It can be difficult for startup companies to raise capital. The good news, however, is there are a number of investment vehicles available to steer them toward success. By understanding all their options, startups and early stage companies can make the best decision for their current needs and future. Let’s dive deeper into the various types of investment instruments that exist.
Simple Agreement for Future Equity or SAFE notes were founded in 2013 by Y Combinator, a Silicon Valley startup accelerator. Even though SAFE notes are designed to be converted to equity at a later date, they’re not loans. As a result, they lack an interest rate and maturity date. Startups don’t have any pressure to convert SAFE notes into equity at a specific date or fundraising round.
Essentially, SAFE notes are agreements or warranties. These investment vehicles fall into several categories, which are based on whether they include or exclude a discount rate and valuation cap. A discount rate refers to a percentage off in the next round while a valuation cap places a maximum ceiling on the valuation of the next round. Here’s a brief overview of the four types of SAFE notes.
Convertible notes are similar to SAFE notes in that they’re designed to be converted into equity at a later date. However, they differ in that they’re considered debt instruments with an interest rate and a maturity date. In general, convertible notes have a discount rate upon conversion. The main components of convertible notes include:
While SAFEs and convertible notes are similar in nature, there are several notable differences between them, including:
Also known as Keep It Simple Security notes, KISS notes are agreements between investors and startup companies. They were designed to standardize the seed funding process and make it easier for startups.
Here’s how a KISS note works: Once the investor invests money, they receive the right to purchase shares in a future equity round. A KISS note is a hybrid between a SAFE and convertible note because it offers the simplicity of a SAFE but adds the investor protections of a convertible note.
KISS, which has been around since 2014, was created by 500 Startups, an early-stage seed fund and incubator with a focus on small to medium sized internet startups. There are two types of KISS notes, including:
Special Purpose Vehicles (SPVs) are legal entities that are created for one particular purpose. Typically, they’re formed as limited liability companies (LLCs) or limited partnerships and considered pass-through vehicles. This means they’re owned by their members and pass through income or losses to those members, in proportion to the ownership each member has.
When a limited partner invests in an SPV, they officially become a member of it. In exchange for their capital, they receive membership interest, which is usually expressed as a percentage. Let’s say a limited partner invests $10k into an SPV. If the SPV raises $100k total, they’ll receive 10% membership interest in it.
As soon as an SPV is done raising capital, it makes a single investment in a startup and sends one wire transfer to it. Then, it appears as a single entry on the company’s cap table, which is a document that outlines ownership.
Just like typical venture funds, SPVs may charge carried interest and management fees. However, all capital is usually paid upfront instead of several times throughout the life of the fund. It’s important to note that each SPV is unique and has its own features, such as hurdle rates, waterfall provisions, distribution timings, and redemption rights.
There’s no denying that finding the right combination of investment vehicles is tricky. But by comparing all of the options out there and weighing their pros and cons, startups can determine the right ones for them.
Are you a startup founder looking to raise capital? Sweater is always looking to invest in innovative companies. Reach out to us at https://www.sweaterventures.com/contact or download the Sweater app today!