1. Introduction
In the dynamic landscape of startup financing, the Simple Agreement for Future Equity (“SAFE”) has emerged as a versatile and transparent instrument. Tailored for the unique needs of startups, the SAFE provides a straightforward framework for investment, ownership calculation, dilution management, and other critical considerations.
This document aims to delve into the key components of the post-money SAFE structure, offering insights into its ownership calculation, handling of dilution and option pool considerations, treatment of pro rata rights, a comparative analysis with priced rounds, and provisions for proceeds in acquisitions. Understanding these aspects is vital for both founders and investors navigating the intricacies of early-stage funding.
2. Calculation of Ownership for Investors
In the post-money safe, the ownership for investors is calculated based on the amount they invest and the post-money valuation cap. The ownership calculation is transparent and immediate, providing clarity for both the founder and the investor.
Here are a couple of examples to illustrate the ownership calculation process:
Example 1: A founder is targeting a $1 million raise and wants to sell 20% ownership.
- The post-money valuation cap is $5 million.
- If the founder raises 500k, the ownership sold would be 500k / $5 million = 10%.
- If the founder raises 800k, the ownership sold would be 800k / $5 million = 16%.
- If the founder raises 1 million, the ownership sold would be 1 million / $5 million = 20%.
Example 2: A founder is raising money with multiple post-money valuation caps.
- Post-Money Valuation Cap #1 is $5 million.
- Post-Money Valuation Cap #2 is $10 million.
- If the founder raises $500k on each cap, the ownership sold would be:
– 500k / 5 million = 10% for Post-Money Valuation Cap #1.
– 500k / 10 million = 5% for Post-Money Valuation Cap #2.
These examples demonstrate how the ownership sold is directly tied to the amount invested and the post-money valuation cap negotiated between the investor and the company.
3. Dilution and Option Pool Considerations
In the post-money safe structure, dilution and option pool considerations play a significant role. Let’s dive into the details and provide examples to help understand these concepts.
Dilution:
(i) Dilution by Equity Financing: In the post-money safe structure, the safes are not diluted by each other. However, they will be diluted by the new money raised in the Equity Financing round. This means that the ownership percentage of the safes will decrease when new funds are raised.
(ii) Dilution by Option Pool: The safes are not diluted by the options granted or the option pool created before the Equity Financing round. The option pool created or increased as part of the Equity Financing (e.g., Series A) is intended to provide equity for new hires after the Equity Financing. However, the safes are diluted by the new or increased option pool adopted as part of the Equity Financing. Therefore, the size of the option pool and any increase in the option pool during the Equity Financing will affect the ownership outcomes.
Example:
- A startup raises $1 million from two safe investors, A and B, using a post-money valuation capped safe with a $10 million cap. This means that each investor will receive 5% of the company upon conversion.
- The startup also issues 10% of the company in employee options, which are subject to vesting and dilution.
- The startup then raises a Series A round of $5 million from a new investor, C, at a $20 million pre-money valuation. This means that C will receive 20% of the company after the conversion of the safes and the option pool increase.
- The startup also increases the option pool by 10% to accommodate future hires.
The cap table in different steps of the transaction will be as shown below:
|
Before the Conversion of the Safe |
After the Conversion
of the Safe |
After the Closing
of Series A |
|
| Founders |
90% |
81% | 56,7% |
| Outstanding Options |
10% |
9% |
6,3% |
| Safe Investor-A |
(No stock ownership before the conversion, the safe gives the investor a right to receive equity.) |
5% | 3,5% |
|
Safe Investor-B |
5% |
3,5% |
|
| Investor C |
– |
– | 20% |
|
Option Pool Increase |
– | – |
10% |
|
Total |
100 % | 100% |
100% |
4. Handling of Pro Rata Rights in the Post-Money Safe
A pro rata right is the right of an investor to maintain their ownership percentage in a company by participating in future financing rounds. In the context of the Post-Money Safe, the pro rata right refers to the right of safe holders to participate in the Equity Financing round (typically the Series A round) in which the safe converts into preferred stock.
In the Post-Money Safe, pro rata rights are not automatically included. A standard pro rata side letter was created that applies to the round in which the safe converts. However, the inclusion of pro rata rights is not a universal standard and depends on the specific circumstances of each company.
For example, if a company raises $500k from 10 angel investor from 50,000 each, their considerations for pro rata rights may be different from a company raising $2,000,000 from a single institutional investor. The pro rata side letter allows for a case-by-case approach in determining the appropriate pro rata rights.
In summary, pro rata rights are not automatically included in the Post-Money Safe and are handled through a separate side letter that applies to the round in which the safe converts. The specific terms of the pro rata rights depend on the agreement between the parties involved.
5. Comparison with Priced Rounds
The post-money safe structure and priced rounds are two different approaches to fundraising, each with its own advantages and considerations. Here is a comparison between the two:
(i) Valuation: In a priced round, the company and investors agree on a specific valuation for the company, both pre-money (before the investment) and post-money (after the investment). This valuation is used to determine the ownership percentage that the investors will receive in exchange for their investment. In contrast, the post-money safe uses a valuation cap to determine the conversion price of the safes into equity. The valuation cap sets a maximum price at which the safes will convert, ensuring that investors are protected from excessive dilution.
(ii) Ownership Calculation: In a priced round, the ownership percentage for each investor is straightforward to calculate based on the agreed-upon valuation. The post-money safe addresses this issue by providing an agreed valuation cap. The valuation cap provides transparency and certainty in the ownership calculation, it gives both investor and the founders of the company an accurate understanding regarding the company’s shareholding structure.
(iii) Dilution: In a priced round, the new investors’ ownership percentage remains fixed unless there is subsequent dilution through the issuance of additional shares. With the post-money safe, the dilution comes from the new money raised in the equity financing round. This ensures that the safes are not diluted by each other but are still subject to dilution by the new investment.
(iv) Option Pool: In a priced round, an option pool is typically established without diluting the seed investors. This pool is used to grant equity to employees hired after the funding round. The post-money safe is regarded as separate financing round and thus the safe investor is not diluted by the granted options and outstanding option pool created before the equity financing round. However, the safe investor will be subject to dilution caused by the option pool increase in the equity financing round.
(v) Ease and Speed: The post-money safe offers advantages in terms of speed, cost, and simplicity compared to a priced round. The negotiation process is streamlined, and the valuation cap provides clarity on the investor’s ownership stake. Priced rounds, on the other hand, may involve more complex negotiations regarding various rights attached to the investment, such as board seats or investor veto rights.
Overall, the post-money safe structure offers speed, cost savings, certainty, transparency, and flexibility, making it an attractive option for early-stage fundraising.
6. Provisions for Proceeds in Acquisitions
The post-money safe structure includes provisions for the distribution of proceeds in acquisitions. According to the post-money safe, the holder has the option to receive value that is the greater of (1) 1x their investment back in cash or other forms of consideration, or (2) the amount payable on the as-converted ownership of the safe. This is determined by the defined term “Proceeds,” which covers all proceeds payouts from the acquisition, whether in the form of stock or cash. The safe holder will receive the portion of Proceeds that is the greater of their investment amount or what would be payable on the as-converted ownership of the safe.
In some acquisitions where the proceeds consist of a mix of cash and stock, recipients of proceeds are given a choice of receiving all cash, a mix of cash and stock, or all stock. The post-money safe specifies that if other company security holders are given this choice, the safe holders will also be treated the same way and given that choice, subject to legal restrictions and constraints. However, if the acquirer mandates a particular cash/stock split and does not provide a choice, then the safe holders would be bound by the terms of the acquisition.
7. Conclusion
In conclusion, the post-money SAFE stands as a pragmatic and efficient financing instrument for startups, offering a balance between simplicity and robustness. The ownership calculation clarity, diligent handling of dilution and option pool dynamics, flexibility in pro rata rights, and provisions for acquisitions make it a compelling choice for emerging businesses. In contrast to traditional priced rounds, the post-money SAFE streamlines the negotiation process, providing founders and investors with a transparent and expeditious means of securing funding. As the entrepreneurial ecosystem evolves, the post-money SAFE remains a valuable tool, fostering collaboration and growth in the dynamic world of startup financing.
The assessments contained in this document do not constitute legal advice or opinions, and Gül & Malkoç cannot be held responsible in any way for these assessments. It is advisable to seek legal counsel for any questions or issues within the scope of this information note.
