This is a lot of money, but the way this additional safe works is a bit scary. It takes on the terms of the lowest cap safe or convertible note between "when you're accepted to Y Combinator" and when you raise a priced round. Obviously the $125k Y Combinator safe is issued after you're accepted, so its cap should be one of the options for the MFN cap based on that wording. I believe Y Combinator's $125k for 7% is a post-money cap safe, which means the cap should be $1,785,714.
This is a pretty low cap and a startup is unlikely to raise more seed rounds at an even lower cap than that, though it could happen. So once you raise a priced round, Y Combinator's additional $375k converts into, at best, 21% of your company, or an even higher percentage if you raise additional safes or convertible notes at a lower cap. This means that as long as you raise a priced round or hit a liquidity event, Y Combinator will own 28% of your company or more in exchange for $500,000. It's not a terrible deal, but it's a massive chunk of your company.
To me, if you've already given up 28% of your company long before you've raised $1 million, you're setting yourself up to eventually have the founders' share of equity at mid-to-high single digits by the time your company IPOs or is acquired as a unicorn. You're basically setting yourself up to be like the Box co-founders, on the opposite end of the spectrum from a high-equity founder group like that of Square (34% at IPO despite raising $500 million in equity financing).
Somebody tell me if I'm wrong about the terms here. I'm a lawyer, but not a venture capital lawyer.
Okay, I'm being told that Y Combinator's $125k safe for the 7% doesn't have a cap. Sorry for not realizing that, they don't seem to mention the lack of a cap in their "deal" descriptions. If that's the case, then it shouldn't affect the MFN safe. Though it's possible that they've modified the $125k safe to have a cap now.
This is a pretty low cap and a startup is unlikely to raise more seed rounds at an even lower cap than that, though it could happen. So once you raise a priced round, Y Combinator's additional $375k converts into, at best, 21% of your company, or an even higher percentage if you raise additional safes or convertible notes at a lower cap. This means that as long as you raise a priced round or hit a liquidity event, Y Combinator will own 28% of your company or more in exchange for $500,000. It's not a terrible deal, but it's a massive chunk of your company.
To me, if you've already given up 28% of your company long before you've raised $1 million, you're setting yourself up to eventually have the founders' share of equity at mid-to-high single digits by the time your company IPOs or is acquired as a unicorn. You're basically setting yourself up to be like the Box co-founders, on the opposite end of the spectrum from a high-equity founder group like that of Square (34% at IPO despite raising $500 million in equity financing).
Somebody tell me if I'm wrong about the terms here. I'm a lawyer, but not a venture capital lawyer.