- The speaker discusses changes in modern startup financing, particularly in the structure, access, and focus of fundraising.
- The process of fundraising has become faster and easier due to online resources and readily available documents.
- Preferred stock financings have remained unchanged, but the timing of when companies do their first fundraising has shifted.
- Valuation and dilution are still important factors for investors and founders in fundraising.
- Communication with investors remains crucial for building relationships and updating progress.
- The traditional method of series A preferred stock financing has become less flexible and costly, leading to the use of bridge loans as a stopgap measure between financings.
- Bridge loans often involve convertible promissory notes, which automatically convert into shares of stock in the next round of financing.

- Convertible promissory notes were initially used as a bridge loan between Series A and Series B funding rounds, but later became popular as a standalone document for fundraising.
- YC introduced the SAFE (Simple Agreement for Future Equity) as a modernized version of the convertible promissory note, which is a single document that converts into stock when the company raises a priced round.
- The SAFE is available online and does not require hiring lawyers.
- Priced rounds are still the primary way for startups to raise money, but using convertible securities for early-stage fundraising is more convenient and flexible.
- The SAFE eliminates the debt aspect of convertible promissory notes while retaining their convenience.
- Startups need to keep track of ownership and be aware of the administrative challenges that come with having multiple investors.
- Convertible securities can result in smaller investor checks and may impact the level of attention and involvement from investors.
- The use of convertible securities is more common on the West Coast and may require education and explanation to investors outside of Silicon Valley.
- Taking small checks from angel investors in early fundraising rounds does not negatively impact the perception of VCs during later priced rounds.

- The speaker discusses the use of equity crowdfunding and regulation crowdfunding for YC funding.
- They mention that while some companies have used crowdfunding, it is still in the testing phase and no YC company has done it yet.
- The speaker also addresses the question of what happens if a company never does a priced round and only raises money from safes.
- They explain that while it is rare for a company to never raise more money, it is possible and there are liquidity concerns for founders.
- The speaker emphasizes that the decision between convertible securities and a priced round depends on what makes sense for the company and its investors.
- They mention that the key term to negotiate in a SAFE is the valuation.
- The speaker also addresses the possibility of adding a special case to the SAFE to address the issue of no priced round in the future.
- They mention that using a SAFE for equity in exchange for services rendered may not be the best approach and suggest exploring other options.
- The speaker mentions an upcoming AMA session where more questions can be answered.

- The speaker discusses changes in modern startup financing, including the structure, access, and focus of fundraising.
- Fundraising has become faster and easier due to online resources and readily available documents.
- The timing of when companies do their first fundraising has shifted.
- Valuation and dilution are still important factors in fundraising.
- Communication with investors is crucial for building relationships and updating progress.
- Bridge loans, often involving convertible promissory notes, are used as a stopgap measure between financings.
- YC introduced the SAFE as a modernized version of the convertible promissory note, which is available online and does not require hiring lawyers.
- Convertible securities are more convenient and flexible for early-stage fundraising.
- Startups need to keep track of ownership and be aware of administrative challenges with multiple investors.
- The use of convertible securities is more common on the West Coast and may require education for investors outside of Silicon Valley.
- Taking small checks from angel investors in early fundraising rounds does not negatively impact the perception of VCs in later rounds.
- Equity crowdfunding and regulation crowdfunding are discussed, but no YC company has done it yet.
- The possibility of a company never doing a priced round and only raising money from safes is rare but has liquidity concerns for founders.
- The decision between convertible securities and a priced round depends on what makes sense for the company and its investors.
- The valuation is a key term to negotiate in a SAFE.
- Adding a special case to the SAFE to address no priced round in the future is mentioned.
- Using a SAFE for equity in exchange for services rendered may not be the best approach.
- An upcoming AMA session is mentioned for more questions to be answered.

YC Partner and GC Carolynn Levy details the basics of startup financing and how modern early stage rounds of financing are done using convertible securities, like the SAFE.

You can find the lecture slides and transcript here: https://www.startupschool.org/videos/79

Find more Startup School and YC content at https://www.startupschool.org/library.

I, like Kevin said, I'm going to talk about modern startup financing.

I have only been practicing law for 21 years, so what's old and what's new only spans that time frame for me.

But I've seen a lot of changes to the startup ecosystem.

YC's been a big part of a lot of the changes to the startup ecosystem in the way that financing is done.

And every corporate lawyer who does private company or public company financing has a lot of these if they have been doing it for long enough.

The legal teams used to get these bound volumes with all of the financing documents in them.

They have our names on them and the date.

This doesn't happen anymore, but I just thought this was, I saved some of mine, I thought this was a good picture for this.

So a lot of you are gonna already know what I'm about to talk about, but since this is startup school, I just wanna give some basics.

So you have a company idea, and the first thing you're gonna do is form a corporation because it's a separate legal entity and it protects the founders from personal liability.

You can probably bootstrap it, you and your co-founders can bootstrap it for a little while, but eventually you're going to want to hire or grow and you need money to do that.

Or What most startups do is they sell a part of their company to raise money.

So when you, as founders, you guys will buy common stock.

That's how you become owners of your corporation.

And typically you will buy common stock for a fraction of a penny.

You may contribute some intellectual property as part of that purchase, but basically you're going to be buying your stock and own 100% of it for nothing.

You cannot raise a meaningful amount of money by selling common stock.

So your option is to sell to investors a completely different class of stock called preferred stock.

Before, another kind of basic thing, I never know what kind of terminology people know, so I thought it'd be really helpful to take a look at this.

These terms right here, so first of all, financing and round, they mean exactly the same thing.

Preferred equity financing, preferred stock round, preferred stock financing, series A financing, series seed financing, these things all basically mean the same thing.

It's fundraising by selling preferred stock at a calculated specific price per share.

These terms, convertible round, note round, safe financing, we're gonna talk about what the safe is, early stage round, early stage financing, These are all ways to describe a fundraising event where you're not selling preferred stock or comma stock, you're selling convertible securities.

Convertible securities are the right to get stock in the future.

It's a thing that, it's not itself stock, It converts into stock later.

So I think that there are about 3 things that have changed a lot over the years.

And by that, I just mean that the actual document that we use for early stage fundraising has changed.

And I'm going to talk about that more in a few slides.

The other thing that is hugely different from the old days is access, because nowadays you can find fundraising documents online.

And they come with annotations and e-signatures, and it's just incredibly easy to get documents.

Back in the olden days, the only way you could fundraise was by hiring a lawyer, because there was no way to get the documents you actually needed to sell your preferred stock.

And the other thing that I think has changed a lot over the years is focus.

I just remember, I don't ever remember anybody ever noticing how much time it took to do these financings in the past and how much focus it took away from founders building their company.

Like I don't remember an investor or a founder ever saying like, gosh, this is taking a month and a half, I'd so much rather be building my company.

I think today people notice and have figured out that it's not in anyone's best interest for people to be spending a lot of time fundraising.

Preferred stock financings are no longer the way that companies do their first fundraising, but that process and those documents themselves really haven't changed over the years.

And I'll talk about that a little bit more in a second, but that's pretty much the same.

The other thing that hasn't really changed is I think there are 2 things that are super important to investors and to founders when they're fundraising, and those 2 things are valuation and dilution.

So valuation is just the value of your enterprise, And dilution is stock, like how much of your company have you sold?

So if you are selling investors a percentage of your company, you previously owned 100% of it, after you sell some, you're not gonna own 100% of it, that's dilution.

And then the last thing, I just really wanted to add in here because I think it's really important to get this point across to people who are starting startups.

Communication with investors has always been important because this is fundamentally about a relationship, right?

Investors are giving you money, and you are being expected to take their money and turn it into a billion dollar business.

Whether or not you are succeeding or failing at that endeavor is so critical to communicate with your investors about that.

So I think that that's something that has not changed over the years.

So as I mentioned before, the old way of raising early money was to do a series A preferred stock financing.

A is the first letter of the alphabet, so the first time that a startup would fundraise, it would be called a Series A preferred stock financing.

So you take the valuation of your company, which is the overall value of your enterprise, you would divide it by the number of outstanding shares of capital stock that's mostly for a series A financing just be the stock that the founders owned.

You would take that price per share and you would sell your preferred stock to your investors.

So now, well back then, angel investors, I'm sure you guys have heard about angel investors, they used to aggregate into consortiums and so they would tend to all band together and write 1 big check.

So for your series A financing, you would have maybe a couple of angel groups, and you would raise about $1.5 to $2 million in your series A preferred stock round.

Angel groups now write individual checks.

Doesn't really happen like in consortiums anymore.

Anyway, then you would negotiate the terms of the preferred stock.

So the lead investor and you, the company, would have you each get your own legal counsel.

The lawyers would go back and forth, they would negotiate the terms with the first stock, which means voting rights, liquidation rights, pro rata rights, and then you'd end up with a set of documents that go in those closing volumes, and there's about 5 of them.

This took months and it was, could cost anywhere in legal fees from $25,000 to $100,000.

Takes a long time, it costs, I just told you it could cost 25 to 100K on legal fees to do this, so it's kind of a big deal.

But I think that the thing that was most broken about it was how inflexible it was.

It used, the cost of starting a company has decreased a ton over the years.

Not so much for software and e-commerce companies, I'm sorry, not so much for hard tech companies, but software and e-commerce companies, the price of actually starting these startups has way decreased.

And as a result, companies actually don't need to raise 1.5 to $2 million just to get off the ground.

And having to do these long, elaborate, expensive financings was not worth it.

So when a company would do a big series A round for its first round and then it was waiting to do its series B financing, sometimes it would run out of money in between.

And so oftentimes the company would then go to its lead finance, its lead investor rather, in their Series A financing, and they would ask for a bridge loan.

A bridge loan is a debt bridge between 2 financings.

And these involve the note purchase agreement and a convertible promissory note, and sometimes there would be common stock warrants that would go with it.

But basically it was a stopgap measure in between financing.

So again, keep in mind, these financings I just told you were long and expensive, so you aren't just doing them all the time.

And this is where bridge loan financings came in.

At the heart of the bridge loan was this convertible promissory note.

And a convertible promissory note was a loan.

It had an interest rate, it had a maturity date, it was a real note, but it also had a mechanic that would cause it to automatically convert into shares of stock when you did that next round.

So if you got a bridge loan in between your Series A and your Series B, your convertible promissory notes would convert into shares of Series B when that financing happened.

But along the way, and I honestly don't remember how this all came about, but people started to realize that just the convertible promissory note, not necessarily the no purchase agreement or the Comstock warrants, but the convertible promissory note itself could actually be used as a standalone document and you could use it to fund companies and you could use it to fund not as a bridge but actually just the very first time that a company needed money.

So this became a very appealing way to do your first fundraising event because instead of having all those documents I described in the series A financing, instead you just had a convertible promissory note, which was obviously gonna be a lot faster, it's only 1 document.

People still hired lawyers for these convertible notes, but only negotiating 1 document, and you're only negotiating maybe maturity date, and interest rate, lots cheaper, and lots more flexible, because now instead of having to do this elaborate financing process and probably wanting to raise a couple million dollars to justify all that effort, you could just raise 50K from an angel.

You could raise 100k from an angel, or even less.

But it's still a promissory note, and a promissory note is still a loan.

We then at YC decided that we could modernize even the convertible promissory note.

And what we did is we came up with something called the SAFE.

The SAFE as an acronym, it stands for Simple Agreement for Future Equity.

Unlike the promissory note, it is 1 simple document.

It converts into stock when the company raises a priced round.

You don't need to hire lawyers to do a safe.

And the most important part of it is that it isn't debt, which is why it needed to exist.

What was broken about convertible promissory notes?

They were only 1 document, they were cheap, they were fast.

Well, because we didn't think it made any sense to use debt to sell equity.

Angel investors are not lenders, and startups don't really want to be borrowers, right?

The whole point of taking someone's 50K and turning it into a billion dollars is everybody, those investors want to be stockholders, and startups don't want to be thinking about accruing interest or when is their note going to be due.

So we thought that it made a lot more sense to take all the debt part out of convertible promisor notes but retain all of the convenience of them.

So I could do an entire lecture on how to use the SAFE and what it's all about, but I've actually already done that.

So there are other Startup School video lectures that you guys can watch to hear a ton more about the safe.

So, safe financing documents are at the top.

We have a user guide that is kind of long, but it has a ton of really good information in it, tons of math examples to use to show you how it converts.

So then the question is, when do priced rounds happen?

They are still the primary way that startups raise money.

They're no longer the way that most startups raise their, do their first fundraising, but built into the safe and other convertible securities like promissory notes is the whole concept that eventually the company's going to do a priced round and those convertible securities are going to convert into that priced round.

So most often, companies will do their first fundraising on a safe convertible promissory note and then they will do a priced round afterward and all of those safes and convertible promissory notes will convert into stock.

Safes and convertible promissory notes cannot convert unless there is a price run done eventually.

So price rounds are still modern, they're just not the modern way to raise your money the first time.

And also I should mention, priced rounds, even though I was kind of laughing at them because they involve a lot of documents and we used to put them in these leather-bound closing volumes for the lawyers to put on their bookshelves, they have actually seen some improvements as well.

They are much more standard than they used to be and they are also, all 5 of the priced round documents, you can get them online these days.

You still, everyone tends to still hire a lawyer for them but.

Okay, so did we perfect modern early stage financing by introducing the safe and by everybody using convertible securities to raise money the first time.

And I would say we've come a long way, but I don't think it's quite perfected.

And the reason is because I mentioned dilution a few minutes ago.

So convertible securities, because people who hold, investors that hold convertible securities are not stockholders, you actually don't, it's very hard to tell how much ownership of your company you have sold when you sell a convertible security.

They're not on your cap table as stockholders, right?

You're still a 100% owner if all you've ever done is sell convertible securities.

But the day of reckoning is coming when you do your priced round and all those convertible securities convert into shares of stock.

And there are a ton of resources and tools on how you can keep track, but you've got to do the work.

There's no excuse for being surprised by realizing you sell 30% of your company to all of your angel investors, so don't let that happen to you.

The other thing that is to be aware of with early stage fundraising using convertible securities is because it's so flexible and easy to raise custom amounts of money, you know you can raise 100K and decide that you can bootstrap on that for a while, and then maybe in a couple months you raise 50K because you just need a little bit more.

It's very flexible, but you can end up with a ton of investors.

Used to be that in the old days you'd maybe have 6 to 10 investors, and now you can have 25, 35 different angel investors who've given you money.

But it can be administratively really challenging, because they become stockholders when you do a price round, and then you need their consent, because corporations have stockholder consents.

Kind of hard to chase down all those signatures.

Again, not a bad thing, just something you gotta be aware of.

And finally, 1 of the side effects of these convertible rounds is that investors write smaller checks, they tend to, and they don't care as much about the investor.

They're not stockholders yet, so they're not quite as invested.

Sometimes investors can drive you insane.

But sometimes they can be really helpful, right?

So having investors who've just written a check and gotten a convertible security as opposed to writing a really big check and being a stockholder, it can mean the difference between how much attention they pay to you.

Again, can be good, can be bad, but it's just a side effect.

Okay, So modern early stage rounds of financing are usually done now using convertible securities like the safe.

Selling preferred stock in priced rounds is still modern.

It tends to be your second fundraising, not your first.

The whole point, as I said before, is focus.

If you don't have to spend a lot of time negotiating documents, if you can get the money in the bank really fast, you can go back to building your company, which is what you want.

Specifically for this crowd, this is not San Francisco, this is Boston.

What safes and convertible securities are completely common on the West Coast, I suspect that you guys will find angel investors and other people in your ecosystem out here that are less familiar with doing financings this way.

So, maybe a little bit of education involved.

You may have investors who say, I've never heard of this safe, I wanna do a convertible promissory note.

Or you may have investors who are just like, what are you talking about?

That's what we're doing if you want my money.

Kind of hard to say outside of the Silicon Valley.

But for the most part, I would recommend that you approach fundraising with this idea of doing convertible securities just because it can be done so fast and so flexibly.

So if you're taking those checks early on for small or big investors, what's the impact as you start to get down the road in the future in fundraising rounds with respect to the way VCs might look at that?

So I do not think, repeat the question, it's long.

Okay, so if you take small checks from angel investors to do your early fundraising, do VCs look at that in a negative light when you go to them to do your priced round?

I mean you've taken small amounts of money, you've gotten X far, right?

Like you've hit all these milestones, you're now going to VCs and saying, please do my priced round.

I think the fact that you raised money from angels and took some small checks just shows how focused you were on getting through that process fast and iterating and getting to the place where you can do a priced round.

Maybe building a little off a smaller check, but do you ever recommend something like equity crowdfunding?

So using regulation crowdfunding for YC funding?

You know, I thought that was super interesting since I've been practicing for 21 years, like that's a huge change, right?

So they changed the SEC changed the rules, you can now you can now actually generally solicit and have your company be crowdfunded where actual strangers can buy your equity.

It has a lot of rules and regulations around it.

I feel like it's still in the testing phase.

Like no YC company to my knowledge has done that yet.

So I don't have any personal experience with it.

But I know some companies have done it and it would be really interesting to go online and see if you can get like download from law firms that have helped with those crowdfunding initiatives to see kind of what the pros and cons were.

So according to the current state charts, what happens if the company doesn't raise the following round?

I heard that there is a company who didn't raise the fund, so the conversion didn't happen.

So he is wondering, what happens if you never do a price round?

You've sold a bunch of safes to investors.

The safe only converts in the event that you raise a price round, your company gets sold, or you go public.

And there is absolutely this concept that, well, what if my company just putters along and never needs to raise any more money?

And my whole point in drafting the safe was to keep it simple.

So I specifically did not try to capture every corner case that's out there.

It is exceedingly rare for a company to be able to take a tiny amount of money that it raises from its safe holders and then go on and never need to, I'm not saying it couldn't happen, but it's pretty rare.

So there's going to be a liquidity, I mean the founders want liquidity too, right?

So how are the founders ever going to get liquidity if they don't sell or go public or raise more money?

And some, you will surely meet some investors who raise that exact point.

Well, with Promise Story notes, at least it was debt, it could be repaid, they knew they were gonna get their money back.

That's not true with the safe, but again, it is like, it's a gamble, it's like, investor, do you want to buy a piece of my company?

And if you don't believe that I'm ever gonna raise money again or that I'm ever gonna do anything with this company, then maybe it's not the right investment.

So there's a million different ways you can respond to that, but basically in all my years of practice, I only ever had 1 client that had only raised 1 round.

Like, it just, companies need more money to grow.

What's the threshold, like, how do you know when to use a safe versus something else instead of a monetary threshold, like $100,000 is too much for a safe, or do you really want a safe?

Okay, what's the threshold for, how do you know which convertible security or should you do a price round?

How do you know basically what you're what to do?

I'm glad you asked that question because I did I wanted to make this point and forgot.

If a VC wants to give you $5 million as your very first fundraise, do it.

I'm not sitting here saying you should never do a price round for your first fundraising event.

So if someone wants you to do a price round and it makes sense for your company, valuation wise, dilution wise, money raising wise, do it.

Otherwise, it does not matter how much you're raising on convertible securities.

It's about what you're comfortable with and it's about tracking dilution, right?

We had a YC company that did a $50 million save and I almost choked because I was like, I didn't build it for that, you know, it's a very simple document, like it made me nervous thinking about it, But it's fine.

So it kind of depends on what your investors want to do with you.

So if they really, really want to do convertible promissory notes, and that's how you're gonna get to the next milestone, and you need that money, take it, right?

But, you know, should you not do a safe just because someone wants to do a $500,000?

are the key terms of the safe that should be negotiated?

Again, this is all in that other lecture, but because you asked, he wanted to know what the key terms of the safe are.

That's the only thing you have to negotiate in a SAFE.

And that's probably, I mean, it's not an insignificant thing, right?

You and your investor have to decide what valuation you're gonna plop into the SAFE as your target valuation, and that's gonna, plays into the math about how it converts, and that plays into dilution too, so you do have to figure that out.

And we do have a version of the SAFE, if you go to the resources tab, you can see all these.

We do have a version of the safe that doesn't actually even have a valuation in there.

So in theory, you could even get away with not even negotiating a valuation with your investors, and you could try it that way.

But really, that's the only thing you need to negotiate.

And Like I said, no lawyers, because what do you need them for?

Well, we have an investor, and he's strictly suggesting to add a special case in the safe.

OK, so this person's investor is saying, let's add something to the safe that will address the issue of what if you never do a priced round and my safe never converts?

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Carolynn Levy - Modern Startup Funding