Growing a startup can be highly challenging, especially when you do not have the funds to grow. That is when companies turn to investors to get some much-needed capital for their company. And these investors normally take equity in the company in exchange for the shares they get. But since the company has no value initially or a very low value, offering shares in exchange for capital can be very hard.
That is why convertible securities were invented, such as KISS convertible notes. They are a document that promises the investor the option to convert these notes into future shares of the company. There are a lot of things that you should know about the 500 startups KISS convertible notes if you want to use them.
KISS or Keep It Simple Security
The 500 startups KISS convertible note, also known as “Keep It Simple Security”, is an agreement made between an investor and the company. The investor invests money in the company, and in exchange receives the right to purchase shares in a future equity round when it occurs. You may like to think of a KISS as a hybrid: it aims to keep the simplicity and user-friendly-ness of a SAFE, but with some of the investor protections found in convertible notes.
The KISS convertible notes were created by 500 Startups, which is an early-stage seed fund and incubator with a focus on consumer and small-to-medium-sized internet startups. They developed the suite of KISS legal documents, following discussions with Silicon Valley law firms and early-stage investors, and made them open-source. This means that the documents created were made publicly available to use. The KISS convertible notes were developed in response to the lack of investor protections in a SAFE which was therefore perceived as too founder-friendly.
Types of KISS Notes
There are two types of KISS convertible notes:
- Debt version: With interest rate and a maturity date – This version tracks a convertible debt structure more closely, as it contains the interest rate and the maturity date clause.
- Equity version: Without interest or maturity date – This one is a middle ground between a convertible note and a SAFE convertible note. This 500 startups KISS note does not accrue interest and does not contain a repayment clause at a maturity date. Due to this, it is normally the most attractive kind of convertible security among many companies.
How a KISS Instrument Works?
A KISS is a lot like a convertible note as it accrues interest at a stated rate (5%) and establishes a maturity date (18 months), after which the investor may convert the underlying investment amount (plus accrued interest) in a newly created series of preferred stock of the company. The KISS convertible notes usually have an MFN clause which allows the investor to get a better security deal in the future if issued by the company.
To explain better, let us say that the investor gets a “KISS A” document for his investment in the company. Now, after a year, another investor comes and invests in the company to get a KISS document with better terms (let’s call this “KISS B”). In this case, the first investor can demand to get the same terms as KISS B for their security as well as per the MFN clause.
KISS investors are normally investing in the company at a very early stage, which means that there is a huge amount of risk at this time. The MFN clause offers downside protection in the event the company does a “down round” (or otherwise grants more favorable terms to other investors) in the future. Another thing about KISS is that it converts automatically to preferred stock when the company raises at least $1M in equity financing.
The maturity date and the cap would be discussed during the deal. By default, KISS convertible notes have an 18-month maturity date. If at least a $1 million equity financing does not occur by the maturity date, the KISS holder can elect to convert at the valuation cap by majority vote. If there is a sale of the company before the conversion to equity, the investor can opt to receive 2x its investment or convert at the valuation cap.
KISS convertible notes also offer additional rights to the major investors (investors who invest at least $50K) including information rights (financials), 1x participation rights in future rounds, and “Major Investor” rights as defined in the next equity financing. Along with this, the investor can transfer its KISS to anyone at any time.
The key features of KISS convertible notes are:
- Identical terms: All the KISS convertible notes are on the same terms, so they do not allow for high-resolution financing (i.e. raising finance at different valuation caps).
- MFN (most favored nation) Clause: In case the company offers a KISS or another convertible instrument with better terms to another investor, they would also have to offer the same to the first investor.
- Control and dividends: An investor does not usually have any management rights or receive any dividends until the KISS converts into shares
- Accounting: A KISS is not treated as debt on the company’s financial statements.
KISS or SAFE?
From the above it can clearly be seen that KISS convertible notes are a great alternative to convertible notes. But there is another convertible security in the market that investors use, the SAFE convertible note. So, which one of them is better: KISS or SAFE?
What are SAFE Notes?
SAFE, also known as “simple agreement for future equity”, is a convertible security that promises the investor to convert their investment into equity in the future. Unlike convertible notes, SAFE notes usually have fewer pages, fewer clauses, and are simpler to understand. Moreover, SAFE notes are not technically debt as they do not have any maturity date or interest.
SAFE convertible notes do have valuation caps, discounts, and “most-favoured-nations” clauses like KISS convertible notes. Although, it is not a must for a SAFE note to have a valuation cap AND a discount. This means that some notes can have just a valuation cap while some can have only the discount, while others can have both. There is also one kind of SAFE note that does not have any discount or valuation cap but has an MFN clause.
With that said, there are a lot of shortcomings of SAFE notes where the entrepreneurs end up paying the price for. Even though Y Combinator invented the notes with a noble goal of being safe to use, they have turned out to be “not safe.” The SAFE notes cause much more dilution than issuers thought when they sign these documents.
Why Should I choose KISS Notes instead of SAFE?
While SAFE convertible notes are not entirely “safe” for investors, that leaves us with the KISS convertible notes that are generally considered to favor not just the entrepreneurs but also investors. In fact, when you are making a deal, you will find your potential investor insisting on getting the KISS convertible notes rather than SAFE notes.
Additionally, angel investors are more concerned about not cashing in when a company they invested in is successful than they are about losing money on a failed startup. Several provisions in a KISS document help protect investors from not getting a return from their thriving portfolio companies, including the “Most Favoured Nation” clause and the conversion to preference shares at maturity. And because of these reasons, it is always a better idea to choose KISS convertible notes over SAFE convertible notes.
Easily Create and Issue KISS Notes using Eqvista
With all clear about what KISS convertible notes are, you can now decide to use it for obtaining your initial funding for your company. But as you do this, remember that it is important to keep track of all these in your cap table. In fact, KISS convertible notes can affect the cap table of your company, and keeping track of these is important for modeling different dilution scenarios.
Here is how you can add the details of KISS convertible note on Eqvista:
Once you are done with the details, click on “Submit”. You will reach the page where you can see the KISS note and its details as shown below.
It is simple to create a KISS convertible note on Eqvista. In addition to this, you can also see how this note will affect the cap table once you have raised another funding round and the KISS note converts. This can be seen using the round modeling tool on Eqvista. This is how it would look like:
And just like this, you can create a KISS convertible note on Eqvista within minutes. In fact, Eqvista was created to make your life easier as a founder. To get an in-depth understanding of how to create a KISS note and the step by step process, check out the article here. To learn more, visit our knowledge center here or contact us with your questions!
