Part4: Comparison of pre-money and post-money SAFEs affect on dilution
Kartik Bandarwad
Venture Scout @ LvlUp Ventures, ExitFund and Yobe | Venture Fellow @ Venture Institute | Data Scientist
In article 1 of the series we explored the fundamentals of SAFEs, highlighting their distinctions from convertible notes, and delving into the concepts of pre-money and post-money SAFEs.
In the second part, we explored the workings of pre-money SAFEs and their impact on dilution when multiple SAFEs are put into play. We uncovered a noteworthy aspect: pre-money SAFEs not only dilute founders but also affect existing SAFE holders. Consequently, it becomes challenging for investors to ascertain their ownership stake in the company until the onset of a financing round — specifically, when assurance is gained that no additional SAFE rounds will be initiated.
In our exploration of Part 3, we delved into the realm of post-money SAFEs and their implications on dilution. Here, we uncovered a critical distinction: in scenarios involving multiple post-money SAFEs, the ownership of existing SAFE holders remains unaffected by new SAFE investors, and dilution is exclusively borne by the founders. Consequently, investors often lean toward post-money SAFEs due to their ability to offer a clearer picture of their ownership stake.
In this article, we will compare both the scenarios and look at how the conversion varies.
Introduction
We will go ahead with the same assumptions as in both article 2 and article 3 with respect to initial shareholding pattern and the number of shares issued initially and also the valuations as it will allow us to compare like for like.
Assumptions
Share-holding pattern before SAFE holders come in be:
3 SAFEs issued at three different valuation caps:
The Series A round happens at a post-money valuation:
Comparison of SAFEs conversion
SAFE 1 conversion
As we can see if there is only one SAFE investor, the ownership percentage for SAFE investor will be the same after conversion, regardless of whether the SAFE is pre-money or post-money. In both cases, the SAFE 1 investor would own 20% of the company.
The calculation of shares in pre-money SAFEs is independent of whether new SAFE investors might participate in the future. It relies on the pre-money valuation cap and the total outstanding shares (excluding those designated for SAFE/Convertible note investors). Conversely, when dealing with post-money SAFEs, the share calculation hinges on ownership following the conversion of all SAFEs (and/or convertible notes). Hence, the precise number of shares to be allocated to SAFE holders cannot be determined until a financing round, at which point it becomes certain that no additional SAFEs will be issued.
SAFE 2 conversion
The ownership pattern differs in both cases if multiple SAFEs are issued. From the table above, we can see that when SAFE 2 investor is converted the ownership of SAFE 1 investor goes down from 20 to 17.5%. Whereas in post-money SAFEs the ownership is same for initial SAFE investor. Again, the number of shares cannot be calculated in post-money until ownership post conversion of all convertibles (SAFEs and/or Notes).
领英推荐
SAFE 3 conversion
As per our assumption three SAFEs are issued and we can calculate the shares for all SAFE holders in case of post-money SAFEs according to the ownership of all SAFE holders post conversion of SAFE 3.
In case of pre-money SAFEs, we can see that the ownership of SAFE 1 investor has gone down from 20 to around 16%, while the ownership of the SAFE 2 investor reduced from around 12.4% to about 11.5% after the conversion of all SAFEs. However, with post-money SAFEs, the ownership of SAFE holders remains unaltered following the conversion.
In post-money SAFEs, founders are significantly diluted compared to pre-money as the dilution is completely borne by founders, unlike in pre-money SAFEs where the dilution is experienced by SAFE holders as well. The investors prefer post-money SAFE over pre-money SAFE as they have a clear understanding of their ownership stake following the conversion of all convertibles (including SAFEs and/or Notes) and also it give them the protection from dilution when other convertibles are issued.
Financing round with Option pool
The Series A round investor invests $5,000,000 at 25,000,000 post-money valuation resulting in 20% ownership post Series-A round. As a part of this financing round an option pool of 10% is created on a post-money valuation.
Post-money SAFEs refer to valuation cap for the SAFE round. Even though SAFE conversion and equity financing round happen at once, the SAFEs are converted first and then Series A round shares are calculated. Hence, even the SAFE investors get diluted during a financing round.
The founders are comparatively diluted much more in case of post-money SAFEs than pre-money SAFEs.
Conclusion
Pre-money SAFEs favor founders more, but they may not be as advantageous for investors as they might be uncertain about their ownership until a priced round occurs (or until the point when no more SAFEs are issued). Additionally, when new SAFE investors join, the dilution also affects existing SAFE holders, further impacting investor outcomes.
Post-money SAFEs were introduced primarily to address this issue. The SAFE holders own a certain percentage of the company based on the valuation cap for the SAFE round and the amount invested. In this case the existing SAFE holders are not affected by new SAFE investors as the dilution in this case is borne by existing shareholders excluding Convertible investors ( Notes/SAFEs). Hence, investors prefer post-money SAFE as it protects them from dilution in case multiple SAFEs are issued.
In either case, founders need to be aware of the SAFEs issued and the ownership they giveaway. From the case we considered, just after a financing round founders got diluted from 90% to less than or around 40%.