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Have a US investor looking for a SAFE? You can now do that on SeedLegals.
Important news for any company looking to raise investment from US investors, SeedLegals’ hugely popular SeedFAST now has an option to match the deal terms expected by US investors looking for the deal terms in Y Combinator’s Post Money SAFE.
In this article I’ll explain what that actually means, give a quick background to convertible notes and SAFEs, explain the pros and cons of YC’s Post Money SAFE, and show you how to do your next US investment on SeedLegals with our version of a SAFE.
In a traditional funding round the founders round up a bunch of investors, agree a valuation with them, and then the investors get shares in the company proportional to their investments and the agreed valuation. If you’ve managed to round up all the investors to fill out your round and managed to agree a valuation with them, brilliant.
But, what if e.g. you wanted to raise €500K, but you have an investor who wants to invest €50K now, and you could really do with that money now? It doesn’t make sense to do a funding round just to raise €50K, what if there was a way for the investor to give you the €50K now, and you promise to give them shares when you do your next funding round, based on the valuation you agree with the new investors in that round?
In the US, Y Combinator were looking for a way to quickly and easily make multiple investments using standardised deal terms and without the insane US legal fees (SeedLegals isn’t in the US yet…). So they came up with a Simple Agreement for Future Equity (SAFE).
Their SAFE become hugely popular too, and now most pre-Seed Round investments in the US are done by SAFE. At Seedlegals we recognised that while this is a great instrument for the US we have to make it suitable for Irish startups raising investment from local investors and also UK investors who want to avail of UK SEIS and EIS tax relief.
If you’re a Irish company raising money from a US investor, chances are high that they’ll ask for a SAFE. At first glance it’s tempting to just download a free SAFE template agreement from the YC web site, but you’ll quickly see that it won’t work, for two key reasons:
The good news is that since a SeedLegals SeedFAST is, at root, the same concept as a SAFE, when you have a US investor just get onto SeedLegals and create a SeedFAST for them, easy.
But wait… not so fast…
The first version of Y Combinator’s SAFE was similar in its key terms to a SeedFAST in that the SAFE converts as if it’s just another investment in the next round, at the same valuation as the other investments in that round (excluding any discount or valuation cap that you gave your SAFE investor).
But, some time ago ago Y Combinator proposed a new version, known as a Post Money SAFE – you can read all about it here.
In this new version, instead of the SAFE converting at the valuation of your next round (ignoring for now any discount or valuation cap that you may have offered to the investor), instead the SAFE converts at the next round valuation less the value of all SAFEs and other convertible instruments.
It’s easiest to understand this visually:
To see the difference, let’s assume you’re planning to raise a total of €500K in your next round, of which you’ll raise €200K in advance subscriptions which will convert in your round, and €300K in new cash investment.
On the left you can see that if you did those advanced subscriptions with SeedFASTs, the investments would all convert at a €2M valuation, and you and your existing shareholders would be diluted by
£500K / £2.5M = 20%
On the right, however, you can see that the Post Money SAFE converts at the valuation you agreed with the investors in your next round less the value of any existing advanced subscriptions, so in this example that would be at a €1.8M valuation.
This means you’re now diluting by
€200K / €2M = 10% for the SAFEs
€300K / €2.3M = 13% for the new investments
for a total of 23% dilution
Y Combinator may have its own rationale for doing things this way, but here’s one way of looking at it:
Y Combinator has a blog post with background and reasoning, but it’s pretty impenetrable to any Irish founder or investor! Basically, US funding rounds are very different to Ireland:
If you’d raised $1M in SAFEs which converted at a $20M valuation, it would make little difference if it converted at $19M instead.
But, if you raised €500K in SeedFASTs and that converted at €1.5M instead of €2M, that’s a major potentially unexpected dilution.
And that’s the issue we have with Post Money SAFEs, they can be dangerous because they can lead to more dilution than founders were expecting.
Take the following scenario:
And there’s the crunch – with the normal Irish way of converting those investments, they would convert at a €2M pre-money valuation.
But, had they been done as Post Money SAFEs, they will convert at a €1.7M valuation, diluting Sinead somewhat more than she had originally planned.
In short, if you can model up front the amount you’ll raise by SeedFAST, and you factor that into your valuation and discounts, great, the Post Money SAFE is fine. But, if things don’t go as planned and you raise way more with advanced subscriptions, well, Post Money SAFEs can turn out to cost you a lot more dilution than you had originally planned, so caution is needed here.