Convertibles Financing for Startups – Part (1)

Written by Ibrahim Shehata

Startup founders always worry when it comes to raising funds. This post focuses on convertibles as a mechanism for financing, especially at the pre-seed stage.

What are the different types of convertibles?

A convertible note is a financial instrument that is frequently used to raise early-stage funding for a startup without diluting the founders’ shareholdings. There are three different types of convertible instruments: Convertible Loan Note, Simple Agreement for Future Equity (SAFE), and Keep It Simple Security (KISS). The preference of investors and which instrument they most typically employ will determine whether a startup chooses a convertible loan note, a SAFE, or a KISS to acquire funds.

What is the difference between pre-money and post-money valuation measures?

Both pre-money and post-money valuation measures are used to value companies, although the timeframe of the valuation differs. In a Series A financing, and following investment rounds, the company will be valued – also known as priced equity rounds. Before and after the investment, the company will be valued differently. The worth of a startup before an investment round is known as a pre-money valuation. The value of your company following an investment round is known as a post-money valuation.

Why is the pre-money valuation important?

The price per share (PPS) that an investor will pay for shares in your company during the financing round is determined by the pre-money valuation. Usually, investors favor a low valuation because it allows them to get the most ownership percentage for their investment.

What is the first thing a startup founder should worry about when raising a Convertible (SAFEs…) Round?

If there is one thing any startup founder should worry about when raising a convertible financing round is to be conscious about building her own cap table first and to make sure that she understands what is going to happen. In other words, she should know upfront how much she will be diluted when the first priced round takes place. To build your cap table for a SAFE round, you can use this template resource: https://www.harvest.builders/free-resources/cap-table-safe-template

What will we talk about in the next episodes of this topic?

We will focus on the nuts and bolts of SAFEs being the most common financing instrument used by startup founders. Especially, what is pre-money SAFE v. post-money SAFE. Also, what should you do about your ESOP when raising a SAFE round. Moreover, we will explain what should a startup founder be careful about when raising SAFEs in a bridge financing round? All this is to make your startup an investor-ready one when raising your first priced equity round.