Understanding The New Post-Money Safe
By Kevin Vela
Last fall, Y Combinator unveiled a new “post-money” Safe as part of the “New Standard Deal”. The intention was to “mak[e] fundraising as simple, fast, cheap and clear as possible for founders.”
Y Combinator goes on to explain that because the new Safe is post-money, includes all of the converting securities, and the conversion formula is exclusive of the next round option pool increase, it makes calculating dilution easy. For example – $50k Safe on a $1M post-money valuation = 5% dilution. Two $50k Safes on a $1M post-money valuation = 10% dilution.
This makes sense, and could be valuable, but it cuts against the grain of founder/investor thinking and requires some distinct term sheet changes to take full advantage of it.
First of all, founders need to start asking for post-money valuations, not pre-money valuations, as has been the convention for as long as I can remember. This means an increase in the valuation figure discussed with potential investors or listed on a term sheet. To accomplish this, founders need to accurately predict how much equity they plan to raise through Safes, or run the risk of taking in more than they had initially planned but being locked into the post-money valuation.
Let me highlight this with an example.
Assume Franny Founder planned to raise $100k in a Safe and wanted to give up 10% of her business. With the old SAFE, she would have set a pre-money valuation of $900k. This is because $900k + $100k = $1M, and $100k/$1M = 10%. The math is simple. What complicates this is that the Safe only converts when there is another round, and that other round would (a) always include more cash (which dilutes the Safe holder) and (b) typically include an increase to the option pool (which also dilutes the Safe holder). Thus, it would be difficult to tell the Safe holder exactly how much she owns for her $100k investment, due to the dilution from the new cash and the increased option pool.
The post-money Safe solves for this, but to the detriment of the founder.
Using the same example as above, let’s say Franny thought she wanted to raise $200k in her Safe round, give up 10% equity for that $200k, and use the new Post-Money Safe. She would thus set the post-money valuation at $2M (or a pre-money valuation of $1.8M). $200k/$2M = 10%. But…(there’s always a but), this assumes that Franny only takes on $200k. What if she ends up taking on $300k that round? Will the first Safe investor agree to an increase in the Safe cap to $2.1M? Or even worse, what happens if Franny’s startup takes on multiple rounds of pre-seed financing (i.e. multiple Safe rounds or Convertible Note rounds)? Because the new Post-Money Safe includes all converting securities when calculating the Safe price, this means that the Safe and other converting securities do not dilute each other; they only convert the previous equity holders (i.e. common stockholders i.e. founders). Remember, when doing share price calculations, the more shares in the denominator, the lower the price. The lower the price, the more shares the investor gets. If an investor gets more shares for the same $$, that means common is being diluted more.
Now, the good thing is that the option pool increase for the subsequent financing round is excluded from the Safe conversion price calculation. This is definitely a positive, and could lead to slightly less dilution for founders from Safe rounds, assuming the company accurately baked the size of the Safe round into the post-money valuation, or even entirely offset the stacked Safe/convertible note round dilution. You can see an example of this in this Safe pro-forma model (note that you’ll need to turn on iterative calculations for the model to work correctly).
To add to these complications, if there is a convertible note round, you’ll need to tweak the convertible note language to make sure the conversion mechanics line up. All of this to say – you had better be working with your attorney throughout the whole process.
Thus, in summary, while the new Post-Money Safe did simplify the process for calculating early-stage equity, it may become problematic under two scenarios: (1) the founder isn’t able to accurately predict how much equity she takes in per round, and (2) the company goes through multiple convertible security (Safe or Convertible Note) rounds. In our experience, early rounds often expand, and/or startups frequently undergo multiple Safe or Convertible Note rounds; in each of these scenarios the companies will be ill-affected by the new Post-Money Safe. But as you’ll see from the model, the effect is not that great.
I am confident that the Post-Money Safe is a good thing, but please make sure it’s used with care.