Part 2: How multiple Pre-money SAFEs affect dilution

6 min readSep 14, 2023

In Part 1 of this series we have seen what are SAFEs, how they are different from Notes, types of SAFEs and their conversion. In this article we will deep dive into pre-money SAFEs and see with example how multiple pre-money SAFEs convert during a financing round.

Introduction

Pre-money SAFEs convert at a pre-money valuation depending on the outstanding shares(excluding the convertibles). This leads to dilution of NOTE and SAFE holders along with founders.

In this article, we will take a look at how multiple SAFEs issued at different valuation caps will convert during a financing event(Series A).

Note:

For simplicity, we will consider all SAFEs with only valuation cap and no discount rate.
The Series A conversion is based on post-money valuation(Percentage-Ownership method)

In case of financing round, in this case Series A, the events occur in the following order:

Conversion of Notes/SAFEs
Option pool creation
New investors invest

Assumptions

Let the share-holding pattern before SAFE holders come in be:

Founders: 90,000
Options issued: 10,000

Lets consider a startup that issues 3 SAFEs at three different valuation cap:

The SAFE 1 investor invests $500,000 at $2,000,000 pre-money valuation cap
The SAFE 2 investor invests $750,000 at $4,250,000 pre-money valuation cap
The SAFE 3 investor invests $1,000,000 at $9,000,000 pre-money valuation cap

Lets consider that the Series A round will happen at a post-money valuation:

Series A investors invest $5,000,000 at $25,000,000 post-money valuation
Option pool of 10% will be created at the post-money valuation of Series A round

Note: The options issued are the options that are already issued to employees whereas option pool is set of shares set aside by the company so that they can be issued at a later date to its employees.

Multiple Pre-money SAFEs Conversion

Share Price = pre-money valuation cap/ Outstanding shares
Shares of SAFE holders upon conversion = Money Invested/ Share Price

Note: Changes to the cap table are made after financing round but to show how multiple SAFEs affect ownership conversion after individual SAFEs are shown

Cap table before SAFEs convert

Initially after the company is founded, founders own majority of the shares and some employees are issued options. In this case, we have assumed that founders own 90% of the total shares issued and 10% are options issued to employees.

When new investors come they are issued new shares(preferred shares) instead of common shares which has some benefits to investors. Preferred shares are typically issued to investors and offer some benefits such as liquidation preference, anti-dilution rights, voting rights and board representation.

SAFE 1 Investor conversion

SAFE 1 investor invests $500,000 at $2,000,000 pre-money valuation cap and 0% discount

SAFE 1 investor shares convert to equity as calculated below:

Price = $2,000,000/100,000 = $20
Shares upon conversion = 500,000/20 = 25,000

After the SAFE converts, investors are issued preferred stocks and founders ownership is diluted from 90% to 72%.

SAFE 2 Investor conversion

SAFE 2 investor invests $750,000 at $4,250,000 pre-money valuation cap and 0% discount

SAFE 2 investor shares convert to equity as calculated below:

Price = $4,250,000/100,000 = $42.5
Shares upon conversion = 750,000/42.5 = 17,647

After this conversion, we can see that both founders and initial SAFE investor both are diluted.

SAFE 3 Investor conversion

SAFE 3 investor invests $1,000,000 at $9,000,000 pre-money valuation cap and 0% discount

Price = $9,000,000/100,000 = $90

Shares upon conversion = 1,000,000/90 = 11,111

This is the cap table after the conversion of all three SAFEs. As we can see from above, the SAFE investors also get diluted with founders during conversion when multiple SAFEs are issued. The SAFE 1 investor ownership went from 20% to 16.26% and also the SAFE 2 investor ownership has decreased. If more SAFEs are issued the existing SAFE investors will be further diluted. The company can raise multiple SAFE rounds, and hence it is difficult for the SAFE investors to know how much ownership they have until they get to a financing round.

Financing round with Option pool Increase

We have assumed that the Series A investors will put in a total of $5,000,000 at $25,000,000 post-money valuation. Hence the Series A investors will together own 20% after the financing round. Also an option pool of 10% will be created on post-money valuation.

Series A investors ownership = ($5,000,000/$25,000,000)*100 = 20%

The Series A investors will not be diluted in this round as the ownership is calculated on a post-money valuation.

Now to calculate the number of shares to be allotted to new investors and the price at which these shares are to be issued, we need to understand the ownership split.

Total shares after SAFE conversion = Common Shares + Preferred shares
Total shares after SAFE conversion = 100,000 + 53,758 = 153,758
Total ownership excluding option pool and series A investors = 70%
Hence new shares to be issued = (.3 *153,758)/.7 = 65,896
Preferred shares to be issued to Series A investors = (.2*153,758)/.7 = 43,931
Common shares to be issued for option pool = New shares to be issued — Shares to be issued to Series A investors = 65,896–43,931 = 21,965

Cap Table after the Series A financing round

The final ownership after the financing round is as shown above in the image. Founders get diluted from 90% to 41% after financing round. Also SAFE investors get diluted in financing round. The SAFE 1 investor initially had 20% ownership before other SAFE investors were onboarded but after the financing round has ownership of around 11.4% due to the dilution from SAFE investors as well as Series A round. Also SAFE 2 investor got diluted from 12.4% before SAFE 3 conversion to 11.48% after SAFE 3 conversion and later to 8% after Series A round.

Both in pre-money and post-money SAFEs, the SAFE investors will get diluted in the financing round.

Conclusion

In this article, we have discussed how multiple pre-money SAFEs convert after a financing round. We have seen that the conversion of SAFEs is a complex process that can have a significant impact on the ownership structure of a company.

Understanding how multiple pre-money SAFEs convert after a financing round is essential for both entrepreneurs and investors. Pre-money SAFEs offer flexibility and simplicity in early-stage investments, but their complexity arises when multiple SAFEs are in play.

When a new pre-money SAFE is issued all the existing SAFE investors ownership is affected during conversion. It is hard for investors to know how much ownership they will have until the beginning of financing round when the SAFEs convert. The more SAFEs issued by the company, the more the existing SAFE investors get diluted. As the SAFEs do not have a maturity date founders might prefer to raise multiple SAFE rounds before a priced round, putting the investors at a risk of more dilution. Hence, investors prefer post-money SAFEs where the new SAFE investors won’t dilute the existing investors.

In the next article, we will see why investors prefer post-money SAFEs over pre-money SAFEs, how the post-money SAFEs convert and they affect dilution.