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Pre-Money vs. Post-Money SAFE

Learn the key differences between the original SAFE and newer SAFE versions, when to use each version, and general issues with SAFEs.


Original "Pre-Money" SAFE

The Simple Agreement for Future Equity ("SAFE") was released by a Y Combinator lawyer in 2013 to provide a simple, standard instrument that could be used to invest in early-stage, bootstrapped startups prior to a larger priced round (usually labeled a "Series A" round). SAFEs were meant to be an alternative to convertible notes which were commonly used in early-stage startup fundraising.


The original SAFE with a valuation cap is known as the "pre-money" version because the valuation of the company is determined "pre-investment" (before adding in the new money coming into the company). The Pre-Money version of the SAFE is no longer available for download on YC's website, but equity management company, Carta, allows users to automate either SAFE version via its platform.


New "Post-Money" SAFE

The newer valuation cap SAFE, released in 2018, is known as the "post-money" SAFE because the valuation is "post-investment" (the cash being added to the company is included in the company's valuation).


YC also corrected certain issues with the original version and reformatted for clarity. For example, a group of SAFEs can now be treated as a financing round (rather than each SAFE a stand-alone investment) so that a majority-in-interest of the SAFE holders in that round can make an amendment to all SAFEs in that round. This makes it much easier for the company to obtain consent from a majority of the SAFE holders in a round rather than each individual SAFE holder.


Both SAFE versions can convert on either a valuation cap or a discount. The original SAFE release included a version with both a valuation cap and discount (and converts at whichever method gives the SAFE holder more shares). But, YC eliminated the SAFE with both a cap and discount in the latest release.


The other SAFE option has a most favored nation (MFN) clause which entitles the SAFE holder to the same terms as any more favorable convertible security issued by the company in the future. This version is generally used when the startup is so nascent it is impossible to value or as a bridge between funding rounds.


Pre-Money vs. Post-Money: Dilution

The biggest change to the valuation cap SAFE is the definition of "Company Capitalization" and the significant dilution it causes for the founders.


In the post-money SAFE, a new term, "Converting Securities," has been added to the "Company Capitalization." Converting Securities is defined as the SAFE at hand, all other SAFEs (from all rounds) and any other convertible securities prior to the priced round that triggers conversion of the SAFE.

This means that all SAFEs and any other convertible securities issued before conversion will increase the denominator (Company Capitalization). The larger the denominator, the lower the SAFE price (numerator) will be (the purchase price per share for the SAFE holders). The lower the SAFE price, the more shares the SAFE holder will be issued when the SAFE converts into equity.


Under the pre-money SAFE, all shareholders (founders, employees, and investors alike) bore equal dilution for any subsequent rounds based on their percentage of ownership. Under the post-money SAFE, only the common shareholders (usually founders and early employees) absorb dilution from any future SAFE or other convertible instruments until a priced round (while the SAFEs are not diluted at all).


This is equivalent to "full-ratchet" anti-dilution for SAFE investors. Full-ratchet anti-dilution is a mechanism used to protect investors if the company has a down-round (lower valuation), and is considered so unfair that it is rarely ever included in modern fundraising agreements. With the post-money SAFE, full-ratchet anti-dilution is automatic, even when the company has a higher valuation in future rounds and there is no justification for this type of investor protection.

YC has done a 180º in moving from the pre-money SAFE (very company friendly) to the post-money SAFE (extremely seed investor friendly).

(Startup Lawyer, José Ancer).


Default or Optional Pro Rata Rights

A pro rata right is a right to invest in future financings to maintain the same percentage of ownership (not an obligation to invest like a pay-to-play provision). Pro rata rights can be full or partial and can have triggers and/or limitations (e.g., limited to only certain funding rounds). Pro rata rights are desirable for investors and are normally a point of negotiation.

Under the original SAFE, by default, every SAFE holder will get a pro rata right to purchase up to its pro rata share of stock in the company in the funding round after the equity financing (after the SAFE has converted in equity). But there is no pro rata right to participate in other convertible funding rounds or the priced round that converts the SAFE. This is really odd.


This means that if the company has a Series A financing, the SAFE holders have the right to invest in a subsequent financing (usually a "Series B," and so on). The issue is that SAFE investors are generally Angel investors who typically do not have the type of capital to meaningfully participate in a Series B or later round. Additionally, Series A investors often negotiate to remove prior pro rata rights anyway. But, the SAFE holders have no pro right to invest in any other pre-Series A round (when they would likely prefer to invest).


Under the new SAFE, by default, no investors get pro rata rights (at any round). The pro rata right is optional and outlined in a side letter with each individual SAFE holder. This allows the company to place its own contingencies on the pro rata right and only offer it to more strategic or larger investors.


SAFE Version Based on Funding Amount

Use logic when deciding which SAFE to use. Consider the amount of money the company needs to raise in the round and how many convertible rounds will be necessary prior to a priced round.


For example, if less than $1M will be raised and it is possible that another convertible round will be necessary before a priced round. Then, the pre-money SAFE may be the most fair as all shareholders will bear their relative portion of dilution in any future convertible round. If more than $3M will be raised, then more experienced investors (and their lawyers) will be involved. This size investor may only invest through the newer post-money SAFE. A priced round should generally be the next funding round to avoid the harsh dilution of the post-money SAFE.


Everybody is Doing It - It Must Be SAFE

The SAFE has become wildly popular for early-stage startup fundraising:

[YC] introduced the [SAFE] in late 2013, and since then, it has been used by almost all YC startups and countless non-YC startups as the main instrument for early stage fundraising.

(YC).


Many great reasons to use a SAFE include:

  • Lower transactions costs (legal for priced round: $10K - $50K).

  • Transaction can be completed quickly (usually less than a week).

  • Shift valuation down the road when the company is ready (has revenue). This can prevent selling too much of the company too soon.

  • Avoid tax/regulatory issues with debt/convertible notes.

  • No maturity date - no looming repayment or pressure for a priced round.

  • No interest rate - the conversion will equal the SAFE amount.

  • Post-money SAFE makes it easy to keep track of equity/dilution.

Nothing is SAFE

Despite YC's best efforts, the SAFE has had legitimate criticism from both startups and investors. Anyone considering using a SAFE for fundraising or investment, should be aware of these issues.


The SAFE was only intended to be used as a short-term bridge ("seed round") prior to a priced round (i.e., one seed round, not multiple seed rounds). The SAFE's efficiency and lack of maturity date has certainly been abused by some startups.

. . . SAFEs enabled a culture of runaway serial seed financings constantly delaying conversion . . .

(Ancer).


(if you know The Twenty Minute VC, you read that in a British accent).


Of course, there are consequences.


Because convertible securities are generally not listed on cap tables, founders are often surprised by how much equity they've actually sold, the impact of which is often not fully felt until the first priced round when the instruments convert.


The harsh dilutive effect of the post-money SAFE was indeed intended to create accountability and curb infinite convertible rounds.

. . . we intend the safe to remain fair to both investors and founders.

(Steve, YC, 2013)


If raising funds under any convertible securities rounds, it is very important to track dilution through an experienced startup lawyer or equity management platform.


SAFEs Are Ubiquitous

The word "SAFE," formed by the agreement's acronym, is now a generic term used to describe all types of convertible instruments, including extensively edited "SAFEs." This has exasperated YC's original intent of providing a simple, standard agreement. Transaction costs have increased as lawyers spend more time editing and reviewing these "SAFE-like" agreements.

There is nothing standard or simple about a SAFE. For instance, different companies offering SAFEs use various terms to describe triggering events—and provisions concerning conversion and the conversion price might be subject to different treatment from issuer to issuer.

(Finra, Be Safe—5 Things You Need to Know About SAFE Securities and Crowdfunding)


That said, standard documents are not one size fits all and the standard SAFE may not fit a startup's funding needs or survive negotiations with investors.


SAFEs Were Meant for Future VC-Backed Startups

Neither version of the SAFE has a maturity date which was intentionally omitted to remove tax and regulatory issues that arise with debt instruments and the pressure to have an equity round before the startup is ready.


However, this means that if the startup never has a priced funding round (the triggering event), the SAFE never converts into equity in the company. The SAFE is not repaid. Nothing happens. Investors, read that again.


Factor in recent trends: cloud storage costs have plummeted with the use of cloud servers. Talented engineers can be hired as independent contractors anywhere in the world. Technology has significantly reduced costs for creating and operating companies. This means that startups, especially SaaS companies can become profitable more quickly and may never need to or choose to take venture capital.


Because SAFE convert automatically upon any priced round (no minimum size), a startup can hold a small, non-VC priced round to convert the SAFEs into equity, without much of discount for the SAFE investors. Lesson for SAFE investors: make sure that raising venture capital is in the company's business plans. Surprisingly few Angel investors ask this question.


To be fair, while convertible notes do have a maturity date, in most cases seed funds are spent quickly and startups would not be able to repay the note amount if called in by the holders. Therefore, the maturity date likely provides an illusory sense of security anyway.


 

Disclaimer: The information on this website is meant to be used for general educational purposes only. This information may not reflect the current law in your jurisdiction and should not be construed as legal or business advice or an advertisement for legal services. You should not act or refrain from acting on the basis of any information in this post or accessible through this website. If you have questions regarding your particular facts and circumstances, seek counsel from an experienced startup lawyer.


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