Ask HN: Paper capital contributions as YC SAFE that converts to common stock?

[systemaccount]

I am slowly ramping up on the options my co-founder and I have to make capital contributions to our bootstrapped C Corp. When we incorporated we each purchased 40% of the available common stock and set aside 10% for early staff leaving 10% available. My proposed strategy is to track all founder capital contributions as SAFEs that will convert to equity issued from the remaining 10% common stock in Series A. All other stock (ESOP or VC) will be sold as preferred stock. Is this a sound strategy? If not, how would you adjust it for a founder team that would prefer not to track capital contributions as debt?

[hdmoore]

Tracking capital contributions as debt is the best choice (after incorporation). Pay yourself back 6% non-compounding interest and make things easy. Don't buy your own equity just to cover short-term expenses. Reach out (email in profile) if you would like to see a template.

Alternatively, refile your articles and stock purchase agreement and tie that capital to the stock purchase or initial contribution. I would still recommend founder loans instead. If you use a SAFE or other convertible debt on amazing terms, future investors may ask for the same terms.

Edit: I financed my startup (https://rumble.run) that way and paid myself back a month ago. Painless all around.

[systemaccount]

Great feedback. We were leaning equity over debt because many articles claim investors dont like seeing debt on the books. Had you considered a contingency plan if you couldn't pay yourself back or had to reduce debt? For example: call it a bad loan and each founder would write it off.

[hdmoore]

On the investor front it depends on the debt size. Most seed-stage investors would prefer debt to a competing investment amount. Loaning yourself up to a year of lean run-rate is probably fine, but much more (hiring, paid user acq, etc) is going to look weird. Future investors may ask you to write off the loan entirely if the terms are nuts (compounding or high interest rate), but shouldn't bat an eye otherwise.

Regarding contingency plans, you don't need to have a hard repayment date in the loan terms and can let it accrue interest indefinitely (until bankruptcy, acquisition, or otherwise). Unlike traditional convertible debt a founder loan normally doesn't "blow up" into a huge equity stake if not paid back.

If things don't work out and you have the opportunity to roll the founding team into an another company (acquihire), loans are an easy thing to assign value to, even if the IP or goodwill is more difficult. Negotiate the loan repayment as a signing bonus if you can.

If things work out and you either raise money or bootstrap to profitability, you can pay off the loans as it makes sense, or just forgive them outright if that's easier. Either way you probably don't need to involve your whole board to manage it, unlike equity changes.

I get the desire as a founder to obtain the same terms on capital as future investors, but it can put you in a weird place and can complicate future fundraising. Props to anyone who can make it work, but I had good luck with the founder loan process and felt like it was the cheapest way to finish bootstrapping (we did).

Good luck either way!

[systemaccount]

This is extremely helpful. Thank you for your insight.

[arcticbull]

Ah yeh that's a much better idea, I retract my suggestion.

[dcaisen]

Not sure if it's the optimal approach, but this is pretty much exactly what we did. At the onset of the company, I made a capital contribution (beyond the small purchase amount of our founder stock) using a standard YC SAFE with no valuation cap/discount (with an MFN clause). When we later raised a friends and family round, we did so via a SAFE as well, this time with a valuation cap, and I swapped my initial SAFE for the F&F SAFE, and we basically just considered it part of that round.

The second part of your plan is unclear to me. When you issue employees options, those will generally be options to buy common stock, not preferred. And if and when you raise a priced VC round for preferred shares, all of your SAFEs will then convert to preferred shares.

[systemaccount]

Regarding the part that's unclear - my understanding is that investors prefer founders own common over preferred stock which is why I proposed our founder SAFEs convert to common while all others to preferred. From your experience it sounds like all SAFEs, including the founders, will convert to preferred.

Thanks for clarifying that ESOP is common stock. In the SAFE guide its unclear where this belongs. I admit I still owe the concept of options more time to digest.

[dcaisen]

When you start the company, you and your co-founders purchase all of the common stock at a de minimis price (and file 83(b) elections!).

The additional preferred shares you would get when this SAFE is converted will almost certainly be very very small compared to your original founder stake - to the point where it's kind of pointless to get it in the first place. Your investors wouldn't want your initial founder equity to be preferred, but they should have no problem with you putting in your own additional money alongside theirs on the same terms. Many investors like to see their founders have skin in the game.

From the founder's perspective, you're better off making a loan to the company, since you're already so rich with equity. That said, in my experience, investors don't like putting money in just to have the founders take money off the table, especially early on. With my first company, we started off with founder loans, and when we raised our first institutional round, our investors insisted we convert those loans into equity at their same price as opposed to paying ourselves back.

That's why my approach with this second company was to go straight with the SAFE off the bat for my capital infusion.

It is possible that our first company was an anomaly - and that founders putting in additional capital via loans is the standard practice and that most investors are totally cool with you getting paid back on those loans.

[arcticbull]

Could each of you just agree to contribute roughly the same quantity of capital and keep the cap table as 40-40-10? Or find some other way of balancing it out that doesn't involve the lawyers? That would save you both a lot of headache and paperwork.

[dustingetz]

how much money are we talking about and how much time since incorporation? and what will the money be used for?

[systemaccount]

Incorporated last month and want to make the first deposit ASAP. We plan to transfer 1K a month from our personal savings for the next year (or until its no longer needed) to cover basic operating expenses, like hosting. We both still have day jobs.

[dustingetz]

so if YC takes 7% seed round takes 23% esop 10, series A takes 25% for 8M$ which is your first priced round and the safes convert, so assuming no angels or friends & family round, VCs have 45 esop 7-10% after dilution, founders splitting 45 so 22% each, so the special $20k safe for bootstrapping costs will convert at 5M cap or something so we’re talking about a balance of 20k/5M = .4% or something ... just get a credit card

[dustingetz]

maybe get a credit card for the business and split the bill each month?