“El GRAN problema” with Post-Money SAFEs

Several years ago, several cookbooks suggested adding vegetables to cupcakes to make them healthier.  That was a fairly silly idea.  Cupcakes were not made to be healthy.  They were made to taste good.  Adding ground-up vegetables to an otherwise delicious cupcake recipe was only going to make the cupcakes less tempting and not much healthier.  

But that is exactly what YCombinator did by encouraging the use of Post-Money SAFEs.  When YCombinator unveiled its original SAFE (or Simple Agreement for Future Equity) in 2013, it was meant to be a very founder-friendly document—and rather unhealthy for the investors. 

The original SAFE was basically a convertible note with no interest or maturity date.  Many investors in Latin America and elsewhere objected to SAFEs (the original pre-money ones). They complained that it was too company friendly, even egregiously so, because if the company never raised a priced equity round, the company would never have to convert or pay back the money invested.  And the more money raised before conversion of the SAFE, the more each investor was diluted.  

Like a parent who now wants to put some vegetables into the cupcake mix, YCombinator’s Post-Money SAFE is an attempt to make the MOST founder-friendly document much more investor-friendly.  

When YCombinator introduced its new SAFE, it promised to make the dilutive effects of each SAFE immediately transparent and predictable for both founders and investors. But not many founders appreciate how it accomplished that, or that Post-Money SAFEs essentially give investors full anti-dilution protection for any additional convertible rounds (notes or SAFEs) before the next priced equity round (conversion event).  A Post-Money SAFE means the founders and employees eat all of that dilution.  With Pre-Money SAFEs and convertible notes, that dilution would have been shared across the cap table. This a huge change to the traditional Pre-Money SAFE used prior to the more widespread use of the Post-Money Safe introduced in 2018.  

If you don’t like math, feel free to stop reading.  But if you want to put some numbers on the differences between Pre- and Post-Money SAFEs, grab a coffee (or a mate).  You will see that the differences are material and not purely cosmetic.  We had many clients switch to Post-Money SAFEs only to realize they unwittingly agreed to sell an extra 5% of their company’s equity. 

The key to avoiding that scenario is recognizing that a Pre-Money Safe uses a pre-money valuation cap, and a Post-Money Safe uses a post-money valuation cap.  The difference is that a post-money valuation cap equals the pre-money valuation cap plus the total amount of SAFE investment.  The biggest mistake founders make with switching to the Post-Money SAFE is not “negotiating up” the valuation cap. If a founder proposed a $3M SAFE with a pre-money valuation cap of $12M, and the investor insists on using a Post-Money SAFE, the founder should negotiate an increase of the valuation cap to $15M. Failure to do so effectively reduces the valuation at which the SAFE will convert. Instead of $3M converting into 20% of the company’s equity as intended, it is now converting into 25% of the company’s equity. 

Post-Money SAFEs definitely take some of the fun out of why SAFEs were created in the first place—to be the most founder-friendly investment document imaginable.  But that’s what happens when the parent (YCombinator in this case) decides to add vegetables to the cupcake batter. 

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