What is the best approach for my startup?
If you have been researching potential funding options for your startup, it is very likely you have come across SAFE notes and revenue sharing. There are pros and cons to both SAFE Notes and Revenue Sharing. Ultimately, it depends on your business needs and preferences which option is best for you. You should consult with startup lawyers on the best way forward.
What are SAFE notes?
SAFE stands for Simple Agreement for Future Equity and has become a popular way for startups to raise funds in their early stages or between funding rounds. It is similar to a convertible note because it converts initial investments into future equity. However, SAFE notes were created as a more flexible and simplistic model than convertible notes. SAFE notes are made from easy to use templates that are usually just five pages.
Click here for a comparison of SAFE notes and convertible loans.
What are the benefits of SAFE notes?
The main appeal of SAFE notes is that they allow for immediate investment in your startup without the complexity of an official funding round. While investors receive their shares at a discount when the Trigger Event occurs (such as the next funding round), this also means that no specific share price needs to be determined at the time of the investment, the valuation cap places a limit on the maximum price for the conversion. A perk of the discount rate is that it can help your startup attract investors with the safeguard of the valuation cap. SAFE notes also do not accrue any interest and require limited negotiation.
What are the downfalls of SAFE notes?
As a SAFE note is not a debt with a maturity date but an interest, it is possible that a SAFE note will never convert into equity if the Trigger Event never occurs. Consequently, sophisticated investors who are aware of this risk may be unwilling to invest in your startup with this method.
A crucial issue with SAFE notes is that they can make it difficult to keep track of how much the shares in the startup have been diluted. Unfortunately, when SAFE notes are not properly accounted for in a capitalisation table, founders often end up realising too little too late that their ownership and therefore, control of the company is much lower than intended.
So, when are SAFE notes a good option?
SAFE notes can be a good option for your startup at an early stage when valuations are difficult and when standard equity raising requires too much time and resources. They can be a useful bridge between funding rounds to reach important breakthroughs for your startup.
To mitigate the cons associated with SAFE notes, the cap table should be drafted to reflect the impact of any SAFE notes before they are issued (i.e. understanding the post-investment valuation and share structure before it occurs).
What is revenue sharing?
Revenue sharing occurs when a capital investment and an additional multiple of that investment is repaid (generally monthly) with a percentage of your company’s profits. The repayments occur until the amount has been paid or until the maturity date at which point any remaining debt must be paid. For example, if an investment of $1000 is made at a multiple of 2, the startup must repay the investor $2000 by the maturity date.
What are the benefits of revenue sharing?
Revenue sharing agreements are flexible and customisable. Unlike a debt with a fixed interest, the revenue sharing model means that your repayments are adjusted based on the startup’s monthly performance (this means a slower month or quarter will have less of an impact on your profit). An investor may prefer a revenue sharing agreement to a SAFE note as the return on their investment is more guaranteed. Finally, revenue sharing does not impact the startup’s equity, meaning ownership of the business is not diluted.
What are the downfalls of revenue sharing?
Investors may not be attracted to a revenue sharing agreement if you are not consistently generating a certain amount of profit. Revenue sharing also places a consistent and long term drain on your ability to reinvest profits into growing the business.
When is revenue sharing a good option?
If your startup is making a steady profit or you can attract an investor willing to accept this model, revenue sharing can be a good option for founders who do not want to dilute their ownership. Crunch the numbers and be sure the monthly repayments are conducive with scaling your startup to where you want it.
There are a number of investment options available and all of them have their pros and cons. Either SAFE notes or revenue sharing may be the best option for your business depending on your short term and long term goals.
At OpenLegal we can help you adopt an investment plan that is tailored to your needs and ensures that your interests are a priority. If you need advice about capital raising, get in touch with our startup team via the contact form or by calling 1300 337 997.