Convertible notes are so 2013.
Los Angeles-based startup accelerator StartEngine announced that it’s switching to SAFE to fund its startups. SAFE (simple agreement for future equity) is a new form of early startup financing that serves as an alternative to convertible notes.
StartEngine founder Howard Marks said the decision is an effort to lure talented entrepreneurs away from other accelerators, by offering them better terms.
“All of our competitors are offering funding in exchange for an equity stake at a set valuation and until recently, we were doing the same thing,” Marks told VentureBeat. “Most accelerators believe that they are taking a risk on an entrepreneur by going in early and so they as the investor should get favorable terms. We are throwing out that model because we realized the we can create and capture the most value by helping entrepreneurs build massive companies. Entrepreneurs who can do that are rare. You need to compete for the opportunity to fund them.”
SAFE was created by Y Combinator partner Carolynn Levy, and the elite accelerator announced last month that it will start using SAFE with its winter 2014 class.
A convertible note is a short-term debt that converts into equity. Investors loan money to a startup, but instead of getting their money back with interest, it converts into equity. This approach enables startups to raise money quickly, without extended negotiations involving lawyers. It was considered one of the most founder-friendly ways to raise seed money.
SAFE means that an investor doesn’t buy stock itself, but the right to buy stock in a future equity round, so there is no debt involved or the need to fix a term or decide on an interest rate.
Marks (and YC founder Paul Graham) described it as a convertible note with all of the benefits, but none of the drawbacks. StartEngine is likely the first of many accelerator programs to follow YC’s example.
Marks said that he and partner Paul Kessler noticed a point of friction between their fund and candidates during interviews, because StartEngine required startups to agree to a valuation of $200,000.
“Because we invest at such an early stage, before all of our competitors that we know of, it’s almost impossible to get valuation right,” Marks said. “Our entrepreneurs want to build multimillion or billion dollar companies, so it’s understandable that they’re reluctant to agree to only a $200,000 valuation. By using the new setup we don’t need to have that discussion with them. SAFE makes it easier for us to just fund and get started right away.”
StartEngine opened in Los Angeles in 2011 with the audacious goal of accelerating and mentoring 120 startups per year, in an effort to put Los Angeles on the map as a tech startup hub. Marks said its goal is to attract promising entrepreneurs to the region, but “the superior lifestyle and weather” of L.A. is not enough.
Now startups accepted into StartEngine will have the option to have $20,000 in SAFE notes deposited into their bank account. i exchange for a 2% advisory stake.
Y Combinator pioneered the accelerator model in 2005 and is generally considered to be the “best.” Scores of comparable programs have cropped up in the ensuing years, but YC has continued to maintain its prestigious stature and create trends within the accelerator and wider startup world.
SAFE is no exception.