Post Money SAFE — Math Problems
We just had another YC Demo Day and as it turns out our founders and venture capital clients needed help with the new post-money simple agreement for future equity (“SAFE”). The following are some key changes introduced in the new Post-Money SAFE as compared to the older Pre-Money SAFE form. Apology for the back to school approach with the math. We try to keep it simple.
Post Money Valuation Cap
The Pre-Money SAFEs convert at pre-money valuation. Such conversion makes it difficult to measure how much equity in the company is being sold in a preferred stock financing. This is because the percentage being sold in the financing is dependent on how many other SAFEs are converting in the round as well as the size of the option pool increase in connection with the financing round. This means the ownership and dilution values are more of an informed estimation, rather than a sure calculation.
The new Post-Money SAFEs use “post-money” valuation cap instead of pre-money cap. For purposes of the SAFE, the post-money cap is “post” the amount of other SAFEs, but prior to the valuation of the company immediately after the preferred stock financing round. The result is that simply dividing the investment amount by the post-money valuation cap provides founders and investors alike with the exact percentage of the company represented by a SAFE immediately prior to the closing of a priced equity round.
For example, a $1,000,000 SAFE with a $10,000,000 post-money valuation cap represents 10% of a company immediately prior to a preferred stock financing (i.e., $1,000,000 divided by $10,000,000). If a founder owned 100% of the company prior to issuing the SAFE, that founder now owns 90%. If a second SAFE is issued to another investor for $600,000 at a $15,000,000 post-money valuation cap, the new investor knows that its SAFE represents 4% of the company (i.e., $600,000 divided by $15,000,000), the first SAFE still represents 10% of the company, and the founder’s share has been diluted to 86%.
Thus, the significant impact of using Post-Money SAFEs is that the SAFEs no longer dilute each other. The founders bear the burden of dilution, but other SAFE holders do not. However, as mentioned earlier the Post-Money SAFE ownership is post all other SAFEs, but not post-Series A. Thus, the SAFEs are like their own round, and they get diluted by Series A and any option pool increase in connection with such equity financing. Further, Post-Money SAFEs make things easier as the post-equity financing option pool is no longer factored into the pre-money calculations, since the amount of the option pool increase is typically unknown at the time SAFEs are issued.
Conversion Calculation
Pre-Money and Post-Money SAFEs also differ in the way in which the conversion share price (“SAFE Price”) for the SAFEs is calculated.
In case of Pre-Money SAFEs, the SAFE price is calculated by dividing pre-money valuation cap by pre-money safe company capitalization. Furthermore, for calculation purposes the pre-money safe company capitalization includes outstanding shares of capital stock, outstanding options, promised options, unissued option pool and option pool increase. Thus, the Pre-Money SAFE calculation does not take into account SAFEs, convertible notes and other similar convertible securities, but takes into account the option pool increase. This leads to more uncertainty in calculation and dilution by other SAFE and convertible security holders.
On the other hand, the SAFE price for Post-Money SAFEs is calculated by dividing post-money valuation cap by post-money safe company capitalization. The post-money safe company capitalization here includes outstanding shares of capital stock, outstanding options, promised options, unissued option pool, and SAFEs, convertible notes and other similar convertible securities. Thus, the Post-Money SAFE calculation accounts for the conversions of all SAFEs, convertible notes and other similar convertible securities and specifically excludes the option pool increase. This gives more certainty in calculation and protection from dilution from other convertible security holders.
Example 1: Post-Money SAFE
Now, let us consider the following scenario to better understand how Post-Money SAFE conversions will play out in case of equity financing.
XYZ, Inc. (the “Company”) raised $1,260,000 from two investors. Investor A purchased a $260,000 safe at a $5,200,000 post money valuation cap and Investor B purchased an $1,000,000 safe at a $20,000,000 post-money valuation cap.
Estimated Dilution
At this point, the Company has sold a minimum of 10% to investors.
Investor A: 260000/5200000 = 5%
Investor B: 1000000/20000000 = 5%
Equity Financing
The Company signed a Series A term sheet to raise $10,000,000 at a pre-money valuation of $40,000,000 (which pre-money valuation includes (i) an ungranted and unallocated employee option pool representing 10% of the fully-diluted post-closing capitalization and (ii) all shares of Company capital stock issued in respect of outstanding safes and/or convertible promissory notes), resulting in a post-money valuation of $50,000,000. Investor C, the lead investor, will be investing $5m for 10% post-closing fully diluted ownership.
Pre-money valuation: $40,000,000
Target available option pool: 10%
Total raise (new cash): $10,000,000
Option pool increase: 14,445 shares
Post-money valuation: $50,000,000
Series A price per share: $307.30
Cap Table Prior to SAFE Conversion and Financing
Post-Money SAFE Conversions:
SAFE price i.e. price per share = post money valuation cap/post-money safe company capitalization
Post-money safe company capitalization = capital stock issued and outstanding + issued, outstanding, and promised options + unissued options pool + converting securities
= 80,000 + 10,000 + 10,000 + (post-money safe company capitalization * 10%)
= 100,000/ (100% — 10%)
= 111,111
(a) Investor A:
SAFE price = 5200000/111111 = $46.80
Shares = SAFE purchase amount/SAFE price = 260000/46.80 = 5,556 (Rounded)
(b) Investor B
SAFE price = 20000000/111111 = $180
Shares = SAFE purchase amount/SAFE price = 1000000/180 = 5,556 (Rounded)
Cap Table after Post-Money SAFE Conversion
Series A:
The Company is raising $10m at a pre-money valuation of $40m. The Series A price per share is calculated as follows.
Series A Price per Share = pre-money valuation / (total fully diluted shares post safe conversion + option pool increase) = 40000000/(111,112 + 4445) = $346.15
The Company will sell 28,890 shares of Series A Preferred Stock ($10,000,000 divided by the Series A price per share of $346.15). Investor C, the lead investor, will purchase 14,445 shares ($5,000,000 divided by $346.15).
Cap Table Post Series A:
Example 2: Pre-Money SAFE
Now let us consider in the above scenario instead of purchasing Post-Money SAFEs in the Company, Investor A purchased a $260,000 safe at a $4,940,000 pre-money valuation cap and Investor B purchased an $1,000,000 safe at a $19,000,000 pre-money valuation cap.
Estimated Dilution
At this point, the estimated dilution of the Company will be the same as in case of Post-Money SAFEs i.e. 10%.
Investor A: 260000/ (260000+4940000) = 5%
Investor B: 1000000/ (1000000+19000000) = 5%
Equity Financing
The Company plans Series A on the same terms as above. That would give us:
Pre-money valuation: $40,000,000
Target available option pool: 10%
Total raise (new cash): $10,000,000
Option pool increase: 14,427 shares
Post-money valuation: $50,000,000
Series A price per share: $346.56
You will notice that the option pool increase and Series A price per share differs from that in Example 1. This is due to the difference in the way in which Pre-Money SAFEs convert (as shown below).
Pre-Money SAFE Conversion
SAFE price i.e. price per share = pre money valuation cap/pre-money safe company capitalization
Pre-money safe company capitalization = capital stock issued and outstanding + issued, outstanding, and promised options + unissued options pool + option pool increase
= 80,000 + 10,000 + 10,000 + 4,427
= 104,427
(a) Investor A:
SAFE price = 4940000 /104,427 = $47.31
Shares = SAFE purchase amount/SAFE price = 260000/47.31 = 5,496 (Rounded)
(b) Investor B
SAFE price = 19000000/104,427 = $181.94
Shares = SAFE purchase amount/SAFE price = 1000000/180 = 5,496 (Rounded)
Cap Table after Pre-Money SAFE Conversion
Conclusion
As seen from the examples above, even though the Company’s estimated dilution for Post-Money SAFEs and Pre-Money SAFEs were the same i.e. 5% each, on conversion only the Post-Money SAFEs actually delivered the fully diluted ownership of 5% to each SAFE holder. The Pre-Money SAFEs diluted each other and the result was that each SAFE holder ended up with 4.95% fully diluted ownership instead of 5%, and with the addition of more SAFE holders the dilution would have increased. Thus, Post-Money SAFEs give more certainty to investors regarding their ownership in the company than Pre-Money SAFEs.
