When pre-money and post-money don't add up :)
Not fun, not pretty, not really entertaining, but hopefully quite useful. Please let me share with you the Post Money SAFE horror story. Not on Netflix anytime soon.
SAFE stands for Simple Agreement for Future Equity. It allows investors and entrepreneurs to agree on a valuation cap and a discount. The SAFE converts at a maximum of the cap or a discounted next-round valuation.
When the SAFE was first launched by Y Combinator a decade ago, people were using Pre-Money SAFE, meaning that investors were investing money without knowing exactly how much ownership they would get, because it depended on how much money the company ended up raising.
For instance, if you were investing 100k on a SAFE with a 6M Pre-Money Cap, if the company ended up raising 1M, you would own 1.4% as an investor at the cap (100k / (6M+1M)) - but if it was 3M, you would own 1,1% (100k / (6M + 3M)).
In order to avoid the mysterious suspense of signing Pre-Money Cap SAFE, Y Combinator introduced the Post-Money Cap SAFE. In short, you invest at a post-money cap that defines exactly how much equity you would own at a minimum by the time the company would raise an equity round.
If you are now investing 100k on a SAFE with a 10M Post-Money Cap, you know that ultimately, before any round, you would own at a minimum 1% (100k/10M).
That sounded great to me. Really clear and simple. I thought that it was great for both investors and entrepreneurs. I didn’t realize that it could also be the foundation of a perfect horror movie (spoiler alert… Entrepreneurs are the victims). Imagine that you’re signing a SAFE for your company before Y combinator, another one while getting in, and another one around demo day. What happens then? Let’s take an example and cry together, shall we?
For the sake of keeping it simple, I didn’t take into account the YC Deal and decided to add up three very similar operations. You’re the sole CEO of a company and own 1,000,000 shares. You are raising three consecutive SAFE notes.
500k at 4.5M pre-money cap or 5M post
1000k at 9M pre-money cap or 10M post
2000k at 18M pre-money cap or 20M post
Now comes an equity round of 8M at 40M Post Money. All your SAFE are on a pre-money cap basis. here is the calculation…
First SAFE : 500k/4.5M pre = 10% = 1,000,000/(1-10%) - 1,000,000 = 111,111
Second SAFE : 1000k/9M pre 10% = 1,000,000/(1-10%) - 1,000,000 = 111,111
Third SAFE : 2000k/18M pre = 10 % = 1,000,000/(1-10%) - 1,000,000 = 111,111
In total, you’ve created 333,333 Shares on top of your 1,000,000 Shares, you still own 1,000,000 / 1,333,333 = 75% of your company.
Now let’s say that all your SAFE were on a post-money cap basis. here is the calculation…
First SAFE : 500k/5M = 10%
Second SAFE : 1000k/10M = 10%
Third SAFE : 2000k/20M = 10%
You agreed to give 10% each time, which in shares equal to : 1,000,000/(1-30%) - 1,000,000 = 428,571 new shares created ! You own 1,000,000 / 1,428,571 = 70% of your company.
If you only had one safe, you wouldn’t feel the difference because it would have been 1,000,000 + 111,111 = 1,111,111 in one case and 1,000,000/(1-10%) = 1,111,111 in the other. But if like some companies, you don’t realize that consecutive post-money cap SAFE aren’t equal to consecutive pre-money cap SAFE, even with the same numbers… Well, after raising your round of 8M for 20% dilution with this great fund, in one case you still own 60% , while in the other… 56% !
It is not rare that a company raises a SAFE before going to YC, then sign the YC deal and then sign again one or two other SAFE after that. And it’s often the case as well without going through YC. In any case, run your simulation (Carta has built a great tool: https://safes.carta.com/) before you sign too many SAFE consecutively…