New Standard Deal
blog.ycombinator.com
blog.ycombinator.com
Interestingly, unless I'm understanding this incorrectly, this change might mean a worse deal for founders going through YC. As the post mentions, when calculating the dilution taken from a post-money SAFE, all other money raised on convertible instruments before an equity raise are excluded.
Functionally, what this means is that while investors on standard SAFEs are diluted by other SAFE investors before an equity round (as are all common holders), investors on post-money SAFEs are not diluted by other investors on SAFEs before an equity round.
So unless I'm misunderstanding this, I believe this means that YC (which was previously a common holder like the founders) will no longer be diluted by the money founders raise on convertible notes or SAFEs before an equity round, whereas before they were diluted by that money.
To demonstrate this, I modeled out a scenario where a company goes through YC, raises $2m on a $10m cap pre-money SAFE after demo day, and then raises a $10m Series A equity round at a $30m pre-money valuation. Scenario A shows the old YC deal where YC has 7% common, and Scenario B shows the new YC deal where YC invests on a post-money SAFE
Scenario A: http://angelcalc.com/model?mod=802&dispShare=0e55666a4ad822e...
Scenario B: http://angelcalc.com/model?mod=803&dispShare=8a50bae297807da...
Note: click "Model" to see the results. In Scenario A, YC is listed as "YC" and in Scenario B YC is listed as "Post SAFE-0 (2.1mm)". As you can see YC ends up with 1.575% more equity in Scenario B.
The simplicity of this change is great but it's important that founders understand the downside as well. Team YC, if I'm misunderstanding this, please let me know.
It's true that founders could compensate for this by raising SAFEs from other investors at a higher valuation, but that is likely to make those raises a little more difficult, so there is some downside.
(1) The modeling you’ve done for the premoney safes is correct, but it’s incorrect for the postmoney scenario. That’s because Angelcalc hasn’t been updated yet for postmoney safes that track the one we released. Angelcalc includes the Series A option pool increase in both flavors of safes, because what people were doing when flipping standard premoney cap safes to postmoney cap safes is they were just changing the pre to post, and nothing else. We deliberately took out the Series A pool increase for reasons that are all detailed in our post. That means both we and the safe holders share the Series A pool increase with the founders, which is not how it’s working on Angelcalc (but we will update it soon).
Also, in your postmoney scenario, the valuation cap for the $2M safe needs to be adjusted to be a $12M postmoney cap safe.
So if you update the postmoney scenario using all of your variables based on the postmoney safe we released, the results are different. I did it by hand on excel - here’s a screenshot:
Happy to send you a copy of the excel file. Also, to be perfectly transparent, these examples are somewhat artificial because they assume a 0% option pool issuance in both cases, which is unlikely to be the case. Safe investors will do better than in the screenshot I sent the more options that are issued before the Series A round. They also have the option now to ask for a template side letter to participate pro rata in the Series A round itself.
(2) The YC deal should be viewed together with the money founders will raise at demo day, i.e. as one continuous round, and thus the combined % of the company you end up selling. That combined % for YC and demo day safes was often too high in the old deal because founders had a hard time understanding how dilution was unfolding. Safe rounds may not have been priced correctly because of that lack of clarity. With these new changes, the days of raising on safes and not knowing how much you owned are over. The days of planning a Series A fundraise not knowing how much you’ve already been diluted are over. We strongly believe that founders will end up less diluted by the combined % of YC and demo day safes. It’s interesting that you would characterize an uptick in YC ownership as “downside” for the founders. I don’t think founders look at our ownership - they look at theirs.
(3) An underlying assumption of your post is that the safes and YC deal are changing, but everything else — valuations, option pools, amounts people raise and dilution transparency (or lack thereof) — will remain the same. The point of us doing this though is that we expect it to change all of those other things. Everything is tied together. As Michael already pointed out, once you can see what’s happening, both investors and founders can take better actions on both fronts. High-res fundraising should also become easier, as Carolynn points out on http://ycombinator.com/documents.
Still not clear on how (in most cases and assuming there is not a 0% option pool pre-equity round) this will not lead to increased expected dilution for founders from the YC deal as compared to the old deal, so would love to play around with your Excel sheet. My email is my HN username at gmail.
Essentially, with this new deal, after equity financing YC will own 7% minus the dilution from the equity round minus dilution from any options pool increase [1]. Previously, after equity financing, YC would own 7% minus the dilution from the equity round minus the dilution from the SAFE round.
While it's true founders are getting a little bump on YC absorbing the dilution from a Series A option pool re-up, in my experience these are typically 5% to maximum 15% increases. Whereas the dilution from post-YC SAFE rounds are typically 15% to maximum 30%. So YC is assuming a potential 5-15% dilution in their ownership while avoiding a 15-30% dilution in their ownership. Translation: YC will own more post-equity financing than they would in the old deal.
This puts a burden on the founders to make up for that increased dilution by raising the post-YC SAFEs at a higher valuation than they otherwise would, which will likely make those raises harder. Alternatively, they can raise their Series A at a higher valuation than they otherwise would to make up for YC's extra ownership, but that will make those raises harder than they otherwise would be. So there is a real dilution downside for founders here.
1: in reality YC will continue to own 7% after the equity round because they'll exercise their pro-rata right during the equity round but that doesn't change the underlying point being made here so will ignore it for simplicity.
I think points #2 and #3 continue to apply. You can't say that the new framework will result in more dilution in "basically every circumstance," because that assumes all of the surrounding aspects of the circumstances will continue to remain the same. I can model out a scenario for you as well that shows a thoughtful founder now able to better plan out a round using a series of escalating valuation caps, rewarding the earliest investors, to raise the same amount of money but for less overall dilution, in precisely the manner described by PG in his original post. Or another scenario where investors are ok with slightly higher valuations because they have certainty of ownership. Or another scenario where a founder who previously would've raised an unnecessary extra 5% now doesn't, because the dilution math is clearer.
Your point about safe dilution being 15-30% is exactly right, and exactly one of the reasons we're doing this. The high part of that range is too high. People are raising too much, on too dilutive terms, because of the lack of transparency. Founder dilution is driven by what everyone else on the cap table is getting, not just us. If that sum total of "everyone else" is still less, founders are still net better off. If you want to frame the dilution aspect all indexed to YC ownership, that's ok, but the outcome was already pre-figured by your choice of framing in the first place. We can agree to disagree on that.
That said, I think one thing we can definitely agree on is that the success or failure of this new framework will be judged by whether founders are more or less diluted in the end, and have a harder or easier time raising money. We've already made our bet, so there's not much to do here but let it play out.
Founder stake goes 48.8% -> 49.6%, a modest 1.63% increase.
YC stake goes 3.68% -> 4.55%, a whopping 24% increase.
Other SAFE investors stake declines 12.5% -> 10.8%, a 13% decrease.
So while the immediate impact on founders appears negligible (assuming all variables stay the same), it would seem that this new model represents a fairly large transfer of ownership from other SAFE investors to YC.
Wouldn't this be a cause of concern for founders? If SAFE investors have a particular percentage ownership in mind, wouldn't this push founders to raise more from them (or give a discount, etc.) and thus increase dilution?
You’re right that many safe investors have a particular % in mind when the invest. The problem with the old framework is that they had no certainty on that. They could invest $1m at $9m premoney cap and think they got 10% but if the company raised more money on a bunch of other Safes or caps, they ended up with a lot less. The dilution confusion impacted both founders and investors alike. In the model you saw, the safe investors got exactly what they bargained for, 16.7% (2m invested at 12m post = 2/12 = 16.7%), and then ended up with ~11% because they were diluted by the Series A round. That’s what happens - each round dilutes the next. It’s also what would happen if those investors just did a priced round instead of using a safe.
The safe investors also now have the option to ask for a side letter that gives them the right to invest Pro Rata at the Series A. They didn’t have this in the prior framework. And if they did do Pro Rata here, they would probably end up with more ownership than they would in the old framework. This is actually more consistent with how most investors invest. Spread bets early and then double down on the ones that are working, based on an ownership level that they know they have today.
This is a common oversimplification, but it's somewhat dangerous and I would be happier if people were more cautious in what they said here. It simply doesn't mean what you said; it means the founder has sold at least 5% of the company. If you're going to either raise 50m or shut the company and ditch your investors, then it's a wash; but if find yourself in a low-money scrappy situation, which realistically is where most non-YC companies are, it's very significant.
Convertibles and other structurally similar securities, in contrast to priced equity rounds, essentially have built-in down-round protection for investors. They have advantages, too, not least the speed in which deals can be done, but if you can do a priced round or a convertible round at similar speed and at similar cost, give serious consideration to taking the priced round.
I think the other thing to take into account is that if you're doing a comparison of safes, notes and priced rounds, it's not just a matter of seeing if speed and cost are equal, but what else you might have to give up in terms of rights. Priced rounds can come with downround protection too (often do), as well as board seats and investor vetoes on financings, sales of the company, etc. Convertible notes are debt so the investors will have a technical right to demand their money back after a set time (maturity).
Also: these terms are completely reasonable and under normal circumstances if I were doing a startup – and this valuation made sense – they'd be terms I'd be happy to take. For the avoidance of doubt, all of this is about the marketing, not the substance; the substance is above reproach.
As you say, speed, costs, rights (board seats, information, pro-rata, drag-along/tag-along, you name it), pref structure, etc are all real things. I just prefer addressing those all up front.
As for "fairness", it's going to ultimately be in the eye of the beholder. You could give employee #12 a 5% stake (which is CEO level at other startups) and yet that employee still feels it's "unfair" even it's explained that he's getting more than anybody else in SV. It's human nature for the employee to think he's worth more, and for the employer to think he's worth less -- and therefore, they negotiate.
[1] deep link to the employee ownership percentages: https://www.holloway.com/g/equity-compensation#_there_are_no...
I've heard plenty of stories of nasty ways companies wrangle hard-earned equity out of employees. I think it'd be great for YC or someone of similar stature to encourage companies to use very standard terms to avoid a lot of the unkind ways employees get screwed. One example would be terribly short windows for exercising options.
I do believe this will change the dynamic for YC founders dramatically 1 - 3 years out if not ready for a Series A (equity round) but need more capital (seed extension). I know many people who raised $500K - $3mm more on SAFEs. Because they were pre-money, the dilution for stacking SAFEs worked. Now, that will be much harder. The next round of financing will need to be an equity round to convert SAFEs to equity. I don't know if this is good or bad, but it will push people very heavily towards an equity round if they need any more funding.
Since keeping cap flat is logistically / emotionally easiest for both sides to swallow, the founder dilution is worse under a "flat" scenario. In the pre-money world, if you did pre-money $10mm cap and raised $2mm, then later another $2mm at same cap, common would own ~71% (10 / 14) on conversion (assuming A is high enough). In post-money world, if you do $12mm cap and raise $2mm (so equivalent to old world in 1st round), then later raise another $2mm with same cap, common would own 67% (8 / 12). That's just 4 - 5%, but a real difference.
So I believe the incentive is higher to do an equity round to convert the post-money SAFEs so they can be a part of the dilution of the new round. Unless I am mistunderstanding how they'd convert or something else here. The math is complicated (which I guess is the whole point of why moving to post-money will improve founders' understanding).
This is right step in simplifying it even further.
Edit: I found it here. https://blog.ycombinator.com/common-misconceptions-about-app...
I didn't realize that this was true. I'm interested in hearing more about what has caused the increase in startup costs.
Extract the more pertinent components of that which matter more to typical SV startups (like cost of employment, rent in expensive metropolitan areas, etc) and you end up with at least 30k.
If the SAFE is a non-priced round, then the amount of equity the investor gets is decided when the conversion happens, so it is an unknown, which is why a cap exists.
Is YC taking 7% + the conversion?
A dollar of VC is generally worth, ceteris paribus, more than a dollar of friends & family money. The coaching, connections, reputation boost when talking to other investors, sales prospects, potential employees, the media, et cetera are meaningful.
Could someone please explain this in laymans terms?
So really, YC is giving you some money to get through demo day, at which point you'll raise real "runway" money from seed funders.
There's a cohort of YC founders that only do YC (or, at least, rely on YC's money for a long time before raising further); those companies get to break-even cash flow quickly and often aren't (or aren't yet) on the "shoot the moon" trajectory VCs are looking for. But those companies aren't made or broken by YC's decision to "fund" them.
Example: raising 1M at 10M cap, 20% discount.
Scenario 1: next priced round at number below 10M - the cap doesn't apply, the discount does.
Scenario 2: next priced round at number between 10M and 12M - the cap doesn't apply, the discount does.
Scenario 3: next priced round at more than 12M - cap applies, discount doesn't.
In short, either cap OR discount are applied, whatever is the most beneficial to the investor.
You're right though that there's a flavor of safes that contain both a discount and a valuation cap, and the investor gets the benefit of whichever approach results in more shares, and your explanation is good.