Part 3: How do multiple Post-money SAFEs affect dilution during a Financing round
In Part 1 of this series we saw what SAFEs are, how they are different from Notes, types of SAFEs and their conversion. In Part 2 of this series we saw with an example how multiple pre-money SAFEs impact dilution and ownership structure of the company.
In this article we will deep dive into post-money SAFEs and see with example how multiple post-money SAFEs convert during a financing round. We will consider the similar assumptions as in pre-money example (article 2 of this series) as it will allow compare how the dilution is affected by both kinds of SAFEs.
Introduction
Post-money SAFEs convert at a post-money valuation. Here post-money is not post-money valuation of financing round but it means the ownership is measured after all the SAFE money is accounted for. This protects SAFE holders from dilution when other SAFE investors come on board and the dilution is experienced only by existing shareholders(shareholders before the safe conversion).
In this article, we will take a look at how multiple post-money 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 ($2,500,000 post-money valuation cap)
- The SAFE 2 investor invests $750,000 at $4,250,000 pre-money valuation cap ($5,000,000 post-money valuation cap)
- The SAFE 3 investor invests $1,000,000 at $9,000,000 pre-money valuation cap ($10,000,000 post-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 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 Post-money SAFEs Conversion
Safe investors Ownership upon conversion (before financing round) = (Amount invested /Valuation cap)*100
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 $2,500,000 post-money valuation cap and 0% discount
SAFE 1 investor ownership can be calculated as below:
- Safe 1 investor ownership = (500,000/2,500,000)*100 = 20%
Number of shares and price per share can be determined when all the SAFE holders ownership is calculated.
Irrespective of how many SAFE investors come in, the ownership of SAFE 1 investor will be fixed at 20% upon conversion(i.e. at the start of financing round). In post-money SAFEs the new SAFE investors will not dilute the existing SAFE investors
SAFE 2 Investor conversion
SAFE 2 investor invests $750,000 at $5,000,000 post-money valuation cap and 0% discount
SAFE 2 investor ownership can be calculated as below:
- Price = (750,000/5,000,000) * 100 = 15%
Number of shares and price per share can be determined when all the SAFE holders ownership is calculated.
As we can see, unlike in pre-money SAFEs where ownership of Safe 1 investor was diluted when safe 2 investor was converted, the ownership of safe 1 investor remains the same.
SAFE 3 Investor conversion
SAFE 3 investor invests $1,000,000 at $10,000,000 post-money valuation cap and 0% discount
- Price = (1,000,000/10,000,000) * 100 = 10%
Number of shares and price per share can be determined when all the SAFE holders ownership is calculated.
We can only calculate the number of shares each investor will get after we know how much ownership do shareholders excluding safe investors account for. Now that we know the ownership of all safe holders, we can calculate the shares to be issued to these investors
Shares to be issued to SAFE holders
- Total SAFE investors ownership = 20 + 15 + 10 = 45%
- 100,000 shares account for 55% ownership
Now that we know the ownership percentages of existing stakeholders excluding safe investors we can calculate the number of shares to be allotted to safe investors
- SAFE 1 investor shares = (0.2*100,000)/.55 = 36,364
- SAFE 2 investor shares = (0.15*100,000)/.55 = 27,273
- SAFE 3 investor shares = (0.1*100,000)/.55 = 18,182
Share prices at which the shares are issued can also be calculated
- SAFE 1 investor share price = 500,000/ 36,364 ≈ $13.75
- SAFE 2 investor share price = 750,000/ 27,273 ≈ $27.5
- SAFE 2 investor share price = 1,000,000/ 18,182 ≈ $55
The final cap looks like this post conversion:
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 + 81,819 = 181,819
- Total ownership excluding option pool and series A investors = 70%
- Hence new shares to be issued = (.3 *181,819)/.7 = 77,922
- Preferred shares to be issued to Series A investors = (.2*666,667)/.7 = 51,948
- Common shares to be issued for option pool = New shares to be issued — Shares to be issued to Series A investors = 77,922–51,948 = 25,974
The final ownership after the financing round is as shown above in the image. Founders get diluted from 90% to around 35% after financing round. This is a significant dilution for founders after a financing round. Also SAFE investors get diluted in financing round. Hence founders need to be cautious while raising multiple SAFE rounds as it can significantly dilute founders.
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 post-money SAFEs convert after a financing round. Post-money SAFEs are not as founder-friendly as pre-money SAFEs as they tend to dilute only founders when new SAFE investors come on board. Also it is the reason why investors prefer post-money SAFEs as they have an idea of how much of the company will they own after conversion(i.e., at the start of financing round as ownership will change after the financing round) even if new SAFE investors come onboard at a later stage.
Post-money SAFEs are a better option as an investor and YC, a startup accelerator that came up with the concept of SAFEs, has stopped issuing pre-money SAFEs and now only uses post-money SAFEs as it helps investors understand their ownership better in case of multiple SAFEs.
In the next article, we will the comparison of post-money SAFEs and pre-money SAFEs, how they convert and affect dilution in case of multiple SAFEs and similar conditions.
