooses on a liquidity event. The investor cannot force conversion after a fixed period.

There are also different types of SAFE notes, namely the pre-money SAFE and the newer post-money SAFE recently developed by Y Combinator. The difference between these is a substantial topic in and of itself ‚Äď we recommend checking out some of the blog articles that others have written about it, like¬†this one.

what is an equity investment?

Unlike a convertible note, under an equity investment, the investor receives shares in the company at the time of their investment. Where the investor is an institutional VC, those shares will typically be preference shares, which may carry the types of preferential rights we discuss in this guide.

pros and cons: benefits of convertible notes

From a founder’s perspective, the biggest benefit of convertible notes over an equity financing is speed. The note is generally a single document with simpler terms to negotiate, and without lots of conditions, representations and warranties.

In addition, the KISS and other most convertible notes are designed to be executed by individual investors, so it is possible to receive funds without closing with all investors simultaneously ‚Äď a ‚Äėrolling close‚Äô.

Here are some other benefits to using convertible notes:

  • they postpone the difficult discussion about the company‚Äôs valuation. It is hard to value startups early on. Deferring the valuation until a larger equity round is raised is one way to address this (this doesn‚Äôt apply if you are using a post-money SAFE).
  • they have a lower cost to execute. Convertible notes are simple and flexible. It involves a single document, whereas even small equity investments can involve a¬†subscription agreement,¬†shareholders‚Äô agreement¬†and a new constitution.
  • there are fewer representations and warranties. Subscription agreements often include multiple representations and warranties which are inappropriate for an early stage startup. A convertible note generally includes only a handful of very focused warranties.
  • they concede much less control. Noteholders typically receive little (if any) control over the company, e.g. no veto or director appointment rights. This works well with the need for startups to pivot and to raise the next round of funding without investor interference
  • less administrative burden.¬†The fewer shareholders you have, the less shareholder notices and other company secretarial formalities you have to deal with.

pros and cons: disadvantages of convertible notes

However, there are some downsides to convertible notes from a founder’s point of view:

  • KISS convertible notes are debt. The clock starts running towards repayment on the maturity date. If you have not completed a¬†qualifying capital raise¬†by that date, the debt needs to be repaid. While it is uncommon for investors to enforce that right and force the winding up the company if the debt cannot be repaid, you may have to renegotiate some form of refinancing with note holders at which point you will be seriously on the back foot. However, this does not apply to SAFE notes which are quasi-equity.
  • preference shares generally issued on conversion. Most convertible notes convert into the class of shares issued to the investors on the next round of financing. In Southeast Asia, this means preference shares. As a result, convertible note investors have the double protection of both a price discount on conversion, plus the liquidation preference negotiated by the subsequent investors
  • detached investors. Convertible notes often don‚Äôt include information or participation rights in later financings. This means convertible note investors are not as involved in the business as they might be by owning equity. But, startups need all the help they can get, so make sure that your note holders are real supporters of the business and can potentially help bring in the next round of funding

Notes remain a very effective tool due to how quickly deals convertible note deals can be closed ‚Äď we have seen convertible note financing rounds closed in Southeast Asia in a few days. For startups looking to raise money fast and get on with growing the business, this speed remains a key factor.

New to Kindrik Partners? View other resources in our series on capital raising in Southeast Asia:

Raising seed capital in southeast asia ‚Äď structure and terms

https://kindrik.sg/guides/raising-seed-capital-in-southeast-asia-part-2/

Introduction

In a previous guide on raising seed capital in Southeast Asia, we discussed getting investor ready, including where Southeast Asian startups should incorporate their company, founder arrangements, and group structure.

In this guide, we talk about how to structure seed investments, the key terms and documentation, and how to go about finding investors.

convertible notes

Many seed investment rounds in Southeast Asia complete using convertible note instruments like the 500 Startups Keep-It-Simple-Security (KISS).  These are unsecured debt instruments that convert to equity when a company completes its next equity raising.

The KISS is the most common type of convertible note used in Southeast Asia.  If you are contemplating a seed round, we suggest you upskill on this document by downloading a version of the KISS adapted for Southeast Asia from our website.

There are other forms of note in use in Southeast Asia, including US style documents.  With these documents, US specific provisions need to be amended, e.g. removing US securities law and taxation language which shouldn’t be relevant for a non-US issuer.

Convertible notes anticipate that the investment amount is drawn down either in a lump sum on one date or, more likely, over a period of time.  The investment amount typically automatically converts to equity on the date of a qualifying capital raise at a discounted price to the next round price, but subject to an overall valuation cap.

If not already converted, the debt may be repayable (potentially at a multiple of the outstanding amount) or convertible at the noteholder’s discretion:

  • on the occurrence of a liquidity event, i.e. the sale of your company
  • at the maturity date for the note. This is often at least 18 months from the initial drawdown.

Convertible notes have been successful in Southeast Asia partly due to the availability of series A money.  This gives noteholders comfort that you are likely to raise follow-on capital quite quickly, which triggers conversion of the note into equity.

key features of convertible notes

Investment Amount
The amount to be invested by the investor (noteholders)
Series
Notes of a particular series are issued on the same terms. Typically, you may have a period of time to issue further notes on the same terms without seeking the consent of existing noteholders. The total investment amount is sometimes drawn down in a lump sum on one date or over a period of time with multiple closings
Interest
This is the annual rate at which interest accrues on the note whilst it is outstanding. In Southeast Asia, the rate varies, but usually is a low amount, e.g., 1% or 2%
Maturity Date
This is the date on which the debt is due for repayment. This should be a reasonable period of time from the date of the note, so that the company can achieve the qualifying capital raise (see below) to trigger conversion.  In Southeast Asia, periods to maturity are generally set at 18 months and can be longer.  Usually, if the company is unable to raise money before maturity, the majority of noteholders can elect for the debt to convert to shares rather than demanding repayment
Qualifying Amount
The investment amount of the notes will automatically convert into shares at the time of the company’s next capital raise.  There is normally a minimum amount that must be raised to trigger conversion (called a qualifying capital raise), which is set to ensure that the raise is a legitimate company financing, not a device to trigger conversion
Discount
Assuming the company’s next financing round is a qualifying financing, the notes will automatically convert into shares often at a discount to the share price paid in that financing.  The discount is intended to compensate investors for the risk they take on by investing at an early stage.  In Southeast Asia, this discount is typically 15-25%.  This follows Silicon Valley norms
Valuation Cap
This addresses an initial concern that investors had with the¬†KISS style and other convertible notes ‚Äď that the company‚Äôs valuation could increase significantly and they would only have the protection of the¬†discount¬†to the price of the next funding round. ¬†The valuation cap effectively caps the price at which investors pay for their shares when the note converts. ¬†If your company raises a financing round at a $5 million pre-financing valuation but the convertible notes have a $2 million valuation cap, your note holders will effectively receive a 60% discount to the price that the new investors are paying. ¬†So consider a valuation cap carefully as it can have a significant dilutive effect on the next round of financing if set too low
Majority-in-Interest
This term simply means those noteholders holding a majority of the total investment amount of the series.  It is useful to incorporate this concept into the document so that key decisions are taken, or rights waived, not by individual investors but on a majority rules basis

convertible notes vs equity

There has been a lot written on this topic.  For a founder’s take on the debate, have a look at the blog Seedinvest: Pros and Cons of Convertible Notes or 500startups KISS blog post.  For an investor point of view, Jason Lemkin’s SaaStr blog post An insiders’ guide to convertible debt vs equity is good read.

From a founder’s perspective, the biggest benefit of convertible notes over an equity financing is speed.  The note is generally a single document with simpler terms to negotiate, and without lots of conditions, representations and warranties.  In addition, the KISS and other most convertible notes are designed to be executed by individual investors, so it is possible to receive funds without closing with all investors simultaneously.

Other benefits of convertible notes include:

  • postpones the difficult discussion about the company‚Äôs valuation. It is hard to value startups early on.¬†Deferring the valuation until a larger equity round is raised is one way to address this.¬†Also, if a third party is prepared to invest at a particular point in time and valuation, it provides some level of market evidence of the valuation for the notes.
  • lower cost to execute. Convertible notes are simple and flexible.¬†It involves a single document, whereas even small equity investments can involve a¬†subscription agreement,¬†shareholders‚Äô agreement¬†and a new¬†constitution
  • fewer representations and warranties. Subscription agreements often include multiple representations and warranties which are inappropriate for an early stage startup.¬†A convertible note generally includes only a handful of very focused warranties, avoiding protracted negotiations and unnecessary time spent on disclosure by the company
  • concedes much less control. Noteholders typically receive little (if any) control over the company, e.g. no veto or director appointment rights.¬†This works well with the need for startups to pivot and to raise the next round of funding without investor interference.¬†Because notes provide this flexibility, there has been good success rate of note financed companies raising a series A follow-on round
  • less administrative burden.¬†The fewer shareholders you have, the less shareholder notices and other company secretarial formalities you have to deal with.

However, there are some downsides to convertible notes from a founder’s point of view:

  • convertible notes are debt. The clock starts running towards repayment on the maturity date.¬†If you have not completed¬†a¬†qualifying capital raise¬†by that date, the debt needs to be repaid.¬†While it is uncommon for investors to enforce that right and force the winding up the company if the debt cannot be repaid, you may have to renegotiate some form of refinancing with note holders
  • preference shares generally issued on conversion. Most convertible notes convert into the class of shares issued to the investors on the next round of financing.¬†In Southeast Asia, this means preference shares.¬†As a result, convertible note investors have the double protection of both a price discount on conversion plus the liquidation preference negotiated by the lead follow-on investors
  • disenfranchised investors. Convertible notes have valuation caps and often don‚Äôt include information or participation rights in later financings.¬†This means convertible note investors are not as involved in the business as they might be by owning equity.¬†But, startups need all the help they can get, so make sure that your note holders are real supporters of the business and can potentially help bring in the next round of funding
  • additional protections. Finally, convertible notes can sometimes include additional protections for noteholders, such as participation rights, additional reporting from the company, and a¬†most-favoured-nation¬†provision (which gives noteholders comfort that they will receive a replacement convertible note if one is subsequently issued on better terms).¬†Avoid these if possible, but if investors insist on them, ensure that they can be waived by a¬†majority of the note holders.

Notes carry some uncertainty, particularly if follow-on money is unavailable,¬† But in Southeast Asia, they remain a very effective tool, predominantly due to how quickly deals are closed ‚Äď we have seen convertible note financing rounds closed in Southeast Asia in a few days.¬† For startups looking to raise money fast and get on with growing the business, this remains a key factor.

seed equity financings

Convertible notes are not always an option since some investors prefer the certainty of equity even on seed rounds.

If the amount being raised is not significant then it is in everyone‚Äôs interests to keep the documentation simple and get the round closed quickly. ¬†Try to avoid ‚ÄúSeries A‚ÄĚ terms and documentation as this is likely to be overkill and is likely to limit your flexibility both in terms of how you grow your business and how you raise further capital.

Small seed investments can be completed using our southeast asia seed investment term sheet, subscription agreement and shareholders’ agreement.

Keep the following tips in mind:

  • issue ordinary shares ‚Äď as soon as companies start issuing¬†preference¬†shares, the deal becomes more complex with discussions on liquidation preferences, conversion mechanics, and anti-dilution rights
  • aim to keep the subscription agreement (which sets outs the mechanics and terms of the investment) simple. Ideally, include only a limited set of representations and warranties covering items such as compliance with reporting obligations, IP ownership, and confirmation of no claims
  • put in place only a simple shareholders‚Äô agreement which contains fundamental rights and obligations for the governance of your company (e.g., information rights, pro-rata participation rights in future financings, and non-competes). Avoid any investor consent rights so that investors do not need to be consulted except for significant capital expenditure or a material change in the direction of the company
  • avoid amending the company‚Äôs articles of association or constitution (as applicable) ‚Äď this should be possible as long as you avoid issuing¬†preference shares
  • aim to have the company‚Äôs lawyer prepare the documents as this usually ensures reasonable first drafts can be presented.

corporate authorities

All seed capital raising transactions in Southeast Asia require corporate authorisations which your company secretary will need to complete.

E.g., in Singapore, directors’ and/or shareholders’ resolutions will need to cover:

  • approval of all the transaction documents, including any convertible note or the subscription and shareholders‚Äô agreements (as applicable)
  • adoption of the new constitution or articles of association of the company (if required)
  • the issue of the subscription shares to the investors
  • the appointment of any investor director(s) to the board of directors
  • an obligation on the investors to pay the subscription monies to the company‚Äôs bank account
  • approval and execution of any service agreement if founders are to become executive directors of the company.

Aside from the transaction documentation, ACRA requires that Singapore based company secretaries carry out stringent know-your-client (KYC) checks on new shareholders.

You should plan for this early in the process to ensure that this investor KYC documentation does not hold up closing the deal.

finding investors

There are now over 25 active venture capital funds based out of Singapore focused on the Southeast Asia region.  Many of these funds have participated in seed investment rounds as well as larger follow-on capital raisings.

Tech-in-Asia have provided a useful directory of VC firms and angel investors with a presence in Singapore that have been investing in startups in the last few years.  Some of these funds were supported by the Singapore government through the National Research Foundations Technology Incubation Scheme (NRF TIS) and the Early Stage Venture Fund (ESVF).  The NRF continues to evolve with the future ESVF initiatives being announced in early 2016.  Further information can be found on the NRF’s website.

In addition, you can meet potential seed investors through various accelerators and incubators in Singapore, e.g. SPH Plug and Play, Joyful Frog Digital Incubator, Muru-d and Startupbootcamp, the latter of which focusses in the area of fintech.  e27 have compiled a more complete list of Singapore accelerators and incubators.

LaunchPad, also known as Block 71, is a startup cluster in Singapore that the government plans to become home to up to 1,000 startups.  Aside from incubators, accelerators, and other startup support services, you may find some potential seed investors as part of that cluster.

Finally, Singapore has a significant density of high net worth individuals (HNWs).  However, many of these HNWs have made their wealth from traditional industries or property, and have never worked in tech.  Working with investors who are new to the tech industry can be difficult, both before and after completing an investment transaction.

securities laws

Companies raising money from investors are promoting the issue of securities and must comply with local securities law in the jurisdictions where the investors are based.  For Singapore issuers, the Securities and Futures Act (Cap. 289) requires that all offers of securities be accompanied by a prospectus unless the offer is subject to an exemption.  Fortunately, the Act provides for many exceptions for private placements and other share issues.

These exemptions include (amongst others):

  • small personal offers where the total amount raised from such offers within any 12 month period does not exceed SGD5m or such other amount prescribed by the Monetary Authority of Singapore (MAS)
  • an offer to no more than 50 persons within any period of 12 months and under certain conditions
  • certain offers of securities of an entity made to existing members or debenture holders of that entity
  • an offer to qualifying persons like employees of the corporation or its related corporations under the specified conditions
  • an offer to¬†institutional investors
  • an offer to specified persons, including¬†accredited investors

Further information can be found at:

8 key features of convertible notes in southeast asia

introduction

Many seed investment rounds in Southeast Asia complete using convertible note instruments like the 500 Startups Keep-It-Simple-Security (KISS). These are unsecured debt instruments that convert to equity when a company completes its next equity raising.

In this guide we cover the 8 key features you should know when working with a KISS convertible note. From our experience, the KISS is the most common type of convertible note used in Southeast Asia. If you are contemplating a seed round, we suggest you upskill on this document by downloading a version of the KISS adapted for Southeast Asia from our website.

There are other forms of note in use in Southeast Asia, including US style documents. With these documents, US specific provisions need to be amended, e.g. removing US securities law and taxation language which shouldn’t be relevant for a non-US issuer.

an overview of how convertible notes work

Convertible notes anticipate that the investment amount is drawn down either in a lump sum on one date or, more likely, over a period of time. The investment amount typically automatically converts to equity on the date of a qualifying capital raise at a discounted price to the next round price, but subject to an overall valuation cap.

If not already converted, the debt may be repayable (potentially at a multiple of the outstanding amount) or convertible at the noteholder’s discretion:

key features of convertible notes in southeast asia

Investment Amount
The amount to be invested by the investor (noteholders)
Series
Notes of a particular series are issued on the same terms. Typically, you may have a period of time to issue further notes on the same terms without seeking the consent of existing noteholders. The total investment amount is sometimes drawn down in a lump sum on one date or over a period of time with multiple closings
Interest
This is the annual rate at which interest accrues on the note whilst it is outstanding. In Southeast Asia, the rate varies, but usually is a low amount, e.g., 1% or 2%
Maturity Date
This is the date on which the debt is due for repayment. This should be a reasonable period of time from the date of the note, so that the company can achieve the qualifying capital raise (see below) to trigger conversion. In Southeast Asia, periods to maturity are generally set at 18 months and can be longer. Usually, if the company is unable to raise money before maturity, the majority of noteholders can elect for the debt to convert to shares rather than demanding repayment
Qualifying Amount
The investment amount of the notes will automatically convert into shares at the time of the company’s next capital raise. There is normally a minimum amount that must be raised to trigger conversion (called a qualifying capital raise), which is set to ensure that the raise is a legitimate company financing, not a device to trigger conversion
Discount
Assuming the company’s next financing round is a qualifying financing, the notes will automatically convert into shares often at a discount to the share price paid in that financing. The discount is intended to compensate investors for the risk they take on by investing at an early stage. In Southeast Asia, this discount is typically 15-25%. This follows Silicon Valley norms
Valuation Cap
This addresses an initial concern that investors had with the KISS style and other convertible notes ‚Äď that the company‚Äôs valuation could increase significantly and they would only have the protection of the¬†discount¬†to the price of the next funding round. The valuation cap effectively caps the price at which investors pay for their shares when the note converts. If your company raises a financing round at a $5 million pre-financing valuation but the convertible notes have a $2 million valuation cap, your note holders will effectively receive a 60% discount to the price that the new investors are paying. So consider a valuation cap carefully as it can have a significant dilutive effect on the next round of financing if set too low
Majority-in-Interest
This term simply means those noteholders holding a majority of the total investment amount of the series. It is useful to incorporate this concept into the document so that key decisions are taken, or rights waived, not by individual investors but on a majority rules basis

Interested in learning more about the mechanics of the convertible note, or have a term sheet that you want us to take a look at? Get in touch.