Why many Austin Startups use Convertible Notes instead of SAFEs for Seed Rounds

Background reading:

Most seed rounds under about $1.5 million in Austin (and Texas generally) are done as “convertible instruments” – convertible notes or SAFEs. Above that mark seed equity (a simplified version of full equity documents) or NVCA-style equity forms become the norm.

SAFEs (simple agreements for future equity) were created in Silicon Valley years ago. At their creation, SAFEs were effectively a convertible note without interest or maturity, but otherwise identical in economics to notes, which made them about as company friendly (and investor unfriendly) of an instrument one would come up with. They dominated SV seed rounds quickly.

Because SV has historically had the most densely populated, and therefore competitive (which is good for companies), VC market, SV financing instruments have generally gravitated toward being much slimmer and more company friendly than other markets. That’s why the original SAFEs became so popular in SV, despite being so investor unfriendly. But in other markets, like Austin, convertible notes still dominated.

To be very clear, “classic” convertible notes are not particularly investor friendly. A conventional convertible note is already the by-product of reducing investor rights and creating a “streamlined” instrument for fast seed round closings. The move from convertible notes to SAFEs (the traditional pre-money SAFEs) simply pushed things over the edge for many non-SV investors, to where they balked.

A few years ago, a new version of the SAFE was released with a post-money calculation. This one had a far more company unfavorable economic structure built into it. For more details on that, see: Why Startups shouldn’t use YC’s Post-Money SAFE. The upshot is that while pre-money SAFEs were considered too biased in favor of companies, the new post-money SAFEs are for most companies too biased in favor of investors. Most startups should avoid Post-Money SAFEs for their seed rounds if at all possible.

This whip-sawing from overly company friendly to overly investor friendly among the SAFE concept has only reinforced why convertible notes remain so popular for most seed rounds outside of Silicon Valley, including in Austin. Virtually every seed investor and startup lawyer understands them, and they can be flexibly and efficiently tweaked to address concerns either side of the deal may have. We’ve posted a public version of our seed round convertible note template here.

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