Revolutionizing the Fundraising Process - The SAFE

[karinw]

TL;DR​

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

Example:

• 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.

Valuation Caps​

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.

Stackin’ SAFEs​

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.

Discounts​

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

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.

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[shinesobright]

@karinw Hi- in your example, what happens if the valuation of the company ends up being less than the valuation cap? Is that a loss for the investor? Will their shares be converted at the current valuation or still at valuation cap?