In the world of startups and venture capital, there are various financial instruments and terms that entrepreneurs and investors alike must understand. When the funding rodeo begins for early age startups, navigating the investment landscape can feel like riding a roller-coaster on an overdrive. Among the initial financial instruments you encounter, SAFEs (Simple Agreement for Future Equity) often take center stage.
But amidst the excitement, a crucial question arises: Pre-money or post-money SAFE? This seemingly small distinction packs a powerful punch, impacting your future ownership and investor dynamics.
In this blog, let's break down the key differences:
Simple Agreement for Future Equity (SAFE) is a convertible security, which means it is a financial asset that allows its owner (investor) to convert it into another asset (e.g. company shares). In simpler terms, it is a legal document that allows early-stage startups to raise capital from investors in exchange for future equity, without determining a specific valuation at the time of the investment. It is essentially a promise of equity in the company later, typically upon a triggering event, such as a priced equity financing round or an acquisition.
The pre-money SAFE sets the terms and conditions for the investment, including the valuation cap and discount rate, and provides investors with the opportunity to convert their investment into equity at a predetermined price. This type of agreement is often used by early-stage startups to attract investors and raise capital without having to determine a specific valuation for the company.
For investors, with a pre-money SAFE, it is impossible to accurately assess the percentage of the company you own in comparison to the founding team and other SAFE investors in the current round. The lack of a formal valuation makes it difficult to determine ownership percentages. The only way to gain clarity on this matter is to wait and see how the math plays out in the future, particularly when the company raises its first price round. At that point, the valuation will be established, and ownership percentages can be calculated based on the investment terms and the company's value at that time.
Let's imagine a startup gearing up for its seed round, attracting investors through pre-money SAFEs. An investor commits $1.5 million to the startup, anticipating shares upon the Series A funding. Fast forward to Series A, the startup's valuation climbs to $25 million. It is only at the beginning of Series A that the investor’s SAFE converts into shares.
The conversion price for the investor’s pre-money SAFE shares is calculated by dividing the pre-money valuation cap by the company capitalization (excluding SAFEs and convertible notes). The investor's stake converts to a 6% ownership share, amidst the possibility of dilution with new investors joining the fray.
A post-money SAFE differs from a pre-money SAFE in several significant ways. The most notable difference is that in a post-money SAFE, the company's valuation includes all shares issued when all SAFEs are converted. This allows investors to accurately determine their ownership stake in the company immediately upon investment.
Essentially, with a post-money SAFE, investors can predetermine their ownership percentage at the start of the next funding round, providing them with a clearer understanding of their potential stake in the company. While this ownership stake may be subject to dilution by new Series A investors, the post-money SAFE offers investors a more precise estimation of their eventual ownership percentage.
Additionally, like pre-money SAFEs, the conversion calculations for post-money SAFEs may be adjusted if the investor is offered a discount rate. Many investors view the post-money SAFE as an improvement over the pre-money SAFE due to its ability to provide a more transparent and predictable understanding of their ownership in the company.
Imagine an investor injecting $1 million into your startup through a post-money SAFE. With a valuation cap set at $20 million, the investor secures a 5% ownership stake in your company. As the SAFE converts into shares at the Series A onset, the investor solidifies their ownership at precisely 10% of the company.
In this scenario, the investor has a clear idea of how its ownership stake might look like.
When deciding between pre-money and post-money SAFEs, founders and investors must carefully weigh the implications and align them with their specific goals and circumstances. While post-money SAFEs offer investors a sense of security with fixed ownership stakes before Series A investors enter the scene, founders may hesitate due to the potential dilution impact on existing stakeholders.
Understanding that dilution can vary depending on several factors, founders might find post-money SAFEs advantageous, as they provide clarity on ownership dilution with each subsequent SAFE issuance. Ultimately, the choice between pre-money and post-money SAFEs hinges on the founder's risk tolerance, negotiation power, and long-term vision for the company. For personalized insights and guidance on navigating the complexities of SAFEs, founders and investors can leverage the expertise of equity experts to make informed decisions tailored to their unique circumstances.
Both SAFEs often include discounts and valuation caps that further impact ownership. Consult experts and carefully consider your funding goals, investor preferences, and future fundraising plans before deciding.
There's no one-size-fits-all answer to the question of which SAFE to choose. Investors need to carefully assess their unique situation, weigh the pros and cons, and not be afraid to negotiate. Remember, it is your startup's journey, and choosing the right SAFE is crucial for a smooth and successful ride.
