Latest / The Series A Show with Fexingo: Early-Stage Funding, Pitch Decks, and Startup Milestones / Why Startups Are Using Rolling Notes Instead of SAFEs
Transcript
- Lucas: If you've been following early-stage funding over the past couple of years, you've probably heard a lot about SAFEs — the Simple Agreement for Future Equity that Y Combinator popularised. But there's a newer instrument that's quietly taking over pre-seed and seed rounds, and it's called the rolling note. Luna: Rolling note. I've seen that term popping up in more pitch decks lately. What exactly makes it different from a SAFE? Lucas: So a SAFE is pretty straightforward — an investor gives you money today, and in exchange they get the right to convert that investment into equity at a future priced round, usually at a discount or a valuation cap. The key is that the terms are fixed at the time of investment. A rolling note, on the other hand, has a valuation cap that increases over time. Luna: Increases? That sounds counterintuitive. Usually you'd think earlier investors get better terms. Lucas: Right, and that's exactly the point. With a rolling note, the cap grows on a schedule — say, every month the cap goes up by a certain percentage or a fixed dollar amount. So the first investor gets the lowest cap, the next investor gets a slightly higher cap, and so on. It rewards early commitment without punishing later investors too harshly. Luna: And the discount rate — is that also rolling? Lucas: Typically the discount is fixed, maybe 20 percent, and it's applied at conversion. But the cap is the variable. So the earlier you invest, the lower your effective price per share. It creates a natural incentive to move fast, without the pressure of a single close date. Luna: So it's like a rolling close but with built-in tiered pricing. I can see why founders would like that — it lets them keep the round open and keep adding investors without renegotiating terms. Lucas: Exactly. And it's not just theoretical. I was looking at a fintech startup called Paddle — no relation to the payments company — that raised a $2 million seed round earlier this year using rolling notes. They set the cap at $8 million for the first month, then increased it by $500,000 per month. They closed the round in about six weeks, with twelve investors, and everyone got a different cap. Luna: That's a pretty clean structure. And I imagine the legal costs are lower than doing a priced round, right? Lucas: Significantly. Rolling notes are usually based on a standard template — there's a Y Combinator version, but also variants from law firms like Orrick or Wilson Sonsini. The docs are maybe ten pages, compared to a hundred for a Series A. So you can save $10,000 to $20,000 in legal fees, which matters at the seed stage. Luna: And what about the investor perspective? I know some VCs have mixed feelings about SAFEs because they can create uncertainty on the cap table. Does a rolling note address that? Lucas: It does, because the conversion mechanics are more predictable. With a SAFE, if the round has multiple caps from different investors, the conversion can get messy. With a rolling note, each investor knows exactly what their cap is, and the conversion waterfall is clearer. Plus, because the cap increases, later investors aren't getting a huge windfall compared to earlier ones, so there's less friction. Luna: There's also the signaling aspect. If a startup uses rolling notes, it might signal that they expect to raise multiple tranches over time, which could be a sign of weaker demand. Or is that not the case? Lucas: It can be, but I think it's more about flexibility. Some of the most oversubscribed seed rounds I've seen recently used rolling notes precisely because they wanted to accommodate a large number of investors without shutting the round too early. It's actually a sign of strong demand if you have a growing cap and people keep jumping in. Luna: Interesting. And speaking of demand, the broader market seems to be warming up to risk again. ARKG, the genomics ETF, is up almost 14 percent in the last five days. That's a big move for biotech, and it suggests investors are willing to bet on longer-term, capital-intensive startups again. Lucas: That's a great point. The ARKG surge is partly driven by a few late-stage biotech IPOs that performed well, but it also reflects a general appetite for early-stage innovation. And rolling notes are particularly suited for sectors like biotech and deep tech, where the timeline to a priced round can be longer and you might need multiple small tranches of capital. Luna: So if you're a biotech founder raising a pre-seed, a rolling note might be a better fit than a traditional SAFE because you can keep the round open while you hit milestones. Lucas: Exactly. And the cap escalation means that investors who come in after you've de-risked the technology still get a fair deal, but the early believers get the best terms. It aligns incentives really well. Luna: One thing I'm curious about — how do rolling notes affect the cap table in terms of dilution? If the cap is increasing, the later investors are effectively paying a higher price, so the founder's dilution is less per dollar raised. Is that right? Lucas: That's exactly right. The earlier investors get a lower effective price, so they get more shares per dollar. Later investors get fewer shares per dollar. That means the founder's dilution is back-loaded, which can be beneficial if the company's valuation is growing. And because the cap is tied to time, it creates a natural progression that mirrors the company's increasing value. Luna: So it's almost like a dynamic valuation mechanism. The company doesn't need to set a fixed valuation upfront, which can be contentious. Lucas: Exactly. And it avoids the awkward conversation where you have to justify a $10 million valuation to one investor and then later accept a lower one from someone else. With rolling notes, the valuation is implicit in the cap schedule, and it adjusts automatically. Luna: Are there any downsides? I imagine if the company takes too long to raise a priced round, the cap could get very high, and early investors might feel like their advantage is eroded. Lucas: That's a real risk. If the cap increases too quickly or the round drags on, the early investors' discount relative to later investors shrinks. Most templates have a cap on the cap — a maximum valuation beyond which the cap stops increasing. So there's usually a ceiling. Also, the note typically converts at the next priced round or at a maturity date, so it's not indefinite. Luna: And what about the maturity date? SAFEs don't have one, but rolling notes usually do, right? Lucas: Yes, rolling notes typically have a maturity date — say, 18 to 24 months. If the company hasn't raised a priced round by then, the note converts at the then-current cap, or sometimes at a discount to a qualified financing. It adds a bit of pressure, but it also gives investors an exit mechanism if the company isn't progressing. Luna: That seems healthier than a SAFE that can theoretically last forever. I know some VCs have complained about 'zombie SAFEs' that never convert. Lucas: Right. Rolling notes force a conversion event, which cleans up the cap table. And because the cap escalates, there's an incentive for the company to raise a priced round before the cap gets too high, which can actually accelerate the timeline to Series A. Luna: So in a way, rolling notes combine the best of SAFEs and convertible notes — the simplicity of a SAFE with the maturity and conversion clarity of a note. Lucas: That's a fair way to put it. And I think that's why we're seeing more adoption. Anecdotally, I've heard from several seed-stage funds that they now prefer rolling notes over SAFEs for new investments, especially when the round is expected to have multiple closings. Luna: It also fits well with the trend of rolling closes that we talked about in earlier episodes. The whole ecosystem is moving toward more flexible, founder-friendly structures that still protect investors. Lucas: Absolutely. And speaking of the ecosystem — these conversations we have on the show are only possible because of listener support. A couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Luna: Yeah, it really does make a difference. Helps us keep the show ad-free and focused on what's actually relevant to founders and operators. Lucas: So back to rolling notes — I think we'll see them become the default for pre-seed rounds within the next year or two, especially as more law firms standardise the templates and more investors get comfortable with the mechanics. Luna: It's one of those innovations that just makes sense. And for founders listening, if you're about to raise a seed round, it might be worth asking your lawyer about rolling notes. Lucas: Definitely. And a quick word of caution — make sure the cap escalation schedule is reasonable. A 10 percent monthly increase might be too aggressive, while 2 percent could be too slow. It depends on your sector and your expected timeline. Luna: Great advice. And as always, thanks for listening — we'll be back next week with another episode. Lucas: Until then, keep building.