For any security to qualify under Section 1202 as Qualified Small Business Stock, the company must first be considered an eligible Qualified Small Business (QSB) meaning:
- It is a domestic C-Corp
- It has less than $50 million in gross assets (when the stock is issued)
- It is an active business in a qualified trade
- Learn more about about the additional requirements to be a Qualified Small Business
The securities themselves must also satisfy certain criteria including:
- They were acquired at original issuance
- They were acquired in exchange for money, other property (not including stock), or as compensation for services provided to such corporation
- They were held for a minimum of five years
For each security type however, when the 5-year holding period begins is determined based on nuances particular to each security type. Depending on the security type the holding period might begin on the purchase date, the exercised date, vesting date, etc.
What is a “KISS Note”?
A KISS Note (Keep It Simple Security) is a security type which has similarities to both SAFE Notes and Convertible Notes and is considered to be more investor-friendly. The similarities can be found in the same method of changing cash investment into some sort of equity within the start up. It combines the directness of a SAFE Note and the protection of a Convertible Note.
A KISS carries an interest rate of 5% and a maturity date of 18 months at which the investor can convert the KISS into preferred stock in the company—if using the “Debt Version” of a KISS Note as described later in the article. Alternatively, the KISS will automatically convert once the company reaches $1 million in equity financing.
Benefits of Issuing KISS Notes
There are many benefits of issuing KISS notes including the same downside protections one would expect from a Convertible Note. Additionally, the MFN clause (Most Favored Nation) benefits investors in the event that future securities are issued with more favorable terms, such as lower valuation caps.
At the maturity date of the KISS, the value (plus 5%) can be converted into stock in the company. Finally, investors who hold a KISS, benefit from shareholder rights and can address any alarming financial issues as well as rights to participate in future funding rounds.
Types of KISS Notes
There are two types of KISS notes. A “Debt Version” KISS is comparable to a Convertible Note as it has both an interest rate and a maturity date. A “Equity Version” KISS is more comparable to a SAFE note in that no interest is accrued and a repayment clause does not take effect upon the maturity date—rather, there is no maturity date.
Downsides of Issuing KISS Notes
KISS notes are considered to be as simple as a convertible note with the protections of a SAFE note; however, they seem to lack popularity because they retained a lot of the same issues that convertible notes face. KISS Notes in a series must have identical terms, which might confuse founders and make them more difficult to understand.
What Clauses are Typical in a KISS Note?
- 5% interest rate
- The maturity or expiration date is 18 months
- The company must have more than $1 million for the financing round
- The investor has the ability to transfer rights to anyone at any time
- The cap or discount can be negotiated on a daily basis
- An MFN is included
- Conversion happens after at least $1 million in equity financing
- Before conversion to equity, investors can get 2x total investment
Read more about SAFE Notes and Convertible Notes and how Section 1202 regulations apply to each.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.
