There are a few key reasons why founders need to be careful with how they structure their “friends and family” round; which is typically their first set of outside checks.
First, an F&F round rarely has a sophisticated investor in it that can reasonably “price” the company via an equity round price or a valuation cap in a note or SAFE. The company is often so early that even attempting to set a valuation can end up being little more than a guess.
Second, the round is often on the smaller side (under $1M) such that any equity structure is likely cost-prohibitive, and using a convertible instrument like a convertible note or SAFE is far more efficient and reasonable.
Third, the next financing after the F&F (typically seed or pre-seed) will often itself be a convertible (note or SAFE) round. This presents a problem when combined with the first point of being unable to set a valuation, because usually the “discount” language in notes and SAFEs applies only to equity rounds. A conventional note or SAFE does not offer a discount on a future convertible round. Yet, your F&F investors will not be happy if they end up paying the same price as seed investors who showed up a year or two later, with the company having been somewhat de-risked. Typically first money in wants the best price for the risk they took on.
For all of these reasons, we believe a slightly tweaked SAFE, what we call an “F&F SAFE,” is the most appropriate structure for a friends and family round. It looks a lot like a typical SAFE, except it has a “convertible super-MFN” provision that offers a discount on a future valuation cap (not just a future equity round valuation). So, for example, if you put a 20% discount in the convertible MFN, if your seed round investors get a $10 million cap, the F&F SAFE will provide for an $8M cap.
This F&F structure allows you to still defer setting a valuation until “professionals” are available (at seed typically), but it also ensures that the discount language fits the context so that your F&F investors, your earliest and riskiest checks, still pay a lower price than your seed investors.
Note: this F&F structure is also optimal for founders when funding their own startups before outside funding arrives.
For more on this, see: “Friends and Family (F&F) SAFEs.” The template F&F SAFE is also downloadable in this template library.