Introduction to SAFE and a "Post-Money Valuation Cap

A SAFE (Simple Agreement for Future Equity) is an investment instrument commonly used in startup financing. It provides a way for investors to invest in early-stage companies without assigning a specific valuation at the time of investment. Instead, the SAFE converts into equity (shares) at a future event, such as the next equity financing round, acquisition, or IPO.

Key Features of a SAFE:

  • No Interest or Maturity Date: Unlike a convertible note, SAFEs do not accrue interest and do not have a set repayment date.

  • Future Conversion: The investment converts into equity at a later date, typically when a priced round occurs.

  • Valuation Cap and/or Discount: SAFEs often include a valuation cap and/or a discount to protect early investors.

Post-Money Valuation Cap

A Post-Money Valuation Cap is a term in SAFE agreements that sets the maximum valuation at which the SAFE will convert into equity after the new investment round.

  • Post-Money Valuation: This refers to the value of the company after the SAFE investment and any other new investments in the same round.

  • Investor Protection: The cap ensures that early investors get a predefined percentage of equity, regardless of how high the company’s valuation is during the conversion event.

  • Impact on Ownership: Since the cap is post-money, the percentage ownership for the SAFE investors is clear from the outset because it is calculated based on the post-money valuation.

Example:

  1. A startup issues a SAFE with a Post-Money Valuation Cap of $10 million.

  2. An investor puts $500,000 into the SAFE.

  3. When the SAFE converts in a priced round, if the startup's post-money valuation is higher than $10 million, the SAFE will convert at a valuation of $10 million (the cap), ensuring the investor gets a larger percentage of equity.

  4. If the post-money valuation is less than $10 million, the SAFE will convert at the actual post-money valuation, as it is lower than the cap.

This structure provides clarity and ensures the early investors are not diluted excessively in later funding rounds.

Y Combinator, ValuationsFrancesca Tabor