Y Combinator recently announced changes to its well-known forms of Simple Agreement for Future Equity (SAFEs). As explained by Y Combinator, these changes are in response to the evolving manner in which SAFEs are being used by start-ups to raise funds. Where SAFEs once served as a “bridge” to an equity round, they are now being issued in such numbers and amounts that they can be deemed to be rounds of their own, often delaying the need for a priced round. As many founders know, when SAFEs convert at a “pre-money” valuation, it can be hard to measure how much equity in the company is being sold in a preferred stock financing. This is because the percentage being sold in the financing is dependent on how many other SAFEs are converting in the round as well as the size of the option pool increase in connection with the financing round. Many of you have probably tried to get a sense of these percentages by using cap table models of a yet-to-materialize priced round, toggling combinations of possible pre-money valuations and option pool increase amounts, not to mention the calculation of the number of shares issued to each SAFE holder upon conversion, each of which dilutes others in the pre-money cap table.
The most significant change to the Y Combinator forms of SAFE is intended to bring clarity to both founders and investors in this not-so-clear situation when valuation caps are used in the SAFE. The new forms eliminate the concept of a pre-money valuation cap and replace it with a “post-money” cap. For purposes of the SAFE, the post-money cap is “post” the amount of other SAFEs, but prior to the valuation of the company immediately after the preferred stock financing round. The result is that simply dividing the investment amount by the post-money valuation cap provides founders and investors alike with the exact percentage of the company represented by a SAFE immediately prior to the closing of a priced equity round.
For example, a $500,000 SAFE with a $10,000,000 post-money valuation cap represents 5% of a company immediately prior to a preferred stock financing (i.e., $500,000 divided by $10,000,000). If a founder owned 100% of the company prior to issuing the SAFE, that founder now owns 95%. If a second SAFE is issued to another investor for $300,000 at a $15,000,000 post-money valuation cap, the new investor knows that its SAFE represents 2% of the company (i.e., $300,000 divided by $15,000,000), the first SAFE still represents 5% of the company, and the founder’s share has been diluted to 93%.
Note the significant changes that result from this simpler modeling: First, SAFEs no longer dilute each other. Second, the founders bear the burden of dilution, but other SAFE holders do not. Third, in order to preserve the clarity and the simplicity of the model, the post-equity financing option pool is no longer factored into the pre-money calculations, since the amount of the option pool increase is typically unknown at the time SAFEs are issued.
A second change to the forms of SAFE is the removal of the pro rata rights provisions that were previously embedded in the forms. This is also a result of the expanded use of SAFEs as a more substantial form of fundraising (and the increased number of SAFE holders for a given company that exist as a result). In lieu of including the provisions in the form, Y Combinator has generated a form of pro rata rights side-letter that can be used by a founder with more discretion to give individual investors pro rata rights in future round(s), as opposed to every SAFE investor. Other changes and improvements were made to the forms of the SAFE, including the addition of a provision stating that the SAFE shall be characterized as stock for U.S. federal and state income tax purposes.
View the Y Combinator’s new SAFE forms.