Entrepreneurs are great at rationalizing things. And, to be fair, we have to be. After all, we have to constantly justify our decisions to build startups since, objectively, building startups isn’t a rational decision.
Unfortunately, this ability to rationalize and justify anything means we’re often good at lying to ourselves. We make excuses for why things aren’t working, and then we convince ourselves those excuses are 100% true. In this issue’s featured article, I give some examples of this happening in relation to fundraising.
While I’m on the subject of things entrepreneurs are great at that cause problems… let’s take a moment to address the problem of argumentative co-founders. I used to argue with my co-founder all the time because we both always thought we were right. Since I’ve seen the same issue cause problems in lots of young startups, in this issue of EOH I’m sharing a strategy for how to turn founder conflict into startup success. Or, at the very least, less arguing.
3 Excuses Founders Make for Why They Can’t Fundraise and What They Actually Mean
Everyone has excuses when they fail, but the best entrepreneurs know how to turn their excuses into successes.
How to Resolve Disagreements Between Co-Founders
Sometimes co-founders argue. It's a natural part of #StartupLife. The key is learning to resolve disagreements quickly and effectively.
Office Hours Q&A
I was reading your article about compensating early investors, and you described a convertible note as the best and basically only viable option.
What about a SAFE? That’s what YCombinator recommends now, right? Wouldn’t that be a better option than a convertible note?
I was wondering if someone would bring this up. Truth be told, I intentionally avoided discussing SAFEs for reasons that had nothing to do with whether or not they’re a good idea. Simply put, trying to explain what a SAFE is and the difference between a SAFE and a convertible note wasn’t the purpose of the article, and I didn’t want to confuse readers. However, since you’ve mentioned a SAFE, I can take a few moments to describe the concept here.
SAFE stands for “Simple Agreement for Future Equity.” It’s a concept invented (or, at the very least, popularized) by YCombinator, the big Silicon Valley startup accelerator. As the name implies, the concept is similar to a convertible note but with one big difference. A convertible note is, technically, a debt instrument, meaning investors are loaning money, and that loan gets converted to equity at some point in the future based on the terms of the note.
In contrast, a SAFE isn’t a loan. It’s a warrant that gives investors the right to purchase equity in the future according to some sort of terms defined in the agreement.
At a high level, the two concepts accomplish the same goal (as described in my article). The biggest difference is that a convertible note is a type of debt, which means, technically, it has to be repaid, whereas a SAFE isn’t and doesn’t have to be repaid.
All things being equal, if I was choosing between one option or the other, I’d personally want a SAFE because a SAFE is more entrepreneur-friendly. But it’s also something lots of investors aren’t familiar with. In addition, because it’s more entrepreneur-friendly, SAFEs can sometimes scare off investors. At the very least, it can encourage them to ask for additional concessions that end up being worse than using a more familiar convertible note structure.
In other words, since all things aren’t equal, I’d stick with a convertible note because, from a practical standpoint, the debt aspect doesn’t actually matter. At least, it never did in my experience. If an investor ever recalled a loan on my startup, it would have killed my company and the investor would lose all the investment anyway. Because of that, if a convertible note is going to make investors more comfortable than a SAFE, I’d rather choose the thing they’re more comfortable with since it’s likely to mean the deal gets closed quicker.
Got startup questions of your own? Reply to this email with whatever you want to know, and I’ll do my best to answer!
Aaron, my take on convertible debt is quite different. You have said: “If an investor ever recalled a loan on my startup, it would have killed my company and the investor would lose all the investment anyway”. Well, it might be true in some cases, but the fact that calling the loan forces the company to file for bankruptcy - could be used by some investors to buy the struggling company “for a song”.
You see, the debt holder, or the so-called “debtor in possession” - could file a “restructuring” proposal with the bankruptcy court. If approved, the existing shareholders lose all their equity as the shares become worthless. The new equity holders can then issue new shares from the treasury – and walk away with the full ownership.
The above scenario couldn’t have happened using SAFE financing. I have experienced such malicious behavior resulting in a “change of control” first-hand. And I do not wish any entrepreneur to go through the same. You’ll be surprised how many times companies are forced into bankruptcy by greedy and unscrupulous investors. My advice: beware of the debt and chose equity financing instead…