Not quite. The way that it works is that the 375k is invested now, but at terms that are determined in the next equity round. If the next round values the company at 10 million, then the 375k would be 3.75% of the company.
The more they grow, the less YC gets for the 375k. But the more they grow, the higher the value of 7% is going to be. And also, the more they grow, the more they are likely to grow in the future. So the 375k share is also more likely to keep growing.
So in a nutshell: the 375k is incentive for the company to grow, which is also in the interests of YC, since they have 7% (+ x%) and in general getting startups to grow is the whole point of YC.
This is also not true. Their uncapped MFN note assumes the terms of the lowest-capped safe (or other investment) after their investment. So if founder accepts $3.75m capped safe soon after YC’s investment, then later raises an equity round at $10m valuation, YC gets 10% more, not 3.75% more at that time. There may be dilution from the equity round but that’s a different matter.
As per https://www.ycombinator.com/deal “The $125k safe and the MFN safe will each convert into preferred shares when your company raises money by selling preferred shares in a priced equity round, which we refer to below as the “Safe Conversion Financing” (this will typically be your “Series A” or “Series Seed” financing, whichever happens first).”
Edit: Sorry, I am absolutely wrong here. I completely misunderstood what nirmel was saying.
They are correct. The MFN safe converts at the best terms. So if there is a SAFE with a post-money $3.75m cap, then even if the next round is priced at $100m, YC gets 10% at that 100m valuation. It converts at an equivalent ownership compared to the cap. That's why caps exist.
The MFN applies to other SAFEs too. YC will get the "best" price during the priced conversion. If you took other money at a lower SAFE, that would peg the "best" price in the conversion -- and thus, that's what YC's $375k would get.
Thank you for the correction. They mention this at the footnote of the article: “1 The $375,000 is on an uncapped safe with ‘Most Favored Nation’ (MFN) terms. MFN means that this safe will take on the terms of the lowest cap safe (or other most favorable terms) that is issued between the start of the batch and the next equity round. Simply put, we’re giving the company money now but at terms you’ll negotiate with future investors.”
You're just providing an alternate scenario that isn't as favorable. And since the initial $125k implicitly has a $2m valuation attached to it, if you raise again at $3.75m, then that's probably not ideal.
So a sensible approach would be to view this as providing an implicit minimum value to target for your next round, i.e., >$5m (7.5%).
