- The session is about startup investments and features Carolyn Levy and Christina Thu as experts in the field.
- Carolyn is the inventor of the SAFE and Kirstie is the CFO of YC.
- The presentation discusses the basics of investing using Y Combinator's SAFE.
- The SAFE is designed for very early stage startups and is a simple agreement for future equity.
- The SAFE does not function as a loan and does not accrue interest.
- The document is 5 pages long and includes two key terms: the amount of money invested and the valuation cap.
- The SAFE does not include voting rights, information rights, or liquidation rights, but does include pro rata rights.
- There are different versions of the SAFE, including capped, discount, uncapped, and MFN.
- The presentation then shifts to discussing how the SAFE converts, including the valuation cap and understanding ownership.

- Valuation cap is negotiated with founders and determines the highest valuation at which a SAFE will convert into shares
- The cap is not the current valuation of the company, but a way to reward early investors
- SAFEs convert into shares during a priced round, which can be any round of financing
- The terms of the priced round do not impact how the SAFE converts, but they do impact the number of shares the SAFE converts into
- Three things happen when a priced round closes: options pool is created/increased, SAFEs convert into shares, and new money is invested
- The number of shares an investor receives is determined by dividing the investment amount by the price per share
- The price per share is calculated by dividing the valuation by the shares issued by the company
- An example is provided to illustrate these calculations and how ownership is distributed among different investors
- SAFE investors may not know their final ownership percentage until after the priced round is completed

- The SAFE investor would own approximately 9% of the company if the SAFEs convert immediately on signing and there is no new money, but this rarely happens.
- The ownership percentage can vary depending on the terms of the priced round and the amount of money invested.
- In a merger or acquisition situation, the SAFE investor can convert their investment into shares of common stock and participate in the proceeds.
- In an acqui-hire situation, the SAFE investor can choose to have their investment paid off.
- In a dissolution situation, the SAFE holders and other investors are next in line to be repaid if there is any money left over after paying off creditors.
- If nothing happens with the company, the SAFE does not address this situation and it is rare in high growth companies.
- The process for signing the SAFE involves a handshake protocol to avoid misunderstandings, and most YC founders use Clerky to send and sign safes.

- Investors should carefully review the details in a signature request and ensure the name and signature block on the safe is correct before signing.
- Investors should be prepared to wire the money as soon as they sign the safe, as it is not valid until the money is wired.
- Good investors sign and wire money quickly, as it is important for founders to raise funds and get back to work.
- When safes convert in a priced round, investors will be asked to sign more documents negotiated by the lead investor and legal teams.
- Investors should review the conversion calculations and cap tables provided, as mistakes are common.
- Founders may provide documents to sign with short notice, but investors should not sign until they are satisfied with the terms.
- Key advice for investors includes focusing on the upside, being helpful without being intrusive, and tolerating failure.
- Safes offer potential for significant returns, and investors have pro rata rights to maintain ownership.
- The vulnerability of the safe as a form of investment is questioned, but it is argued that the potential upside outweighs the risks.
- Founders determine how much money to raise on safes, and investors may face different caps if additional safes are signed with other investors.

- Founders are advised to be careful about dilution when selling part of their company
- Valuation caps in investments often follow a herd mentality and are unlikely to change drastically
- If an investor is not respecting the rights in the safe, the safe holder should fight back and make them honor the contract
- Investing as an LLC or individual depends on the circumstances and pooling money together may require creating an LLC or fund structure
- Pro rata rights were not included in the conversion round of safes because seed rounds looked different at the time, but this may change in the future
- Private placement memorandums are not necessary for safes and safes generally work around the world, but research should be done to ensure validity in other countries
- It is becoming less common for safes to convert in the pre-money stage and pro rata rights may become more important in the future.

- The speaker discusses the evolution of the SAFE (Simple Agreement for Future Equity) and how it is used to define capitalization and conversion prices.
- Founders often struggle to understand the process and terms related to fundraising and dilution.
- It is recommended that founders take the time to model out their cap tables to eliminate confusion.
- There is case law that protects individual investors from liability when investing in startups.
- The optimal legal structure for startups is typically a Delaware C-Corp, but investing in foreign companies may require additional research.
- Most Favored Nation (MFN) clauses are not standard in safes, but can be negotiated if both parties agree.
- Safes and convertibles can be confusing, and tools like AngelCalc can help model safe conversions.
- Transparency is important in startup investing, and investors should ask founders if any of their rights have changed.
- The speaker emphasizes the importance of supporting founders and avoiding unnecessary debt that could harm a company.
- The session will continue with presentations on founder meetings and insights from experienced investors.

- The session is about startup investments and features Carolyn Levy and Christina Thu as experts in the field.
- The presentation discusses the basics of investing using Y Combinator's SAFE, which is a simple agreement for future equity.
- The SAFE does not function as a loan and does not accrue interest.
- The document is 5 pages long and includes two key terms: the amount of money invested and the valuation cap.
- The SAFE does not include voting rights, information rights, or liquidation rights, but does include pro rata rights.
- There are different versions of the SAFE, including capped, discount, uncapped, and MFN.
- The presentation then shifts to discussing how the SAFE converts, including the valuation cap and understanding ownership.
- SAFEs convert into shares during a priced round, which can be any round of financing.
- The terms of the priced round do not impact how the SAFE converts, but they do impact the number of shares the SAFE converts into.
- The number of shares an investor receives is determined by dividing the investment amount by the price per share.
- An example is provided to illustrate these calculations and how ownership is distributed among different investors.
- In a merger or acquisition situation, the SAFE investor can convert their investment into shares of common stock and participate in the proceeds.
- In an acqui-hire situation, the SAFE investor can choose to have their investment paid off.
- In a dissolution situation, the SAFE holders and other investors are next in line to be repaid if there is any money left over after paying off creditors.
- The process for signing the SAFE involves a handshake protocol to avoid misunderstandings, and most YC founders use Clerky to send and sign safes.
- Investors should carefully review the details in a signature request and ensure the name and signature block on the safe is correct before signing.
- Good investors sign and wire money quickly, as it is important for founders to raise funds and get back to work.
- When safes convert in a priced round, investors will be asked to sign more documents negotiated by the lead investor and legal teams.
- Key advice for investors includes focusing on the upside, being helpful without being intrusive, and tolerating failure.
- Safes offer potential for significant returns, and investors have pro rata rights to maintain ownership.
- Founders determine how much money to raise on safes, and investors may face different caps if additional safes are signed with other investors.
- Founders are advised to be careful about dilution when selling part of their company.
- Valuation caps in investments often follow a herd mentality and are unlikely to change drastically.
- If an investor is not respecting the rights in the safe, the safe holder should fight back and make them honor the contract.
- Investing as an LLC or individual depends on the circumstances and pooling money together may require creating an LLC or fund structure.
- Pro rata rights were not included in the conversion round of safes because seed rounds looked different at the time, but this may change in the future.
- Private placement memorandums are not necessary for safes and safes generally work around the world, but research should be done to ensure validity in other countries.
- It is becoming less common for safes to convert in the pre-money stage and pro rata rights may become more important in the future.
- The speaker discusses the evolution of the SAFE and how it is used to define capitalization and conversion prices.
- Founders often struggle to understand the process and terms related to fundraising and dilution.
- It is recommended that founders take the time to model out their cap tables to eliminate confusion.
- The optimal legal structure for startups is typically a Delaware C-Corp, but investing in foreign companies may require additional research.
- Most Favored Nation (MFN) clauses are not standard in safes, but can be negotiated if both parties agree.
- Safes and convertibles can be confusing, and tools like AngelCalc can help model safe conversions.
- Transparency is important in startup investing, and investors should ask founders if any of their rights have changed.
- The speaker emphasizes the importance of supporting founders and avoiding unnecessary debt that could harm a company.

Startup Investor School is a free, 4-day course designed to educate early stage investors interested in investing in startups. We'll cover the fundamentals of investing, from investing instruments to legal and accounting basics to evaluating startups and managing deal flow. Our hope is that more people, from a wide range of backgrounds will consider investing in startups and that those who do will be better at it.

Learn more at https://investor.startupschool.org/

All right, this next session is actually 1 of my very favorites because there's so much mystery in the fundamentals of how you actually do a startup investment, what it really means and how it works.

And there are no 2 people who are greater experts in that on the planet than my colleagues, Carolyn Levy and Christina Thu, who have dealt with these issues with I guess thousands of companies now.

Certainly all 16 or 1700, what is the actual number?

Anyway, hundreds of companies, they know this stuff better than anyone.

Carolyn is the person who actually invented the safe.

She used to be attorney at Wilson Sonsini before coming here and Kirstie is the CFO of YC.

You can guess who said what, because I don't know.

1 said, all investors who can help should do so.

Asking for additional shares is just asking for a freebie.

I'm guessing that's Kirstie, but I'm not sure.

Having money is very valuable, but someone who helps with strategy and direction is priceless, so choose wisely.

Yeah, I have no idea which quote is mine and which 1 is Kirstie's.

And we were going to introduce ourselves, but since Jeff just did it, we will move right along.

Like Jeff said, this is the mechanical part.

This presentation is about how to invest using Y Combinator.

OK, so as I was saying, this presentation is about how to invest using Y Combinator's SAFE, which is the first thing I'm going to talk about.

And then Kirstie's going to describe how the SAFE converts in an equity financing.

I'm going to talk about how the SAFE converts in other events.

A quick word about process, and then we had some advice that Sam kind of covered, but we'll just reiterate it, because it's important.

Okay, so a lot of you raised your hand when Jeff asked, or Sam asked, how many people have already angel invested.

So I'm wondering how many of you have already used the SAFE?

Okay, so I'm going to talk about the basics.

For some of you that's going to be stuff you already know, but for those of you who've never used it, hopefully that will be helpful.

Okay, we drafted the SAFE for very early stage startups.

So that means that the company maybe hasn't, or definitely hasn't raised a priced round, doesn't have any preferred stock outstanding.

You absolutely can use the SAFE for companies that are later stage, that have already raised a priced round and issued preferred stock.

In fact, some of you may have already done that.

But we intended it for very early stage startups.

A time when you may not want to use the safe is if you are looking at a company that has already issued convertible promissory notes to earlier investors.

And if that's the case, you're going to want to go ahead and just use that same note, not use the safe.

And that's because it's a lot less complicated for a company to have all of its investors on the same document, and it's also more fair to have all the investors on the same footing.

So obviously if you find a company you want to invest in and they are actually doing a priced round, you are going to invest in that priced round and buy preferred stock.

But for the vast majority of early stage startups, they don't have a lead investor, They don't have a person setting the terms, setting the price of the round.

And most of the time for very early stage startups, they don't even know what they're doing yet.

And that's where the SAFE comes in because for these very, very early stage companies, they just wanna raise a little bit of money from their friends and from family and from angels.

And with the SAFE, they can do that very efficiently, very quickly, and very cheaply because neither the investors nor the company need to get legal counsel.

Okay, the SAFE as an acronym stands for Simple Agreement for Future Equity.

As I said before, it is a convertible security.

It converts into shares of the company's stock.

You, the investor, give money to the startup right now, and at some point in the future, you're going to get your stock.

1 of the most important things, I say this a lot, the safe is not a loan, it is not debt, it does not accrue interest, There is no right to be repaid at some point in the future at some maturity date.

Compare that to a set of financing documents, which is about 5 documents and none of them are 5 pages long.

I'm going to show you this is what the intro paragraph of the SAFE looks like.

You can see that there are 2 blank spaces there.

The first 1 is the amount of money that you're going to invest in the startup, and the second 1 is the valuation cap.

Kirstie's going to get into detail about what the valuation cap is when she speaks next.

But those are the only 2 things that you negotiate with the company.

After the intro paragraph, there is a whole section that describes the conversion events, which we will get into in a minute.

There is a section of definitions, because it's a legal document, we always have to have definitions.

An example of boilerplate, company makes reps and warranties to you about the status of the company.

You make some representations to the company about being an accredited investor and then there's a really skinny miscellaneous section at the end.

I want to point out what is not in the safe.

For those of you who own preferred stock, have made an investment in a company and gotten preferred stock, you will know about voting rights and information rights and liquidation rights.

Those are not in the SAFE, because the SAFE is not yet stock.

When your SAFE converts and you get preferred stock, you will be piggybacking on all those same rights that the lead investor in the round has negotiated for the preferred stock.

So you won't find those things in the safe.

So what you will find in the safe is pro rata and Sam conveniently defined that for some of you who don't know, who didn't know what it was before, it's the right to buy more stock in future rounds so that you maintain your percentage ownership of the company.

The SAFE has a section that says that you will get those pro rata rights in the next round, not the conversion round, but the next round.

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

So what I've been talking about is what we call the capped safe.

It's the 1 that has the target valuation.

Kirstie's going to describe that in a lot more detail.

It's the most commonly used safe that we have, but there are a couple of other versions of the safe that I'll go over briefly.

There is something called a discount safe.

Instead of negotiating that valuation cap in the intro paragraph, you and the company will negotiate a discount rate, And the discount rate will then apply to the shares when you convert the safe.

Typical discount rate ranges in between 10 and 20%.

So for example, if the series A round that your safe is converting in is the lead investor has priced it at a dollar per share and you've negotiated a 20% discount, your effective price is 80 cents a share.

There's also an uncapped safe, which not very common to use.

This has neither a target valuation nor a discount, so really you're just converting your safe into the same price that the Series A is paying.

There's no reward for being the early money.

That's why it's a pretty unusual safe to have, but Occasionally a company has such great demand that they can get away with serving up an uncapped safe.

And then a third version is what we call the MFN safe.

It's a concept we borrowed from contract law.

And there is no target valuation in this safe, but there's this paragraph that says that if a subsequent investor negotiates a target cap, rather a target valuation or a discount, you get to amend your safe to take the terms that that investor got.

All right, so now we're going to talk about how the safe converts, and we'll cover how the valuation cap works, the maths behind the safe converting, so this is going to turn into a maths class, and also how to understand your ownership.

This is 1 of the things that, as Carolyn mentioned, is 1 of the things that you will negotiate with the founders.

And you'll also hear it referred to not only as a valuation cap, but a target valuation, or just simply a cap.

And the cap's the highest valuation that your SAFE will convert at.

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

And it's important to note that people get really confused with the cap, they think it's a current valuation of the company, that's really not what it is.

All it is is a way for you to be rewarded for coming in at the earlier stage, when in theory you're investing at a riskier stage, it's the way for you to get your reward and your bonus.

And so ideally what you really should be thinking is, if I'm putting money in at this cap, then what do I think the series A price, how much higher do I think the next price round's price is going to be?

And ideally you want that high because then your reward is better.

Okay, so your safe will convert into shares when the company completes an equity financing, i.e.

And different companies, depending on the stage of the company, that priced round might be called a Series C, it might be a Series A, or there might be some situations where they've already raised a Series A and there's some safes bridging them to the Series B.

So it's just whatever the next price round is.

And we'll try to refer to it just as a priced round here, but sometimes it just slips in that it's a Series A, but it can be any priced round.

And in that equity financing, the company, the founders, will negotiate with a lead investor in that round and will create a term sheet that sets out the terms of that round.

And those terms don't impact how your safe converts, because that's set out in the safe itself.

But what it does impact is how many shares the safe converts into, as we'll go over in a moment.

And so when the priced round closes, 3 things happen.

And in the documents, they're all happening at the same time, but in the calculations, they actually go in order, and you'll see why in a moment.

So First of all, an options pool is created or increased if the company already has 1.

And usually the closing option pool, which is negotiated as part of the term sheets negotiations, it usually is around 10% of the post round shares.

And that's kind of what makes this calculation a little bit complicated, as we'll see in a moment.

Next thing is that the SAFEs convert into shares.

And although the SAFEs themselves don't state this, The term sheet will usually specify that the SAFEs convert in the pre-money.

And what that basically means is that the shares that the SAFEs have converted into are considered when the price per share for the lead investor is being calculated.

And again, you'll see that in an example in a moment.

And then thirdly, the new money comes in.

So the lead investor and anybody else who's investing in the round at that time will invest their money and buy their shares.

So, at a very high level for any investor, the number of shares that an investor will receive is the investment amount divided by a price per share.

And the price per share is calculated by dividing a valuation by the shares issued by the company.

And the shares issued by the company is otherwise often, or always referred to in the documents as the capitalization of the company.

And so for a safeholder, the valuation is usually the cap, and the capitalization is usually the issued shares plus the increased options pool.

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

So on the left over here we have an example situation.

So we have founders who have 9000000 shares issued.

There's 3 founders in this example and they're all sharing the shares equally.

And at demo day in March, the company raises $800,000 on safes, and they all have the same valuation cap.

Often it can take that long, maybe even longer before a priced round happens, and they raise a priced round which is where they raise $4 million at a $16 million pre-money valuation.

And the terms that are negotiated in the term sheet as well are that the options pool will be increased to 10% of the post money and the safes convert in the pre-money.

And I'm not going to get into the calculation of how the options pool increase number works because it gets very circular, as I'll show you in a moment.

But just trust me, that is going to increase to this very not-round number of just over 1.4 million shares.

So, the first thing that happens, we've increased our options pool.

The next thing that happens is that our SAFEs convert.

So, the SAFE capitalization, as defined in the SAFE, is the issued shares plus the increase in the options pool, so 10.43 million shares.

The SAFE conversion price is the valuation cap, because the cap is less than the priced round, divided by that capitalization to give a conversion price of 77 cents.

So the shares that the safe investor buys are the $800,000 investment divided by this conversion price to give us just over 1 million shares.

So then the next thing that happens is our new money calculation happens.

So this is the lead investor in the price round.

So this time the capitalization doesn't include just the issued shares and the increase in the options pool, it also includes the shares that the SAFEs have converted into.

So this time we have a capitalization of 11.4 million shares.

And then the price per share is calculated, again, using the price per share, sorry, the valuation from the term sheet, the 16 million, divided by the 11.47 million shares to give a price per share of 139.

And so those, that $4 million from the new money investors will buy 2.87 million shares.

Okay, so bringing this all together, this is a very simple cap table.

It's much prettier than cap tables normally look.

So for those of you that are not familiar with cap tables, how this works is it's just a way of explaining the ownership of the company and who owns what and in what proportions.

So here you can see that we have our 3 founders, they own common shares, their numbers haven't changed, the number of shares that they have stays the same.

We have our increased options pool, this is where the employees will be issued shares from in the future.

And then we have our safe investor who has their 1 million approximately shares and you have the price round investor who has the 2.8 million shares.

And these safe investor and priced investor has preferred shares, founders and employees have common shares.

So what you can see from here is that even though the safe investor has put in $800,000 of the total 4.8 million that the company raised, proportionally between these 2 investors they actually have a much higher number of shares And that's the cap coming into play, and that's how the safe investor gets the reward for their early investing.

It also shows percentage ownership, and you can see that my maths did work.

Our options pool is 10% of the total post money shares, which is the total of these 2 numbers.

Now safe investors have quite a hard time of it.

Because at the time that you actually sign your SAFE, you don't really know how much ownership you're going to wind up with after the priced round.

And the reason for that is that even though the SAFE says how the safe's going to convert, it doesn't specify how many shares it's going to convert into because that is dependent on the terms of the priced round.

And so in this example, the safe investor has just over 7% of the shares.

And the way you can think about it when you're signing your safe, if you're thinking about ownership, is kind of a rule of thumb of $800,000 invested at an 8 million cap gives an 8.8 million post money valuation of the company.

So the SAFE investor would own approximately 9% of that.

But that assumes that the SAFEs convert immediately on signing and there's no money.

So the reason why this 7% is not 9% is why it's less is because the safes have been diluted by the new money coming in.

And just as an example to just explain a little bit more, if the terms of the priced round had all been exactly the same, except that the investor had only put in $2 million instead of $4 million, then the ownership here would be just over 8%.

So that just tells you exactly, you really can't tell how much you're going to get until the price drowned.

Because that's quite difficult, it's important to do your own modeling and to think about how you, you know, what scenarios could happen to explain your ownership going forward.

And so there's a couple of things that we can, that we have shared with you to help with that.

Jeff, wherever he's gone, has written some software called AngelCalc and that is a modeling software that allows you to see various different scenarios and there's also going to be a spreadsheet that I'm going to put on to the resources page at the Investor School website so that you can see, you can play around with the calculations and you can see how SAFEs might convert in the future.

Okay, so suppose you've invested in a company And before it raises a price round, something else happens.

And examples of what else could happen is that it could get acquired, it could fail, or nothing could happen.

Okay, I think it's easiest to understand what happens in the safe in a merger acquisition situation if you look at both extreme ends of the spectrum.

The first 1 extreme end would be, you know, a home run situation.

And by home run, actually I think Sam mentioned this as well, this term.

This is where an acquiring company is coming in and paying a lot of money for the startup you invested in.

Well, you are going to convert it into shares of common stock.

You're going to do that by using the target valuation to determine the number of shares of common stock you get, and then you are going to participate in the proceeds of that merger along with the founders and the other common stockholders.

In that case, you can expect a return that is well in excess of what you paid for your safe.

This is also what would happen in an IPO, by the way.

Other end of the spectrum is the acqui-hire.

And I don't know if this is a term that all of you in the room are familiar with, but this is a situation where an acquiring company is coming in and just taking the talent out of the startup that you invested in, so the founders and key employees, they are not paying money for the intellectual property or any other assets, and these are deals where there is usually very little money.

In that situation, you are going to elect to have your safe paid off.

So The safe gives you the option, and because most deals aren't at these 2 extremes of the spectrum, they're somewhere in the middle, what you need to do when you're confronted with this situation is actually do the math and figure out how you get the best result, whether it's converting into shares of common stock and taking in merger proceeds or just getting paid back.

So sometimes a company raises money from you and other angel investors and just can't make it work.

Hopefully they try really hard, but sometimes it just doesn't happen and they fail.

And when failure happens, companies need to go through an actual dissolution process.

And part of the process requires that creditors be repaid.

In a dissolution situation, they need to pay off their trade debt, which is vendors and landlords, and they obviously have to, have to, have to pay their salary, any employees they have, they have, need to pay the salaries.

If there is any money left over, the safe says that you are next in line.

So if there's money, the safe holders and any other investors will get paid back.

Often, it's pennies on the dollar, but they get something before stockholders get anything.

And honestly, in a dissolution situation, not only is there never any money for stockholders, but there's rarely enough to pay back investors either.

This is usually just a total failure and you can expect this to happen some of the time.

So this would be a situation where the company has raised from angels and actually become self-sustaining, profitable, and they just putter along and suddenly they have no desire to raise a priced round and nobody's knocking at their door to acquire them.

Well, the SAFE doesn't address this and there's a reason why the SAFE doesn't address this situation.

Number 1, when you try to draft for all these corner cases, it stops being a simple document and becomes a very complicated document and a very long document.

And number 2, this just doesn't happen very often.

In high growth world, this is extremely rare.

But if you want to fund lifestyle companies, you definitely do not want to use the safe because then you're going to have this problem all the time.

If you have accidentally funded a lifestyle company, then I think our advice would be to go talk to the founders about it.

Because hopefully you invested in really good people and they would want to do right by you and figure out how to make you whole.

That kind of goes back to Sam's point about being really careful about the founders you choose to put your money into.

OK, so we've talked about what the safes are and how they convert.

But now let's talk about the process for actually signing the safe and then also for converting it into the shares.

So the first thing in this process is the handshake protocol and the reason why we created this is to help to avoid misunderstandings.

Founders are by nature very optimistic and we've seen many situations where the investors said something like, yeah I'm interested, meaning I'm interested in finding out more about the company.

And the founder hears this as, I'm going to invest in your company.

Cue lots of misunderstandings and confusion.

So the handshake protocol is just simply a set of emails that sets out in writing the key terms and make sure that everybody is in agreement.

So the founder sends an email to the investor and says just confirming that you're in for X dollars at Y cap and then you reply to the email to confirm.

And at this point there's a handshake deal and it's considered bad practice at this point to back out.

And again reputation is everything in this world.

So you know you don't want to be doing things like backing out because it can harm your reputation.

And on the flip side, the founders are under no obligation to take your money until that handshake deal is completed.

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Carolynn Levy and Kirsty Nathoo - Startup Investor School Day 1