The YC Combinator Simple Agreement for Future Equity has undergone some recent modifications to add clarity to Founders’ and SAFE-holders’ actual holdings in a company. Below we will give you the scoop on what has changed exactly and how this will affect a startup company and its investors.
The basics of each SAFE is its conversion formula which equals the amount of the SAFE divided by the conversion price. A conversion price will be the lesser of the price per share based on the valuation cap provided for in the SAFE or based on the discount provided for in the SAFE. Previously, the conversion price would be obtained by dividing the valuation cap by capitalization (1) inclusive of an option pool increase but (2) exclusive of convertible securities (including SAFEs).
Under the new SAFE, the elements of the capitalization are flipped so that it is defined as (1) exclusive of an option pool increase, but (2) inclusive of convertible securities (including SAFEs).
For those of us who are more visual, here is a table setting forth the main difference between the versions of the SAFEs:
Pre-Money vs. Post-Money
Previously, SAFEs had a pre-money calculation which means that what is expressed is the value of the company prior to the SAFE investment. Now the calculation is referred to as post-money but a clearer expression would be post-SAFE money, as the company’s value is expressed after the SAFE investment but no money from a Series A Financing is included in the calculation.
Why even make the change?
The new SAFE makes the math a lot easier for founders and investors alike. Under the old SAFE, it was unclear what equity percentage the investors would actually acquire in the company until the SAFE actually converted. Now, this percentage is known at the time of the SAFE issuance. Not only will the Investor see what ownership it is acquiring under the SAFE, the Founders will also be able to determine how much dilution the SAFE will be causing to their ownership by dividing the investment amount by the valuation cap.
Here’s an example:
Under the new SAFE, a $500K SAFE with a $5M “Post-Money” valuation cap represents 10% of the company ($500K/$5M = 10%). The founder knows, therefore, that he or she owns the remaining 90%.
Because the old SAFE conversion price, included in the denominator, the amount of the size of the option pool increase, a founder did not know how much dilution each SAFE was causing to the founder’s equity position until the option pool increase was determined at the time of the financing.
What are the costs/benefits of the change?
Because the option pool is no longer included in the denominator of the conversion price calculation, but other convertible securities are included in the denominator, these can be offsetting in many cases in terms of the dilution founders and current shareholders experience with respect to SAFEs. However, the benefit would be that if the size of the SAFEs converting into equity is larger than the size of the equity pool increase, the founders would typically experience less dilution under the terms of the old SAFE than they would under the terms of the new SAFE.
What are the other changes made by YC?
It no longer obligates company to provide pro rata right to SAFE holders in future offering. Another change is that SAFE is characterized as stock for income tax purposes.
It is worth noting that if a company has already existing SAFEs, it may cause less confusion to stay on the old SAFE path rather than introducing the new SAFEs with differing calculations. Ultimately, also time will tell as to what extent these new SAFEs will be embraced.