Review of Y Combinator Safes

How founder-friendly are they?

I orchestrated a study in 2019 with attorneys who reviewed the six most popular startup financing documents—all of which were produced by investor-funded organizations. After pouring through 298 pages of legalese, the attorneys found the top six financing documents were, on average, only 38% compatible with Founder Friendly Standard. Y Combinator Safes are silent on a number of important issues. See for yourself by viewing our infographic where you can drill down and compare the term sheets.

Many founders don’t realize how much of a company they’re giving away with YC Safes

Review written by Ryan Juliano, Vice President, Head of Platform, and Attorney at Howell Legal on June 6, 2019.

The below review of the Y Combinator (YC) Safes compares them to the Founder Friendly Standard. Y Combinator publishes four variants of post-money Safes:

  1. Valuation Cap, no Discount
  2. Discount, no Valuation Cap
  3. Valuation Cap and Discount
  4. MFN, no Valuation Cap, no Discount

When I refer to YC Safes, I’m talking about all four variants. The only difference between the Safes in this comparison occurs in Section 1.5 below on the topic of anti-dilution.

Section 1.1 of the Founder Friendly Standard says:

Individuals who work for the company and are instrumental in its inception (“Founders”) receive a class of equity such as Common Stock which provides no less than twenty-four (24) votes to one (1) vote of stock held by investors or employees.

Y Combinator Safes do not address the voting rights of the founders, investors, or employees. Typically, experienced investors will expect that Safes will convert into a class of preferred stock with terms consistent with the National Venture Capital Association’s (“NVCA”) standard documents. For the remainder of my answer, I’ll be referring to the NVCA documents. Those documents do not provide for the super-voting founder equity described in Section 1.1.

Section 1.2 of the Founder Friendly Standard says:

Investors receive a class of equity such as Class A Preferred Stock which will have one vote per share with a higher par value justified by a liquidation preference.

Each YC Safe is a convertible security that will convert into preferred stock at the company’s next equity financing. Preferred stock that is consistent with the NVCA documents has one vote for each share of common stock into which the preferred stock is convertible. Initially, the preferred stock is typically convertible into common stock on a 1:1 basis, subject to adjustment for dilutive issuances. Although preferred stock in the NVCA model has a liquidation preference, it does not have a higher par value.

Section 1.3 of the Founder Friendly Standard says:

Employees and contractors receive a class of equity such as Class B Common Stock which carries one vote per share and does not have a liquidation preference.

Y Combinator Safes do not address employee or contractor equity.

Section 1.4 of the Founder Friendly Standard says:

The first board consists only of Founders. The term of the board is one year. After the first year, a new board is elected by the equity holders at the annual meeting. Board decisions are made by a majority vote of the board. Board members cast no more than one vote each on any decision. Board committees are disallowed for at least the first two (2) years.

Y Combinator Safes do not address board composition. Under the NVCA documents, holders of preferred stock typically have the right to appoint a board observer or director.

Section 1.5 of the Founder Friendly Standard says:

New equity of any kind, including stock option pools, dilutes all equity holders equally. Therefore, no investor in the company has anti-dilution rights of any kind.

With discount-only or MFN Safes, the amount of equity into which Safes are convertible is entirely dependent on the pricing of the next equity financing, so there is no dilution to measure until after the conversion.

YC Safes with valuation caps effectively give the holders full-ratchet anti-dilution rights. They are guaranteed a minimum percentage of the company (on a post-money basis). If the valuation of the next equity financing is below the cap, the Safe holders receive a higher percentage of the company, diluting all other stockholders.

Most commonly, the NVCA documents give preferred stockholders weight-average anti-dilution protection, which means that stockholders other than the preferred stockholders take most of the dilution.

Section 2.1 of the Founder Friendly Standard says:

Founders agree in writing they will give and receive performance reviews at the end of each fiscal quarter for the first four (4) years.

YC Safes do not address performance reviews.

Section 2.2 of the Founder Friendly Standard says:

Sweat equity vests each month over a period of four (4) years with a one (1) year vesting cliff. Vesting begins on the date shares are issued.

Y Combinator Safes do not address vesting terms for “sweat equity.” However, the NVCA documents often require uniform vesting terms, and 4-year vesting with a 1-year cliff is the most commonly prescribed schedule.

Section 2.3 of the Founder Friendly Standard says:

Founders keep all information confidential and assign the company all intellectual property created within the scope of their work for the company.

YC Safes do not address founder confidentiality and IP assignment.

Section 2.4 of the Founder Friendly Standard says:

Due to potentially devastating tax consequences, the company tells individuals receiving sweat equity in the United States to consult with a tax professional about making an election under Section 83(b) of the Internal Revenue Code. Founders who live or pay taxes outside the United States are similarly advised to consult tax professionals about applicable local and national taxes.

YC Safes do not address 83b elections or other founder tax consequences.

Section 2.5 of the Founder Friendly Standard says:

Non-compete restrictions only apply to employee or independent contractor agreements and do not survive termination. The company’s bylaws and other investor agreements are either silent on the issue of non-competition or expressly allow competition.

Y Combinator Safes meet section 2.5 of Founder Friendly Standard because they are silent on the issue of non-competition.

Section 3.1 of the Founder Friendly Standard says:

For at least the first two (2) years of operations, the company will not agree to pay the legal expenses of any investor as a condition of investment.

Y Combinator Safes are silent on the payment of legal expenses.

Section 3.2 of the Founder Friendly Standard says:

For at least the first two (2) years of operations, the company does not agree to binding arbitration with any investor.

Y Combinator Safes do not include an arbitration clause.

Section 3.3 of the Founder Friendly Standard says:

For at least the first two (2) years of operations, the company does not agree to binding arbitration with any Founder.

YC Safes do not include an arbitration clause.

Section 4.1 of the Founder Friendly Standard says:

Upon any transfer or sale of Founders’ super-voting equity, the portion of equity transferred converts to the class of equity described in Section 1.3. This also includes any transfer to a Founder’s estate, spouse, or heirs.

YC Safes do not deal with the transfer or sale of founder equity.

Section 4.2 of the Founder Friendly Standard says:

The company has the right of first refusal on any transfer or sale of equity for up to forty-five (45) days, but it cannot veto a transfer or sale. This provision is void after a company’s stock is listed on a public exchange such as the NASDAQ, OTCBB, New York Stock Exchange, etc.

YC Safes are not transferable, other than to affiliates of the holder. The NVCA documents do not subject investor stock to a right of first refusal.

Should startups insist on Founder Friendly Standard terms when negotiating with angels or venture capitalists?

While the Founder Friendly Standard sections are indeed “founder-friendly,” many of them are significantly different from market terms for venture capital deals. I think including them in a company’s organizational documents will add a fair amount of complexity beyond what’s in the standard set of tech startup forms.

While I could tell a client that the Founder Friendly Standard terms were—in and of themselves—more founder-friendly than what’s typical, I’d also have to advise them that many of the terms would be rejected by investors, and the documents would likely need to be revised before a financing, unless the company has significant leverage. Without significant negotiating leverage, insisting on terms consistent with the Founder Friendly Standard could likely cost a founder the deal.

INFOGRAPHIC: How does Founder Friendly Standard compare to term sheet templates from 500 Startups, Y Combinator, NVCA, Gust, and Sam Altman?

Limit of Liability/Disclaimer of Warranty: Ryan Juliano (“Author”) is not providing any financial, economic, legal, accounting, or tax advice or recommendations on this site. Although Author is an attorney licensed in Rhode Island, California, and New York, the information contained on this site was prepared for general information purposes only, does not constitute research, advice, or a recommendation from Author to the reader and is not a substitute for personalized financial or legal advice. Neither Author nor any of his affiliates make any representation or warranty as to the accuracy or completeness of the statements contained on this site. Author and his affiliates expressly disclaim any liability (including any direct, indirect, or consequential loss or damages) for all posts and their content.

Leave a Reply

Your email address will not be published.