The biggest advantage of the post-money safe is that the amount of ownership sold is immediately transparent and calculable for both the founder and the investor. This Quick Start Guide will show how to take advantage of this new structure for the most common use cases. For an in-depth discussion of the new structure and features of the safe generally, please review the rest of the Post-Money User Guide that follows. If you are an investor, we also recommend reviewing the “What if I’m an investor?” subsection in the Post-Money User Guide.
Note: in the examples below, if the valuation in the round in which the safe converts is less than the Post-Money Valuation Cap or too close to the Post-Money Valuation Cap, the safes may convert into more than the estimated ownership. Please see the Q&A section in the User Guide.
1. Raising money with a Post-Money Valuation Cap and calculating ownership sold
A founder is targeting a $1 million raise and 15% ownership sold.
Post-Money Valuation Cap is $6.7 million ($1 million / 15% = ~$6.7 million).
“I’m targeting $1 million at $6.7 million post / $5.7 million pre. Post-money cap is $6.7 million.”
If the founder raises...
$500k, then the ownership sold would be 0.5/6.7 = ~7.5%
$800k, then the ownership sold would be 0.8/6.7 = ~12%
$1 million, then the ownership sold would be 1/6.7 = ~15%
2. Raising money with multiple Post-Money Valuation Caps and calculating ownership sold
A founder is targeting a $1 million raise and 15% ownership sold.
Post-Money Valuation Cap #1 is $5.5 million.
Post-Money Valuation Cap #2 is $8.3 million.
If the founder raises $500k on each cap, then she will have sold ~15%
$500k / $5.5 million = ~9%
$500k / $8.3 million = ~6%
3. Estimating the future dilutive impact of pro rata rights provided in the optional side letter
The pro rata right entitles the safe holders to subscribe for a percentage of the total round equivalent to their as-converted ownership (e.g. 15% if they invested $750k at a $5 million Post-Money Valuation Cap). You can therefore backsolve dilution based on an assumption of how much the new investors in the Equity Financing will demand. That formula is just the following:
Safe fund raise
Company sold 15% of the Company pre-Series A in safes by raising $750k at a $5 million Post-Money Valuation Cap
Company gave every safe investor a pro rata side letter
Company issues 8% of the Company pre-Series A in options to people hired between the safes and the Series A
Series A assumptions
Lead investor and other new investors will own 25% post-Series A, not including the safe investors pro-rata
Option pool increase that creates a 10% unissued and available option pool post-Series A
Estimated dilutive impact post-Series A:
Safe Pro Rata Allocation %:
25% / (100% - 15%) - 25% = 4.41%
Series A New Investors + Safes with pro rata:
25% + 4.41% = 29.41%
Series A dilution:
29.41% investments + 10% option pool = 39.41%
Adding it all up:
15% * (100% - 39.41%) = 9.09%
8% * (100% - 9.09% - 39.41%) = 4.12%
Series A dilution:
Note #1: the 8% in options issued between the safes and the Series A are diluted by the safes and the Series A terms.
Note #2: the safe ownership is post-safes. It is not post-Series A. The safes are like their own round, which means they are diluted by the Series A (just like everyone else).
In this User Guide, the new version of the safe is referred to as the “new safe,” “post-money safe,” “Standard Safe” or simply “safe.” The original version of the safe replaced by the new safe is referred to exclusively as the “original safe.”
In late 2013, Y Combinator introduced the original safe, or the Simple Agreement for Future Equity. At the time of introduction, startups and investors were primarily using convertible notes for early stage fundraising. The original safe was intended to be a replacement for convertible notes, and it has generally been successful in doing so.
More than four years after introducing it, we decided it was time for the original safe to evolve. The most significant change in the new safe is that it is now a post-money convertible security, as explained in detail below. This change is a response to a shift we’ve observed in the way that early stage companies raise money from investors, which is to treat safe-based financings as independent seed rounds capable of providing multi-year runways, rather than shorter-term bridges to priced preferred stock rounds.
In the new safe, we have also removed the pro rata right that existed as a default option in the original safe. That pro rata right applied 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). Instead, we created a standard side letter with pro rata rights that apply to the round in which the safe converts (e.g. if the safe converts in the Series A, the pro rata right applies to the Series A), which can be used if and when the parties agree to it. Although our original goal was to create a universal standard for pro rata rights for all start-up companies, our experience has been that we can’t do this in a way that makes sense for all parties. For example, a company raising $500,000 from 10 angels investing $50,000 often has significantly different considerations than one raising $2,000,000 from a single institutional investor. Also, the pro rata rights contained in the original safe were often misunderstood by both founders and investors as applying to the round in which the original safe converted (the Series A), rather than the round after the one in which the original safe converted (the Series B). So the standard pro rata side letter is an acknowledgment that this right is best handled case by case, and that the prior form of the right often wasn’t what founders and investors were expecting.
There are a few other changes that were incorporated into the new safe, and a complete listing of them can be found in Appendix III. Most importantly, the new safe is still a simple, standardized document, it retains the benefits of certainty and speed, and it continues to require little to zero in transaction costs for companies and investors.
Following the format of the original safe primer, this User Guide describes why, when and how to use the new post-money safe.
The information below applies specifically to a safe with a Post-Money Valuation Cap. Other versions of the safe are described in Appendix I.
What do we mean by “post-money” safe
There are two important aspects to what we mean by “post-money” in the new safe:
The valuation cap in the safe is stated in terms of a post-money valuation (in contrast, the valuation cap in the original safe was based on a pre-money valuation). A post-money valuation and a pre-money valuation are just two different ways of framing the same valuation of the company, but at different points in time. A pre-money valuation is the valuation of the company immediately before the company receives the investment in the financing in question. A post-money valuation is just the valuation immediately after the investment is
made. For example, if a company is raising $2 million at a $10 million pre-money valuation, generally that’s the same as saying that it is raising $2 million at a $12 million post-money valuation.
Safe conversion shares are calculated on a “post” money basis, specifically:
The Post-Money Valuation Cap is “post” all of the safe money. It is NOT also “post” the Equity Financing (e.g. Series A) money. As mentioned above, we believe the market has evolved to raising independent financing rounds using original (pre-money) safes. So it would be inconsistent for the post-money safes to have their post-money valuation calculated to include money raised in the Equity Financing round. Doing that, in some cases, would even result in the sum of the money raised on safes and in the Equity Financing exceeding the Post-Money Valuation Cap of the safes, which would be an absurd outcome (see the Q&A section for more on this topic). The result is that while the safes are not diluted by each other, the safes will be diluted by the new money raised in the Equity Financing.
The Post-Money Valuation Cap is “post” the Options and option pool existing prior to the Equity Financing. It is NOT also “post” the new or increased option pool adopted as part of the Equity Financing (e.g. Series A). Again, this is consistent with treating the safes as an independent fundraise from the Series A in which they convert (assuming the Series A is the Equity Financing converting the safes). The option pool that is created or increased as part of the Series A is intended to provide equity for the people hired after the Series A, with the money raised in the Series A. This means that the safes are not diluted by
the Options granted or the pool created following the safe fundraise but prior to the Series A, which makes sense because that’s the hiring pool enabled by the safe money. But the safes are diluted by the new or increased option pool adopted as part of the Series A, because otherwise, the safes would be forcing the founders to bear all of the dilution for two rounds of hiring rather than one, despite only providing enough capital for one round of hiring.
The reasons to use the safe for early stage fundraising haven’t changed. Founders can close with an investor as soon as both parties are ready to sign and the investor is ready to wire money, instead of trying to coordinate a single close with all investors simultaneously. And as flexible, one-document security without numerous terms to negotiate, safes save startups and investors money in legal fees and reduce the time spent negotiating the terms of the investment. Founders and investors will usually only have to negotiate one item: the valuation cap. Because a safe has no expiration or maturity date, there will be no time or money spent dealing with extending maturity dates, revising interest rates or the like.
But the more important question for users of the original safe is, why use the new safe? Because the post-money safe is the best way for both companies and investors to understand ownership. The original safe was standardized on a pre-money basis and inclusive of the Series A option pool increase, which made it difficult for founders to calculate precisely how they were being diluted when raising money. The answer to “how much of the company are we selling” was dependent on a recursive loop of how much was raised on other original safes, plus a hypothetical assumption about the Series A option pool increase that would be negotiated years later.
These unknowable elements meant that founders had a hard time planning out their fundraise so that they could sell an intended and expected portion of their company. Founders might intend to sell around x% of their company. But they didn’t have the best tools to accomplish this goal, which meant that they often ended up selling a lot more than they really wanted to, when they didn’t have to. The post-money safe should now help founders better align their intentions with outcomes, because calculating dilution and ownership requires little more than simple addition and division, and this simple calculation will make planning around those factors easier as well.
Now as ever, most startups need to raise money soon after formation in order to fund their day-to-day operations, and the safe is a vehicle for investors to fund companies at that very early stage. Unlike the sale of equity in traditional priced rounds of financing, a startup can issue a safe quickly and efficiently, without multiple documents that require significant legal time. Like the original safe, the new safe is still a one-document security, although we have a new, standardized pro rata side letter that serves as an optional companion to the new safe, described in further detail in the Q&A section.
The process hasn’t changed: an investor and the company still agree on the amount to be invested and the valuation cap, they mutually date and sign a safe, and the investor sends the company the purchase amount. What happens next? Technically nothing, until the occurrence of one of the specific events described in the safe (priced round, sale of the company or dissolution). However, we strongly recommend that companies keep an accurate cap table to record and track how the safes will convert into stock, which should be much easier with the new safe.
What if I’m an investor?
An investor generally only has to think about his/her own investment, rather than the structure of the entire round, and there are three questions that are most common:
What ownership am I getting for my investment?
This wasn’t actually a question that an investor could answer under the original, pre-money cap safes because:
The company could raise as little or as much as it wanted on top of the pre-money valuation.
The investor didn’t necessarily know how much had been raised on other safes, and their corresponding valuation caps, before the investment.
The investor didn’t necessarily know how much was raised on safes, and their corresponding valuation caps, after the investment.
The ownership calculation included an unknowable variable, which was the Series A option pool increase.
The safes all diluted each other.
For example, if an investor gave a company a $500k investment at a $4.5 million pre-money valuation cap, the implied ownership was not necessarily 500 / (4,500+500) = 10%. Any of the following could have been the result:
The company had already raised $250k on a pre-money valuation cap of $2.75 million, which meant that the $500k in safes on the $4.5 million pre-money valuation cap represented less than 10% because they would be diluted by the $250k in safes at the lower valuation cap, and vice versa, even though the $500k came later.
The company raised $1.5 million more on the same terms, after the $500k, so the total implied ownership for the $500k million was closer to 500/(4,500+2,000), plus the dilution from the $250k prior safes = ~7%.
Each of the figures above would also undergo some future adjustment based on the size of the option pool and option pool increase in connection with the Series A.
The end result is that under the original safe, an investment of $500k at a $4.5 million pre-money valuation cap only produced a distribution of ownership outcomes, rather than a definite ownership outcome. In other words, an investment on those terms might result in a median ownership of something like 8% post-conversion, but could also result in materially more or less ownership, like so (see next page):
So if the investor was investing under the original safe with these distributions, then with the new safe, the investor could invest that $500k at a Post-Money Valuation Cap that implies a slightly higher pre-money valuation, i.e. the post-money safe allows the investor to exchange lower starting prices for more certainty on ending ownership. For example, the investor could opt to invest $500k on a post-money safe with a Post-Money Valuation Cap of $5.5 million (which implies a slightly higher pre-money of $5 million instead of $4.5 million), which locks in ~9% ownership until the safes convert and are diluted by the Series A round, rather than rolling the dice on a $500k investment at a $4.5 million pre-money valuation cap, which could result in a range of outcomes (some better and some worse).
Now investors can directly negotiate with the company on the amount of ownership they are looking for in relation to the amount they are investing. The valuation cap becomes a transparent product of that negotiation over ownership, and vice versa. A new investor can now say “I’d like X% for $Y” and be a lot more certain that this is what he/she will actually get.
2. Would it be better to just do a priced round?
We think investors appreciate the speed, cost and simplicity advantages of the safe, but over the years, we’ve heard some investors express a preference for priced rounds.
One of the primary reasons certain investors prefer priced rounds has been the ownership uncertainty issue discussed above. With that solved, the question of priced round versus safe can be reduced to what other rights an investor is looking for -- e.g. board seats, investor veto rights, info rights, etc. that often come attached to a priced round -- and whether those rights are important or appropriate for the fundraise being proposed.
3. How should I think about pro rata rights?
The first question is whether an investor’s strategy and resources make follow-on investments important and feasible to begin with, since low or no follow-on activity makes the pro rata side letter an unnecessary negotiation point.
Another question is whether it would be preferable to maximize starting ownership instead, by investing a larger amount at current prices, or negotiating for a lower Post-Money Valuation Cap in lieu of follow-on pro rata rights.
Assuming the answers to these questions lead an investor to conclude that a pro rata right to participate in the Equity Financing (e.g. Series A) is important, there isn’t much else to this other than asking the company for the pro rata side letter as part of the safe investment and negotiating that ask if necessary. Please see Section E.1 (page 14) in the Q&A for additional guidance about pro rata rights.
The Usual Disclaimer
The information in this User Guide (which includes the Quick Start section) is provided only as general information for educational purposes, and to provide some insight into our thinking and the process by which we arrived at the new safe. This User Guide is not being provided in the course of an attorney-client relationship and is not intended to be legal advice. This User Guide should not be used as a substitute for competent legal advice from a licensed attorney in your state.
This User Guide is also provided strictly as an explanatory and illustrative document, and should not be construed as interpreting, providing an opinion on, or affecting in any way the terms or outcome of any particular transaction executed with one or more safe forms, the terms and outcome of which are governed only by the applicable fully executed agreement(s). Nothing in this User Guide should be incorporated or deemed to be incorporated (directly or by reference) into any contract, agreement or similar document or instrument without the express written consent of each of the parties to such contract, agreement or similar document or instrument. Likewise, any tax-related information contained in this User Guide was not intended or written to be used, and should not be used, to avoid tax-related penalties under any applicable laws.
Y Combinator and each of its affiliates and affiliated persons expressly disclaim any responsibility for any consequences of using this User Guide any version of the safe (or original safe) or any other document found on Y Combinator’s website.