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SAFEs and KISSes: the (New) Way to Invest in Start-ups

by | May 16, 2023 | Legal

In the ever-changing world of startups, not only are there great innovations in the products and services created, but also in the ways in which those start-ups try to raise investor capital such as through a Simple Agreement for Future Equity (SAFE) or a Keep It Simple Security (KISS). Never heard of those types of contracts, you are not alone. But before diving into their details, let’s look at the underlying issues which they seek to address.

One of the biggest challenges for start-up investors is to figure out how to value your startup (what is a reasonable price per share to pay). Is it the next Shopify or will be a dud and yet another name in the long list of failed great ideas? No one and can really know, but to stand a chance your investor needs to do some serious due diligence.

What is due diligence? Due diligence is a process of examining your company’s books, contracts, products, and financials to get as complete of a picture as possible to figure out whether it is worthwhile to invest and if so, at what price. The problem is that due diligence is very time-consuming and therefore quite expensive, so small investors are not keen to go through (and pay for) such an exercise. This puts those investors in an unfortunate position where they are interested in investing in your company, but they have no way to confirm whether your company’s proposed valuation actually makes sense. Your company is also in a jam since it needs that investor capital, but it doesn’t want to pay for a business evaluator or to finance its potential investor’s due diligence.

The solution: your investor proceeds with the investment and piggybacks on someone else’s due diligence to value your company. What do I mean by that? First, your investor agrees to invest a certain amount of money, say $25,000, in your company. This investment is subject to the condition that it will be converted into shares at a later date after someone else makes a sizeable investment, and at the same price per share as that which is used for that sizeable investment.

SAFEs and KISSes seek to do precisely that while trying to keep their terms as simple as possible to reduce the complexity of investing and the need to expend resources to negotiate their terms. The goal is to make it as easy as possible for companies to raise money and for investors to invest. A particular aspect of those two contracts is that they both normally contain a valuation cap and a discount rate.

A Valuation Cap is the maximum value of your company at which your investor’s investment will be converted into shares, meaning that even if the large investor invests at a valuation above the valuation cap amount, your initial investor’s price is capped at the valuation cap amount.

A Discount Rate is a percentage reduction which your initial investor receives if his or her investment converts at a value below with the valuation cap, so to say, if the large investor deems that the value of your company is less than the valuation cap, then the investment converts into shares at that lower value minus the discount rate.

Both the valuation cap and the discount rate seek to reward your initial investors for their trust, and to compensate them for the risk of investing earlier in your company.

I should also mention that both SAFEs and KISSes can also convert independent of a large investment after the expiry of a certain delay or upon a liquidity event which is normally associated with the change of control of your company (a new majority shareholder) or the liquidation or winding up of your company.

So what’s the difference between those two agreements? SAFEs simply convert at their maturity date or upon a triggering event (large investment, dissolution event, change of control event, etc.) without charging any interest, whereas KISSes charge interest during that intervening period.

In today’s high interest rate environment, KISSes are more popular since they account for the fact that your investor’s investment money could be generating interest instead of waiting to be converted into shares, say by being invested in a GIC (guaranteed investment certificates). That being said, this interest can either be paid out by your company in cash or can be converted to equity alongside the capital of the investment. Aside from the question of interest, KISSes and SAFEs are quite similar. And, just like any contract, they can be tailored to meet your particular needs and situation.

So now that you know some new ways how to raise investor capital, it’s time to finance your new side project or to invest in your friend’s. Best of luck!

Matthew Meland

Matthew Meland

Lawyer at FFMP, entrepreneur, blogger

As a lawyer with a diversified civil and commercial law practice, I often work with start-ups and small businesses. On the side, I am involved in several businesses from education services to high-tech.


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