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How the Post-Money SAFE (Simple Agreement for Future Equity) works - YouTube
Channel: StartupSOS
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the simple agreement for future equity
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has been a very popular investment tool
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for early-stage startups for the last
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several years but in 2018 Y Combinator
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updated it and made some pretty
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significant changes we'll explain how
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the new safe works in this video hi I'm
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Stephen Morrison I use this startup SOS
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channel to provide practical how-to
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advice for first-time entrepreneurs so
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the topic today the new safe based on
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post-money valuation so as we said in
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the previous video on the original safe
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a safe is a convertible security and
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that part didn't change it's a way for
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an investor to provide funding to a
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start-up with a relatively simple legal
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document and put off until the future
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the conversion of that money into
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ownership of the company so hence a
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convertible security money that later
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converts into stock into ownership in
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the company so why update the safe in
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2018 well a couple reasons first of all
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safe investments we're getting bigger
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and bigger companies were raising a lot
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of money with a safe and it became more
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reasonable to think of the safe as a
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round in and of itself are actually a
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series of safes so that was part of the
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the thought process part of what came
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along with that amount of money being
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raised as safes was it became difficult
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for investors to understand really how
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much of a company what percent of the
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ownership were they getting and it
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became difficult for startups to getting
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a good view of how much dilution they
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were getting because of all of this
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money they were taking in the form of a
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safe so the update was meant to address
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both of those issues so what didn't
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change in the safe well one thing that
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didn't change was what causes the
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conversion from from the safe dollars
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into ownership and that's an equity
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investment an equity investment of any
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size just like before in the original
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safe and like the original safe no
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interest rate and no maturity date so
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the two big things that make it very
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different from a convertible note the
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other thing that didn't change is the
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safe comes in four
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versions the first or standard version
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has evaluation cap that no discount the
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second has a discount but no valuation
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cap the third has both evaluation cap
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and a discount and then the fourth like
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the original safe has no evaluation cap
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no discount but an MF n a most favored
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nation clause now to understand
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discounts and the MF n you might check
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out the previous video on the safe
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because those worked the same way
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there's a link right up at the top of
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the screen to that previous video what
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did change or I think the number one
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biggest change was that the valuation
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cap on the new safe is based on post
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money value not pre money value the
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original safe it was pre money just like
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a convertible note this is post money
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and we'll try to explain what the heck
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does that mean a couple of other changes
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pro-rata rights now are optional the
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other change actually with the pro rata
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rights is that for the new safe the pro
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rata rights the right to purchase more
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shares to maintain a percent ownership
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only applies to that first round of
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equity food the one that causes the safe
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to convert the other thing that's
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different with the safe is there's
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language in it now that says thou shalt
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not modify these terms y combinator
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really wants you to use one of the four
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versions of the safe as written now
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there's no legal constraint of course on
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doing that people can certainly modify
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the legal documents how I really want
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but the intent of Y Combinator is that
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you use one of the four versions as is
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what does this mean to have a safe based
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on the post money cap well think of the
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safe as being around in and of itself in
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fact it's a little more general in that
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think of the convertible securities that
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you use to raise money as being around
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in and of themselves that would be the
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safe vehicles but you might also do say
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a convertible note another convertible
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type of security so think of those
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combined together as being around in and
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of themselves the post money cap relates
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to a cow
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on the post money value of that round
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that round of convertible securities not
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on the round of the equity investment
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that causes that safe and other
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convertible security money to convert
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into ownership and I think the best way
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to explain that is probably to walk
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through an example so let's say we have
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a startup that has a cap table in other
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words an ownership a stock ownership
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table that looks something like this
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you got the founders owning most of the
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company except for 750,000 shares that
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are allocated for options and so the
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total number of shares on their own or
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allocated is 10 million and now let's
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say we go out and raise some safe
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investment dollars so investor a to
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start with provides $200,000 in safe
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funding with an agreement that there's a
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four million dollar post-money valuation
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200,000 is five percent of 4 million so
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what the company is committing to to
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that investor is that in this round of
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safe investment that investor is going
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to get at least 5 percent ownership in
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the company with that $200,000
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investment later the company does
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another investment round with investor
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be an investor B invests $800,000 and
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the company has made more headway so
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they have set a higher post-money
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valuation cap of eight million dollars
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well eight hundred thousand is ten
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percent of eight million so the
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commitment the companies making to this
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investor is that for the eight hundred
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thousand that investor will get at least
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10 percent of the company since the
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investor is investing so much the
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company is making one other commitment
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which is the investor has the right to
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purchase additional shares in the equity
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round to maintain that 10 percent
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ownership that would be the pro rata
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right so that's our round of safe
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funding what does that mean in terms of
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stock well so far the company has
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committed 15% ownership to to safe
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investors both of whom got different
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terms so now let's say there's an
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of investment and the companies offered
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a five million dollar investment with a
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fifteen million dollar pre-money
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valuation well the post money cap on
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those two investments both of those were
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lower than the pre money value of this
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upcoming round we'll call them a Series
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A so definitely will have the safe
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preferred shares kicking in to provide a
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lower price for those safe investors
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here's how you figure that out so the
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company has ten million fully diluted
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shares between what the founders have
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and the shares that are either committed
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to or actually provided to employees or
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others in the form of stock options so a
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total of 10 million shares and they've
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made a commitment 15 percent ownership
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to these two investors so how much stock
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will they have to issue in order to have
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stock to provide to those investors and
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have them own 15 percent well the total
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stock that they need times 0.8 five has
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to be equal to 10 million so that the 10
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million is 80% 85% of the ownership that
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leaves 15 percent ownership for the safe
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investors well do the math you divide
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point eight five into ten million and
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what you get is about eleven point seven
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million shares of stock that's what
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they'll need to have about 1.7 million
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shares to issue to those those investors
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and again do the math that means that
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the two investors will own fifteen
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percent of the company so that you can
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think of as the safe round that's the
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calculation that you do just immediately
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before doing the next calculation for
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the equity conversion but before we look
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at the equity numbers let's ask what are
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our safe investors paying for their
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stock well start with the investor a the
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first investors made two hundred
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thousand dollars and received five
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hundred and eighty eight thousand shares
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of stock do the division and that
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investor paid about thirty four cents
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per share the later investor invested
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more but in a higher post-money
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valuation received about 1.1 million
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shares
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so do the math again and that investor
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paid 68 cents for each share of stock so
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before we move ahead and look at the
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impact of the equity investment let's
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take a look at our safe preferred cap
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table in other words the ownership of
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the company once you take all of the
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safe conversions into account so the
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founders still have their 9.25 million
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shares investor a received five hundred
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and eighty eight thousand two hundred
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and thirty five shares and investor B
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has just over 1.1 million shares again
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the option pool is still sitting there
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at seven hundred fifty thousand soar at
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our eleven million seven hundred
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sixty-four thousand seven hundred and
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six shares and then we do the numbers
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for the equity investment so if you
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recall it was a fifteen million dollar
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pre-money valuation that the Series A
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investors gave to the company but beyond
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that the Series A investors did
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something that often happens which is
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they're requiring the company to
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allocate additional shares of stock for
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the option pool because the investors
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want to make sure that there is stock
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available in the form of options for the
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employees for compensating the employees
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that the company is going to have to
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bring on board so again a very very
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common requirement so now in addition to
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the eleven million shares outstanding
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which included the addition for the safe
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money they now have these additional
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shares allocated for options so a total
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fully diluted capitalization of about
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thirteen and a half million shares of
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stock now that we know the fully diluted
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number of shares of stock we can
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calculate the stock price it's simply
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the pre money value divided by the
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number of shares do that math and it's
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just a little bit over a dollar and
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eleven cents per share so now the
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question is how many shares of stock of
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additional stock will accompany have to
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issue in order to have enough stock such
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that they can sell it to these new
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investors for five million dollars well
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yet do the math and it comes out that
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they'll need just over 4.4 million
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shares of stock to have
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enough and it all our 11 cents to raise
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that five million dollars
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we'll call the elite investor investor
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see they're going to provide four
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million dollars of that money
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remember investor B has a pro rata right
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so we're going to assume that that
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investor B will buy more stock to
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maintain their investment percentage and
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there'll be as some other miscellaneous
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investors that make up the difference
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for the total of five million dollars so
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what does the cap table look like after
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the series a investment well the
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founders still have their nine point two
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five million shares and investor a still
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have the five hundred and eighty
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thousand shares that they had investor B
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has exercised their pro rata right so
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they had just a little over 1.1 million
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shares now they have a little over 1.6
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million now investors see the equity
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investor in this new round owns twenty
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percent just over 3.5 million shares of
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stock the other investors come in and
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invest in the rest of the stock to round
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out to five million dollars and the
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option pool now that's both allocated as
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as well as committed is of course a lot
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bigger now because of the additional
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shares that the investor C required that
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the company issue prior to this round so
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now the total capitalization is just
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over seventeen point nine million shares
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of stock fully diluted ie counting both
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the shares actually issued as well as
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everything in the option pool the
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ownership of the founders as you can see
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is down getting pretty close to fifty
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percent the investor a who in the
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preferred round had five percent is down
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to three point three investor B who in
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the preferred round was committed ten
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percent is now down to nine eleven point
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one if you look at the actual issued
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stock not counting the allocated but not
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awarded options they are indeed at ten
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percent of course investors see is it at
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20 percent because they invested four
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million in a round that was well 15
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million pre with a 5 million vestment 20
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million post investment and of course
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for a million dollars is 20 percent of
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that 20 million so they're at
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percent and then you can see where the
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the rest of the numbers fall out so
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hopefully that helps you understand a
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little bit better the process of
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determining the number of shares that
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have to be issued to provide the shares
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for the safe investors which will then
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lets you calculate the price they're
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paying then you add in the new options
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that the equity investors are requiring
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and then you can calculate the share
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value of the stock for the equity
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investors and then finally determine how
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many shares the stock have to be issued
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in order to have enough stock to cover
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that in this case five million dollar
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investment so the safe preferred is the
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type of stock that's going to be issued
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to the safe investors if they're paying
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less for the stock in that equity in
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that conversion round then the Series A
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or the the equity investors and that
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will happen if if a discount kicks in or
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if their cap kicks in to result in them
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paying less now if there's no discount
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and if the post money cap ends up being
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lower than the pre-money valuation in
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the round then there is no difference in
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the price and the safe investors
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actually convert their funds into the
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same preferred shares as the series a
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investors so the safe preferred only
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happens if the safe investors pay less
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for their stock than was paid for by the
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equity investors in the round that
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converted the safe and of course as same
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as is the case for the original safe the
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difference in the safe preferred is the
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liquidation preference the conversion
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price and the dividend rate and we went
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through an example of how that works in
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the previous video again there's a link
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to that right up there what are the
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advantages of this new version of the
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safe well of course it has a lot of the
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same advantages as the original safe it
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delays the valuation so your your funds
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convert to stock in the future when
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hopefully you're worth more then you're
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reducing your your dilution it's a very
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simple legal document certainly compared
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to the typical priced round which
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much more complex and that makes it
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low-cost from a legal point of view and
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and relatively simple to negotiate so a
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more practical way of raising money than
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than a price round certainly for an
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early stage funding round you can do
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multiple closes with a safe with with as
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in our example of different terms for
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different investors that's a lot easier
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to do than with a priced round where
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there's there's more coordination know
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interest rate know maturity date so
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that's an attraction compared to a
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convertible note and the the other
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benefit the big benefit compared to the
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original safe is just more transparency
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transparency for the investors as to
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what percent of the company they're
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getting transparencies for the
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entrepreneurs about how much dilution
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they're taking on in order to to close
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these safe dollars so what are the
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drawbacks well it's maybe a little more
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complex than the original safe because
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you have to go through a couple of steps
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to calculate you know the amount of safe
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stock that's going to be issued and then
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calculate the Series A but I would say
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the the the big drawback is really the
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dilution hit you're in in this version
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of the safe you're guaranteeing a
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minimum percent ownership to the safe
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investors and that guarantee is is going
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to reduce the ownership of the founders
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because that's the only other place for
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for that stock to come from so compared
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to looking at pre money value from the
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original safe
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the founders can end up with a little
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bit less ownership on the other hand
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it's a big attraction for the investors
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because the investors have a much
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clearer idea of what percent they're
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getting for their investment in the
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company and that makes it more
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attractive to them which maybe makes it
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a little bit easier to close around so
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that's a good thing for the entrepreneur
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so that's a quick overview of the simple
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agreement for future equity the new
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version 2018 based on the post-money
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valuation if that was helpful please
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click like and share it with other
[1054]
entrepreneurs if you haven't subscribed
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yet please click the subscribe button
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down in the corner and if you have any
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questions please leave a comment I'll
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certainly try to answer any questions
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that you have and keep in mind we have
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one more coming up in this series upon
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the series seed which is a priced equity
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round using a standardized set of
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documents so when you click on that
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subscribe button
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think about clicking the bell too and
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you'll get a notification when that
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video becomes available that's it for
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now thank you very much for watching
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