1.Introduction to the Post-Money Safe
Raising capital is one of the most challenging and crucial tasks for any startup. Traditionally, startups have used instruments such as equity, debt, or convertible notes to obtain funding from investors. However, these instruments have some drawbacks and limitations, such as valuation complexity, legal costs, maturity dates, interest rates, etc. To address these issues, Ycombinator, a leading startup accelerator and seed fund, introduced a new and simple financing instrument called simple agreement for future equity (“SAFE”) in 2013 for early stage fundraising.
A safe is a contract between a startup and an investor, where the investor provides cash to the startup in exchange for the right to receive equity in the future, at a later round of financing or an exit event. Unlike a convertible note, a safe does not have a maturity date, an interest rate, or a debt obligation. It is simply a promise to issue equity in the future, based on certain triggers and terms.
The main motivation and benefit of using a safe is to simplify and expedite the fundraising process for early-stage startups. A safe allows startups to raise capital quickly and easily, without having to negotiate valuation or deal with complex legal documents.
The original safe (with pre-money valuation cap) was replaced by the post-money safe in 2018 to adapt to the changing fundraising landscape.
The post-money safe differs from the original safe in several ways. One significant change is that it is a post-money convertible security, meaning that it takes into account the valuation of the company after the investment is made, while a pre-money valuation is the valuation immediately before the investment. Additionally, other changes have been made to improve clarity and consistency.
The post-money safe retains the benefits of simplicity, standardization, and low transaction costs for both companies and investors. It allows startups to treat safe-based financings as independent seed rounds, providing multi-year runways instead of shorter-term bridges to preferred stock rounds.
2.Evolution from the Original Safe
In 2018, Y Combinator decided to evolve the original safe and introduced the post-money safe as a replacement. The most significant change in the post-money safe was that it became a post-money convertible security. This change was made in response to the way early stage companies were raising money from investors, treating safe-based financings as independent seed rounds capable of providing multi-year runways.
The post-money safe aimed to provide a better understanding of ownership for both companies and investors. The original safe was standardized on a pre-money basis, making it difficult for founders to calculate their exact dilution when raising money. The post-money safe, on the other hand, allowed for a more straightforward calculation of ownership, as it tracked how the safes would convert into stock.
3. Key Features of the Post-Money Safe
The key features of the post-money safe are as follows:
(i) Valuation Cap: This is the maximum valuation at which the safe will convert into equity. It is a way of rewarding early investors for taking more risk and providing a price protection in case of a high valuation in the future round. The valuation cap in the post-money safe is stated in terms of a post-money valuation, which is the valuation of the company immediately after the investment is made. This provides clarity and transparency to investors regarding the potential ownership they will have in the company.
(ii) Discount: This is the percentage discount that the safe investor will receive on the price per share of the future round. It is another way of rewarding early investors for taking more risk and providing a price advantage in case of a low valuation in the future round. For example, if an investor invests $100,000 in a safe with a 20% discount, and the startup raises a Series A round at a $1 per share price, the investor will receive equity at a $0.8 per share price.
(iii) MFN clause: This stands for most favored nation clause. It is a provision that gives the safe investor the right to amend the terms of the safe to match any better terms offered to other investors in the same or subsequent safes. For example, if an investor invests $100,000 in a safe with a $10 million valuation cap and a 20% discount, and the startup later issues another safe with a $5 million valuation cap and a 25% discount, the investor can choose to apply the lower cap and the higher discount to their safe.
(iv) Pro rata right: This is the right of the safe investor to maintain their percentage ownership in the startup by investing in future rounds of financing. It is a way of protecting the safe investor from dilution and allowing them to increase their stake in the startup.
(v) Conversion into Stock: The post-money safe provides a clear framework for how the safes will convert into stock. It eliminates the complexities and uncertainties associated with the original safes, making the conversion process more straightforward.
(vi) Proceeds and Liquidity Events: The post-money safe includes provisions for the distribution of proceeds in case of a liquidity event, such as an acquisition. It ensures that safe holders have the option to receive value that is the greater of their investment back in cash and/or other forms of consideration or the amount payable on the as-converted ownership of the safe.
4. Advantages of the Post-Money Safe
The post-money safe structure for raising funds offers several advantages compared to other methods:
(i) Speed: The post-money safe allows for faster fundraising as founders can close deals with investors as soon as they are ready to sign and wire money. There is no need to coordinate a simultaneous closing with all investors, which can save time and expedite the fundraising process.
(ii) Cost savings: The post-money safe is a simple, standardized document that requires little to no transaction costs for companies and investors. This means that startups can save money on legal fees and reduce the time spent negotiating complex terms of the investment.
(iii) Financial Simplicity: A safe does not have a maturity date, an interest rate, or a debt obligation. It does not create any pressure or liability for the startup, and does not affect their cash flow or balance sheet.
(iv) Administrative Ease: A safe does not give the investor any equity or ownership in the startup at the time of investment. It only gives them the right to receive equity in the future, based on certain triggers and terms. This means that the investor does not have any voting or governance rights until the safe converts into equity. That gives the company an easier administrative situation in comparison with an equity financing round.
(v) Certainty and transparency: The post-money safe allows investors to negotiate the amount of ownership they are looking for in relation to their investment. The valuation cap becomes a transparent product of this negotiation, providing more certainty on the investor’s actual ownership stake.
(vi) Flexibility: The post-money safe does not have an expiration or maturity date, eliminating the need for extensions or revisions. This flexibility makes it easier for both companies and investors to navigate the fundraising process.
Overall, the post-money safe structure offers speed, cost savings, certainty, transparency, and flexibility, making it an attractive option for early-stage fundraising.
5. Conclusion
In conclusion, the post-money SAFE has emerged as a dynamic and flexible instrument in the area of startup financing. Throughout this document, we’ve discussed its key features, advantages, and considerations for both investors and entrepreneurs. The post-money SAFE provides a transparent framework for valuation and equity distribution, striking a balance between investor protection and startup growth. Its simplicity and efficiency make it an attractive option for early-stage funding rounds.
A safe should also be used with transparency and communication, as both the startup and the investor should understand the terms and implications of the safe, and keep each other informed and updated on their progress and plans.
In the next chapter of our Startup Dairy, we’re going to discuss in detail the calculation of ownership, dilution effect, conversion mechanisms and other crucial topics in relation to the post money SAFE. Stay tuned for the next chapter of our Startup Dairy.
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.
