The Safe, the Kiss, and the Note: A Survey of Startup Seed Financing Contracts

Over the past decade, there has been an explosion in seed financing for early-stage technology startups. Increasingly, this seed financing is channeled to these companies via an entirely new form of investment contract: the deferred equity agreement. The deferred equity agreement—like the convertible note (its more traditional close cousin)—allows investors to fund a new venture quickly and cost-effectively without having to reach an agreement with the startup's founders on the company's current valuation.

One version of this deferred equity agreement created by the premier Silicon Valley startup accelerator Y Combinator—the Simple Agreement for Future Equity (SAFE)—made its debut in 2013. Another version created by a different startup accelerator called 500 Startups—the Keep It Simple Security (KISS)—first appeared in 2014. While these instruments have attracted extensive attention in the startup blogosphere, there exists remarkably little information about the role they play in the real world. Nobody seems to know, for example, precisely who is using these new contracts. It is likewise unclear where exactly these agreements are being used. In a very real sense, the discussion about these new contractual forms is occurring in an empirical black hole.

Our forthcoming article in the Minnesota Law Review Headnotes aspires to bring light to the darkness. In partnership with Thomson Reuters Practical Law, we attempted to remedy the existing informational deficit in this area by conducting an online survey of startup lawyers in the United States and Canada. The purpose of this survey, which ran in the spring and summer of 2018, was to obtain more detail from practicing startup lawyers about the types of investment contracts that they see in the early-stage startup finance space. More than 300 startup lawyers—hailing from 32 US states and four Canadian provinces—responded to the survey.

Generally speaking, the survey set out to answer questions across five dimensions:

1. Awareness. Have the survey respondents ever heard of the SAFE or the KISS?
2. Use. Have the survey respondents ever been involved in a representation in which a SAFE or a KISS was used?
3. Market Share. In the context of seed financing transactions, what percentage of transactions utilized a SAFE or a KISS as compared to priced equity or the classic convertible note?
4. Modifications. Do companies and investors routinely modify the ‘standard’ terms set forth in the SAFE and the KISS?
5. Preferences. Did the respondents prefer the SAFE to the KISS? How did they perceive the ‘brand’ of each type of investment contract?

In answering the first two questions posed above, we analyzed the survey responses primarily through two lenses. First, we analyzed the questions through the lens of geography. We sought to determine whether these instruments were known and used in startup ecosystems outside of Silicon Valley. Second, we analyzed the questions through the lens of expertise. We sought to determine whether the responses varied depending on whether an attorney spent all of her time doing startup work—a startup aficionado—or was more of a dabbler in the startup world.

Drawing upon this original lawyer survey data, our article offers a snapshot of the current landscape for startup seed financing contracts. This snapshot will be of interest to legal scholars and practitioners for several reasons.

First, our article constitutes the first systematic attempt to document the spread of an important contractual innovation—the deferred equity agreement—throughout the United States and Canada. History is replete with stories about moments of discovery. We remember Archimedes and his bathtub not because we are interested in fluid dynamics but because it so perfectly captures the excitement associated with a new idea. The fact remains, however, that the moment of discovery is only the first step in a very long journey. For an idea or an innovation to change the world—or even a small piece of it—it must spread and diffuse and become known to others. These stories of diffusion are rarely as exciting as the story about the initial discovery. Nevertheless, if we truly wish to understand the process of innovation, we must move beyond the origin story to the process by which that innovation diffuses across a community.

Second, our article shows that the traditional dichotomy between ‘West Coast’ and ‘East Coast’ venture financing deal terms is rapidly being replaced by a new dichotomy between startup lawyering ‘aficionados,’ who devote the majority of their practice to representing startup companies and their investors, and ‘dabblers’, who spend only a small portion of their time working in the startup space.

Third, our article offers important insights into the existing legal literature that views contracts as products. We argue that the SAFE and the KISS—whatever their legal merits—bear more than a passing resemblance to the branded swag that is commonly given away by companies to build brand awareness. This is a significant finding with implications that go well beyond this particular area of the law.

Finally, our snapshot of seed financing contracts is relevant to practicing lawyers, particularly as these attorneys seek to advise clients on the extent to which these newer deferred equity contracts are actually being used by similarly situated companies and investors.

John Coyle is the Reef C. Ivey II Term Professor of Law at the University of North Carolina School of Law.

Joseph Green is Senior Legal Editor (Startups & Venture Capital) at Thomson Reuters Practical Law in New York City.