Bridge Financings: Raising Money Between Equity Rounds — Part 3
SAFEs and convertible notes were designed to be used before a priced equity round, and many of the terms don’t align with parties’ intentions between rounds.
This is part 3 of a series walking through the right changes to make to SAFEs/notes to reflect the right economics between equity rounds.
See Part 1 — The Valuation Cap and Part 2 — The Discount.
Part 3 — Timing
In startup investments, timing is important. The closer you get to the next equity round, the justifications for a valuation cap and discount diminish. If the equity round is imminent or in process, parties will often forego the cap and discount entirely. If structured as a convertible note, the parties may agree interest is repayable in cash (instead of equity) at the next round to more closely resemble the economics of a prepayment on the round.
If the next round is a few months away, it’s often not worth the effort to haggle on a SAFE/note valuation if the parties can piggyback on the diligence and investment analysis of the next equity round investor. Instead, they may agree on a discount-only SAFE/note, with the discount befitting the expected timeline until the next round.
If investors see significant risk the next equity round doesn’t happen within the expected timeline, the parties may consider these alternatives:
#1 — Fixed valuation (or cap) that kicks in if the next equity round does not occur within X months
#2 — The Straight Line Method — SAFE/note converts at a valuation between the valuations of the last equity round and the next equity round based on when the SAFE/note financing occurred between those rounds. For example:
- Series A valuation was $50M
- SAFE/note round occurred 18 months after the Series A closing
- Series B valuation is $100M and closes 24 months after the Series A closing
- SAFE/note valuation = $50M + 18/24 * ($100M — $50M) = $87.5M
- Notice in the chart below this method results in a straight line between the Series A, SAFE, and Series B valuations.¹
Startups aim for hockey stick growth, so depending on the startup’s growth curve, it may be more appropriate to connect the Series A and Series B with an exponential growth curve rather than a straight line.
Special thanks to Jeremy Raphael for his insights.
Part 4 — Exits and Convertible Note Nuances (Maturity and Interest)
Footnotes:
- Pre vs. post-money valuations are ignored for simplicity. Technically, rather than valuation, the discount is based on the investment price per share, which solves for the pre vs. post-money valuation complexities. Using the same example, if the Series A price per share was $5 and the Series B price per share is $10, then the SAFE would convert at $8.75 per share.
