How a SAFE converts: your ownership after the priced round

A SAFE is the most common way to back a startup before it raises a priced round. It is quick to sign and cheap to paper, which is why founders like it. What it does not do is tell you, on the day you sign, how many shares you own. That number appears only when the company raises a priced round, and by then the round's terms have already decided part of it.

This article takes one cheque from signing to Series A, with the figures worked through at each step.

What a SAFE is, and what it is not

A SAFE, a simple agreement for future equity, is a right to receive shares later. You pay now. The company issues you shares when it next raises a priced equity round, at a price set by the SAFE's terms.

It is not debt. There is no interest, no repayment date and no security. If the company never raises a priced round and never sells, the SAFE may never convert.

Most SAFEs signed today follow the post-money form published by Y Combinator. The terms that decide your outcome are:

• Valuation cap. The highest company value at which your money converts.
• Discount. A percentage off the round price, if the SAFE has one.
• Side letters. Most often a pro rata right to invest in the next round.

Post-money and pre-money caps

A post-money cap values the company including all the SAFE money raised before the priced round. That makes your ownership at conversion easy to work out: divide what you invested by the cap. $25,000 on an $8,000,000 post-money cap is 0.3125% of the company, however much other SAFE money the founders raise at that cap.

A pre-money cap leaves the SAFE money out. Every other SAFE that converts alongside yours takes a slice before the round, so your stake is smaller than the simple division suggests, and you cannot know by how much until the founders stop raising.

If a term sheet or a SAFE does not say which kind of cap it is, ask before you sign.

A worked example

Take one cheque through to the Series A. The figures are rounded so each step is easy to follow.

Your percentage has fallen, but your shares were bought at the cap, half the Series A price. Valued at the Series A price, your stake is now worth $50,000 on paper.

The option pool takes its share too

Series A term sheets usually ask the company to enlarge its employee option pool, and to do it before the new money goes in. The new investors then own their full percentage after the round, and the pool increase comes out of everyone who held shares before it: founders, earlier investors and converting SAFEs.

Run the same round with a pool top-up of 5% of the post-money company:

The pool top-up cost this holder $3,125 of paper value and about 0.016 percentage points. On a single small cheque that is modest. Across a portfolio, and across several rounds, it adds up, and it rarely appears on the founder's update.

When the round prices below the cap

A cap protects you only when the round values the company above it. If the company raises at or below the cap, your money converts at the round price, the same price the new investors pay, and the cap does nothing.

Suppose the Series A comes in at $6,000,000 pre-money with $2,000,000 of new money, an $8,000,000 post-money value:

• With a cap only, you convert at the round price. Your $25,000 buys 0.3125% of the post-money company, worth exactly what you paid.
• With a 20% discount, you convert at 80% of the round price. The same $25,000 buys 0.3906%, worth $31,250 at the round price.

This is why some angels still ask for a discount alongside a cap. It is the term that rewards early risk when the next round is flat or weak.

Terms that change the conversion

The ones you will meet most often:

• Discount. Typically 10 to 20% off the round price. Where a SAFE has both, you convert at whichever gives you more shares.
• Most favoured nation. If the company later signs a SAFE on better terms, yours can be amended to match.
• Pro rata side letter. A right to invest in the next priced round to keep your percentage. You still have to write the cheque.

What to record in your tracker

When you sign, record:

1. The amount, the cap and whether the cap is post-money or pre-money.
2. Any discount, most favoured nation clause or side letter.
3. The date, and the entity you invested into.

When it converts, record:

1. The share class and the number of shares issued to you.
2. The conversion price, and whether the cap, the discount or the round price set it.
3. The round's post-money value and any pool increase, so you can check the share count against the cap table.

The SAFE dilution calculator runs the same steps on your own numbers, including the pool and a discount.

This article is general information, not investment, tax or legal advice. Early-stage investing is high risk; you could lose all the money you invest.