Concepts to Understand for SAFEs

Priced Round

A "priced round" is a capital raising initiative by a company where the company:

• issues shares; and
• sells them to investors for a specified price.

The first priced round conducted by a startup is often the 'Series A' round.

Pre-Money Valuation

A "pre-money valuation" of a company is the valuation of a company immediately prior to the Priced Round.

For example, if a company had 2,000 shares issued, and then had a Priced Round in which an additional 500 shares were sold to investors for $1,000 each, the pre-money valuation would be the 2,000 initial shares at $1,000 each, for a total valuation of $2,000,000.

SAFEs usually use a pre-money valuation (but don't confuse that with a "Pre-Money SAFE").

Post-Money Valuation

A "post-money valuation" of a company is the valuation of a company immediately after the Priced Round.

For example, if a company had 2,000 shares issued, and then had a Priced Round in which an additional 500 shares were sold to investors for $1,000 each, the Post-Money Valuation would be the 2,500 total shares at $1,000 each, for a total valuation of $2,500,000.

The only difference between a Post-Money Valuation and a Pre-Money Valuation is the amount of capital invested in the Priced Round.

SAFE

"SAFE" stands for "Simple Agreement for Future Equity".

It's an agreement where an investor provides money to a startup in exchange for equity at some point in the future. Usually, the money converts to equity when a Priced Round occurs.

Startups use SAFEs when they want to avoid the complexities around valuation and investor co-ordination that comes with a Priced Round.

How SAFE conversion works

SAFEs convert when a Priced Round occurs, at a price determined by the price of the Priced Round.

To give an unusually simple example:

Alice invests under a SAFE and the SAFE specifies:

• Alice is investing $50,000; and
• the SAFE converts at the exact price of the Priced Round.

A Priced Round then occurs. The Priced Round investors purchase shares at a price of $50 per share.

Alice's investment converts to shares at this price. Alice receives 1000 shares ($50,000 investment / $50 per share).

SAFE Valuation Caps and Discount Rates

To give early investors a commercial incentive to invest, SAFEs usually specify:

• that the investors money will convert to some minimum percentage of the company (Valuation Cap); and / or
• that the investor's money will convert to equity at a better rate than later investors (Discount Rate).

Let's consider a simple example.

A company is created. There are 900 shares owned by the founders. Alice invests in the company via a SAFE.

The SAFE specifies that:

• Alice is investing $50,000;
• the Valuation Cap placed on the company is $500,000; and
• the Discount Rate is 0.85.

A Priced Round occurs. The Priced Round investors purchase 1,000 shares at a price of $600 per share. This is equivalent to a Pre-Money Valuation of $540,000 (900 shares * $600 per share).

Discount Rate Method

Applying the Discount Rate results in a price of $510 per share ($600 * 0.85). This would mean Alice would be entitled to 98 shares ($50,000 / $510).

Valuation Cap Method

The amount of $540,000 is higher than the Valuation Cap, so Alice's money converts to equity at the price determined by the Valuation Cap.

$50,000 is 10% of the $500,000 Valuation Cap, so Alice is entitled to 10% of the company prior to the Priced Round. This equates to Alice being issued 100 Shares.

Final Result

SAFEs are drafted so that, when there are multiple ways to calculate the shares, the one that provides the investor with more shares applies.

In this case, the Valuation Cap method gives Alice more shares, so that's the calculation method that applies and Alice is issued with 100 shares.

Fully Diluted Share Capital (SAFE)

The "fully diluted share capital" of a company is a calculation that results in a number of shares counting:

• the actual number of issued shares; and
• current rights to shares held as if exercised (to get shares).

Depending on the terms of the SAFE this can include:

• employee share options;
• other SAFEs;
• convertible notes; and
• other convertible instruments.

SAFEs use this concept to calculate the number of shares that a SAFE investor is entitled to.

Let's consider a simple example.

A company has 1,000 shares issued to the founders. They have granted an employee an option to purchase 100 shares.

In this case, the fully diluted share capital is 1,100 shares, even though the options haven't been exercised yet.

Valuation Cap (SAFE)

Money invested via a SAFE usually converts to equity when a Priced Round occurs.

It doesn't make sense for the money to convert at the same price that the investors in the Priced Round pay because the SAFE investors invested earlier with more risk. Consequently, SAFE investors expect to get a better price per share.

The most common way of handling this is to specify a maximum company "valuation cap". This is equivalent to specifying a minimum percentage ownership for the SAFE investor.

For example, if Alice invested $20,000 in a company under a SAFE that specified a Valuation Cap of $1,000,000, Alice would be entitled to a minimum of 2% of the Fully Diluted Share Capital of the company, prior to the Priced Round.

If taking the price per share from the Priced Round would have resulted in a better deal for Alice, she'd get that many shares instead.

Discount Rate (SAFE)

The other common way for SAFE investors to have a commercial edge over later investors is for the SAFE to specify a "discount rate" on the price that occurs during a Priced Round.

For example, if Alice invested $20,000 in a company under a SAFE that specified a Discount Rate of 0.9, and the price from the Priced Round was $100 per share, Alice's money would convert to equity at 0.9 * $100 = $90 per share.

Alice would be entitled to 222.22 shares ($20,000 divided by $90).

Pre-Money SAFE

A "pre-money SAFE" is one where an investor's money converts to equity without taking other SAFEs and convertible notes into account.

That is, the SAFE converts to equity pre other convertible instruments. This means that the SAFEs dilute each other. This is better for the existing shareholders commercially.

Let's consider a simple example.

A company is created. There are 1,000 shares on issue to the founders. Two investors invest via SAFEs:

• Alice for $80,000; and
• Bob for $100,000.

They're both similar SAFEs with a Valuation Cap of $800,000.

A Priced Round occurs. The Priced Round investors purchase a total of 1000 shares for $1,000,000.

• The Priced Round investors paid $1,000 per share.
• The Fully Diluted Share Capital of the company is the 1,000 shares that existed prior to the Priced Round.

Valuation Cap calculation

• The Valuation Cap divided by the Fully Diluted Share Capital leads to a price of $800 per share.
• Alice would be entitled to 100 shares ($80,000 invested / $80 per share).
• Bob would be entitled to 125 shares ($100,000 invested / $80 per share).

As a pre-money calculation, the shares issued to Alice and Bob and not added to the total 1,000 shares for the purposes of calculating the Fully Diluted Share Capital.

Final Result

The final cap table for the company is:

Post-Money SAFE

A "post-money SAFE" is one where an investor's money converts to equity while taking other SAFEs and convertible notes into account.

That is, the SAFE converts to equity post other convertible instruments. This means that SAFEs don't dilute each other. This is worse for the existing shareholders commercially.

Let's consider a simple example.

A company is created. There are 1,000 Shares on issue to the founders. Two investors invest via SAFEs:

• Alice for $80,000; and
• Bob for $100,000.

They're both similar SAFEs with a Valuation Cap of $800,000

The Fully Diluted Share Capital of the company is the:

• 1,000 shares that existed prior to Priced Round; PLUS
• shares from the SAFEs / convertible notes.

Valuation Cap calculation

In the case of a Post-Money SAFE, it's simplest to think of the Valuation Cap method as a way for an investor to get a minimum percentage of the company immediately prior to the Priced Round (SAFE investors are then diluted by the priced round).

Bob invested $100,000 with a Valuation Cap of $800,000. His investment was 12.5% of the Valuation Cap, so he's entitled to own 12.5% of the company shares (immediately prior to the Priced Round).

Similarly, Alice is entitled to own 10% of the company shares.

The effect of the post money calculation is that the percentages that the investors get in shares subtracts directly from the percentages held by existing shareholders (100% - 12.5% - 10%).

The remaining 77.5% of the shares are the founders' 1,000 shares. This means that 1% of the company is 12.90 shares.

So:

• Alice is entitled to 129.03 shares;
• Bob is entitled to 161.29 shares.

Final Result

With the Valuation Cap method, the final cap table for the company is:

Why do Alice and Bob have less than the 10% and 12.5%? Because those percentages were calculated before the Priced Round Investors diluted them.