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What are the key elements of a SAFE founders overlook?
SAFEs have become the default tool for raising pre-seed capital for startups. Because of this, many founders have started to take for granted the complexity of the SAFE. While it may practically be a simple instrument for raising capital as it allows you to avoid needing to actually issue shares, legally there are terms in a SAFE that can be complex and difficult to grasp for those that don’t take the time to fully understand what they signing.
Let’s talk about three key things you need to understand before entering into a SAFE.
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Dilution - Unlike equity investments, because you don’t issue shares when signing a SAFE, until a conversion/fundraising event that causes you to issue shares, investors who signed a SAFE don’t get diluted. This means that if you sign a SAFE (where you’ll end up giving up 20% eventually) and sign another safe in a year (where you’ll end up giving up 20% eventually) then in two years when you raise $5M at a $25M valuation you’ll be giving up 20% to each investor from every round, meaning that overnight you’ll lose 60% of your company. If instead you had done equity deals all along, after raising your third round, you would still have 51.2% instead of just 40% because those investors in the first and second rounds would have also been diluted. If you don’t understand this, you can end up going from 100% ownership to losing most of your company in a single day.
Discounts - When a safe has a “Discount, “ you are setting the benefit that investors signing the SAFE will get over those who invest in the next round. So if you give a 20% discount today, for example, then close a deal at a $20M valuation next year, those who invested today will have their shares converted at a $16M valuation. They get a 20% better deal than your next round of investors.
Valuation Cap - To prevent investors from being punished if a company’s valuation skyrockets, many SAFEs have a valuation cap. This is the maximum valuation that their investment will convert at. So if you signed a deal with a $5M valuation cap and then raise at $20M next year, your investors from today will still get to convert their investment at a $5M valuation. Be sure to remember that most SAFEs combine a discount and valuation cap. So if you have a 20% discount and a $5M cap and raise at $20M, then they get to convert at a $5M valuation, but if you raise at a $6M valuation, then they get to convert at a $4.8M valuation.
Are you comfortable with SAFEs? |
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Onwards and Upwards,
