Contracts Primer

## What contracts are used on Wefunder? The most common contracts used on Wefunder are: - SAFE (Simple Agreement for Future Equity) - Convertible Note - Preferred Stock - Revenue share Below is a quick overview of what each of these contracts are and the major terms typically within them. However, it's very common for companies to customize these basic contracts to suit their needs so make sure to always review the actual contract before investing. ## What is a SAFE? When investors purchase SAFEs, they are buying the ability to obtain equity (Preferred Stock) in the future. Investors' SAFEs will convert into Preferred Stock when the company sells shares of Preferred Stock in the future (this is called an 'Equity Financing Round' or 'Priced Round'). When that happens, SAFE-holders get equity at one of two prices--either the Valuation Cap or a Discount off the later valuation when the SAFE converts. They get the better deal, but not both. With a SAFE, these are the two major terms to keep in mind: the "Valuation cap" and the "Discount." **For example:** - A company raises on a $10M valuation cap, 20% discount SAFE. A year later, they sell equity at a $20M valuation. In this scenario, SAFE investors get equity as if the company were valued at $10M since $10M (valuation cap) < $16M (20% discount off of $20M). The **valuation cap** determines the price here. - Now let's say the company raises on a SAFE with a $10M valuation cap and 20% discount again. However, a year later, they sell equity at a $12M valuation. In this scenario, SAFE investors receive the discount price ($9.6M) since 20% off of $12M is lower than the valuation cap. The **discount** determines the price here. On Wefunder, most companies set a Valuation Cap and a Discount--it's a nice way of saying, "No matter what happens in the next round, you're getting a better deal for investing now." Early-stage startups use SAFEs to delay the difficult task of figuring out how much a startup is worth. That's why SAFEs have a Valuation Cap instead of a valuation, as they would in a priced round. SAFEs are a much cheaper and simpler contract than priced equity rounds, which may require months of negotiation and extensive paperwork. Unlike a Convertible Note, a SAFE is not a loan. As such, it does not accrue interest, have a maturity date, or have a legal obligation to be paid back. This makes it a simpler and cheaper way to finance a startup, but it does mean that if the SAFE never converts, investors will never see a return. As always, investing in startups is risky and you shouldn't invest more than you can afford to lose. Further reading: - [Carolynn Levy (co-author) explains SAFEs](https://www.youtube.com/watch?v=Sk5B2Ud1DVg&list=PLQ-uHSnFig5NxhuvY98-04LtNeVJueVwx) - [Y Combinator SAFE User Guide](https://bookface-static.ycombinator.com/assets/ycdc/Website%20User%20Guide%20Feb%202023%20-%20final-28acf9a3b938e643cc270b7da514194d5c271359be25b631b025605673fa9f95.pdf) - [SAFE's 101](https://wefunder.com/updates/139885-safes-101) ## What is a Convertible Note? A convertible note is an unsecured loan that converts to stock at a future priced round. It's very similar to a SAFE except that if the convertible note doesn't convert into stock by the maturity date, investors will get paid back like a loan. Convertible notes will most often convert into stock at a 'qualified financing'. A qualified financing is a priced round that typically raises at least $1M, although this threshold can vary depending on the terms of the note. That means if the company raises only $500k in their next priced round, your convertible note won't convert into equity yet. Like a SAFE, a convertible note has a Valuation Cap and a Discount that determine how much stock you will get when it converts. Unlike a SAFE, but just like a loan, it also has an Interest Rate and Maturity Date that determines how much you'll get paid back if it doesn't convert. To learn more about Valuation Caps and Discounts, see the SAFE section above. Learn more about convertible notes [here](https://wefunder.com/updates/90547-how-convertible-notes-work). ## How does Preferred Stock work? As a non-lead investor investing a small amount, the essential terms to pay attention to are the Post-Money Valuation or the Pre-Money Valuation. This is what the company is considered worth; with it, you can calculate your percentage ownership. Comparatively, the price of the stock is relatively meaningless. Most priced round contracts for venture-backed companies are based on the National Venture Capital Association templates. ## How do revenue share or loans work? ### Revenue Shares High-growth startups rarely raise seed-stage funding with loans, as debt doesn't offer enough return to account for the risk investors are taking. However, loans or promissory notes can be more appropriate for cash-generating small businesses. One benefit of investing with a loan is receiving cash every quarter or year, as the principal is repaid alongside the interest rate. The downside of debt is you have no equity stake if the company suddenly becomes much more valuable. A [Wefunder Revenue Share Loan Agreement](https://wefunder.com/contract_packages/770/templates/2257/preview.pdf?t=1586541832324) is a promissory note paid back from a share of the business's revenues. Important terms in this note include: - Gross or Net Revenues. Net revenues exclude returns or shipping costs. - Revenue Percentage. This is the percentage of revenue that is shared. - Repayment Amount. Typically 1.5-3.0X, this is the maximum amount you will be paid back. - Quarterly or Annual Disbursement. Companies choose to make annual or quarterly payments. - Defer Payments. By default, every company can miss one payment without being in default. - Secured or Unsecured. Some loans may be secured with all business property, while others are not. ### Promissory Notes Some businesses choose not to share their revenue and instead offer something more like a car loan, using the [Wefunder Promissory Note](https://wefunder-production.s3.amazonaws.com/static/SampleLoan.pdf). Important terms in this note include: - Interest Rate. The interest rate per annum. - Maturity Date. How many years until the loan is fully paid back? - Quarterly or Annual Disbursement. Companies choose to make annual or quarterly payments. - Grace Period. By default, these loans are deferred until 30 days after their crowdfunding deadline. Some businesses may defer the start of their loan at a later date, such as when their business is scheduled to open. - Defer Payments. By default, every company can miss one payment without being in default. This will allow businesses time to recover if they have a bad year. - Secured or Unsecured. Some loans may be secured with all of the business's property, while others are not. - Personal Guarantee. Some loans may have an individual that personally guarantees payment. - Subordination. Some loans are subordinate to a major bank lender. ## More learning - **[Common stock](https://help.wefunder.com/hc/t6vc02j1gl/article/875a9eb9-common-stock)** - **[Preferred stock](https://help.wefunder.com/hc/t6vc02j1gl/article/3167780c-preferred-stock)** - **[Convertible notes](https://help.wefunder.com/hc/t6vc02j1gl/article/38d6b1e1-convertible-note)** - **[Promissory notes](https://help.wefunder.com/hc/t6vc02j1gl/article/e2a3459d-promissory-note)** - **[Rev share](https://help.wefunder.com/hc/t6vc02j1gl/article/65108baa-revenue-rev-share)** - **[SAFE's](https://help.wefunder.com/hc/t6vc02j1gl/article/05de966f-safe-simple-agreement-for-future-equity)** - **[Valuation cap](https://help.wefunder.com/hc/t6vc02j1gl/article/81c78099-valuation-cap)**