Guide to Pre-Money vs Post-Money SAFE
This article will give you a detailed idea of pre-money SAFE, post-money SAFE and the pre-money vs post-money SAFE investor’s perspective.
Let’s say you’re a venture capitalist looking to put some money into a new software company. Although this startup shows great potential, it is lacking in some key areas. The firm can’t offer stock to investors since it doesn’t yet have any. There is a lack of capital on the part of the company’s founders to cover the transaction fees of a legally complicated fundraising agreement. What is the next step to take? Fortunately, there exists a specialized contract designed precisely for this objective – A SAFE.
When compared to issuing shares, the paperwork and negotiation involved in a SAFE (Simple Agreement for Future Equity) are typically much lower. Still, many startup founders find it difficult to wrap their heads around SAFEs, particularly the distinctions between SAFEs established before (Pre-money) and after (Post- money) funding. This article will give you a detailed idea of pre-money SAFE, post-money SAFE, and most importantly, the pre-money vs post-money SAFE investor’s perspective.
Pre-money SAFE vs Post money SAFE
With a SAFE, an investor may fund a startup in return for potential stock in the company at a later date. The process is as straightforward as its name suggests. Money invested does not accrue interest or have a set repayment schedule but rather becomes equity in the company at the time of the next fundraising round. This might be a win-win situation for the startup’s creator and the investor since there is nothing in the way of paperwork or intensive legal representation. Yet, there’s a lot that you must know about pre-money SAFE and post Money SAFE, which we will discuss in this section.
The term “Simple Agreement for Future Equity” refers to a contract between a seed-stage business and an investor. Unfortunately for the investor, the business does not yet have an official value and hence no shares to offer. By acting as an agreement to exchange current payments for future stock, a SAFE sidesteps this problem. SAFEs are sometimes referred to as “convertible securities” because they allow investors to convert their cash into equity at a future date.
Typically, SAFEs stipulate that the investor will receive the securities in the following priced financing round. In most cases, the value of the firm at the moment determines the investor’s share allocation. However, if the SAFE includes a valuation cap, that limits how much the shares may be worth when determining the conversion price, the price at which the claims can be purchased with the SAFE may change.
What is pre-money SAFE?
A Pre-money SAFE is a convertible security agreement that specifies the terms under which a convertible security held by an investor in a startup company will be converted into equity. Pre-money SAFEs were developed by Y Combinator to make early-stage company financing easier. When there are only a small number of SAFE investors (which includes the founders), each additional SAFE holder dilutes the original SAFE investors. There is a lot of ambiguity for investors and entrepreneurs as the ownership of each SAFE holder is not established until a fresh fundraising round takes place.
How does pre-money SAFE work?
Assume you are conducting a seed round of funding. You enter into pre-money SAFE agreements to receive funds from several investors. The lack of a formal valuation for your firm necessitates that you hold off on offering those investors any equity in the business.
You’re just promising your investors shares at some unspecified future time. The SAFE investments are often converted into shares when the company raises its first priced round (such as a Series A).
Benefits of pre-money SAFE
When compared to traditional equity investments, which typically involve lengthy contracts, extensive negotiations, and heavy involvement from lawyers, SAFEs quickly gained popularity as a means of raising capital for new businesses. However, there are other benefits to a Pre-money SAFE as the following:
- Simple and flexible – This type of SAFE agreement gives business owners a straightforward idea of how much their firm is worth in the future, which improves their chances of securing capital. Pre-money SAFE notes may still be utilized for low-dollar investments and when there is uncertainty about whether or not the company can raise capital in a priced-equity transaction.
- Efficient and cost-effective – Since the value of a share depends on the company’s valuation, the startup cannot currently issue shares to the investor. Your firm can hold off giving away shares, which is considered a cost-effective approach from the company’s perspective.
- Reduced dilution for founders – Due to the uncertainty of each investor’s ownership stake before the next funding round, pre-money SAFEs are less likely to create investor dilution. It confirms the company’s decision-making authority and the investors’ stake in it at every point in time.
- Attractive to investors – Pre-money SAFEs involve an investor providing funding to a company in return for equity in the company at a future period. Investors find it impressive as it offers a starting point for talks and a framework for settling on investment conditions.
- Reduced risk for both parties – It’s a less complicated option for initial funding than convertible notes, and it eliminates the need for interest payments and a set repayment schedule. It also improves deal legitimacy by guaranteeing that investors are paying a price that is commensurate with the worth of the firm.
Example of pre-money SAFE
Let’s take a look at a potential investor’s experience with a pre-money SAFE and how it may unfold:
- A seed round is a pre-money SAFE in which the investor contributes $1.5 million to an emerging firm. SAFEs are used by the company to attract further investors.
- This $1,500,000 is not converted into shares right away for the investor. Instead, the investor will be given a guarantee that, after the business gets its Series A funding, she would be given shares worth $1.5 million.
- The investor won’t know what percentage of the business she owns before Series A is completed. Keep in mind that there are other, similarly cautious investors out there. The investor won’t know how much of the business she owns until she converts her SAFEs into shares. She isn’t shocked by the ambiguity, but she is adjusting.
- An investor’s SAFE automatically becomes a share purchase at the start of Series A. By dividing the pre-money valuation cap by the firm capitalization, the conversion price for the investor’s pre-money SAFE shares may be determined.
- The investor finds out that her $1.5 million has turned into a 7% share in the firm, which has been formally valued at $25 million. In Series A, this stake could be reduced when new investors come on board.
What is post-money SAFE?
The post-money SAFE capitalization of a firm is the sum of the pre-conversion capitalization (shares held by founders and any shareholder on the cap table before the conversions) and the total number of shares issued upon conversion of SAFEs. The total number of convertible securities shares, including those issued as investments, are factored in the calculation of a post-money ceiling. This enables the SAFE investor to lock in their stock proportion relative to the pre-round shareholders.
Investors and founders benefit from post-money SAFE because they have a better idea of their relative ownership stakes in the company before the subsequent funding round that prompts the conversion.
How does post-money SAFE work?
This conversion is triggered by the SAFE round cap, not the equity round cap when all convertible securities are converted. The post-money SAFE capitalization of a firm is the sum of the pre-conversion capitalization (shares held by founders and any shareholder on the cap table before the conversions) and the total number of shares issued upon conversion of SAFEs. It is uncertain what proportion of the company the SAFE investors will ultimately hold when the current fundraising round is completed. They will, however, have greater assurance of ownership than they would with pre-money SAFEs.
Benefits of post-money SAFE
When utilizing a post-money SAFE, the capitalization of the company encompasses all the shares that have been issued upon the conversion of all the SAFEs. The post-money SAFE is often regarded as a superior option to the pre-money SAFE by numerous investors. Here are several advantages of this agreement.
- Clear valuation – When their SAFE vests in shares at the commencement of Series A, investors will own exactly that amount of the firm. There is a lot of transparency in this circumstance, which is excellent for investors.
- Reduced negotiation – There is less room for negotiating when it comes to ownership stakes when employing a post-money SAFE since you are setting fixed stakes for each investment.
- Attractive to investors – Investors prefer a post-money SAFE because it provides a higher level of confidence over a pre-money SAFE but still falls short of absolute certainty. With the SAFE note, both entrepreneurs and investors may conclude investments swiftly and with few complications.
- Reduced dilution for existing shareholders – The danger of early-stage dilution may be mitigated by the use of post-money SAFEs. It considers investments utilizing the post-money SAFE to serve as an independent “funding round”. Each investor providing funding for the round will have precise knowledge of their ownership percentages.
- Flexible terms – Post-money SAFEs are advantageous to startups and investors because they are flexible, one-document security systems that do not need the negotiation of various clauses.
Example of post-money SAFE
Let’s think about the possible outcomes of a SAFE once investors have received their money.
- A seed round involves an investor contributing $1.5 million to a firm in exchange for equity at a post-money SAFE value maximum of $25 million. Our investor has guaranteed a fixed 5% ownership position in the firm, regardless of the number of additional SAFE investors that join.
- This $1,500,000 is not converted into shares right away for the investor. No stock is issued at the moment of investment, as is the case with a pre-money SAFE.
- Investor’s SAFE is converted to 7% ownership in the company’s shares at the start of Series A. The investor’s ownership is not diluted by the conversion of other SAFEs.
- The investor’s 7% ownership is affected by the entry of new Series A investors. The situation of dilution is certain, no matter what you do. Everyone’s part of the company’s ownership is reduced to accommodate new investors.
Pre-money SAFE vs Post money SAFE investor’s perspective
Investors and founders in a pre-money SAFE don’t know how their ownership stake will stack up against that of other investors until the next funding round is complete. Investors prefer a post-money SAFE over a pre-money SAFE because it provides a higher level of assurance. And if your SAFE has a 10% value limit, they know exactly how much of the firm they’ll control when the shares convert.
Founders may also profit from post-money SAFEs. Sometimes it’s useful to know just how much of your business you’re giving up right now. It also facilitates easier, more open, and quicker negotiations with investors.
Key differences between pre-money SAFE and post-money SAFE
The consensus is that pre-money SAFEs benefit the firm, whereas post-money SAFEs benefit the investors. To prevent disputes regarding value down the line, many companies employ pre-money SAFEs when seeking funding from several investors. The negotiating process is typically streamlined by using a post-money SAFE when seeking financing from a single investor.
When using a pre-money SAFE, both founders and investors are required to wait to determine how their share of ownership percentage stacks up against that of other investors in a subsequent round. This is the primary distinction between SAFEs issued before and after the issuance of funds.
How to choose the right SAFE for your startup?
Investors may be enticed by the post-money SAFE, but it isn’t the optimal choice in every circumstance.
In all honesty, SAFE investors should benefit from knowing they have a fixed ownership position in the company before Series A investors come on board. A founder may be hesitant to award SAFEs with set ownership percentages since he or she would be on the hook for dilution from subsequent SAFE raises, which might be detrimental to the company’s long-term viability.
Dilution, conversely, may be affected by a wide variety of events, so a post-money SAFE can even turn out to be advantageous to a founder. After all, a founder would do well by understanding how much their ownership is being diluted with each SAFE they sell, rather than finding out the hard way.
Manage your cap table for shareholders with Eqvista!
Before agreeing to use a pre- or post-money SAFE with an investor, founders should be aware of the differences between the two. Depending on the founders’ preferred SAFE structure, they may need to revise the proposed valuation ceiling. Keeping tabs on your company’s shareholders requires diligent cap table monitoring. Eqvista’s cap table provides several options for handling your business’s information and stock distributions. For further information on our comprehensive cap table guide or the Eqvista cap table programs, please contact us right away!