In this blog series, we review the most common types of securities used in financing emerging companies, and highlight key issues worth considering for each.  Over the course of four posts, we’ll touch on the sale of (1) equity securities, (2) convertible debt, (3) SAFEs/KISSes, and (4) debt (non-convertible), non-dilutive funding and bootstrapping. In this third post of four, we address the financing of a venture through the sale of convertible instruments such as SAFEs and KISSes.  

Other Convertible Instruments: the SAFE, the KISS and the IRR Instrument

The Simple Agreement for Future Equity (SAFE) and Keep It Simple Securities (KISS) each refer to specific form documents for convertible equity designed to be simple and produce quick, efficient transactions. They were both developed by startup accelerators in the 2010s (by YCombinator and 500Startups, respectively) interested in creating easy-to-use standard forms that balanced founder and investor interests.  Several lawyers at Wiggin and Dana conceived of the Interim Rate of Return (IRR) Instrument to better align the company with its investors, but that’s a newer and less familiar instrument at this point. 

Like convertible debt, these documents are convertible instruments through which an investor gives money to the company at closing, for the promise that the investor will be given a to-be-determined number of shares at a future financing. Also, like convertible debt, the parties often negotiate the inclusion and amount of a discount and/or valuation cap, or in the case of the IRR Instrument, a return rate.

However, the SAFE and one version of the KISS (the equity version) are generally not considered debt instruments. The IRR Instrument is also intended to not constitute a debt instrument.  The investors give the money in exchange for the promise of future shares only. There is no obligation for the company to pay the money back. Thus, interest does not accrue, and there is no maturity date (the KISS is made available in an equity version and a debt version – the debt version does include an interest rate and maturity date). The lack of debt-like features removes some of the pressure on the company with respect to the timing of its next financing. Note that this doesn’t mean that the investors can never collect if the company fails to reach financing – if the company gets acquired or dissolves, the investors are generally entitled to recoup their investment, or a multiple thereof.

For founders, a major benefit of these form documents is that they are short, and in the case of the SAFE and KISS, are available for free and have a recognized reputation. Keep in mind, though, that the efficiency of any convertible instrument comes at the cost of uncertainty. Due to their relative novelty, the courts have not yet developed a body of law for these instruments, and not every investor will be familiar (or comfortable) with them. The company may have to help an investor feel secure in choosing this option.

More generally, the standardized veneer of these instruments should not prevent founders from negotiating for terms that are favorable to the company. Strive to understand the terms of the agreement and how they may be adjusted for your particular circumstances. If you’re short on negotiation capital, you might focus on impact items such as the valuation cap, discount, rate of return, pro rata rights, and most favored nation status.

When to use it:

  • You have an investor who is comfortable with these instruments
  • You need cash and growth to attract potential shareholders
  • You have limited resources
  • You want flexibility on when to hold the next financing and do not want a maturity date to dictate the date for it

In the next and final post, we will consider (non-convertible) debt, non-dilutive grant funding and bootstrapping as options to fund your venture.