On the merits of uncapped SAFEs
I read a tweet thread about why uncapped SAFEs are bad-bad-bad. I won't dignifiy it with a link here. Like most things in life, it’s doubtful that they’re universally good or bad — unless you happen to be a stage-specific VC constrained to pre-seed/seed investing (in which case you’re likely to think they are unequivocally always terrible, and especially for you).
From the perspective of a board member with fiduciary responsibilities, it’s obvious that the ‘bad’ are far outnumbered by the times in which uncapped notes advance the interests of early shareholders (meaning all equity-compensated employees, and not just founders).
This post doesn’t aim to convince VCs that they should be doing uncapped notes. And while I believe Series A funds will opportunistically end up doing more uncapped deals over the medium-term anyway, you don’t need to believe that’s true to following along here. Instead I want to speak to founders in a position to raise on an uncapped basis who are considering whether or not they should.
Common arguments against uncapped SAFEs
- “You can’t model how much you’re giving away.” Yes you can. You can absolutely make sensible assumptions, which is what any future-looking model requires anyway. Using tools like Carta or LTSE Equity — without writing any code or Excel formulas — you can easily game-plan various conversions. The mental math is actually easier if your SAFEs are all uncapped, versus a mix of capped and uncapped (or having one or more different caps, or notes with caps and discount rates).
- “Uncapped investors are lower quality.” You might not raise from conventional tier-one VCs, but it doesn’t mean you’re raising ‘dumb money’, or from low-quality VCs either (although the odds might be higher). There are good reasons quality investors can be motivated to extend uncapped notes. More on this later.
- “Uncapped investors want you to raise your next round at a low valuation.” Sure. But this argument can also be leveed against pro-rata rights. Ultimately VCs want to show their LPs returns. It’s easier to raise more money from LPs off the back of outstanding results than it is to actively depress startup valuations, and the reputational impact of fucking over your own portfolio really isn’t worth it. This is a red herring.
- “Uncapped SAFEs are bad for investors, because it means they’re buying in at the next round’s price.” They might be less preferable for investors, but it’s generally false to say that they’re buying in at the next round’s price (investors will typically seek a discount on an uncapped note, to reflect the additional risk they take on by coming in earlier). Undoubtedly, however, the prices do converge and it is fair to say that for a seed-stage only investor having a price that is relative to the Series A one might not be ‘venture scale’, as on an <18-month horizon, even at a 30% discount, their $1 investment will now only be worth $1.30. But for multi-stage funds and those who can afford to invest beyond seed, these investments are very much still venture-scale and can be justified to LPs as a means of guaranteeing placement in more competitive rounds without exhausting oneself in Series A shenanigans (both negotiation of price and arguing over allocation). Uncapped SAFEs may break existing seed-only investors’ models but they will generally lead to more innovation and entrepreneurship — good for the ecosystem overall — by encouraging more top talent to consider venture investment, rather than artificially constrain themselves to bootstrapping. There are a lot of exceptionally good, price-sensitive founders out there who don’t want to commit to caps too early in the day.
Ultimately, if you’re not excelling in some way, you’re probably not going to be able to raise on an uncapped basis anyway. It’s still a rare occurrence. But I believe it’s likely to become more common as competition for the best companies intensifies further.
People telling founders it’s in their interest to raise on worse terms when they have great terms offered are generally repping their own self-interest, or sucking up to vested interests motivated by the same.
In truth, your Series A investors don’t care if you raised your seed with uncapped notes, so long as you’re using standard-form instruments (of which the uncapped SAFE is one, thanks to YC…)
Your Series A and later-stage investors actually want you as a founder to have higher ownership — it keeps you motivated, and means you’ve more ground to cede to them later. They like that. So if that’s what your uncapped SAFEs ensure, then great.
Angels writing angel-sized checks hate them. Cheap VCs hate them. Younger outfits with smaller funds hate them. But you, as a founder, should not fear the uncapped note provided that you:
- leave enough space in your models for serious Series A investors to come in at the valuation you’re targeting; and
- only raise money from people you respect.
When to take uncapped notes
- From existing investors who want to continue working with you, and who you want to continue working with. For example, when an investor has already expressed a commitment to take up an existing pro-rata right — or who has seen how the sausage is made and now wants to buy in further.
- When raising from angels who believe in the product, and aren’t bound by traditional fund concerns. e.g. when raising money from folks who believe in you (or your product) and don’t have set ‘venture scale returns’, just a high degree of confidence that over a ~5 year time horizon their investment in you is going to be worth some multiple of what they’re putting in. Jason Lemkin agrees.
- When you could already raise a Series A, but with a little more runway/evidence think you could eke out an even better valuation. Take the uncapped SAFE. Just make sure you’re leaving enough room at the cap table for a prospective lead, and that any discount doesn’t outweigh the expected benefit.
- When you want to raise as much money with as little dilution as possible. There’s some spectrum between value-add investors and “all the money”. Tier-one VCs would have you think the ideal lies at one end (leveraging sterling reputations to win deals at lower valuations). The world’s most problematic investors would have you believe it’s at the absolute other end. The ideal is likely somewhere in-between. Try not to get screwed by either.