Quick Start Guide: Understanding Safe Post-Money Valuations

QUICK START GUIDE

The biggest advantage of the post-money safe is that the amount of ownership sold is immediately transparent and calculable for both the founder and the investor. This Quick Start Guide will show how to take advantage of this structure for the most common use cases. For an in-depth discussion of the structure and features of the safe generally, please review the rest of the Post-Money User Guide that follows. If you are an investor, we also recommend reviewing the "What if I'm an investor?" subsection in the Post-Money User Guide.

Note: in the examples below, if the valuation in the round in which the safe converts is less than the Post-Money Valuation Cap or too close to the Post-Money Valuation Cap, the safes may convert into more than the estimated ownership. Please see the Q&A section in the User Guide.

1. Raising money with a Post-Money Valuation Cap and calculating ownership sold

   A founder is targeting a $1 million raise and 15% ownership sold.

   • Post-Money Valuation Cap is $6.7 million ($1 million / 15% =~ $6.7 million).
   • "I'm targeting $1 million at $6.7 million post / $5.7 million pre. Post-money cap is $6.7 million."

   . If the founder raises ...

   • $500k, then the ownership sold would be 0.5/6.7 =~ 7.5%

   • $800k, then the ownership sold would be 0.8/6.7 =~ 12%

   • $1 million, then the ownership sold would be 1/6.7 =~ 15%

2. Raising money with multiple Post-Money Valuation Caps and calculating ownership sold

   A founder is targeting a $1 million raise and 15% ownership sold.

   • Post-Money Valuation Cap #1 is $5.5 million.

   . Post-Money Valuation Cap #2 is $8.3 million.

   • If the founder raises $500k on each cap, then she will have sold ~15%

     • $500k / $5.5 million =~ 9%

     • $500k / $8.3 million =~ 6%

3. Estimating the future dilutive impact of pro rata rights provided in the optional side letter

   The pro rata right entitles the safe holders to subscribe for a percentage of the total round equivalent to their as- converted ownership (e.g. 15% if they invested $750k at a $5 million Post-Money Valuation Cap). You can therefore backsolve dilution based on an assumption of how much the new investors in the Equity Financing will demand. That formula is just the following:

   Safe Pro Rata Allocation % = Series A New Investors % Series A New Investors %

   Example:

   (100% - Safes with Pro Rata %) Safe fund raise

   • Company sold 15% of the Company pre-Series A in safes by raising $750k at a $5 million Post-Money Valuation Cap
   • Company gave every safe investor a pro rata side letter
   • Company issues 8% of the Company pre-Series A in options to people hired between the safes and the Series ASeries A assumptions
   • Lead investor and other new investors will own 25% post-Series A, not including the safe investors pro rata
   • Option pool increase that creates a 10% unissued and available option pool post-Series A

   Estimated dilutive impact post-Series A:

   Safe Pro Rata Allocation %: 25% / (100% - 15%) - 25% = 4.41%

   Series A New Investors + Safes with pro rata: 25% + 4.41% = 29.41%

   Series A dilution: 29.41% investments + 10% option pool = 39.41%

   Adding it all up: Safe dilution: 15% * (100% - 39.41%) = 9.09%

   Options dilution: 8% * (100% - 9.09% - 39.41%) = 4.12%

   Series A dilution: 39.41%

   Total: 52.62%

   Note #1: the 8% in options issued between the safes and the Series A are diluted by the safes and the Series A terms.

   Note #2: the safe ownership is post-safes. It is not post-Series A. The safes are like their own round, which means they are diluted by the Series A (just like everyone else).

POST-MONEY SAFE USER GUIDE

In this User Guide, the post-money safe is referred to as the "post-money safe," "Standard Safe" or simply "safe." The original version of the safe replaced by the post-money safe is referred to exclusively as the "original safe."

In late 2013, Y Combinator introduced the original safe, or the Simple Agreement for Future Equity. At the time of introduction, startups and investors were primarily using convertible notes for early stage fundraising. The original safe was intended to be a replacement for convertible notes, and it has generally been successful in doing so.

In 2018, more than four years after introducing the safe, we decided it was time for the original safe to evolve. The most significant change was that it became a post-money convertible security, as explained in detail below. This change was aresponse to a shift we observed in the way that early stage companies raise money from investors, which is to treat safe- based financings as independent seed rounds capable of providing multi-year runways, rather than shorter-term bridges to priced preferred stock rounds.

In the post-money safe, we removed the pro rata right that existed as a default option in the original safe. That pro rata right applied to the financing after the round in which the original safe converted (e.g. if the original safe converted in the Series A, the pro rata right applied to the Series B). Instead, we created a standard side letter with pro rata rights that apply to the round in which the safe converts (e.g. if the safe converts in the Series A, the pro rata right applies to the Series A), which can be used if and when the parties agree to it. Although our original goal was to create a universal standard for pro rata rights for all start-up companies, our experience was that we couldn't do this in a way that made sense for all parties. For example, a company raising $500,000 from 10 angels investing $50,000 often has significantly different considerations than one raising $2,000,000 from a single institutional investor. Also, the pro rata rights contained in the original safe were often misunderstood by both founders and investors as applying to the round in which the original safe converted (the Series A), rather than the round after the one in which the original safe converted (the Series B). So the standard pro rata side letter is an acknowledgment that this right is best handled case by case, and thatthe prior form of the right often wasn't what founders and investors were expecting.

A list of other changes that have been incorporated into the post-money safe can be found in Appendix III. Most importantly, the post-money safe is still a simple, standardized document, it retains the benefits of certaintyand speed, and it continues to require little to no transaction costs for companies and investors.

Following the format of the original safe primer, this User Guide describes why, when and how to use the post-money safe.

The information below applies specifically to a safe with a Post-Money Valuation Cap. Other versions of the safe are described in Appendix I.

What do we mean by "post-money" safe

There are two important aspects to what we mean by "post-money" in the post-money safe:

1. The valuation cap in the safe is stated in terms of a post-money valuation (in contrast, the valuation cap in the original safe was based on a pre-money valuation). A post-money valuation and a pre-money valuation are just two different ways of framing the same valuation of the company, but at different points in time. A pre-money valuation is the valuation of the company immediately before the company receives the investment in the financing in question. A post-money valuation is just the valuation immediately after the investment is made. For example, if a company is raising $2 million at a $10 million pre-money valuation, generally that's the same as saying that it is raising $2 million at a $12 million post-money valuation."
2. Safe conversion shares are calculated on a "post" money basis, specifically:

   • The Post-Money Valuation Cap is "post" all of the safe money. It is NOT also "post" the Equity Financing (e.g. Series A) money. As mentioned above, we believe the market evolved to raising independent financing rounds using original (pre-money) safes. So it would be inconsistent for the post- 3money safes to have their post-money valuation calculated to include money raised in the Equity Financing round. Doing that, in some cases, would even result in the sum of the money raised on safes and in the Equity Financing exceeding the Post-Money Valuation Cap of the safes, which would be an absurd outcome (see the Q&A section for more on this topic). The result is that while the safes are not diluted by each other, the safes will be diluted by the new money raised in the Equity Financing.

   • The Post-Money Valuation Cap is "post" the Options and option pool existing prior to the Equity Financing. It is NOT also "post" the new or increased option pool adopted as part of the Equity Financing (e.g. Series A). Again, this is consistent with treating the safes as an independent fundraise from the Series A in which they convert (assuming the Series A is the Equity Financing converting the safes). The option pool that is created or increased as part of the Series A is intended to provide equity for the people hired after the Series A, with the money raised in the Series A. This means that the safes are not diluted by the Options granted or the pool created following the safe fundraise but prior to the Series A, which makes sense because that's the hiring pool enabled by the safe money. But the safes are diluted by the new or increased option pool adopted as part of the Series A, because otherwise, the safes would be forcing the founders to bear all of the dilution for two rounds of hiring rather than one, despite only providing enough capital for one round of hiring.

Why use the safe for early stage fundraising

The reasons to use the safe for early stage fundraising haven't changed. Founders can close with an investor as soon as both parties are ready to sign and the investor is ready to wire money, instead of trying to coordinate a single close with all investors simultaneously. And as a flexible, one-document security without numerous terms to negotiate, safes save startups and investors money in legal fees and reduce the time spent negotiating the terms of the investment. Founders and investors will usually only have to negotiate one item: the valuation cap. Because a safe has no expiration or maturity date, there will be no time or money spent dealing with extending maturity dates, revising interest rates or the like.

But the more important question for users of the original safe is, why use the post-money safe? Because the post-money safe isthe best way for both companies and investors to understand ownership. The original safe was standardized on a pre- money basis and inclusive of the Series A option pool increase, which made it difficult for founders to calculate precisely how they were being diluted when raising money. The answer to "how much of the company are we selling?" was dependent on a recursive loop of how much was raised on other original safes, plus a hypothetical assumption about theSeries A option pool increase that would be negotiated years later.

These unknowable elements meant that founders had a hard time planning out their fundraise so that they could sell an intended and expected portion of their company. Founders might intend to sell around x% of their company. But they didn't have the best tools to accomplish this goal, which meant that they often ended up selling a lot more than they really wanted to, when they didn't have to. The post-money safe should now help founders better align their intentions with 1 The exception is when there is a negotiated agreement, usually in a priced round context, that the pre-money valuation will not actually include safes or notes converting in the round, or portions of the option pool. For example, if the company is raising a $10 million Series A at $40 million pre-money, but the parties agree that $1 million in outstanding safes converting at a $10 million Post-Money Valuation Cap will not be in the pre-money, then the Series A new money is not getting 20% ownership (10/(10+40) = 20%), it will be getting a little bit less because it will be diluted by the $1 million in safes. Thus in this footnote example, the effective post-money valuation will be greater than $50 million.

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