Every entrepreneur who has just started their company would understand the challenges of raising funds. Even though there are several sources to raise seed funds, there is other stuff to take care of.
The same is the case when a startup does not carry much value to move forward with outside funding or go through standard-priced equity rounds.
Convertible Notes are a great alternative for startups to raise funding without the hustle and bustle of arriving at a valuation for the company up-front.
There are different convertible notes, such as KISS and SAFE Notes. This article tells you what the different forms are and what is best suited for you as an investor or a startup founder.
Convertible Notes, KISS Notes, and SAFE Notes
Convertible notes are an excellent option for startups in their initial stages and have recently become popular amongst founders to raise seed funding.
Convertible notes are securities offered to investors in bonds or preferred shares that can later be converted into common stock. Bondholders can convert their position as a creditor into equity holders when the convertible notes reach a trigger event.
KISS Notes and SAFE Notes were created to address the complications and challenges of convertible notes. In addition, the creators of KISS and SAFE instruments aimed to make funding faster and easier for companies.
Both instruments convert into equity after the first round of funding. However, some differences between them determine if it is suitable for a company or not.
Before we understand KISS Notes and SAFE notes, some terms need to be understood:
Discount refers to the discounted conversion price from the price paid by the investors at the next round of funding or the trigger event. For instance, if a convertible note is placed at a discount of 20%, and if the stock is priced at $2 per share, the share price would be at $1.6 per share when the convertible note matures.
The valuation cap indicates the ceiling on the investor’s valuation at the next round of funding. For instance, if the convertible note places a valuation cap of $3 million, and the note matures at $5 million, the convertible note will convert at a $3 million valuation.
An investor can convert at the lowest price when the convertible note has a discount and valuation cap.
Most favored nation provisions
Some convertible notes contain a term where if a company offers additional notes in the future, the investor can opt to exchange their convertible note with those with better terms.
For instance, if a convertible note was issued with a 20% discount and later issued with a 50% discount, the investor can opt to receive the 50% discount under those terms.
Difference Between KISS Notes and SAFE Notes
Knowing the difference between KISS Notes and SAFE Notes can help you understand what brings more value to your company. Here are some key differences to help make your decision-making process more manageable:
KISS stands for “Keep It Simple Security.” KISS Notes were created by 500 Startups in 2014 to standardize the seed funding process and make it easier for startups.
KISS Notes are a form of convertible security that converts into equity at a trigger event. Being a convertible instrument, KISS Notes do not require any valuation before issuing shares.
There are two forms of KISS Notes:
A Debt KISS note has accruing interest and a maturity date. In contrast, an Equity KISS note does not have a maturity date or accruing interest.
Based on both parties’ legal documentation or agreement, KISS Notes convert into stocks based on the discount and valuation cap.
SAFE stands for “Simple Agreement for Future Equity.” KISS Notes were created by YCombinator in 2013 to help startups get funding easily. With SAFE Notes, investors can convert their SAFE notes into shares in the next round of funding.
When issuing notes, investors are given a warrant that gives them the right to convert notes into rights, which is very attractive.
Sometimes, a SAFE note has a discount rate and a valuation, which plays a significant role in the notes. These factors determine the number of shares the investor can convert the SAFE notes into.
Usually, four main factors are involved in a SAFE Note that determine how it affects investor rights:
- Cap, No Discount- SAFE Notes only have a valuation cap and no discount
- No Cap, Discount- SAFE Note has a Discount on the share price in the future but does not have a Cap.
- Cap and Discount – SAFE Notes have a valuation cap and a discount.
- MFN or Most Favored Nation with no cap, no discount- SAFE Notes do not have a discount or a valuation cap but carry an MFN clause or element.
What Works Best for your Startup?
Both KISS and SAFE notes are beneficial for investors and startups.
KISS Notes accommodate several clauses for investors, which can benefit them if the startup fails. As a result, they are usually the preferred convertible notes during negotiation.
SAFE Notes are considered more flexible when a startup has different types of investors. In addition, SAFE Notes are lighter on the debt and do not carry any interest or maturity date, which can be favorable for startup owners.
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