Here’s why no serious investor will consider your pre-money SAFE
You’ve pitched to my group of 100 angel investors. We’re impressed with your product, your team, your presentation. You get to the last slide and ask us to invest $1M in your SAFE with a $10M valuation cap.
Hands go up around the room. First question: “Is that $10M pre or post?”
You fumble. You don’t know. You promise to check with your lawyer or your accountant or your CFO and get back to us.
Nobody will tell you this, but sorry, you just failed. We’ll ask more questions in the time allotted to Q&A, listen politely to your answers, and later inform you that sorry, there wasn’t enough interest from our group but we wish you great success.
What just happened?
There are 2 kinds of SAFEs: the pre-money and post-money SAFE. (There’s also the discount-only SAFE, but that’s such a non-starter it isn’t even in the conversation.) The only thing worse than using the wrong one (pre-money SAFE) instead of the right one (post-money SAFE) is not knowing the difference.
There’s only a minor variation the wording between the two different types of SAFE, but a world of difference in what the investor is getting. The post-money SAFE is a good instrument for early-stage investment; the pre-money SAFE is avoided by serious investors.
The Difference Between Pre-Money and Post-Money Valuations
The calculation to convert between pre and post-money valuations seems trivially simple:
Post-Money Valuation = Pre-Money Valuation + Money Invested
If you raise $1M on a $10M pre-money valuation, the post-money valuation is $11M.
Simple? Sure seems that way. Even dumb investors ought to be able to do the arithmetic. We shouldn’t care whether the investment is framed as pre or post-money. But…this misses the most critical point.
The post-money valuation is the pre-money valuation plus ALL investment prior to the conversion of the SAFE to preferred shares.
If you only have 1 round of SAFEs prior to Series A, then the calculation is indeed simple: $10M pre + $1M SAFE = $11M post when I receive my shares.
But let’s say you previously raised $1M in a friends and family round. Now that post-money valuation isn’t $11M but $12M. Oh, don’t forget the strategic investor that put in another $1M on a convertible note. Now the post-money valuation is $13M. Hmm.
But I could live with that. You can tell me the total amount you’ve raised to date. Here’s the real problem: the post-money valuation also includes all the money you’ll raise in future rounds prior to issuing preferred shares. And the future is unknown even if you claim to have a inviolate, foolproof plan. Meaning the price I’m paying to invest in your startup is unknown.
If your next round is a priced round (issuing preferred shares at a set price per share), then I get my shares at the expected $13M valuation. Great.
However, if you raise a seed round of $4M on a SAFE or convertible note, the price I pay for my shares goes up to $17M. Another $3M bridge round? The meter is still running, now to $20M.
The shares I thought I was buying at a $10M valuation end up actually costing me $20M. Would I have invested in the company at a $20M valuation? Probably not.
Why Does the Pre-Money SAFE Even Exist?
The original SAFE created by Y-Combinator used a pre-money valuation cap. That was a hold-over from the convertible notes everyone was using at the time.
The convertible note uses a pre-money valuation because the document was repurposed from its original use for large loans by private equity to public companies. In that context, a pre-money valuation makes sense.
The pre-money valuation was fine for an accelerator, but investors balked at using it. So in 2018, YC updated the original SAFE with v1.1, switching to a post-money valuation cap that investors found much more attractive.
The most recent data from Carta shows that 81% of SAFEs are post-money, 14% pre-money, and 5% with no valuation cap. Among my investment groups, pre-money or uncapped valuations are non-starters.
Why Is a Pre-Money Convertible Note Okay and a Pre-Money SAFE Not?
The Carta data also shows that 15% of pre-seed/seed deals use convertible notes with a pre-money valuation cap. My investment groups will accept a pre-money note, but not a pre-money SAFE. This sounds contradictory, but it’s not.
The key difference is that a convertible note has a maturity date, typically 12–24 months. That means the startup has only 18 months or so to raise a priced round or has to pay back the full amount of the investment or declare bankruptcy. The clock is ticking.
It’s pretty unlikely that the startup will raise this round, another large round on SAFEs or convertible notes, and still raise a priced round within 18 months when the note matures. So I’m comfortable that I have a reasonable handle on what my equity will cost when the note converts.
In addition, almost all convertible notes also include a 20% discount off the priced round price, and pay 8% interest on the time until conversion, giving some additional benefit to being an early investor. As long as the maturity is under 2 years, I can live with a pre-money valuation cap.
In contrast, the SAFE has no maturity date. The startup might raise a priced round in 12 months, in which case the post-money valuation is what I expected when I invested, or it might not convert for 10 years after 5 more rounds of SAFEs and convertible notes. The valuation has gone up year after year, and so has the price I’ll pay when my SAFE converts to equity.
Key Takeaways
- If you want investment from experienced investors, the post-money SAFE, convertible note, or preferred shares are the only viable options. Don’t waste your time proposing a pre-money SAFE, uncapped SAFE or convertible note, or common shares.
- Gotta understand the terms you’re offering when talking to investors. Be prepared to defend them.
- Post-money valuation = pre-money valuation + ALL investment prior to conversion
The startup, SüprDüpr, has already raised $400M in venture capital. But is it a good investment? That depends on whether their technology works, and whether it’s killing their users. Find out in my award-winning Silicon Valley novel, To Kill a Unicorn. 4.8 stars on Amazon!
