Simple Unit Round of Financing (SURFs)

When founders are looking for financing, they are often met with an array of confusing terms. A common approach to early-stage investing for many founders is to raise capital using a form of debt, either using a Convertible Note or a SAFE. Both structures have some benefits, but they can also cause issues for founders.

The popularization of the SAFE was caused by a macro-level trend in SF back in 2010.

Convertible notes have won. Every investment so far in this YC batch (and there have been a lot) has been done on a convertible note.

— Paul Graham (@paulg) August 28, 2010

YC contributed to this trend in 2013 by introducing their own version of the convertible note, which they called a SAFE (Simple Agreement for Future Equity).

Typically, a convertible note is debt that can convert into equity with certain triggers. A SAFE is similar to a convertible note but legally is not considered debt.

The pros of both of these instruments are that they make it faster for founders to raise a round of financing because they are delaying the negotiation of the company valuation. Both Convertible Notes and SAFEs use a valuation cap. Many founders and some investors think of this as an implied valuation of the business, but that’s not the case. The cap is the maximum valuation the investor will accept.

This can be problematic if founders have multiple Convertible Notes and SAFEs stacked up. It becomes very difficult to tell how much dilution has occurred until there is a priced financing round. Fred Wilson has more on this issue. In essence, the pre, post, discounts, and caps make it very difficult to tell what the dilution actually is. This is compounded by common mistakes in those earliest stages.

In any event, all of these instruments delay the inevitable—agreeing on a valuation. This means that founders and investors do mental math with percentages rather than understanding the share price.

The Simple Unit Round of Financing

Let’s go SURFing.

I’m proposing a new equity instrument called a SURF. The idea is that it’s similar to a SAFE, but it’s predictable for both the investors and, more importantly, the founder.

A typical SURF agreement would define a series of waves of investments. As an example of a pre-seed SURF:

• $300K at a $3M valuation (10%)
• $700K at an $8M valuation (8.75%)

The waves in a SURF agreement don’t dilute one another. Similar to a post-money SAFE. The dilution is fully predictable (18.75% in this example for a total of $1M in capital). The SURF acts like an option pool, in that the shares for the SURF are set aside by the founders. This also creates incentives to be an earlier investor, as early waves have better valuation and are likely to fill up faster.

Waves aren’t obligations for the founder; later waves don’t have to be executed. In the above example, if a later-stage investor doesn’t want to invest at the second wave, they can always offer an equity-based round or a traditional SAFE or Convertible Note. Unallocated waves can also be canceled, effectively improving the ownership stake of existing shareholders.

The SURF is more advantageous for both the investor and the founder. The investor gets actual equity—not a note and not debt. The founder has predictable dilution and speed of closing.

Pros:

• Retain the speed benefits of SAFEs and Convertible Notes.
• Allows the market to decide the valuation by incrementally increasing valuation with demand.
• Incentivizes earlier investors to participate rather than wait.
• Actual equity, so discounts, pre/post-money calculations, and other factors are not taken into account.

Cons:

• Any new structure may be unfamiliar to investors, and they may prefer to invest under more familiar terms such as a SAFE, even though it’s no better.
• Legal costs of closing a priced round may be higher. Standard priced round legal documents may be complicated because early-stage companies can have messy cap tables, option pools, and other complexities.
• If founders use SURF in combination with SAFE, they may further complicate their actual ownership calculation.

There may be better itterations of this concept but it’s time to explore alternatives to the SAFE instrument.