The terms appear to be structured so that founders have a long runway and fewer financial distractions leading to better products and better customer development which leads to better valuations and therefore better angel exits. It appears to have all the elements to create a virtuous cycle.

Aside:The longer term somewhat reminds me of the approach Microsoft takes with BizSpark.

This is the first time I've seen the optional conversion into Series AA at a $5 million valuation. If it's optional at the company's option, that eliminates the one and only risk I could think of: the lender calling back the principal + interest of the note. At 2% interest, that's just another 3.12% dilution to the founder(s) on top of YC's 2-6% (source: http://www.google.com/search?sourceid=chrome&ie=UTF-8...).

So, unless I'm missing something, worst case is you get into YC, you get $165K, and you still own ~90% of your company. That's a no-brainer deal.

This answers the early sale question. In the event of a sale before the note is converted through other means, the investors can convert at $5 million valuation. That could be a lot of upside for them, though I expect this will not be a common case.