SAFEs and Pre vs Post Money Valuations
Breaking down Y Combinator's Simple Agreement for Future Equity
I played the drums in my elementary school’s fifth grade band. But since then, the only instruments I’ve picked up are financial instruments.
Please forgive me.
In today’s issue we’ll be breaking down the SAFE, or Simple Agreement for Future Equity, the best way for startups to attract initial cash. While discussing this kinda revolutionary financial instrument for early stage startups, we’ll also tackle pre vs post money valuations.
Thanks for reading Mostly metrics! Subscribe for free to receive new posts and support my work.
Disclaimer: Opinions are my own. Not investment advice. Do your own research.
SAFEs are a creative alternative to priced equity rounds or debt
SAFEs, unlike convertible notes, are not debt, do not carry interest, do not have a maturity date
SAFEs convert to equity when the company raises a priced round in the future or is sold
Pre Money is the company’s valuation before Cash is injected
Post Money valuation is the Pre Money valuation plus the Cash raised
What’s a SAFE?
The Simple Agreement for Future Equity was invented by Y Combinator in 2013. It allows initial investors to fund a good business concept without dithering over valuation.
Spoiler alert: it’s really hard to come up with a price per share for something that’s still an idea on a piece of paper.
A SAFE is neither debt nor equity. And it doesn’t accrue interest or have a maturity (read: expiration) date. But it does convert into equity when / if the company raises a priced round or gets acquired.
On the surface, SAFEs are, as their name sake states, simple. But since financial analysts are involved, there are many ways to crank the volume up to 12 on the difficulty scale. We’ll cover some of these bells and whistles as well.
But before we go any further, what’s the difference between pre and post money?
Pre Money vs Post Money
Pre-money is the hypothetical valuation founders and investors negotiate on before the check is written.
Post-money is how much the company is worth after terms are agreed upon and the company receives the money. Post-money valuation includes the latest capital injection. The company is theoretically worth more “post-money” because it now has that money on it’s balance sheet (read: in the bank).
Post Money = Pre Money Valuation + Investment
Big Data Co. is raising $10M on a $40M Pre Money
Post Money = $40M + $10M = $50M
OK, with that under our belt, let’s apply some SAFE scenarios.
A valuation cap is a ceiling imposed on the price at which a SAFE will convert to stock ownership in the future. It is the maximum valuation at which an investor can convert a SAFE into equity: a pre-negotiated amount that serves to “cap” the conversion price once shares are issued.
Let’s go through an example.
Investor A invests $200K on a $4M post money cap.
$200K / $4M = 5% ownership
That means the investor is guaranteed at least 5% of the company, even if the company raises at a valuation above $4M in their first priced round
Six months later the company raises at a $6M post money valuation
The investor’s position is still 5% even though the valuation is higher
Therefore, their position is converted to $300K “worth” of equity even though they only invested $200K
Sophisticated investors generally insist on a cap; without one, their investment will be watered down if the company's value starts to skyrocket.
Companies can raise multiple SAFEs before doing a priced round. And they can change the terms in each SAFE as the company gains (or loses) traction.
Using the same example as above:
Investor A puts in $200K on a $4M post money cap
$200K / $4M = 5% ownership
That means Investor A will minimally get 5% of the company, even if the company raises at a valuation above $4M in their first priced round
In 6 months the company completes another SAFE:
Investor B puts in $800K on a $8M post money valuation cap
$800K / $8M = 10% ownership
That means Investor B will minimally get 10% of the company, even if the company raises at a valuation above $8M in their first priced round.
If you’re doing the math at home, the founders know they have given up a total of 15% of the company (5% + 10%) in exchange for $1M in cash ($200K + $800K).
Note that none of this will show up on the cap table until that first priced round, so on paper it still looks like the founders still own 100%.
OK, now 4 months later they raise a priced Series A round from Investor C:
Investor C leads the round for $2M at a $10M valuation
$2M / $10M = 20% ownership
Investor A converts their 5% Post Money SAFE into equity (5% of $10M = $500K worth of equity, even though they only put in $200K)
Investor B converts their 10% Post Money SAFE into equity (10% of $10M = $1M worth of equity, even though they only put in $800K)
Let’s check the scoreboard: The founders have now given up 5% + 10% + 20% = 35% of the company for $3M ($200K + $800K + $2M) and still own 65% post Series A.
While the cap places a ceiling on the value of the next round of funding for investors, a discount offers them a certain percentage off. Caps and discounts cannot be used simultaneously; when the next round occurs, an investor must choose between the two and calculate which one will work out better for them financially. Let’s try out a SAFE with a 10% discount.
Investor A puts in $200K at a 10% discount.
6 months later, Investor C leads the round for $2M at a $10M valuation
This means Investor A can convert their shares at a $9M valuation, getting more shares than they ordinarily would as a result
Pre Money vs Post Money SAFEs
OK, so this is when most readers tune out and chalk up what they’ve learned so far to a W. Continue at your own risk - figuring out this part put me in a mental pretzel.
As we addressed above, the ownership percentage and dilution in a post money SAFE is always known. But there’s also this thing called a Pre-Money SAFE, where the ownership and dilution is TBD. The investor has to wait and see how much equity they get in the company depending on the valuation and calculating all the other SAFEs that the founder’s executed.
Example of a Pre-Money SAFE:
Investor D puts in $200K as part of a pre-money SAFE. The startup also raises money from other investors in the form of SAFEs.
The investor must wait until the Series A to know exactly how much of the company she owns. Remember: there are other SAFE investors, too. Only after the conversion of the SAFEs into shares will the investor know her ownership percentage in the company. The investor isn’t super-pumped about this lack of clarity, but they’re dealing with it.
The startup is officially valued at $20 million pre money and the investor learns that her $200K investment has converted into a 1% pre money ownership stake. This stake may be diluted by the new investors coming on board in the Series A.
The startup raises $5M making hte Post Money $25M
The original SAFE investor now has a final Post Money Fully Diluted Ownership percentage of 0.8%
That was a lot of uncertainty, hence why the Post Money SAFE with a Valuation Cap was invented, and became the most common type of SAFE. The Post Money SAFE simplifies ownership percentages for everyone - investors know relatively how much of the company they are getting and the founder’s know how much they are giving up.
As such, the most common type of SAFE is Post Money with a Valuation Cap.
Most Favored Nations Clauses
Say you are stackin’ SAFEs and offering slightly different terms to different investors. This is common and usually the terms get “worse” for investors as SAFEs progress and the company has more traction than the first SAFE.
However, to guard against bad throwing in a MFN clause ensures that if future SAFEs investors receive better terms (e.g., lower valuation caps or larger discounts) MFN SAFE holders will have the option of getting those same terms.
Smart Stuff I Read at 2AM:
The SAFE - Y Combinator
The Complete Guide to SAFEs - Dorm Room Fund
Pre Money vs Post Money SAFE - Carta
Pre vs Post Money - Investopedia
Valuation Caps - Parsa Law
Valuation Caps - Dreamit.com
Pre Money Safes - Cooley
Pre Money Safe examples - Pulley
What I’ve Been Reading:
I’ve worked on both the funding and funded sides of the table over the course of the last ten years. I remember the trepidation I had in making the plunge over to the operating side. It felt like a leap of faith at the time - I knew there were great opportunities but had zero idea what type of roles there were.
I ended up accepting a pretty broad strategy role at software company, which led me to a chief of staff role, and later a head of FP&A role.
And to be honest, it all worked out, but - I was flying COMPLETLEY blind.
I wish there was a resource like Ali Rohde jobs at the time.
Ali Rohde Jobs is a free weekly newsletter curating the latest:
Chief of Staff,
Join 4,000 other operators who see the most exciting roles -- like BizOps at Notion, Chief of Staff at Worklife, or fintech investor at a16z -- as soon as they're posted.
If you want to work in BizOps or become a Chief of Staff in tech, this is the place to subscribe.
What I’m Looking Forward to This September:
All this talk about SAFEs and raising money reminded me - there’s an exciting demo day coming up.
BoomStartup is an open accelerator program for entrepreneurs seeking community, expert advice, and funding that takes businesses to the next level.
They’re holding their demo day on September 13th. Accredited investors and those who want to listen in to some kickass pitches can register here.
Quote I’ve Been Pondering:
“Yesterday’s price is not today’s price”