FAQS
Why Are Post-Money SAFEs Worse Than Pre-Money SAFEs For Founders?
- Financing
- SAFEs, Notes, and Convertible Securities
TLDR: The post-money valuation caps found in post-money SAFEs are preferred by most investors but can result in unexpected and outsized dilution for founders.
Background
- During a priced equity fundraising round such as a Series A, all outstanding convertible notes and SAFEs are converted into shares alongside issuance of new shares to the Series A investors.
- The original form of SAFE created and made popular by startup accelerator Y-Combinator uses a “pre-money” valuation cap, meaning that the Series A SAFE conversion price is calculated by dividing the SAFE’s valuation cap by the company’s pre-conversion capitalization (typically any outstanding common and preferred shares and existing option pool). This structure is favorable for founders because the dilution created by any subsequent SAFEs issued before the Series A is borne by both founders and investors. This mimics how dilution works in a typical preferred stock financing.
- In 2018, Y-Combinator updated their original form of SAFE to instead calculate the SAFE conversion price per share using a “post-money” valuation cap. This means the SAFE conversion price per share is calculated by dividing the valuation cap by the company’s current capitalization (outstanding common and preferred shares and existing option pool) PLUS the converting securities (all SAFEs and convertible notes), but still before the new money converts in to shares. For an in-depth discussion on these and other changes to Y-Combinator’s SAFE, see Y Combinator Releases New 'Post-Money' Forms of SAFEs.
Dilution from Post-Money Cap SAFEs is borne only by existing stockholders, not SAFE holders.
Because the post-money valuation cap calculation takes into account all converting securities, using a post-money SAFE allows investors to know exactly what percentage of the company each will own before dilution by an equity round. However, the downside is that each subsequent post-money SAFE entered into DIRECTLY DILUTES the existing equity holders (usually just founders and option-holders for an early-stage company), rather than spreading it between the equity holders and other SAFE owners. The SAFE holder is guaranteed an UNDILUTABLE percentage of the company regardless of the amount of money raised until a preferred stock financing converts the SAFEs. This outcome is economically illogical compared to the same financings being conducted via the sale of pre-money cap SAFEs or preferred stock.
When seeking additional funding beyond the original post-money SAFEs, companies should sell preferred stock, which would convert the SAFEs into equity, in order to avoid the dilution from the financing to be borne only by the holder of common stock and options.
However, if the company raises money using post-money SAFEs (and knows exactly the maximum amount it will raise) and is positive that it will raise additional funds via a preferred stock financing, then a financing round conducted via post-money SAFEs may be acceptable.
An Example:
To illustrate, consider a company with 10,000,000 founder shares that is raising three rounds, each consisting of a $1 million SAFE. The examples below outline one scenario using pre-money SAFEs and one using post-money SAFEs (both with a $10 million valuation cap). Looking at the tables below, note that the post-money SAFE’s price per share decreases and dilution to founders increases as more SAFEs are issued.
Pre-Money SAFE:
| INITIAL | ROUND 1 | ROUND 2 | ROUND 3 | ||||||||
| Owner | Shares | % | Owner | Shares | % | Owner | Shares | % | Owner | Shares | % |
| Founders | 10,000,000 | 100% | Founders | 10,000,000 | 90.9% | Founders | 10,000,000 | 83.3% | Founders | 10,000,000 | 76.9% |
| SAFE 1 | 1,000,000 | 9.2% | SAFE 1 | 1,000,000 | 8.3% | SAFE 1 | 1,000,000 | 7.7% | |||
| SAFE 2 | 1,000,000 | 8.3% | SAFE 2 | 1,000,000 | 7.7% | ||||||
| SAFE 3 | 1,000,000 | 7.7% | |||||||||
| Price Per Share | - | 100% | Price Per Share | $1.00 | 100% | Price Per Share | $1.00 | 100% | Price Per Share | $1.00 | 100% |
Post-Money SAFE:
| INITIAL | ROUND 1 | ROUND 2 | ROUND 3 | ||||||||
| Owner | Shares | % | Owner | Shares | % | Owner | Shares | % | Owner | Shares | % |
| Founders | 10,000,000 | 100% | Founders | 10,000,000 | 90.0% | Founders | 10,000,000 | 80.0% | Founders | 10,000,000 | 70.0% |
| SAFE 1 | 1,111,111 | 10.0% | SAFE 1 | 1,250,000 | 10.0% | SAFE 1 | 1,428,571 | 10.0% | |||
| SAFE 2 | 1,250,000 | 10.0% | SAFE 2 | 1,428,571 | 10.0% | ||||||
| SAFE 3 | 1,428,571 | 10.0% | |||||||||
| Price Per Share | - | 100% | Price Per Share | $0.90 | 100% | Price Per Share | $0.80 | 100% | Price Per Share | $0.70 | 100% |
Founders should carefully consult with their attorneys when deciding between pre-money and post-money SAFEs. Additional factors such as varying valuation caps, discount rates, and expansion of option pools can also significantly impact ownership. A competent startup attorney will work with the company to model various potential scenarios to ensure that founders can completely understand the risks to their ownership stake. Where possible, founders should typically negotiate to raise capital using pre-money SAFEs.
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