The simple agreement for future
equity has been a very popular
investment tool for early stage
startups for the last several years.
But in 2018, Y
Combinator updated it and made
some pretty significant changes.
We'll explain how the new SAFE works
in this video.
Hi, I'm Steve Morris and I use the
StartupSOS Channel to provide
practical how to advice for
first time entrepreneurs.
So the topic today, the new
SAFE based on post money
valuation.
So as we said in the previous video
on the original SAFE, the SAFE
is a convertible security and that
part didn't change.
It's a way for an investor to
provide funding to
a startup with a relatively
simple legal document and put
off until the future fhe
conversion of that money
into ownership of the company.
So hence a convertible security
money that later converts
in to stock and ownership in
the company.
So why update the safe in
2018?
Well, a couple of reasons.
First of all, SAFE investments
were getting bigger and bigger.
Companies were raising a lot of
money with a SAFE.
And it became more reasonable to
think of the SAFE
as a round in
and of itself, or actually a series
of SAFEs.
So that was part of the thought
process.
Part of what came along with that
amount of money being raised as
safes was it became difficult
for investors to understand really
how much of the company, what
percent of the ownership were they
getting.
And it became difficult for startups
to get a good view of how
much dilution they were getting
because of all of this money they
were taking in the form of a safe.
So the update was meant to address
both of those issues.
So what didn't change in the SAFE?
Well, one thing that didn't change
was what causes the
conversion from from the SAFE
dollars into ownership.
And that's an equity investment, an
equity investment of any size.
Just like before in the original
safe. And, like the original
SAFE, no interest rate and
no maturity date.
So the two big things that make it
very different from a convertible
note.
The other thing that didn't change
is the SAFE comes in four versions.
The first or standard version has a
valuation cap, but no discount.
The second has a discount, but no
valuation cap.
The third has both a valuation cap
and a discount.
And then the fourth, like the
original safe, has no valuation cap,
no discount but an MFN
- a most favored nation
clause.
Now, to understand discounts
and the MFN you might check out
the previous video on the SAFE
because there was work the same way.
There's a link right up at the top
of the screen to that previous
video. What did change?
Boy, I think the number one biggest
change was that the valuation
cap on the new safe
is based on post money
value, not pre money
value.
The original SAFE, it was pretty
money, just like a convertible note.
This is post money and we'll try to
explain what the heck does that
mean? Couple of other changes.
Pro rata rights now are
optional.
The other change actually with a pro
rata rights is that for
the new SAFE, the pro rata
rights to the right to purchase
more shares to maintain a percent
ownership only applies
to that first round
of equity issued, the one that
causes the safe to convert.
The other thing that's different
with the SAFE is there is language
in it now that says though shalt
not modify these terms.
Y Combinator really wants you to use
one of the four versions of the safe
as written.
Now, there is no legal
constraint, of course, on doing
that. People can certainly modify
the legal documents however they
want. But the intent
of Y Combinator is that you use
one of the four versions, as
is. What does this mean to have
a SAFE based on the post money
cap? Well, think of
the SAFE as being around
in and of itself.
In fact, it's a little more general
than that. Think of the convertible
securities that you use
to raise money as being around
in and of themselves.
That would be the SAFE
vehicles. But you might also do
see a convertible note, another
convertible type of security.
So think of those combined together
as being a round in and of
themselves.
The post money cap relates
to a cap on the post money value
of that round, that round of
convertible securities, not
on the round of the
equity investment that causes
that SAFE and other convertible
security money to convert
into ownership.
And I think the best way to explain
that is probably to walk through
an example.
So let's say we have a startup that
has a cap table.
In other words, an ownership of
stock ownership table that looks
something like this.
You've got the founders owning most
of the company except for 750,000
shares that are allocated for
options, and so the total
number of shares either owned
or allocated is 10
million.
And now let's say we go out and
raise some safe investment
dollars. So Investor A
to start with provides
$200,000 in SAFE funding
with an agreement that there's a $4
million dollar post money
valuation.
$200,000 is 5 percent
of 4 million.
So what the company is committing
to to that investor is that
in this round of safe
investment, that investor
is going to get at least 5 percent
ownership in the company with
that two hundred thousand dollar
investment.
Later, the company does
another investment round with
investor be an investor, B
invests $800,000
and the company has made more
headway. So they've set a higher
post money valuation cap
of $8 million .
Well, $800,000 is 10
percent of a million.
So the commitment the company is
making to this investor is that for
the $800,000, that investor
will get at least 10 percent of
the company. Since the investor is
investing so much, the company
is making one other commitment,
which is the investor has
the right to purchase additional
shares in the
equity round to maintain
that 10 percent ownership.
That would be the pro rata right.
So that's our round of SAFE funding.
What does that mean in terms of
stock?
Well, so far, the company has
committed 15 percent ownership
to two safe investors,
both of whom got different terms.
So now let's say there's an equity
round of investment and the company
is offered a $5 milion investment
with a $15 million
pre money valuation.
Well, the post money cap
on those two investments, both
of those were lower than the pre
money value of this upcoming
round will call into a Series A.
So definitely we'll have
the SAFE preferred shares kicking
in to provide a lower price
for those SAFE investors.
Here's how you figured that out.
So the company has 10 million fully
diluted shares between what the
founders have and the shares that
are either committed to or
actually provided to
employees or others in
the form of stock options.
So a total of 10 million
shares and they've made a commitment
to 15%
ownership to these two investors.
So how much stock will they
have to issue in order to
have stock to provide to those
investors and have them own 15
percent? Well, the total stock
that they need times
.85 has to be equal to 10
million. So the 10 million
is 85 percent of the ownership, that
leaves 15 percent ownership
for the safe investors.
Well, do the math.
You divide point 8.5 into 10 million
and what you get is about
11.7 Million shares of stock.
That's what they'll need to have,
about one point seven million shares
to issue to those
those investors.
And again, do the math.
That means that the two investors
will own 15 percent
of the company.
So that you can think of as
the SAFE round.
That's the calculation that you do
just immediately before doing
the next calculation for the equity
conversion.
But before we look at the equity
numbers, let's ask, what are
our SAFE investors paying for
their stock?
Well, start with the investor.
A the first investor made
$200,000 and received
588,000 shares of stock.
Do the division and that
investor paid about 34
cents per share.
The later investor invested
more, but in a higher post,
money valuation received
about 1.1 Million shares.
So do the math again.
And that investor paid
68 cents for each share of stock.
So before we move ahead and look at
the impact of the equity investment,
let's take a look at our safe
preferred cap table.
In other words, the ownership of the
company.
Once you take all of the safe
conversions into account.
So the founders still have their
9.25 Million shares.
Investor A received
588,235 shares.
And investor B has just
over 1.1 Million shares.
Again, the option pool is still
sitting there at 750,000.
So we're at our
11,764,706
shares and then
we do the numbers for the equity
investment.
So if you recall, it was a 15
million dollar pre money valuation
that the series A investors gave
to the company.
But beyond that, the series had
investors who did something that
often happens, which is they're
requiring the company to allocate
additional shares of stock
for the option pool because
the investors want to make sure
that. There is stock available in
the form of options for the
employees for compensating the
employees that the company is going
to have to bring on board.
So again, a very, very common
requirement.
So now, in addition to the 11
million shares outstanding, which
included the addition for
the SAFE money,
they now have these additional
shares allocated for options.
So a total fully diluted
capitalization of about thirteen
and a half million shares
of stock.
Now that we know the fully diluted
number of shares of stock,
we can calculate the stock price.
It's simply the pretty money
value divided by the number
of shares.
Do that math. And it's just a little
bit over a dollar and eleven
cents per share.
So now the question is how many
shares of stock of additional
stock will the company have to issue
in order to have enough stock
such that they can sell it to
these new investors for five
million dollars?
Well, do the math.
And it comes out that they'll need
just over four point four million
shares of stock to have enough,
at a dollar and 11 cents to raise
that five million dollars.
Will call the lead investor investor
C.
They're going to provide four
million dollars of that money.
But remember, investor B has a
pro-rata, right, so we're going to
assume that the investor B will buy
more stock to maintain
their investment percentage.
And there'll be some other
miscellaneous investors that make up
the difference for the total of five
million dollars.
So what does the cap table look like
after the series A investment?
Well, the founders still have their
nine point two five million shares.
An investor A still has the five
hundred eighty thousand shares that
they had.
Investor B has exercised
their pro-rata right.
So they had just a little over one
point one million shares.
Now they have a little over one
point six million.
Now investors C the equity
investor in this new round owns
20 percent and just over three point
five million shares of stock.
The other investors come in
and invest in the rest of the
stock to around out to five million
dollars. And the option pool
now that's both allocated
is as well as committed is
of course a lot bigger now because
of the additional shares that the
investors see required that the
company issue prior to this
round. So now the total
capitalization is
just over seventeen point nine
million shares of stock
fully diluted, i.e.
counting both the shares actually
issued as well as everything in
the option pool.
The ownership of the founders,
as you can see, is down getting
pretty close to to 50 percent.
The investor A who
in the preferred round had 5 percent
is down to three point three.
Investor B who in the preferred
round was committed 10 percent is
now down to nine point one.
If you look at the actual issued
stock not counting
the allocated but not awarded
options, they are indeed
at 10 percent.
Of course investor sees it at
20 percent because they invested 4
million and around that was
well 15 million pre with
the five million investment.
Twenty million post investment.
And of course, four million dollars
is 20 percent of that 20 million.
So they're at 20 percent.
And then you can see where the the
rest of the numbers fall out.
So hopefully that helps you
understand a little bit better the
process of determining the number
of shares that have to be issued to
provide the shares for the safe
investors, which will then let you
calculate the price they're paying.
Then you add in the new options
that the equity investors are
requiring and then
you can calculate the share
value of the stock for the equity
investors, then finally
determine how many shares of stock
have to be issued in order to have
enough stock to cover that.
In this case, five million dollar
investment.
So the SAFE preferred is the type
of stock that's going to be issued
to the SAFE investors
if they're paying less for
the stock in that equity - in that
conversion round - than
the series A or the
equity investors.
And that will happen if if a
discount kicks in or if
their cap kicks in to result
in them paying less.
Now, if there is no discount
and if the post money
cap ends up being lower than
the pre money valuation in the
round, then there
is no difference in the price
and the SAFE investors actually
convert their funds into the
same preferred shares as
the series A Investors.
So the SAFE preferred
only happens if the
safe investors pay less
for their stock than was paid for
by the equity investors in
the round that converted the SAFE.
And of course, as same
as is the case for the original
safe, the difference in
the SAFE preferred is the
liquidation preference, the
conversion price and the dividend
rate, and we went through an example
of how that works in
the previous video.
Again, there's a link to that right
up there.
What are the advantages of this
new version of the safe?
Well, of course, it has a lot of the
same advantages as the original
safe.
It delays the valuation.
So your your funds
convert to stock in the future when
hopefully you're worth more then
you're reducing your
your dilution.
It's a very simple legal document,
certainly compared to the typical
price round, which is much more
complex.
And that makes it low cost from a
legal point of view and and
relatively simple to negotiate.
So a more practical way of raising
money than than a price round
certainly for an early stage
funding round.
You can do multiple closes with
a SAFE with - as in our
example - different terms for
different investors.
That's a lot easier to do than with
a priced round where there's there's
more coordination.
No interest rate, no maturity date.
So that's an attraction compared to
a convertible note.
And the the other
benefit -the big benefit compared to
the original SAFE is just more
transparency.
Transparency for the investors as to
what percent of the company they're
getting. Transparency for
the entrepreneurs about how much
dilution they're taking on
in order to close these
safe dollars.
So what are the drawbacks?
Well, it's maybe a little more
complex than the original safe
because you have to go through a
couple of steps to calculate
the amount of safe
stock that's going to be issued and
then calculate the series A.
But I would say that the the big
drawback is really the dilution
hit. You're in this version
of the SAFE, you're guaranteeing
a minimum percent ownership
to the SAFE investors.
And that guarantee
is is going to reduce the
ownership of the founders
because that's the only other
place for for that stock to come
from. So compared to looking
at pre money value
from the original SAFE,
the founders can end up with a
little bit less ownership.
On the other hand, it's
a big attraction for the investors
because the investors have a much
clearer idea of what percent
they're getting for their investment
in the company, and that makes
it more attractive to them, which
maybe makes it a little bit easier
to close around.
So that's a good thing for
the entrepreneur.
So that's a quick overview of the
simple agreement for future equity.
The new version, 2018
based on the post money valuation.
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Thank you very much for watching.