Pre-Money SAFE vs. Post-Money SAFE: What’s the Difference?
Pretend you’re a venture capital investor and you’re interested in investing some money in an early-stage tech startup. This startup has a lot of promise, but there are a few important things it doesn’t have. For one, the startup has no shares of company stock to issue to investors. And its founders don’t have the money to pay for the transaction costs associated with a legally complex fundraising agreement. What to do? Fortunately, there is a type of agreement specifically designed for these types of situations. It is called a Simple Agreement for Equity Funding—or a SAFE, for short.
A SAFE allows for an investor to give money to an early-stage startup in exchange for the right to future equity. As its name implies, the transaction is refreshingly simple. The invested money doesn’t come with an interest rate or a loan maturity date; instead, it converts into shares when the next financing round happens. The lack of paperwork and hardcore lawyering involved makes this a potentially great deal for founder and investor alike.
Of course, even things designed to be simple can feel complex and overwhelming at times, and SAFEs are no different. In this guide, we’ll walk you through the basics of SAFEs and introduce you to the two key types: pre-money SAFEs and post-money SAFEs. Knowing which type of SAFE makes sense for your startup can save you a lot in stress (and ownership dilution) during your next funding round.
- What is a SAFE?
- What is a pre-money SAFE?
- What is a post-money SAFE?
- How to choose the right type of SAFE for your startup
What is a SAFE?
A Simple Agreement for Equity Funding (we’ll call it a SAFE from here on out) is an agreement that an early-stage startup makes with an investor—typically when raising money during a seed round.
Because the startup doesn’t yet have a formal valuation, it doesn’t have shares to issue to the investor. A SAFE gets around this issue by serving as an agreement that the investor will pay money now and receive shares of company stock later. Because a SAFE involves converting money into equity at a later date, SAFEs are often referred to as convertible securities.
Under most SAFEs, the investor receives the shares in the next priced round of financing (usually a Series Seed or Series A round). The number of shares the investor receives is typically based on the valuation of the company at that time. But heads up: the pricing of shares into which the SAFE is convertible may differ if the SAFE has a valuation cap, which puts a ceiling on how the shares are valued when calculating the conversion price.
A brief history of SAFEs
Given their popularity, you might be surprised to learn that SAFEs are a relatively recent invention. The tech startup accelerator Y Combinator launched the SAFE in 2013 as a response to startups looking for a faster, easier way to raise money in advance of a priced round of financing.
Y Combinator’s first SAFE was considered a “pre-money” SAFE. In a pre-money SAFE, the investor doesn’t yet know what percentage of the company they actually own, relative to the founders and other SAFE investors. Only after all SAFEs convert into shares during the next priced funding round will each SAFE investor know how their ownership percentage compares to that of other investors.
We’ll explain why that’s the case in a minute. For now, suffice it to say that pre-money SAFEs come with a fair bit of uncertainty—and investors tend to not like uncertainty! In response to this, Y Combinator introduced the “post-money” SAFE in 2018. This new post-money SAFE gives the investor more clarity on what percentage of the company they will own once their money is converted into shares.
Now that we’ve got the basic history out of the way, let’s dive into how pre-money SAFEs and post-money SAFEs actually work—and what implications they hold for founders and investors.
What is a pre-money SAFE?
In a pre-money SAFE, the investor gives a certain amount of money to a startup in exchange for shares received at a later date. The startup can’t give shares to the investor yet, because the value of a share is based on the valuation of the company—and no valuation exists yet.
Sounds kind of vague, right? It actually gets more vague due to a concept known as dilution. Multiple investors can be SAFE holders, and every time a new SAFE is issued, that SAFE dilutes the ownership percentage for every other SAFE holder (and for the founder, too). These SAFE investors won’t know what percentage of the company they own until the next financing round, when their investment is converted into shares along with all the other SAFE holders’ investments.
This is due to how the value of converted shares in a pre-money SAFE is calculated. The conversion price for each share is determined in part by the company capitalization, or the total value of the company’s equity. The company capitalization in a pre-money SAFE is a pre-money valuation, meaning it does not include all the shares issued to all the SAFE and convertible note holders. This makes it difficult for individual investors to tell how their ownership percentage breaks down until after their shares—and the shares of every other convertible security holder—are converted.
It’s worth noting that the math on the conversion price for each share can be different if the SAFE investor receives a discount rate. Otherwise known as a “bonus rate,” this rate gives the SAFE investor a discount on the price paid by other investors when the SAFE converts into company shares. So, if a SAFE investor invests $1 million into a company with a 50% discount rate, their $1 million would convert at a price that’s half-off what other investors might get.
Example of a pre-money SAFE
Let’s walk through a step-by-step example of how a typical pre-money SAFE could play out from the perspective of an investor:
- In a seed round, an investor gives $1 million to a startup as part of a pre-money SAFE. The startup also raises money from other investors in the form of SAFEs.
- The investor receives no immediate shares for this $1 million. Instead, she receives a promise to be granted shares valued at $1 million when the startup raises its Series A.
- The investor must wait until the Series A to know exactly how much of the company she owns. Remember: there are other SAFE investors, too. Only after the conversion of the SAFEs into shares will the investor know her ownership percentage in the company. She isn’t super-thrilled about this lack of clarity, but she’s dealing with it.
- At the beginning of the Series A, the investor’s SAFE converts into shares. The conversion price for the investor’s pre-money SAFE shares is calculated by dividing the pre-money valuation cap by the company capitalization (excluding SAFEs and convertible notes).
- The startup is officially valued at $20 million and the investor learns that her $1 million investment has converted into a 5% ownership stake. This stake may be diluted by the new investors coming on board in the Series A.
What is a post-money SAFE?
A post-money SAFE differs from a pre-money SAFE in some key aspects. Most important is that, with a post-money SAFE, the company capitalization includes all the shares issued when all the SAFEs are converted.
Many investors consider the post-money SAFE to be an improvement upon the pre-money SAFE. That’s because it gives investors the ability to immediately calculate exactly how much ownership of the company they are purchasing with their investment.
In a post-money SAFE, the investor can basically pre-determine what her ownership stake in the company will be at the beginning of the next funding round. This ownership stake may be affected and diluted by the new Series A investors coming in, so it’s not totally certain what her ownership stake will end up being. Still, a post-money SAFE gives the investor a much better idea of where her ownership percentage will ultimately land.
As with pre-money SAFEs, the conversion math on post-money SAFEs may change if the SAFE investor is given a discount rate.
Example of a post-money SAFE
Now, let’s consider how a post-money SAFE could play out from the perspective of an investor:
- In a seed round, an investor gives $1 million to a startup in a post-money SAFE with a $20 million post-valuation cap. Regardless of any other SAFE investors that come on board, our investor has ensured a predetermined 5% ownership stake in the company.
- The investor receives no immediate shares for this $1 million. As with a pre-money SAFE, no shares are granted at the time of the investment.
- At the beginning of the Series A, the investor’s SAFE is converted into shares equaling a 5% ownership stake in the company. Other SAFEs are converted, too, but they do not dilute the investor’s ownership stake.
- New Series A investors come in and affect the investor’s 5% stake. There’s no getting around the dilution here. When new investors come on board, everyone’s shares are diluted in order to give them a stake in the company.
Pro rata rights and the optional pro rata side letter
Another difference between pre-money and post-money SAFEs involves pro rata rights. As you may recall from our guide on the subject, pro rata rights are rights that entitle existing investors to keep their initial ownership percentage in subsequent rounds of financing.
Pre-money and post-money SAFEs both may include pro rata rights, but they go about it a bit differently.
In pre-money SAFEs, pro rata rights exist as a default option. According to Y Combinator’s documentation, “the pro rata right applies to the financing after the round in which the original SAFE converted (e.g. if the original SAFE converted in the Series A, the pro rata right applied to the Series B).” This created some confusion for investors who assumed and/or wanted the pro rata right to apply to the same round in which the SAFE is converted, and for founders who didn’t necessarily want to grant pro rata rights to every investor.
To address this, post-money SAFEs include an optional side letter with pro rata rights that apply to the round in which the SAFE converts. So, if the SAFE converts in a Series A, the pro rata rights would apply to that round. This letter is optional and may not be included in every post-money SAFE.
How to choose the right type of SAFE for your startup
While the post-money SAFE may be appealing to investors, it’s not always the best solution for everyone.
Sure, SAFE investors may appreciate the certainty of knowing that they’ve each locked in a fixed ownership stake prior to Series A investors coming on board. But a founder may hesitate to grant SAFEs with such fixed ownership percentages, because the founder or other starting stakeholders would be the ones taking on the dilution from any additional SAFEs raised.
On the other hand, dilution may differ depending on a number of factors, and a post-money SAFE may even end up benefiting a founder. After all, it’s helpful for a founder to know how much each subsequent SAFE they sell dilutes their ownership—versus being surprised after all the dust settles.
If you still have questions about SAFEs, we have answers. Schedule a call with one of our equity experts and take the next step today.